TIF Solution One - 5A

Canadian Tax Principles 2018 / 2019

Test Items Solutions – Chapters 1 to 10

Test Items Solutions Table of Contents – Chapters 1 to 10

The .PDF version of the Test Items Solutions is available 1at the Instructor’s Resource Centre on the
online catalogue listing for this book, at

catalogue.pearsoned.ca

The table of contents is hyperlinked to the beginning of each Solution. To go to a Solution, hold down
the Control key and click on the solution listing. Control + Home will bring you back to this table of
contents from anywhere in the document.

Chapter One Test Item File Solutions.....................5

TIF Solution One - 1...............................................................5

TIF Solution One - 2.............................................................10

TIF Solution One - 3.............................................................12

TIF Solution One - 4.............................................................16

TIF Solution One - 5A...........................................................21

TIF Solution One - 5B...........................................................22

TIF Solution One - 6.............................................................23

TIF Solution One - 7.............................................................25

TIF Solution One - 8.............................................................28

TIF Solution One - 9.............................................................29

TIF Solution One - 10...........................................................30

TIF Solution One - 11...........................................................31

TIF Solution One - 12...........................................................32

TIF Solution One - 13...........................................................33

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TIF Solution One - 14...........................................................34

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Chapter Two Test Item File Solutions...................38

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Chapter Three Test Item File Solutions................64

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TIF Solution Three - 18.......................................................100

Chapter Four Test Item File Solutions................101

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TIF Solution Four - 2...........................................................104

TIF Solution Four - 3...........................................................105

TIF Solution Four - 4...........................................................108

TIF Solution Four - 5A........................................................119

TIF Solution Four - 5B........................................................120

TIF Solution Four - 6...........................................................121

TIF Solution Four - 7...........................................................123

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Chapter Five Test Item File Solutions.................143

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TIF Solution Five - 3...........................................................148

TIF Solution Five - 4...........................................................151

TIF Solution Five - 5A.........................................................159

TIF Solution Five - 5B.........................................................160

TIF Solution Five - 6...........................................................161

TIF Solution Five - 7...........................................................163

TIF Solution Five - 8...........................................................166

TIF Solution Five - 9...........................................................170

TIF Solution Five - 10.........................................................172

TIF Solution Five - 11.........................................................174

TIF Solution Five - 12.........................................................177

TIF Solution Five - 13.........................................................178

TIF Solution Five - 14.........................................................179

Chapter Six Test Item File Solutions...................182

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TIF Solution Six - 6.............................................................199

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TIF Solution Six - 8.............................................................202

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TIF Solution Six - 10...........................................................204

TIF Solution Six - 11...........................................................205

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TIF Solution Six - 14...........................................................210

TIF Solution Six - 15...........................................................211

TIF Solution Six - 16...........................................................213

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Chapter Seven Test Item File Solutions.............221

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Chapter Eight Test Item File Solutions...............259

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TIF Solution Eight - 4..........................................................269

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Chapter Nine Test Item File Solutions................315

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Chapter Ten Test Item File Solutions..................365

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Chapter One Test Item File Solutions

TIF Solution One - 1

1. The other sources of federal revenues that are shown in Figure 1-1 of the text are:

 Corporate income taxes.

 Non-resident income taxes.

 GST.

 Customs and import duties.

 Other excise taxes.

 EI premiums.

2. In the Income Tax Act, the term “person” can refer to an individual, a corporation, or a trust.

3. Provincial income taxes on individuals are calculated by applying a provincial rate schedule to the
same Taxable Income figure that is used to calculate the federal income tax for individuals.
Provincial credits are then applied to the resulting figure. The provincial brackets may differ from
the federal brackets. In addition, provincial credits may be different than the federal credits.

4. There are many examples that could be used here. The text divides them into resource allocation
(e.g., public health care), distribution effects (e.g., federal GST credit), stabilization effects (e.g.,
deficit reduction), and fiscal federalism (e.g., allocations to various levels of government).

5. Examples provided in the text are as follows:

 Tax revenues are used to provide public goods and services.

 Excise taxes are used to discourage the consumption of alcohol and tobacco products.

There are, of course, many other examples that could be cited.

6. The Canada Child Benefit system is designed to assist families with children. It would appear that
the government is encouraging people to have children. The fact that the benefits are reduced as
income increases suggests that it is also designed to assist lower income families care for these
children.

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7. There are a number of possibilities here. They include:

 Progressive rates increase the complexity of the system.

 Progressive rates are unfair to individuals with highly variable income streams.

 Progressive rates are unfair to single income family units.

 Progressive rates lead to pressure for various types of tax concessions.

 Progressive rates discourage high income individuals from making additional efforts.

 Progressive rates encourage tax evasion.

8. While the sales tax rate is the same for all individuals without regard to their income level, lower
income individuals normally spend a higher percentage of their total income. Since the sales tax is
levied on the amounts spent, this means that the sales tax paid by lower income individuals
represents a larger percentage of their income. As a consequence, they are generally considered to
be regressive in nature.

9. Horizontal equity is achieved when taxpayers in similar economic circumstances are subject to
similar levels of taxation. Vertical equity is achieved when taxpayers in different economic
circumstances are subject to taxes in a different manner.

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10. The reasons that are listed in the text are as follows:

 It is less costly to administer tax expenditures than it is to administer government funding

programs.

 More decisions are left to the private sector so that funds may be allocated more efficiently.

 Tax expenditures reduce the visibility of certain government actions. This is particularly
beneficial if some social stigma is attached to the programs. For example, a child tax benefit
system is more acceptable than increasing social assistance payments.

 Tax expenditures reduce the progressivity of the tax system. As many of the tax expenditures,
such as tax shelters, are more available to higher income taxpayers, they serve to reduce
effective tax rates in the higher rate brackets.

11. This situation reflects the fact that when a new Section is added, it has been more convenient to
attach a decimal designation to the new Section, as opposed to renumbering all of the Sections that
follow the new Section. As an example, over several years, the Department of Finance has added
five new Sections after Section 12. They have been numbered Section 12.1 through Section 12.5.
If they had used whole numbers for these new Sections, it would have been necessary to renumber
all of the remaining Sections in the Act each time a new Section was added.

12. The purposes of these treaties are as follows:

 They attempt to avoid double taxation of taxpayers who may have reason to pay taxes in more
than one jurisdiction.

 They try to prevent international evasion of taxes.

13. The required four items can be selected from the following:

 CRA Web Site

 Interpretation Bulletins

 Income Tax Folios

 Information Circulars

 Income Tax Technical News

 CRA News Releases, Tax Tips, and Fact Sheets

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 CRA Guides

 CRA Pamphlets

 Advance Income Tax Rulings

 Technical Interpretations

14. For individuals and inter vivos trusts, the taxation year is equal to the calendar year. In contrast,
corporations can always use a fiscal period. A fiscal period can end on any date, with the only
constraint being that it cannot exceed 53 weeks for a corporation. With respect to testamentary
trusts, prior to 2016, like corporations, they could always use a non-calendar fiscal year. In 2016
and subsequent years, their use of non-calendar fiscal periods is significantly restricted (see Chapter
19).

15. The circumstances that would result in a non-resident person having to pay income taxes in Canada
are as follows:

 The non-resident person earns employment income in Canada.

 The non-resident person carried on a business in Canada.

 The non-resident person has a gain on the disposal of a taxable Canadian property.

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16. As stated in the text, residence is the cornerstone of Canadian income taxation. If a person is
considered a resident of Canada in a given year, that person will be subject to Canadian income tax
for that year on all sources of income. Alternatively, if the person is a non-resident, Canadian Part I
tax will only apply to Canadian employment income, Canadian business income, and gains on the
disposition of Taxable Canadian Property.

17. As stated in S5-F1-C1, the primary factors that will be considered by the CRA are as follows:

 Whether the individual is continuing to maintain a dwelling in Canada.

 Whether the spouse or common-law partner of the individual remains in Canada.

 Whether the individual has dependants who remain in Canada.

18. The main factors here would be:

 Does the individual have a dwelling in Canada?

 Does the individual’s spouse or common-law partner live in Canada?

 Do the dependants of the individual live in Canada?

Other factors that could be mentioned include:

 Owning personal property in Canada (such as furniture, clothing, automobiles, and recreational
vehicles).

 Social ties with Canada (such as memberships in Canadian recreational and religious
organizations).

 Economic ties with Canada (such as employment with a Canadian employer and active
involvement in a Canadian business, and Canadian bank accounts, retirement savings plans,
credit cards, and securities accounts).

 Hospitalization and medical insurance coverage from a province or territory of Canada.

 A driver’s license from a province or territory of Canada.

 A vehicle registered in a province or territory of Canada.

 A seasonal dwelling place in Canada or a leased dwelling place.

 Holding a Canadian passport.

 Membership in Canadian unions or professional organizations.

19. As noted in the text, S5-F1-C1 identifies the following factors:

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Intent The issue here is whether the individual intended to permanently sever residential ties
with Canada. If, for example, the individual has a contract for employment, if and when he
returns to Canada, this could be viewed as evidence that he did not intend to permanently
depart. Another factor would be whether the individual complied with the rules related to
permanent departures (i.e., as noted in Chapter 8, there is a deemed disposition of an
individual’s property at the time of departure from Canada, resulting in the need to pay taxes on
any gains).

Frequency Of Visits If the individual continues to visit Canada on a regular and continuing
basis, particularly if other secondary residential ties are present, this would suggest that he did
not intend to permanently depart from Canada.

Residential Ties Outside Of Canada A further consideration is whether or not the individual
establishes residential ties in another country. If someone leaves Canada and travels for an
extensive period of time without settling in any one location, it will be considered as evidence
that he has not permanently departed from Canada.

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20. A Canadian resident normally becomes a non-resident on the latest of the following days:

 on leaving Canada,

 when a spouse and/or dependants leave Canada, and

 on becoming a resident of another country.

21. As a sojourner, Jane would be assessed Canadian income taxes on her world wide income for the
entire year. As she would not be considered a resident of a province, she would be assessed an
additional federal income tax of 48 percent of her basic federal tax otherwise payable.

In contrast, Jack would only be assessed Canadian income taxes on his world wide income for the
210 day period prior to his departure from Canada. In addition, he would be assessed provincial
income tax in the province of Manitoba for this 210 day period.

22. The required three items could be selected from the following:

Permanent Home If the individual has a permanent home available in only one country, the
individual will be considered a resident of that country. A permanent home means a dwelling,
rented or purchased, that is continuously available at all times. For this purpose, a home that
would only be used for a short duration would not be considered a permanent home.

Centre of Vital Interests If the individual has permanent homes in both countries, or in
neither, then this test looks to the country in which the individual’s personal and economic
relations are greatest. Such relations are virtually identical to the ties that are examined when
determining factual residence for individuals.

Habitual Abode If the first two tests do not yield a determination, then the country where the
individual spends more time will be considered the country of residence.

Citizenship If the tie-breaker rules still fail to resolve the issue, then the individual will be
considered a resident of the country where the individual is a citizen.

Competent Authority If none of the preceding tests resolve the question of residency then, as
a last resort, the so-called “competent authority procedures” are used. Without describing them
in detail, these procedures are aimed at opening a dialogue between the two countries for the
purpose of resolving the conflict.

23. If an enterprise is incorporated in Canada after April 26, 1965, it will always be considered resident
in Canada. However, if it is incorporated in Canada prior to April 27, 1965, it will only be
considered resident in Canada in those situations where it either:

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 carried on business in Canada at any time after that date; or

 was resident in Canada at any time after that date (as measured by the location of the mind and
management of the corporation).

24. Limon Inc. is a U.S. resident because it was incorporated in that country. It is also a Canadian
resident under the mind and management test. In such dual residency cases, the tie-breaker rule in
the Canada/U.S. tax treaty indicates that the taxes will be assessed in the country of incorporation.
That means that Limon Inc. would be subject to U.S. income taxes.

25. The components of Net Income For Tax Purposes are employment income, business and property
income, net taxable capital gains, other sources of income, and other deductions from income.

26. The phrase “the amount, if any” is used throughout the Income Tax Act to indicate that only positive
amounts should be considered. In the context of ITA 3(b), the requirement that negative amounts
be ignored, in effect, prevents the deduction of current year allowable capital losses in excess of
current year taxable capital gains in the determination of Net Income For Tax Purposes.

27. Tax avoidance is a form of tax planning in which the taxpayer, through means that are within the
boundaries of tax legislation, arranges his affairs in a manner that allows him to receive benefits
without the payment of taxes. Tax planning to achieve tax deferral involves either the delayed
recognition of income, or the accelerated recognition of deductions. The payment of tax is delayed,
as opposed to permanently avoided.

28. Income splitting involves efforts to share the total income accruing to an individual with family
members or other related parties. It will only benefit a taxpayer who is in a high tax bracket in
those circumstances where there are family members or other related parties who are in lower tax
brackets.

29. The basic type of tax planning that is involved in Registered Retirement Savings Plans is tax
deferral — a tax savings results from making contributions that will have to be paid back at a later
point in time. There may also be an element of avoidance in that, after retirement, an individual
may be in a lower tax bracket than he was during his working years. If this is the case, there will be
an absolute reduction in taxes. (This assumes that the basic rate structure is unchanged.)

30. The basic goals of tax planning can be summarized as follows:

 Tax avoidance - To permanently avoid the payment of some amount of tax.

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 Tax deferral - To delay the recognition of certain types of income or accelerate the timing of
certain deductions.

 Income splitting - To have a family or other related group’s aggregate taxable income allocated
as evenly as possible among the members of the group.

He should contribute the $5,000 to the spousal RRSP. By contributing to an RRSP he will be
deferring taxes. By contributing to a spousal RRSP he is also income splitting and there may be
possible tax avoidance if his spouse is taxed at a lower rate when the funds become taxable to her.

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TIF Solution One - 2

1. True.

A value added tax is a tax levied on the increase in value of a commodity or service that has
been created by the taxpayer’s stage of the production or distribution cycle.

2. False.

Only individuals, corporations, and trusts are taxable entities for income tax purposes.

3. True.

Partnerships engaged in commercial activity are taxable entities for GST purposes.

4. False.

In general, provincial taxes are based on a specified percentage of federal taxable income.

5. False.

The federal government collects taxes for Ontario.

6. True.

Even if the rate is the same on all transactions, it will be a higher rate on the taxable income of
lower income individuals because they spend a larger percentage of their income.

7. False.

Progressive rates discourage both employment and investment, thereby limiting economic
growth.

8. True.

Tax expenditures are less costly to administer than direct funding programs.

9. True.

Part I of the Income Tax Act is the largest and the most important part.

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10. False.

The citation ITA 61(4)(b)(ii) would be read Section 61, Subsection 4, Paragraph b,
Subparagraph ii.

11. True.

While individuals and inter vivos and most testamentary trusts must use a calendar taxation
year, other taxpayers, corporations and testamentary trusts that have been designated as
graduated rate estates, can choose to use this period as their taxation year.

12. False.

The provisions of the international treaty will prevail.

13. True.

An income tax is payable for each taxation year on the Taxable Income of every person
resident in Canada at any time in the year.

14. False.

Canadian income taxes are assessed on residents of Canada.

15. False.

S5-F1-C1 makes it clear that the length of the period of time during which the individual is
absent from Canada is not a determining factor with respect to residency.

16. False.

Such part year residents will only be taxed on their world side income for the portion of the
year prior to their moving to Canada.

17. True.

18. False.

Whether the individual continues to maintain social ties is not one of the three most significant
factors.

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19. False.

The length of the period of absence from Canada is not considered a factor in determining
residency retention.

20. True.

A part year resident for the current year is an individual who either establishes residency in
Canada during the current year or, alternatively, terminates residency in Canada during the
current year.

21. False.

The 183 days do not have to be consecutive.

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TIF Solution One - 3

Canadian Tax System
1. C. Head Tax

2. C. Walters and Walters, a group of CPAs operating as a partnership.

3. D. All of the above could be required to file a GST return.

4. A. Personal income tax

5. D. Each province can establish rules for determining the Taxable Income of individuals.

6. C. Individuals, trusts and corporations

7. B. Provincial, federal, and international

Tax Policy Concepts

8. B. Extremely high rates of tax will always encourage individuals to work harder so that
they will have more after tax income.

9. C. Ensure fairness in the allocation of resources to different levels of government.

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10. B. A progressive rate system provides greater stability in the context of changing
economic conditions.

11. B. A regressive tax is one which results in lower effective tax rates for higher income
taxpayers.

12. A. It is more costly to administer tax expenditures as opposed to program spending.

13. B. Inelasticity.

14. C. Simplicity.

15. A. Neutrality.

16. D. Horizontal equity.

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Income Tax Reference Materials

17. D. The Income Tax Act is the most important source of information for dealing with
matters related to the federal income tax.

18. D. All Parts of the Income Tax Act contain at least one Section.

19. B. Income Tax Folios.

20. C. Dominion Tax Cases.

21. C. Unreported revenues from business transactions.

22. B. The Income Tax Regulations.

23. D. When there is a conflict between the Canadian Income Tax Act and an international
agreement, the terms of the Canadian Income Tax Act prevail.

Liability For Tax

24. B. Corporations must use the calendar year as their taxation year.

25. A. is a resident of Canada.

26. D. Bunly Im, a resident of the United States who earns interest income in Canada.

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27. C. Rental income earned in Canada

Residence
Residence Of Individuals
28. C. The individual has become a resident of another country.

29. D. She did not leave taxable Canadian property in Canada.

30. C. An individual who immigrates to Canada during the year is a resident of Canada for
tax purposes for the full calendar year.

31. B. Bob, Charles, and Dick.

32. A. To be a resident for tax purposes, an individual must be a Canadian citizen.

33. A. The country in which the individual earns business income.

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34. C. Jamal is considered a non-resident of Canada.

35. A. Ravi is a citizen of India, where he was born and lived until moving to Canada on
March 1 of the current year. He was transferred by his employer to its Canadian head office.

36. B A non-resident

37. D A part-year resident

Residence Of Corporations
38. D. Exeter Ltd. was incorporated in Alberta in 1956. However, it has never carried on
business in Canada and its management has always been located in Montana.

Residence Of Corporations And Individuals

39. B. A corporation that was incorporated in North Dakota but carries on all of its business
in southern Manitoba.

40. B. Karen Cotin, a computer programmer, had been employed by ABC Systems Ltd. in
Toronto. In 2017, she accepted a minimum two-year contract with CS Services Inc. in London,
England. Her position with CS Services Inc. started October 1, 2017. Before moving to
England, where she will join her fiance, Karen terminated the lease on her apartment in
Toronto and sold her car. It appears Karen has severed all ties with Canada.

Alternative Concepts Of Income

41. C. Net Income For Tax Purposes requires that costs be matched with revenues.

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42. B. Net income is determined by adding together several different types of income which
are added together based on an ordering rule.

Calculation Of Net Income For Tax Purposes

43. D. If a business loss exceeds all other positive sources of income, Net Income For Tax
Purposes is equal to nil.

44. C. Business losses can be netted against employment income in determining the positive
amounts to be included under ITA 3(a) and 3(b).

45. C. $45,000

46. B. $ 22,000 ($34,000 + $4,000 - $2,000 - $14,000)

47. B. Nil, with a business loss that can be used in either the previous 3 years or in the next
20 future years of $12,000 (34,000 + 6,000 + 4,000 – 2,000 – 54,000)

48. B. That the current year allowable capital losses can only be deducted to the extent that
there are taxable capital gains during the current year.

49. D. $32,000 [$45,000 + (1/2)($20,000 - $12,000) - $3,000 - $14,000]

Net Income To Taxable Income

50. B. A deduction for the extra costs related to living in prescribed areas of the Canadian
north.

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51. D. The excess of allowable capital losses over taxable capital gains for the year.

Tax Planning
52. C. Accelerated depreciation (CCA) on rental properties.

53. D. Tax avoidance.

54. B. Tax deferral.

55. C. Making use of the lifetime capital gains deduction.

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TIF Solution One - 4

Exam Exercise One - 1 Solution (Taxable Entities For Income Tax Purposes)
Sally Forbes, the Forbes family trust, and Forbes Enterprises Ltd. could be required to file income tax
returns. Forbes Boutique, Forbes and Delaney, and the Forbes Foundation are not taxable entities for
income tax purposes.

Exam Exercise One - 2 Solution (Taxable Entities For GST Purposes)

Under the GST legislation, all of the listed entities could be required to file a GST return. Where only
individuals, corporations and trusts can be required to file an income tax return, the definition of a
person (i.e., taxable entity) is much broader for GST purposes. As is explained in detail in Chapter 21,
whether an entity is required to file a GST return is dependent on the level of commercial activity.

Exam Exercise One - 3 Solution (Federal And Provincial Taxes Payable)

Federal Tax Payable [(15%)($37,500)] $5,625

Provincial Tax Payable [(8.2%)($37,500)] 3,075

Total Tax Payable [(15% + 8.2%)($37,500)] $8,700

Exam Exercise One - 4 Solution (Federal And Provincial Taxes Payable)

Federal Tax Payable [(15%)($26,700)] $4,005

Provincial Tax Payable [(10%)($26,700)] 2,670

Total Tax Payable [(15% + 10%)($26,700)] $6,675

Exam Exercise One - 5 Solution (Regressive Taxes)

Samantha’s HST paid totals $28,080 [(13%)($216,000)]. Based on her Taxable Income of $625,000,
this would represent an effective rate of 4.5 percent ($28,080 ÷ $625,000).
Martha’s HST paid totals $2,782 [(13%)($21,400)]. On her Taxable Income of $12,000, this would be
an effective rate of 23.2 percent ($2,782 ÷ $12,000).

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Exam Exercise One - 6 Solution (Regressive Taxes)

Veronica’s HST paid totals $21,060 [(13%)($162,000)]. Based on her Taxable Income of $843,000, this
would represent an effective rate of 2.5 percent ($21,060 ÷ $843,000).
Her sister’s HST paid totals $4,680 [(13%)($36,000)]. On her Taxable Income of $8,000, this would be
an effective rate of 58.5 percent ($4,680 ÷ $8,000).

Exam Exercise Solution One - 7 (Non-Resident Liability For Tax)

She is not correct. Under ITA 2(3) she would be subject to Canadian taxes on employment income
earned in Canada, but not on her U.S. employment income.

Exam Exercise Solution One - 8 (Non-Resident Liability For Tax)

He is not correct. Under ITA 2(3) he would be subject to Canadian taxes on the gain resulting from a
disposition of Taxable Canadian Property.

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Exam Exercise Solution One - 9 (Residential Ties)

While the situation is not completely clear, it is likely that the CRA would conclude that Mr. Resner is
no longer a Canadian resident. By retaining his residence, he has maintained one of the primary
residential ties. However, the fact that he was not able to sell the property, accompanied by the long-
term lease to a third party, would probably be sufficient evidence that this is not a significant residential
tie. The retention of his membership in the Chartered Professional Accountants Association Of Alberta
would be viewed as a secondary residential tie. However, it is unlikely that this tie would be sufficient
to cause Mr. Resner to be viewed as a Canadian resident.

Exam Exercise Solution One - 10 (Temporary Absences)

Mary did, in fact, sever most of her residential ties with Canada. This would suggest that she would not
be considered a Canadian resident during the two years she worked in New York City. However, the
fact that she returned frequently to visit her boyfriend might lead the CRA to assess her on the basis of
being a Canadian resident during this period, but it is not clear that such an assessment would be
successful.

Exam Exercise Solution One - 11 (Temporary Absences)

While John severed the great majority of his residential ties with Canada, two factors would suggest that
the CRA would likely view him as a Canadian resident during the 18 months that he is absent from the
country:

 His frequent visits to spend time with his dog.

 Perhaps more importantly, the fact that he claimed a Canadian address to maintain access to the
Ontario health care system would be viewed as a very significant factor.

While the answer is not clear cut, our opinion would be that these factors would lead to the conclusion
he maintained his Canadian residency. Given the fact that he appears to be defrauding the Ontario
health care system, he might be wise to avoid disputing his continued residency.

Exam Exercise Solution One - 12 (Part Year Residence)

Melissa would be taxed on her worldwide income for the part of the year that she was resident in
Canada. This would be the period January 1 through July 1, the date that her husband and children fly to
the U.S. July 1 would be the latest of: the date that Melissa leaves Canada (March 15), the date that
Melissa establishes U.S. residency (March 15), and the date that her husband and children depart Canada
(July 1). It is unlikely that the fact that her house was not sold until a later date would influence her
residence status.

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Exam Exercise Solution One - 13 (Part Year Residence)

For residency purposes, an individual is considered to have ceased being a resident of Canada at the
latest of three dates:

1. The date the individual leaves Canada.

2. The date the individual’s family leaves Canada.

3. The date the individual establishes residency in another country.

In Barton’s case the latest of the dates would be July 1, 2019, the date on which he receives the required
residency documents. Given this, Barton would be considered a Canadian resident for the entire 2018
taxation year. In addition, he would be a part year resident for the period January 1, 2019 through June
30, 2019.

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Exam Exercise Solution One - 14 (Individual Residency)

Under ITA 250(1)(c)(i), Mrs. Sothor would be a deemed Canadian resident because of her position as a
Canadian ambassador and the fact that she was a Canadian resident at the time she was appointed to this
post. As her husband is exempt from Tanzanian taxation due to his relationship to a deemed resident,
he is a deemed resident of Canada under ITA 250(1)(g). Of her two children, the younger son would be
a deemed resident under ITA 250(1)(f) as he is a Canadian ambassador’s dependent child. However, the
older son would not be a deemed resident because his income exceeds the base for the basic personal tax
credit for 2018 of $11,809 and he would therefore not be considered a dependant.

Exam Exercise Solution One - 15 (Individual Residency)

While Ms. Washton is the child of a Canadian High Commissioner, it appears that she is no longer a
dependant of this individual. It would also appear that she has income in excess of the base for the basic
personal tax credit for 2018 of $11,809. As a consequence, she would not be considered a deemed
resident under ITA 250(1).

Exam Exercise Solution One - 16 (Corporate Residency)

As the Company was incorporated in Canada after April 26, 1965, it would be deemed to be a Canadian
resident under ITA 250(4). While the problem does not provide enough information to determine this, it
is possible that the Company has dual residency with the country or countries where it does business.
This could result in the application of one or more international tax treaties. Note that, in general,
where a corporation does business is not relevant to the residency decision.

Exam Exercise Solution One - 17 (Corporate Residency)

As Wolfhowl Ltd. was incorporated in Canada prior to April 27, 1965, it will only be considered to be a
Canadian resident if it has carried on business in Canada or become a Canadian resident subsequent to
April 26, 1965. As the director’s meetings were held in Canada until 1971, this would suggest that the
“mind and management” of the Company was in Canada during this period. This would make the
Company a Canadian resident subsequent to April 26, 1965. However, as the mind and management of
the corporation is in the United States, it would also be considered a resident of that country. In such
dual residency situations, the Canada/U.S. tax treaty tie breaker rules indicate the Company will be
considered a resident of the country of incorporation, which in this case would be Canada.

Exam Exercise Solution One - 18 (Corporate Residency)

While Acton Enterprises was not incorporated in Canada, it would appear that the “mind and
management” of the Company is now located in Canada. This means that the Company would be
considered a Canadian resident for the 2018 taxation year. However, as it was incorporated in the U.S.,
it would also be considered a resident of that country. In such dual residency situations, the tie breaker
rules indicate the residence would be based on the country of incorporation. This would mean that
Acton Enterprises would not be a Canadian resident during 2018.

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Exam Exercise Solution One - 19 (Net Income For Tax Purposes)

Ms. Nexus’ Net Income For Tax Purposes would be calculated as follows:

Income Under ITA 3(a):

Net Employment Income $66,000

Interest Income 10,250 $76,250

Income Under ITA 3(b):

Taxable Capital Gains $13,500

Allowable Capital Loss ( 24,000) Nil

Balance From ITA 3(a) And (b) $76,250

ITA 3(c) Deductions:

Spousal Support ( 14,000)

RRSP Contributions ( 3,000)

Balance From ITA 3(c) $59,250

Deductions Under ITA 3(d):

Net Rental Losses ( 6,750)

Business Loss ( 28,000)

Net Income For Tax Purposes $24,500

She has an unused allowable capital loss carry over of $10,500 ($24,000 - $13,500).

Exam Exercise Solution One - 20 (Net Income For Tax Purposes)

Mr. Nicastro’s Net Income For Tax Purposes would be calculated as follows:

Income Under ITA 3(a):

Net Employment Income $45,000

Interest Income 4,500 $49,500

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Income Under ITA 3(b):

Taxable Capital Gains $13,500

Allowable Capital Loss ( 18,200) Nil

Balance From ITA 3(a) And (b) $49,500

ITA 3(c) Deductions:

Spousal Support ( 24,000)

Balance From ITA 3(c) $25,500

Deductions Under ITA 3(d):

Business Loss ( 23,000)

Net Rental Loss ( 14,500)

Net Income For Tax Purposes Nil

At the end of this year, Mr. Nicastro would have an unused allowable capital loss carry over of $4,700
($13,500 - $18,200). In addition, he would have a non-capital loss carry over of $12,000 ($25,500 -
$23,000 - $14,500).

Exam Exercise Solution One - 21 (Tax Planning)

This transaction clearly involves tax deferral, in that the contribution will be deductible and the earnings
on the contribution will accumulate on a tax free basis. However, all of these amounts will be taxable
when they are withdrawn from the plan. There may also be tax avoidance. This will happen if Mr.
Bronson is taxed at a lower rate when the funds become taxable.

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Exam Exercise Solution One - 22 (Tax Planning)

This transaction involves tax avoidance. Ms. Bloom can receive this benefit from her employer without
being assessed a taxable benefit. Extra salary would be taxable.

Exam Exercise Solution One - 23 (Tax Planning)

Natasha is involved in income splitting, tax deferral, and possibly tax avoidance. She is getting the
deduction from Taxable Income now and her spouse will be taxed on the income in the future. The tax
deferral occurs as the contribution is currently deductible and the earnings on the contribution will
accumulate on a tax free basis. However, all of these amounts will be taxable when they are withdrawn
from the plan. Tax avoidance will occur if John is taxed at a lower rate than is currently applicable to
Natasha when the funds become taxable to him.

Exam Exercise Solution One - 24 (Tax Planning)

Contributions to a registered pension are deductible in the year in which they are made. They are not
taxed until retirement benefits are received under the terms of the plan. This involves tax deferral and, if
Ms. Jones is taxed at a lower rate after she retires, tax avoidance has also been accomplished.

Exam Exercise Solution One - 25 (Tax Planning)

This transaction involves income splitting. It would appear that her daughter is in a lower tax bracket
than Mrs. Theil. This means that the income on the Canada Savings Bonds will be taxed at a lower rate
than would be the case if the bonds remained in Mrs. Theil’s hands.

Exam Exercise Solution One - 26 (Tax Planning)

This transaction involves income splitting. As Norman’s son is over 18 years of age, the dividends will
be taxed in his name and not attributed back to his father. Provided he is in a lower tax bracket than
Norman, this will reduce the family’s overall tax burden.

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TIF Solution One - 5A

The correct definitions for each of the listed key terms are as follows:

A. 1

B. 8

C. 9

D. 3

E. 5

F. 2

G. 6

H. 7

The two unused definitions are as follows:

Income Tax Folios = 4

Progressive Tax System = 10

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TIF Solution One - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.

The correct definitions for each of the listed key terms are as follows:

A. 1 (not 12)

B. 10

C. 13

D. 4 (not 7)

E. 6 (not 11)

F. 3 (not 14 which is also an unused definition)

G. 8

H. 9 (not 2)

The two unused definitions are as follows:

Income Tax Folios = 5

Progressive Tax System = 14

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TIF Solution One - 6

Note The descriptions of these tax measures are significantly simplified. The objective of this
problem is to present the basic ideas so they can be understood by students at this introductory
level, while still providing a basis for discussion. It is obvious that there is no definitive
solution to this problem. The analysis provided below is intended to be no more than
suggestive of possible points that could be made. There are, of course, many alternative
solutions.

Increase In The Maximum Tax Rate

Possible comments here would be as follows:

Adequacy As this increase was accompanied by a reduction in the second tax bracket from
22.0 percent to 20.5 percent, as well as a number of new spending initiatives, the government
felt that this increase was necessary in order to provide compensating revenues.

International Competitiveness The fact that, in most provinces, the maximum tax rate on
individuals is over 50 percent makes Canada less competitive with many other jurisdictions. In
particular, in the United States, maximum tax rates on individuals are generally much lower.

Repeal Of The Family Tax Cut

Possible comments here would be as follows:

Simplicity And Ease Of Compliance This was an extremely complex provision that few
individuals, other than those working as tax professionals really understood. Elimination of the
provision reduces the complexity of the Canadian tax system.

Equity Or Fairness The family tax cut was widely criticized for providing most of its benefits
to middle and upper income Canadians. Lower income individuals rarely benefitted from its
provisions. It can be argued that the elimination of the family tax cut improves the fairness of
the system.

Reduction In Contributions To Tax Free Savings Accounts

Possible comments here would be as follows:

Adequacy The reduction in the 22 percent tax bracket to 20.5 percent and several new and
expensive programs have increased the government’s need for additional revenues. Reducing
this limit on the amount of investment income that can be earned tax free will increase
revenues.

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Balance Between Sectors As this provision is only available to individuals, the ability to earn
tax free investment income reduces taxes for this group of taxpayers. A reduction in the
maximum contribution has the effect of increasing taxes for the group. This serves to increase
the already heavy tax burden on this group of taxpayers.

Small Business Tax Rate

Possible comments here would be as follows:

Certainty By clearly indicating that the small business tax rate will remain at 10.5 percent for
the foreseeable future, certainty is increased for this group of taxpayers.

Neutrality The small business tax rate is designed to assist a specific group of taxpayers. The
fact that the scheduled reductions in this rate have been cancelled is an unfavourable event for
this group.

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Early Child Educator School Supply Tax Credit

Possible comments here would be as follows:

Simplicity And Ease Of Compliance The large number of existing tax credits and the fact
that new ones are added nearly every year, has greatly increased the complexity of the
Canadian tax system. Another addition will exacerbate this problem. Additional complexity is
also created by issues such as defining eligible supplies and determining who qualifies for the
credit.

Neutrality This credit results in a benefit related to the costs associated with being a particular
type of employee. It is not neutral in that it does not provide similar benefits for the costs
associated with other types of employment (e.g., construction workers cannot deduct the cost of
protective clothing).

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TIF Solution One - 7

If this problem is used on an examination, great flexibility will be required in marking the student’s
responses. There is obviously no one solution to this problem and, given this, marks will have to be
allocated on the basis of the reasonableness of the student’s answers.
We would also note that we do not present the following as a comprehensive solution. It simply reflects
some of the points that could be made with respect to the alternatives that are described in the text. The
list of characteristics is as follows:

 Equity Or Fairness

 Neutrality

 Adequacy

 Elasticity

 Flexibility

 Simplicity And Ease Of Compliance

 Certainty

 Balance Between Sectors

 International (Provincial in this case) Competitiveness

Alternative 1
The following comments could be made with respect to this alternative:

Adequacy The introduction of a provincial sales tax (PST) could provide adequate revenues to
solve the deficit problem.

Neutrality Whether a sales tax would be neutral would depend on its application. If it applied
to all goods and services, it could be considered neutral. However, if it provides exemptions
for certain types of goods and services (an exemption for basic food products), it would
influence the allocation of resources.

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Fairness As noted in the text, sales taxes of any type are regressive and this can be viewed as
unfair to lower income individuals.

Certainty Sales taxes make it clear to individual taxpayers the amounts that will have to be
paid. However, certainty can be compromised if the application of the sales tax involves
numerous exemptions.

Ease Of Compliance Here again, it depends on how the tax is applied. If it applies to all
goods and services, compliance is not too difficult. However, compliance could become very
complex if various types of exemptions are available. Also increasing complexity would be
variances between the application of this tax and the application of the federal GST.

Alternative 2
The following comments could be made with respect to this alternative:

Adequacy, Neutrality, Fairness, And Certainty The comments on alternative 1 would be

applicable here.

Ease Of Compliance The major advantage of this Alternative over Alternative 1 is ease of
compliance. When there is a separate PST, taxpayers will have to file both a GST return and a
PST return. Note, however, when a province chooses to apply HST to different items than
those covered by the GST legislation, compliance is made more difficult.

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Alternative 3
The following comments could be made with respect to this alternative:

Adequacy Cuts in expenditures can provide for the required deficit reduction.

Ease Of Compliance As the subject of the cuts have little choice in the matter, compliance is
not an issue. However, implementation could present many problems for targeted
organizations, particularly if the cuts are not anticipated.

Fairness This alternative is targeted at the needs of students. This could be viewed as
favouring older individuals who are not participating in educational programs and/or do not
have children involved in educational programs.

Provincial Competitiveness University students have considerable mobility and could decide
to search for positions in the universities of other provinces. However, they may be faced with
higher out-of-province tuition, as well as the costs of living away from home. With respect to
families with children in elementary or high school, a decline in the quality of schools could
discourage immigration to the Province.

Alternative 4
The following comments could be made with respect to this alternative:

Adequacy And Ease Of Compliance The comments on Alternative 3 would be applicable

here.

Fairness The impact of this change would be broadly based. However, it could be viewed as
being unfair to those individuals with health problems. It is likely that the impact of cuts in
health care would be felt most by older individuals. There is an additional fairness question in
terms of whether the current health care system is adequately funded. If it is not, then the
proposed cuts could be unfair to everyone with health problems.

Alternative 5
The following comments could be made with respect to this alternative:

Adequacy It is likely that the introduction of progressive rates on individuals would assist
with deficit reduction. Note, however, that an offsetting factor could be that individuals are
less willing to work more when the result will be a higher rate of tax.

Ease Of Compliance As discussed in the text, progressive rates add complexity and
encourage evasion.

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Fairness Most analysts view progressive rates as being fair in that individuals with higher
income will have higher rates. The basis for this argument is ability to pay.

Alternative 6
The following comments could be made with respect to this alternative:

Adequacy Increases in corporate tax rates could contribute to deficit reduction.

Ease Of Compliance Given that corporate income tax is already in place, an increase in rates
would not add to compliance issues.

Balance Between Sectors This change would result in heavier reliance on the corporate
income tax, as compared to the amounts resulting from the application of the individual income
tax. Without knowing the current balance between these two sectors, it is difficult to comment
on this change.

Provincial Competitiveness If the increase in the corporate tax rate results in a rate that is
higher than other provinces, the result could be some loss of corporate business in Alsaskatoba.

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Alternative 7
The following comments could be made with respect to this alternative:

Adequacy Provided this fee did not discourage immigration to Alsaskatoba, this fee could
help reduce the deficit.

Fairness There is an argument, based on the fact that new immigrants use provincial
resources, (e.g. health care for example), that such a tax would be fair to the current residents of
Alsaskatoba.

Provincial Competitiveness This fee will clearly discourage immigration, making it more
difficult to attract individuals from other provinces.

There are, of course, many other comments that could be made on all of these alternatives. We would
also note that there is another issue with respect to all of these alternatives. This is the question of
political acceptability. If the residents of Alsaskatoba have never had a sales tax, this alternative may
not be acceptable, without regard to other considerations.

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TIF Solution One - 8

Mr. Morris would fall under the part year resident rules and would only be assessed for Canadian taxes
on worldwide income during the portion of the year prior to his ceasing to be a resident of Canada.
By selling his house, disposing of other personal property, and resigning from various social and
professional clubs, Mr. Morris appears to have done most of the things that would be required to
establish that he had made a clean break from Canada as of April 1. However, S5-F1-C1 indicates that,
in general, the CRA will view an individual as becoming a non-resident on the latest of three dates:

 The date the individual leaves Canada.

 The date the individual’s spouse or common-law partner and dependants leave Canada.

 The date the individual becomes a resident of another country.

Because of the continued presence in Canada of the spouse and dependent children of Mr. Morris, he
would be considered a resident of Canada until June 30, the latest of the relevant dates.
In terms of tax consequences, he would be subject to Canadian taxes on his salary until March 31. He
would then be subject to U.S. taxes on income earned in that country after March 31. However, he
would also be liable for Canadian taxes during the period April 1 through June 30. While he would be
eligible for a tax credit for U.S. taxes paid on this income, the fact that Canadian taxes are generally
higher than those in the U.S. would probably result in a liability for Canadian taxes during this period
until his family departs from Canada.

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TIF Solution One - 9

Case A
As Mr. Plesser became a Canadian resident on July 1 of the current year, he would be subject to
Canadian Part I tax on his worldwide income for the part of a year subsequent to that date. This would
include all of his employment income, as well as one-half (£5,500) of his U.K. interest.

Case B
Members of the Canadian armed forces are deemed to be Canadian residents without regard to where
they actually live. As Mrs. Jurgens is exempt from German taxation due to her relationship to a deemed
resident, she is a deemed resident and will be subject to Canadian taxation on her employment income.

Case C
While Ms. Mennan has a small Canadian savings account, it is unlikely that the CRA would consider
this a sufficient tie with Canada to view her as a resident. She would be considered a non-resident.
With respect to the interest she received, Part XIII would not be applicable because it is an arm’s length
payment and does not involve participating debt. In addition, as was noted in Case C, the Canada/U.S.
tax treaty has a provision which does not allow either country to assess taxes on interest paid to residents
of the other country.

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TIF Solution One - 10

Canada/U.S. Tax Treaty Tie Breaker Rule
In cases of dual residency for corporations, where a corporation could be considered a resident of both
countries, the Canada/U.S. tax treaty indicates that the corporation will be deemed to be a resident only
in the country in which it is incorporated.

Case A
While Bonix is no longer operating in Canada, it was incorporated here and it is deemed a Canadian
resident. However, as the mind and management of the Company are currently in the United States, the
Company is also a resident of the U.S. Using the tie breaker rule, Bonix will be considered a resident of
Canada.

Case B
Dorad Inc. was not incorporated in Canada and its mind and management are not currently located here.
Therefore, Dorad would not be considered a resident of Canada.

Case C
The mind and management of Upton Inc. are in Canada and this suggests that the Company is a resident
of Canada. However, as Upton Inc. was incorporated in the U.S., it is also a resident of the U.S. Using
the tie breaker rule, the Upton Inc. will be considered a resident of the U.S. and a non-resident of
Canada.

Case D
Carlin Inc. was incorporated in Canada which means Carlin is a deemed resident of Canada. However,
because the mind and management of the Company are in the United States, it is also a resident of the
U.S. Using the tie breaker rule, Carlin Inc. will be considered a resident of Canada.

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TIF Solution One - 11

A. Molly London would be considered a part year resident of Canada until October 31, the date of her
departure and would be taxed on her worldwide income for this period. As her presence in Canada
during the first part of the year was on a full time basis, she would not fall under the sojourning
rules.

B. Daryl Bennett would not be considered a Canadian resident. As a result, none of his income would
be subject to Canadian taxes. He sojourned in Canada for less than 183 days. He would therefore
not be considered a deemed resident by the sojourner rule. As his residential ties appear to be in the
U.S., he would be a U.S. resident. His Canadian citizenship would not affect his residency status.

C. Under the mind and management rule, Tweeks Inc. would be considered resident in Canada for the
full year and would be taxed on its worldwide income for the year. While Tweeks Inc. was not
incorporated in Canada, it would appear that its mind and management are located in Quebec. This
would result in Tweeks Inc. being treated as a Canadian resident.

However, as Tweeks was incorporated in the U.S., it would also be considered a resident of that
country. Given this dual residency, the tie-breaker rules in the Canada/U.S. Tax Treaty would
resolve the situation by making the Company a resident of its country of incorporation. This would
result in Tweeks being considered a resident of the U.S., and a non-resident of Canada. Its income
would be taxed in the U.S.

D. Bordot Industries would be deemed a Canadian resident because it was incorporated in Canada
subsequent to April 26, 1965 [ITA 250(4)(a)].

However, because the mind and management of the Company is in the U.S., it would also be
considered a resident of that country. Given this dual residency, the tie-breaker rules in the Canada/
U.S. Tax Treaty would resolve the situation by making the Company a resident of its country of
incorporation. This would make Bardot Industries a resident of Canada, with its worldwide income
taxed in Canada.

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TIF Solution One - 12

Part A
As she is exempt from taxation in Indonesia because she is related to a deemed resident, Dorothy would
be a deemed resident of Canada for income tax purposes during the current year under ITA 250(1)(g).

Part B
As she is present in Canada on a temporary basis for more than 183 days per year, she would be
considered a sojourner. Under ITA 250(1)(a), this would make her a Canadian resident for income tax
purposes for all of the current year.

Part C
Because he has an employment contract that requires him to return to Canada, he will be a Canadian
resident for income tax purposes during the current year. Although he has severed his ties with Canada,
the requirement to return would show that he does not intend to permanently leave Canada.

Part D
Millicent would be a Canadian resident for income tax purposes during the current year. An individual
is not considered to have departed from Canada until the latest of the departure date, the date of
departure for their spouse and children, and the date on which residence is established in a different
country. As her family is staying in Canada and Millicent will not be establishing residency in another
country, she will remain a Canadian resident during her trip.

Part E
ITA 250(4)(c) indicates that a corporation is resident in Canada if it was incorporated in Canada prior to
April 27, 1965 and carried on business, or was resident in Canada, in any year ending after April 26,
1965. However, as the mind and the management of the company is in the U.S., it is also a resident of
that country. In cases of dual residency for corporations, where a corporation could be considered a
resident of both countries, the Canada/U.S. tax treaty indicates that the corporation will be deemed to be
a resident only in the country in which it is incorporated. Given this, Berkley Management would be a
resident of Canada.

Part F
The company was not incorporated in Canada and the mind and management of the company is not in
Canada. Lorris Ltd. is not a resident of Canada.

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TIF Solution One - 13

Case A
The Case A solution would be calculated as follows:

Income Under ITA 3(a):

Employment Income $17,000

Net Rental Income 8,500 $25,500

Income Under ITA 3(b):

Taxable Capital Gains $17,400

Allowable Capital Losses ( 19,200) Nil

Balance From ITA 3(a) And (b) $25,500

Subdivision e Deductions ( 6,300)

Balance From ITA 3(c) $19,200

Deduction Under ITA 3(d):

Business Loss ( 12,300)

Net Income For Tax Purposes (Division B Income) $ 6,900

In this Case, Ms. Burke has an unused allowable capital loss carryover of $1,800 ($17,400 - $19,200).
The lottery winnings are not subject to tax.

Case B
The Case B solution would be calculated as follows:

Income Under ITA 3(a):

Employment Income $42,100

Interest Income 8,200 $50,300

Income Under ITA 3(b):

Taxable Capital Gains $22,400

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Allowable Capital Losses ( 19,200) 3,200

Balance From ITA 3(a) And (b) $53,500

Subdivision e Deductions ( 4,200)

Balance From ITA 3(c) $49,300

Deduction Under ITA 3(d):

Unincorporated Business Loss ( 51,000)

Net Income For Tax Purposes (Division B Income) Nil

In this Case, Ms. Burke’s Net Income For Tax Purposes (Division B income) is nil. There would be an
unused business loss carry over of $1,700 ($49,300 - $51,000).

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TIF Solution One - 14

Case A
The Case A solution would be calculated as follows:

Income Under ITA 3(a):

Employment Income $126,100

Business Income 14,100 $140,200

Income Under ITA 3(b):

Taxable Capital Gains

[(1/2)($56,400)] $28,200

Allowable Capital Losses

[(1/2)($72,300)] ( 36,150) Nil

Balance From ITA 3(a) And (b) $140,200

Spousal Support Payments [(12)($600)] ( 7,200)

Balance From ITA 3(c) $133,000

Deduction Under ITA 3(d):

Net Rental Loss ( 4,600)

Net Income For Tax Purposes (Division B Income) $128,400

In this Case, Carl has an unused allowable capital loss carry over of $7,950 ($28,200 - $36,150). The
lottery winnings would not be included in income.

Case B
The Case B solution would be calculated as follows:

Income Under ITA 3(a):

Employment Income $89,000

Interest Income 3,100

Net Rental Income 8,600 $100,700

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Income Under ITA 3(b):

Taxable Capital Gains

[(1/2)($46,200)] $23,100

Allowable Capital Losses

[(1/2)($26,300)] ( 13,150) 9,950

Balance From ITA 3(a) And (b) $110,650

Deductible RRSP Contribution ( 8,600)

Balance From ITA 3(c) $102,050

Deduction Under ITA 3(d):

Unincorporated Business Loss ( 187,400)

Net Income For Tax Purposes (Division B Income) Nil

In this Case, Carl has an unused business loss carry over of $85,350 ($102,050 - $187,400).

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TIF Solution One - 15

Case A
The Case A solution would be calculated as follows:

Income Under ITA 3(a):

Employment Income $34,000

Income From Property 21,000 $55,000

Income Under ITA 3(b):

Taxable Capital Gains $42,000

Allowable Capital Losses ( 57,000) Nil

Balance From ITA 3(a) and (b) $55,000

Subdivision e Deductions ( 5,500)

Balance From ITA 3(c) $49,500

Deduction Under ITA 3(d):

Business Loss ( 36,000)

Net Income For Tax Purposes (Division B Income) $13,500

Miss Bain would have a carry over of unused allowable capital losses in the amount of $15,000
($57,000 - $42,000).

Case B
The Case B solution would be calculated as follows:

Income Under ITA 3(a):

Employment Income $18,500

Income From Property 12,000 $30,500

Income Under ITA 3(b):

Taxable Capital Gains $ 9,000

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Allowable Capital Losses ( 12,000) Nil

Balance From ITA 3(a) and (b) $30,500

Subdivision e Deductions ( 10,500)

Balance From ITA 3(c) $20,000

Deduction Under ITA 3(d):

Business Loss ( 28,200)

Net Income For Tax Purposes (Division B Income) Nil

As Miss Bain’s business loss exceeds the balance from ITA 3(c), her Net Income For Tax Purposes
(Division B income) is nil. This means there would be a carry over of unused business losses in the
amount of $8,200 ($28,200 - $20,000) and of unused allowable capital losses in the amount of $3,000
($12,000 - $9,000).

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TIF Solution One - 16

Case 1
The Case 1 solution would be calculated as follows:

Income Under ITA 3(a):

Net Employment Income $82,438

Interest Income 3,521 $85,959

Income Under ITA 3(b):

Taxable Capital Gains $16,346

Allowable Capital Losses ( 3,478) 12,868

Balance From ITA 3(a) And (b) $98,827

RRSP Contribution ( 6,420)

Balance From ITA 3(c) And Net Income For Tax Purposes $92,407

In this Case, Mr. Bowman has no loss carry overs at the end of the year.

Case 2
The Case 2 solution would be calculated as follows:

Income Under ITA 3(a):

Net Business Income $56,782

Income Under ITA 3(b):

Taxable Capital Gains $3,426

Allowable Capital Loss ( 4,560) Nil

Balance From ITA 3(a) And (b) $56,782

Spousal Support Payments ( 18,000)

Balance From ITA 3(c) $38,782

Deduction Under ITA 3(d):

Net Rental Loss ( 6,742)

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Net Income For Tax Purposes (Division B Income) $32,040

In this Case, Mr. Bowman has a carry over of $1,134 ($4,560 - $3,426) in unused allowable capital
losses.

Case 3
The Case 3 solution would be calculated as follows:

Income Under ITA 3(a):

Net Employment Income $36,582

Income Under ITA 3(b):

Taxable Capital Gains [(1/2)($8,426)] $4,213

Allowable Capital Losses [(1/2)($6,220)] ( 3,110) 1,103

Balance From ITA 3(a) and (b) $37,685

Child Care Costs ( 2,860)

Balance From ITA 3(c) $34,825

Deduction Under ITA 3(d):

Net Business Loss ( 47,384)

Net Income For Tax Purposes (Division B Income) Nil

In this Case, Mr. Bowman would have a business loss carry over in the amount of $12,559 ($47,384 -
$34,825).

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Case 4
The Case 4 solution would be calculated as follows:

Income Under ITA 3(a):

Interest Income $ 4,850

Net Business Income 35,682 $40,532

Income Under ITA 3(b):

Taxable Capital Gains [(1/2)($8,460)] $4,230

Allowable Capital Losses

[(1/2)($18,462)] ( 9,231) Nil

Balance From ITA 3(a) And (b) $40,532

Moving Expenses ( 5,643)

Balance From ITA 3(c) $34,889

Deduction Under ITA 3(d):

Net Rental Loss ( 51,462)

Net Income For Tax Purposes (Division B Income) Nil

Mr. Bowman would have a rental loss carry over in the amount of $16,573 ($51,462 - $34,889) and
unused allowable capital losses in the amount of $5,001 ($9,231 - $4,230).

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Chapter Two Test Item File Solutions

TIF Solution Two - 1

1. For an employer to grant this request, the reason for the reduction must be documented in a
reasonable fashion and it must be recurring. While there are other examples, the one mentioned in
the text involves an individual with deductible spousal support payments.

2. While there are other possibilities, the ones that are mentioned in the text are:

 Normal withholding is based on rates in a low tax rate province, but the individual resides in a
high tax rate province (e.g., the individual works in Alberta, but lives in Saskatchewan).

 An individual receives large amounts of taxable spousal support payments that are not subject
to withholding.

3. Individuals are required to make instalment payments if their net tax owing is greater than $3,000
($1,800 in Quebec) in the current year and in either of the two preceding years. An alternative
approach would be to indicate when instalments are not required. The statement here would be that
instalments are not required when the net tax owing for the current year, or for each of the two
preceding years is $3,000 or less.

4. An individual can choose from three different methods in determining their instalment payments:

Method 1 The instalments could be based on one-quarter of the estimated net tax owing for
the current year.

Method 2 The instalments could be based on one-quarter of the net tax owing for the previous
year.

Method 3 The first two instalments could be based on one-quarter of the net tax owing for the
second previous year, with the third and fourth instalments based on one-half of the net tax
owing for the previous year, less the sum of the first two instalments paid.

5. The CRA’s instalment reminder results in total instalment payments equal to the net tax owing in
the previous taxation year. If the estimated net tax owing for the current year is less, lower
instalments could be paid using the estimated current year net tax owing as the base.

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6. If the client has debt on which he is paying non-deductible interest (e.g., interest on non-business
credit cards), you should determine the applicable rates. If he is paying at a rate in excess of the
rate he will be charged on deficient instalments (i.e., the prescribed rate plus 4 percent), he might
consider paying down the debt in lieu of making instalment payments. Alternatively, if the rate that
he is paying on the personal debt is lower, he should make an effort to pay his instalments. The
excess penalty under ITA 163.1 would also have to be taken into consideration if the instalment
payments are large.

7. Interest on later instalments is calculated using the highest prescribed rate (the regular rate plus 4
percentage points) applied for the period from the date the instalment is due until the balance due
date for the total tax payable.

8. She should file the return on the due date, regardless of whether she has the funds to pay the balance
owing. Whether or not she files, she will have to pay interest on the balance owing. However, if
she delays filing until early July, she will not only have to pay the non-deductible interest, she will
also be subject to an immediate penalty of 5 percent of the balance owing, plus an additional 1
percent per complete month for the period from April 30, for a total penalty of 7 percent.

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If, within the last three years, there has been another late filing of her return, the penalty can double
to an immediate 10 percent, plus 2 percent per month. The monthly penalty will be assessed for a
maximum of 20 months.

9. Corporations are generally required to make either monthly or quarterly instalment payments
throughout their taxation year. The only exception to this is when the estimated taxes payable for
the current year, or the taxes payable in the preceding year, are $3,000 or less.

10. A corporation that is not a small CCPC can choose from three different methods in determining
their instalment payments:

Method 1 The instalments can be based on one-twelfth of the estimated taxes payable for the
current taxation year.

Method 2 The instalments can be based on one-twelfth of the taxes payable for the previous
taxation year.

Method 3 The first two instalments can be based on one-twelfth of the taxes payable for the
second previous year. The remaining 10 instalments will then be based on the taxes payable
for the previous taxation year reduced by the amounts paid in the first two instalments, with
this amount divided by 10.

11. A corporation that is a small CCPC can choose from three different methods in determining their
instalment payments.

Method 1 The instalments can be based on one-fourth of the estimated taxes payable for the
current taxation year.

Method 2 The instalments can be based on one-fourth of the taxes payable for the previous
taxation year.

Method 3 The first instalment can be based on one-fourth of the taxes payable for the second
previous year. The remaining three instalments will then be based on the taxes payable for the
previous taxation year reduced by the amount paid in the first instalment, with this amount
divided by three.

12. Corporate tax returns must be filed within six months of the end of the corporation’s taxation year.
In contrast, the balance due date is either 2 months after the end of the corporation’s taxation year
(general rule) or 3 months after the end of the corporation’s taxation year (qualifying CCPCs). As a
consequence, payment is always required prior to the due date for filing the corporate tax return.

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13. There are a number of situations that could be cited. The ones listed in the text are as follows:

 Reassessment can occur at any time if the taxpayer or person filing the return has made any
misrepresentation that is attributable to neglect, carelessness or willful default, or has
committed any fraud in filing the return or in supplying information under the Income Tax Act.

 Reassessment can occur at any time if the taxpayer has filed a waiver of the normal time limit.
A taxpayer can revoke such a waiver at any time.

 Reassessment can occur outside the normal reassessment period if an individual or

testamentary trust has requested a reduction in taxes, interest, or penalties. The ability to use
this provision is limited to ten years after the particular year in question.

 Reassessment can occur beyond the normal reassessment period when reassessment within the
normal period affects a balance outside of this period.

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 Reassessment can occur outside the normal reassessment period in situations where the
taxpayer is claiming certain specified deductions, such as a loss carry back for that year.

14. The general and informal procedures differ as follows:

 Under the informal procedures, the tax involved must be less than $25,000, or the loss in
question is less than $50,000.

 Under the informal procedures, an individual can represent himself, or be represented by

someone other than a lawyer (e.g., an accountant).

 Under the informal procedures, the taxpayer cannot be assessed court costs.

 Under the informal procedures, if the taxpayer loses, there is no appeal to a higher court.

 Informal procedures usually resolve a dispute much more quickly than the general procedures.

15. Tax evasion is described on the CRA web site as follows:

Tax evasion typically involves deliberately ignoring a specific part of the law. For example,
those participating in tax evasion may under-report taxable receipts or claim expenses that are
non-deductible or overstated. They might also attempt to evade taxes by wilfully refusing to
comply with legislated reporting requirements.

A less clear description of tax avoidance is as follows:

When tax planning reduces taxes in a way that is inconsistent with the overall spirit of the law,
the arrangements are referred to as tax avoidance. The Canada Revenue Agency’s
interpretation of the term “tax avoidance” includes all unacceptable and abusive tax planning.
Aggressive tax planning refers to arrangements that “push the limits” of acceptable tax
planning.

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TIF Solution Two - 2

1. False.

The deficiency must be recurring, not just for a particular year.

2. False.

There are two filing due dates for individuals. April 30 or, for individuals earning business
income, June 15. In addition, deceased taxpayers may have a different filing date.

3. True.

4. True.

5. False.

The acceptable approach is to use one-quarter of the net tax owing for the current year.

6. False.

The interest rate applicable on refunds to individuals is 2 percentage points less than the
interest rate on amounts owing to the CRA.

7. False.

There is no penalty for late payment of taxes. The penalty is for late filing of a return.

8. True.

9. False.

Corporations, other than some CCPCs, must pay the balance of tax owing no later than two
months after the end of their fiscal year.

10. True.

11. False.

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Deliberately ignoring a specific provision in the Income Tax Act is tax evasion, not tax
avoidance.

12. True.

13. True.

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TIF Solution Two - 3

Individual Filing Requirements
1. C. If an individual has no Taxable Income for the year, they do not have to file an income
tax return

2. D. A self employed individual with a net business loss for the year does not have to file
an income tax return for the year.

3. C. If an individual has disposed of a capital property during the year, they are required to
file an income tax return, even if no tax is payable.

4. B. John must file a tax return on or before June 15, 2019.

5. B. April 30, 2019.

6. B. June 15, April 30.

7. E. Nil. The late filing penalty amounts to 5 percent of the tax that was unpaid at the
filing due date. Since Ms. Deveco has paid more than her net tax owing by April 30, 2019,
there are no penalties or interest.

8. A. The final tax return of individuals who die between January 1 and October 31 must be
filed no later than April 30 of the following year. The 6-month filing extension provided by
ITA 150(1)(b) only applies where an individual dies between November 1 of the year and April
30 of the following year.

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9. D. June 15, 2019.

10. B. June 15, 2019, his regular filing date for his 2018 tax return.

11. C. August 1, 2019.

12. A. April 30, 2019

Individual Instalments
13. B. Charlotte Bronte, who realized capital gains of $3,500 in 2017 and $4,000 in 2018.
With her only other income during the years 2015 through 2018 being $5,000 in employment
income, the net tax owing on the taxable one-half of the capital gains plus the employment
income would be less than $3,000.

A. is not correct. Although there is a requirement to pay instalments, the minimum instalment
would be nil because the prior year’s net tax owing was nil.

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14. C. $1,875 ($7,500 ÷ 4).

15. B. $3,750 ($15,000 ÷ 4).

16. A. Jane White, who received a one-time bonus of $60,000 last year and, because her
employer had not deducted enough tax, found herself with net tax owing of $8,200.

17. D. If Larry has as much income in 2019 as he had in 2018, he will have to pay
instalments during 2019.

18. C. When net tax owing is over $3,000 for the current year and one of the two prior years.

19. A. To pay the amounts provided by the CRA in their instalment reminder on or before the
required dates. B is wrong as the estimate for the current year may be too low.

Interest And Penalties

20. A. Dora should pay off her credit card balance before making instalment payments.

21. B. The penalty for a first offence is 5% + 1% per full month late to a maximum of 12
months. Since the return was more than 19 months late, the maximum penalty is 17% of
$15,500 = $2,635.

22. C. A taxpayer who has a balance owing files their tax return late, with the payment
enclosed.

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Corporate Filing Requirement

23. B. All corporations must file their income tax returns electronically. If their gross
revenues are less than $1,000,000, they can file a paper return.

24. E. Six months after the fiscal year end.

25. D. The return would be due on May 31, 2019, six months after the taxation year end.

26. D. The penalty would be 5 percent of the tax unpaid at the date the return was due to be
filed, plus 1 percent per month for three months, a total of 8 percent. This amounts to $200
[(8%)($2,500)].

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27. D. Two months after the end of the fiscal year, or three months after the end of the fiscal
year if the corporation is a small CCPC.

Corporate Instalments
28. C. Twelve payments of $6,250 per month.

29. B. Its preceding year’s taxes payable of $13,200, divided by twelve months.

30. B. The only correct approach listed is to pay monthly instalments equal to 1/12th of the
current year’s estimated tax liability.

31. A. Monthly, based on the estimated tax for the current year.

32. A. Taxable income cannot exceed $500,000 for the corporation and its associated
corporations for the current taxation year and the two previous years.

Assessments And Appeals

33. B. April 30, 2020.

34. C. When a return has been reassessed once, no further reassessments are permitted.

35. B. The change is based on a successful appeal to the courts by another taxpayer.

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36. E. For individuals, the notice of objection must be filed before the later of: 90 days from
the date of the notice of assessment or reassessment, and one year from the filing due date for
the return under assessment or reassessment.

37. C. Her notice of objection must be filed before the later of: 90 days from the date of the
notice of assessment (July 18, 2019), and one year from the filing due date for the return (April
30, 2020).

38. D. It must be filed no later than 90 days after the date of the notice of assessment.

39. D. April 30, 2020.

Tax Planning
40. D. tax planning.

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TIF Solution Two - 4

Exam Exercise Solution Two - 1 (Individual Due Dates)
While Mr. Brown’s 2018 tax return does not have to be filed until June 15, 2019, his tax liability must
be paid by April 30, 2019 in order to avoid the assessment of interest.

Exam Exercise Solution Two - 2 (Individual Due Dates)

While Ms. Farrel’s 2018 tax return does not have to be filed until June 15, 2019, her tax liability must be
paid by April 30, 2019 in order to avoid the assessment of interest.

Exam Exercise Solution Two - 3 (Deceased Taxpayer Due Date)

Mr. Klause’s 2018 tax return must be filed by the later of six months after the date of his death and his
normal filing date. Given that his income is from an unincorporated business, his normal filing date for
the 2018 return would be June 15, 2019. However, the later date is September 1, 2019, six months after
the date of his death.

Exam Exercise Solution Two - 4 (Deceased Taxpayer Due Date)

Ms. Klump’s 2018 tax return must be filed by the later of six months after the date of her death and her
normal filing date. Six months after her death would be June 1, 2019. However, because she has
income from an incorporated business, her normal filing date would be June 15, 2019. Given this, the
later date is June 15, 2019.

Exam Exercise Solution Two - 5 (Individual Instalments)

As the net tax owing for the current year and one of the two preceding years exceeds $3,000, she is
required to make instalment payments. The best alternative for instalment payments would be to use the
current year estimate. This would result in required instalment payments of $900 ($3,600 ÷ 4) to be
paid on March 15, June 15, September 15, and December 15. Note, however, that if the estimated taxes
payable are below actual taxes payable for 2018, instalment interest may be charged.

Exam Exercise Solution Two - 6 (Individual Instalments)

The net tax owing amounts can be calculated as follows:

2016 $11,000 ($56,000 - $45,000)

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2017 $2,800 ($49,000 - $46,200)

2018 $20,000 ($65,000 - $45,000)

As the net tax owing exceeds $3,000 in the current year and the second preceding year, instalments are
required. The Instalment Reminder will have March 15 and June 15 instalments of $2,750 each
($11,000 ÷ 4). There would be no further instalments required for 2018 as his net tax owing for 2017 is
only $2,800 and he would already have paid $5,500 [(2)($2,750)].
The best alternative for instalment payments would be to use the prior year option. This would result in
required instalment payments of $700 ($2,800 ÷ 4) to be paid on March 15, June 15, September 15, and
December 15.

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Exam Exercise Solution Two - 7 (Individual Instalments)

The net tax owing amounts can be calculated as follows:

2016 $5,000 ($83,000 - $78,000)

2017 Nil ($76,000 - $77,000). Note this is nil, not a negative amount.

2018 $4,000 ($63,000 - $59,000)

As the net tax owing exceeds $3,000 in the current year and the second preceding year, instalments are
required. The three alternatives for calculating instalment payments are as follows:

 Based on the estimate for the current year, the instalments would be $1,000 ($4,000 ÷ 4).

 Based on the estimate for the preceding year, the instalments would be nil.

 Based on the second preceding year, the first two instalments would each be $1,250 ($5,000 ÷ 4).
As the net tax owing for the previous year is nil, no further instalments would be required.

The best alternative would be to base the payments on the previous year, resulting in instalments of nil.

Exam Exercise Solution Two - 8 (Penalties And Interest For Individuals)

Given the size of her net tax owing, ITA 163.1 will not be applicable and there will be no penalties for
late instalments. However, a penalty of 8 percent of taxes payable will be assessed for filing three
complete months late (5 percent, plus 1 percent per month). If, in one of the three preceding taxation
years she has also late filed, the penalty could be 16 percent (10 percent, plus 2 percent per month) if
the CRA has already sent a request for the return.
Interest will be assessed on the deficient instalments, the balance owing on her filing date, and the
penalty assessed for late filing. It will be assessed at the prescribed base rate plus 4 percent for the
period May 1 through August 24, 2019.

Exam Exercise Solution Two - 9 (Penalties And Interest For Individuals)

A penalty of 9 percent of Tax Payable will be assessed for filing 4 complete months late (5 percent, plus
1 percent per month). There will be no interest on late instalments because, with the previous year’s Tax
Payable at nil, the required instalments were nil. This would also mean that the ITA 163.1 penalty could
not apply.
Interest at the prescribed base rate plus 4 percent will be assessed on the balance owing on his filing date
and the penalty assessed for late filing for the period May 1 through September 12, 2019.

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Exam Exercise Solution Two - 10

(Corporate Instalments - Regular And Small CCPC)
Not Small CCPC The first two instalments would be based on the second preceding year and would be
$5,958.33 each ($71,500 ÷ 12). The remaining 10 instalments would be based on the preceding year,
less the $11,916.66 paid in the first two instalments. The amount would be $8,168.33 [($93,600 -
$11,916.66) ÷ 10]. The instalments would be due on the last day of each month in 2018.
Small CCPC In this case, the first instalment would be based on the second preceding year and would
be $17,875 ($71,500 ÷ 4). The remaining 3 instalments would be based on the preceding year, less the
$17,875 paid for the first instalment. The amount would be $25,241.67 [($93,600 - $17,875) ÷ 3]. The
instalments would be due on the last days of March, June, September, and December, 2018.
Note that when the initial instalment(s) are based on the second preceding year, the total amount of
instalments will be the same as when all of the instalments are based on the first preceding year.
However, using the second preceding year is preferable in that it provides some deferral of taxes.

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Exam Exercise Solution Two - 11

(Corporate Instalments - Regular And Small CCPC)
Not Small CCPC The minimum instalments would be based on the estimated taxes payable for 2018.
The amount would be $4,358.33 ($52,300 ÷ 12). The instalments would be due on the last day of each
month in 2018. Note that, if the estimate for 2018 is too low, interest will be assessed on the deficiency.
Small CCPC In this case, all four instalments would be based on the estimated taxes payable for 2018.
The amount would be $13,075 ($52,300 ÷ 4). The instalments would be due on the last days of March,
June, September, and December, 2018.
Note that when the initial instalment(s) are based on the second preceding year, the total amount of
instalments will be the same as when all of the instalments are based on the first preceding year.
However, using the second preceding year is preferable in that it provides some deferral of taxes.

Exam Exercise Solution Two - 12

(Corporate Instalments - Regular And Small CCPC)
Not Small CCPC Minimum instalments would be based on the estimate for the current year. The
monthly amount would be $4,683.33 ($56,200 ÷ 12). If the second previous year was used, the first two
installments would be lower. However, as the remaining instalments would be based on the previous
year’s $93,400, the total would be significantly larger. The instalments would be due on the last day of
each month during the period October, 2017 through September, 2018. Note that, if the estimate for
2018 is too low, interest will be assessed on the deficiency.
Small CCPC Minimum instalments would be based on the estimate for the current year. The monthly
amount would be $14,050 ($56,200 ÷ 4). The instalments would be due on the last day of December,
2017, March, 2018, June, 2018, and September, 2018.

Exam Exercise Solution Two - 13 (Corporate Due Dates - CCPC)

Grange Inc.’s tax return is due six months after its year end, on September 30, 2018. As it is a CCPC
that claims the small business deduction, and its Taxable Income for the preceding taxation year did not
exceed $500,000, the final tax payment is due three months after the year end. This would be June 30,
2018.

Exam Exercise Solution Two - 14 (Corporate Due Dates)

Lawnco Inc.’s tax return is due six months after its year end, on July 31, 2018. As Lawnco is a public
company that is not eligible for the small business deduction, the final tax payment is due two months
after the year end, on March 31, 2018.

Exam Exercise Solution Two - 15 (Corporate Due Dates - CCPC)

Breyson’s tax return is due six months after its year end of June 30, 2018. This would be December 31,
2018. As it is a CCPC that claims the small business deduction, and its Taxable Income for the

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preceding taxation year did not exceed $500,000, its final tax payment is due three months after the year
end on September 30, 2018.

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Exam Exercise Solution Two - 16 (Notice of Objection)

A notice of objection must be filed by the later of:

 90 days after the date on the Notice of Reassessment (September 30, 2020); or

 one year after the due date for filing the return that is being reassessed (April 30, 2020).

The later of these two dates is September 30, 2020.

Exam Exercise Solution Two - 17 (Notice of Objection)

A notice of objection must be filed by the later of:

 90 days after the date on the Notice of Reassessment (June 6, 2020); or

 one year after the due date for filing the return that is being reassessed (June 15, 2020).

The later of these two dates is June 15, 2020.

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TIF Solution Two - 5A

The correct definitions for each of the listed key terms are as follows:

A. 9

B. 4

C. 6

D. 3

E. 1

F. 7

G. 2

H. 5

The two unused definitions are as follows:

Assessment = 10

GAAR = 8

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TIF Solution Two - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.
The correct definitions for each of the listed key terms listed below.

A. 12 (not 14)

B. 5 (not 9)

C. 7 (not 2)

D. 4

E. 1

F. 8 (not 10)

G. 3

H. 6

The two unused definitions are as follows:

Assessment = 13

GAAR = 11

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TIF Solution Two - 6

Part A - Case 1
Barry’s net tax owing in each of the three years is as follows:

2016 = $2,456 ($14,256 - $11,800)

2017 = $1,626 ($15,776 - $14,150)

2018 = $4,083 ($16,483 - $12,400) Estimated

While the net tax owning in the current year is expected to exceed $3,000, it did not exceed $3,000 in
either of the two previous years. The payment of instalments is not required.

Part A - Case 2
Barry’s net tax owing in each of the three years is as follows:

2016 = Nil ($14,256 - $14,920) Note that a negative number is not used here.

2017 = $4,376 ($15,776 - $11,400)

2018 = $3,257 ($16,483 - $13,226) Estimated

As his net tax owing is expected to exceed $3,000 in 2018 and was more than $3,000 in 2017, the
payment of instalments is required.
Instalments under the three acceptable alternatives would be as follows:

Alternative 1 Using the estimated net tax owing for the current year would result in quarterly
instalments of $814.25 ($3,257  4), for a total amount of $3,257.

Alternative 2 Using the net tax owing for the previous year would result in quarterly
instalments of $1,094 ($4,376  4), for a total amount of $4,376.

Alternative 3 Using the net tax owing for the second previous year would result in the first
two instalments being nil. The remaining two instalments would be $2,188 ($4,376  2), a
total of $4,376.

The best choice would be Alternative 1. While the first two instalments are lower under Alternative 3,
the total for the year under Alternative 3 is $1,119 ($4,376 - $3,257) higher.

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Part A - Case 3
Barry’s net tax owing in each of the three years is as follows:

2016 = $3,036 ($14,256 - $11,220)

2017 = $2,501 ($15,776 - $13,275)

2018 = $3,610 ($16,483 - $12,873) Estimated

As his net tax owing is expected to exceed $3,000 in 2018 and was more than $3,000 in 2016, the
payment of instalments is required.
Instalments under the three acceptable alternatives would be as follows:

Alternative 1 Using the estimated net tax owing for the current year would result in quarterly
instalments of $902.50 ($3,610  4), for a total amount of $3,610.

Alternative 2 Using the net tax owing for the previous year would result in quarterly
instalments of $625.25 ($2,501  4), for a total amount of $2,501.

Alternative 3 Using the net tax owing for the second previous year would result in the first
two instalments being $759 ($3,036  4) each, a total of $1,518. The remaining two
instalments would be $491.5 [($2,501 - $1,518)  2], a total of $983. When combined with
the first two instalments, the total for the year would be $2,501 ($1,518 + $983).

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The best choice would be Alternative 2. While the total for the year under Alternative 3 is the same, the
first two instalments are lower under Alternative 2, allowing for a small amount of tax deferral.

Part B
In Case Two and Case Three, the required instalments would be due on March 15, June 15, September
15, and December 15, 2018.

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TIF Solution Two - 7

Need For Instalments
Instalments are required when an individual’s “net tax owing” exceeds $3,000 in the current year and in
either of the two preceding years. In somewhat simplified terms, “net tax owing” is defined as the
combined federal and provincial taxes payable, less amounts withheld under ITA 153. Mr. Boardman’s
net tax owing figures are as follows:

2016 = $750 ($62,350 - $61,600)

2017 = $16,020 ($29,760 - $13,740)

2018 = $4,980 ($52,370 - $47,390) Estimated

As Mr. Boardman’s net tax owing in 2018 (the current year) and his net tax owing in 2017 (one of the
two preceding years) is greater than $3,000, he is required to make instalment payments.

Amounts
If Mr. Boardman bases the first two quarterly payments on the 2016 net tax owing, they would only be
$187.50 each ($750 ÷ 4). However, the payments for the last two quarters would be $7,822.50 each
{[$16,020 - (2)($187.50)] ÷ 2}, resulting in total instalment payments of $16,020.
A preferable alternative would be to base the payments on the estimated net tax owing for 2018. These
payments would be $1,245 each ($4,980 ÷ 4), for a total of $4,980.

Payment Dates
The quarterly payments would be due on March 15, June 15, September 15, and December 15 of 2018.

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TIF Solution Two - 8

Case One
1. As the corporation’s tax payable for both the current and the preceding year exceeds $3,000,
instalments are required. As the corporation is a small CCPC, instalments will be quarterly.

2. The three acceptable alternatives would be as follows:

 Quarterly instalments of $43,085 ($172,340 ÷ 4) based on the current year estimate.

 Quarterly instalments of $46,635 ($186,540 ÷ 4) based on the first preceding year.

 One instalment of $38,410 ($153,640 ÷ 4) based on the second preceding year, followed by
three instalments of $49,376.67 [($186,540 - $38,410) ÷ 3], a total of $186,540.

3. The best alternative in terms of minimum instalments would be four instalments of $43,085, for
total payments of $172,340. The instalments are due on March 31, June 30, September 30, and
December 31, 2018.

Case Two
1. As the corporation’s tax payable for both the current and the preceding year exceeds $3,000,
instalments are required. As the corporation is a small CCPC, instalments will be quarterly.

2. The three acceptable alternatives would be as follows:

 Quarterly instalments of $43,085 ($172,340 ÷ 4) based on the current year estimate.

 Quarterly instalments of $40,855 ($163,420 ÷ 4) based on the first preceding year.

 One instalment of $38,410 ($153,640 ÷ 4) based on the second preceding year, followed by
three instalments of $41,670 [($163,420 - $38,410) ÷ 3], a total of $163,420.

3. The best alternative would be one payment of $38,410, followed by three payments of $41,670.
While the total instalments are the same $163,420 in both the second and third alternatives, the
third alternative is preferable because the first payment is lower. This provides a small amount of
tax deferral.

The instalments are due on March 31, June 30, September 30, and December 31, 2018.

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Case Three
1. As the corporation’s tax payable for both the current and the preceding year exceeds $3,000,
instalments are required. As the corporation is not a small CCPC, monthly instalments are required.

2. The three acceptable alternatives would be as follows:

 Monthly instalments of $14,361.67 ($172,340 ÷ 12) based on the current year estimate.

 Monthly instalments of $15,545 ($186,540 ÷ 12) based on the first preceding year.

 Two monthly instalments of $12,803.33 ($153,640 ÷ 12) based on the second preceding year,
followed by 10 monthly instalments of $16,093.33 {[($186,540 - (2)($12,803.33)] ÷ 10}, a
total of $186,540.03.

3. The best alternative in terms of minimum instalments would be 12 instalments of $14,361.67,

resulting in a total of $172,340 of instalment payments.

The instalments would be due on the last day of each month, beginning in January, 2018.

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Case Four
1. As the corporation’s tax payable for both the current and the preceding year exceeds $3,000,
instalments are required. As the corporation is not a small CCPC, monthly instalments are required.

2. The three acceptable alternatives would be as follows:

 Monthly instalments of $14,361.67 ($172,340 ÷ 12) based on the current year estimate.

 Monthly instalments of $13,618.33 ($163,420 ÷ 12) based on the first preceding year.

 Two monthly instalments of $12,803.33 ($153,640 ÷ 12) based on the second preceding year,
followed by 10 monthly instalments of $13,781.33 {[$163,420 - (2)($12,803.33)] ÷ 10}, a total
of $163,420.

3. The best alternative would be two payments of $12,803.33, followed by ten payments of
$13,781.33. While the total instalments are the same $163,420 in both the second and third
alternatives, the third alternative is preferable because the first two payments are lower. This
provides a small amount of tax deferral.

The instalments would be due on the last day of each month, beginning in January, 2018.

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TIF Solution Two - 9

While there are alternatives in all Cases, the following answers represent the “minimum” instalments, as
required in the problem.

Case One
Mr. Shivraj’s net tax owing in each of the three years is as follows:

2016 = $2,300 ($13,500 - $11,200)

2017 = $3,300 ($16,200 - $12,900)

2018 = $3,300 ($18,400 - $15,100) Estimated

As his net tax owing is expected to exceed $3,000 in 2018 and was more than $3,000 in 2017, the
payment of instalments is required.
Since the net tax owing is the same in the current year and the preceding year, the total instalments will
equal $3,300 under any of the alternatives. The best alternative would be to base the first two
instalments on 2016. These would be $575 ($2,300 ÷ 4) each and would offer a small amount of
deferral over the preceding year or current year alternatives. The remaining two instalments would each
be $1,075 {[$3,300 - (2)($575)] ÷ 2} for a total of $3,300.
They would be due on March 15, June 15, September 15, and December 15.

Case Two
Mr. Shivraj’s net tax owing in each of the three years is as follows:

2016 = $4,300 ($13,500 - $9,200)

2017 = $5,900 ($16,200 - $10,300)

2018 = $3,500 ($18,400 - $14,900) Estimated

As his net tax owing is expected to exceed $3,000 in 2018 and was more than $3,000 in both the first
and second preceding years, the payment of instalments is required.
Using the 2018 net tax owing would result in minimum instalment payments of $875 ($3,500 ÷ 4) for a
total of $3,500.
They would be due on March 15, June 15, September 15, and December 15.

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Case Three
Mr. Shivraj’s net tax owing in each of the three years is as follows:

2016 = $3,400 ($13,500 - $10,100)

2017 = Nil ($16,200 - $16,300) Note that a negative number is not used here.

2018 = $3,700 ($18,400 - $14,700) Estimated

As his net tax owing is expected to exceed $3,000 in 2018 and was more than $3,000 in 2016, the
payment of instalments is required.
Using the 2017 net tax owing would result in minimum instalment payments. Based on this year, the
required quarterly instalments would be nil.

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TIF Solution Two - 10

Case One
1. As the corporation’s tax payable for both the current and the preceding year exceeds $3,000,
instalments are required. As the corporation is a small CCPC, instalments will be quarterly.

2. The three acceptable alternatives would be as follows:

 Quarterly instalments of $23,650 ($94,600 ÷ 4) based on the current year estimate.

 Quarterly instalments of $25,350 ($101,400 ÷ 4) based on the first preceding year.

 One instalment of $21,625 ($86,500 ÷ 4) based on the second preceding year, followed by three
instalments of $26,591.67 [($101,400 - $21,625 ÷ 3], a total of $101,400.

3. The best alternative in terms of minimum instalments would be four instalments of $23,650, for
total payments of $94,600. The instalments are due on March 31, June 30, September 30, and
December 31, 2018.

Case Two
1. As the corporation’s tax payable for both the current and the preceding year exceeds $3,000,
instalments are required. As the corporation is a small CCPC, instalments will be quarterly.

2. The three acceptable alternatives would be as follows:

 Quarterly instalments of $23,650 ($94,600 ÷ 4) based on the current year estimate.

 Quarterly instalments of $23,025 ($92,100 ÷ 4) based on the first preceding year.

 One instalment of $21,625 ($86,500 ÷ 4) based on the second preceding year, followed by three
instalments of $23,491.67 [($92,100 - $21,625) ÷ 3], a total of $92,100.

3. The best alternative would be one payment of $21,625, followed by three payments of $23,491.67.
While the total instalments are the same $92,100 in both the second and third alternatives, the third
alternative is preferable because the first payment is lower. This provides a small amount of tax
deferral.

The instalments are due on March 31, June 30, September 30, and December 31, 2018.

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Case Three
1. As the corporation’s tax payable for both the current and the preceding year exceeds $3,000,
instalments are required. As the corporation is not a small CCPC, monthly instalments are required.

2. The three acceptable alternatives would be as follows:

 Monthly instalments of $7,883.33 ($94,600 ÷ 12) based on the current year estimate.

 Monthly instalments of $8,450.00 ($101,400 ÷ 12) based on the first preceding year.

 Two monthly instalments of $7,208.33 ($86,500 ÷ 12) based on the second preceding year,
followed by 10 monthly instalments of $8,698.33 {[($101,400 - (2)($7,208.33)] ÷ 10}, a total
of $101,400.

3. The best alternative in terms of minimum instalments would be 12 instalments of $7,883.33,

resulting in a total of $94,600 of instalment payments.

The instalments would be due on the last day of each month, beginning in January, 2018.

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Case Four
1. As the corporation’s tax payable for both the current and the preceding year exceeds $3,000,
instalments are required. As the corporation is not a small CCPC, monthly instalments are required.

2. The three acceptable alternatives would be as follows:

 Monthly instalments of $7,883.33 ($94,600 ÷ 12) based on the current year estimate.

 Monthly instalments of $7,675 ($92,100 ÷ 12) based on the first preceding year.

 Two monthly instalments of $7,208.33 ($86,500 ÷ 12) based on the second preceding year,
followed by 10 monthly instalments of $7,768.33 {[($92,100 - (2)($7,208.33)] ÷ 10}, a total of
$92,100.

3. The best alternative would be two payments of $7,208.33, followed by ten payments of $7,768.33.
While the total instalments are the same $92,100 in both the second and third alternatives, the third
alternative is preferable because the first two payments are lower. This provides a small amount of
tax deferral.

The instalments would be due on the last day of each month, beginning in January, 2018.

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TIF Solution Two - 11

While there are alternatives in all Cases, the following answers represent the “minimum” instalments, as
required in the problem.
In all three Cases, the current year alternative is the best, but you should note that if the estimated net tax
owing is lower than the actual net tax owing, she may be charged interest on the insufficient instalments
if the interest totals more than $25.

Part A - Case One

Ms. Sloan’s net tax owing in each of the three years is as follows:

2016 = $500 ($23,600 - $23,100)

2017 = $4,300 ($25,400 - $21,100)

2018 = $3,900 ($27,200 - $23,300) Estimated

As her net tax owing is expected to exceed $3,000 in 2018 and was more than $3,000 in 2017, the
payment of instalments is required.
Under the CRA approach, the first two instalments would be $125 [($500  4)] each, for a total of
$250. The remaining two instalments would be $2,025 [($4,300 - $250)  2], for a total of $4,050.
This would bring the total instalments for the year to $4,300 ($250 + $4,050). A better solution would
be to base the instalments on the estimated 2018 results. Each instalment would be $975 ($3,900  4).
The resulting total of $3,900 would be less than the $4,300 total under the CRA approach.

Part A - Case Two

Ms. Sloan’s net tax owing in each of the three years is as follows:

2016 = Nil ($23,600 - $24,100)

2017 = $6,800 ($25,400 - $18,600)

2018 = $3,500 ($27,200 - $23,700) Estimated

As her net tax owing is expected to exceed $3,000 in 2018 and was more than $3,000 in 2017, the
payment of instalments is required.
Under the CRA approach, no payment would be required for the first two instalments. However, the
remaining two instalments would be $3,400 each [($6,800 - Nil)  2], bringing the total for the year to
$6,800. A better solution would be to base the instalments on the estimated 2018 results. Each
instalment would be $875 ($3,500  4). The resulting total of $3,500 would be less than the $6,800
total under the CRA approach.

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Part A - Case Three

Ms. Sloan’s net tax owing in each of the three years is as follows:

2016 = $4,500 ($23,600 - $19,100)

2017 = $5,200 ($25,400 - $20,200)

2018 = $2,900 ($27,200 - $24,300) Estimated

As her net tax owing is not expected to exceed $3,000 in 2018, the payment of instalments is not
required.

Part B
In Case One and Case Two, the required instalments would be due on March 15, June 15, September 15,
and December 15.

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TIF Solution Two - 12

Case One
1. As the corporation’s tax payable for both the current and the preceding year exceeds $3,000,
instalments are required. As the corporation is not a small CCPC, monthly instalments are required.

2. The three acceptable alternatives would be as follows:

 Monthly instalments of $5,241.67 ($62,900 ÷ 12) based on the current year estimate.

 Monthly instalments of $5,658.33 ($67,900 ÷ 12) based on the first preceding year.

 Two monthly instalments of $4,800 ($57,600 ÷ 12) based on the second preceding year,
followed by 10 monthly instalments of $5,830 {[($67,900 - (2)($4,800)] ÷ 10}, a total of
$67,900.

3. The best alternative in terms of minimum instalments would be 12 instalments of $5,241.67,

resulting in a total of $62,900 of instalment payments.

The instalments would be due on the last day of each month, beginning in January, 2018.

Case Two
1. As the corporation’s tax payable for both the current and the preceding year exceeds $3,000,
instalments are required. As the corporation is not a small CCPC, monthly instalments are required.

2. The three acceptable alternatives would be as follows:

 Monthly instalments of $5,241.67 ($62,900 ÷ 12) based on the current year estimate.

 Monthly instalments of $5,116.67 ($61,400 ÷ 12) based on the first preceding year.

 Two monthly instalments of $4,800 ($57,600 ÷ 12) based on the second preceding year,
followed by 10 monthly instalments of $5,180 {[($61,400 - (2)($4,800)] ÷ 10}, a total of
$61,400.

3. The best alternative would be two payments of $4,800, followed by ten payments of $5,180. While
the total instalments are the same $61,400 in both the second and third alternatives, the third
alternative is preferable because the first two payments are lower. This provides a small amount of
tax deferral.

The instalments would be due on the last day of each month, beginning in January, 2018.

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Case Three
1. As the corporation’s tax payable for both the current and the preceding year exceeds $3,000,
instalments are required. As the corporation is a small CCPC, instalments will be quarterly.

2. The three acceptable alternatives would be as follows:

 Quarterly instalments of $15,725 ($62,900 ÷ 4) based on the current year estimate.

 Quarterly instalments of $16,975 ($67,900 ÷ 4) based on the first preceding year.

 One instalment of $14,400 ($57,600 ÷ 4) based on the second preceding year, followed by three
instalments of $17,833.33 [($67,900 - $14,400) ÷ 3], a total of $67,900.

3. The best alternative in terms of minimum instalments would be four instalments of $15,725, for
total payments of $62,900. The instalments are due on March 31, June 30, September 30, and
December 31, 2018.

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Case Four
1. As the corporation’s tax payable for both the current and the preceding year exceeds $3,000,
instalments are required. As the corporation is a small CCPC, instalments will be quarterly.

2. The three acceptable alternatives would be as follows:

 Quarterly instalments of $15,725 ($62,900 ÷ 4) based on the current year estimate.

 Quarterly instalments of $15,350 ($61,400 ÷ 4) based on the first preceding year.

 One instalment of $14,400 ($57,600 ÷ 4) based on the second preceding year, followed by three
instalments of $15,667.67 [($61,400 - $14,400) ÷ 3], a total of $61,400.

3. The best alternative would be one payment of $14,400, followed by three payments of $15,667.67.
While the total instalments are the same $61,400 in both the second and third alternatives, the third
alternative is preferable because the first payment is lower. This provides a small amount of tax
deferral.

The instalments are due on March 31, June 30, September 30, and December 31, 2018.

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TIF Solution Two - 13

The following additional information would be relevant in considering Mr. Simon’s situation:

A. Determination of the date of the Notice of Reassessment. A notice of objection must be filed prior
to the later of:

 90 days from the date of the Notice of Reassessment; and

 one year from the due date for the return under reassessment.

In this case, the later date is clearly 90 days after the date of the Notice of Reassessment.

B. Determination of the date of the Notice of Assessment for the 2014 taxation year. A three year time
limit applies from the date of the Notice of Assessment. As the Notice of Assessment for 2014
could have been sent in early April, 2015, this reassessment could be within the three year limit.

C. Determination of whether Mr. Simon has signed a waiver of the three year time limit or if he is
guilty of fraud or misrepresentation. If the reassessment is not within the three year time limit, Mr.
Simon would not usually be subject to reassessment. However, if Mr. Simon has signed a waiver of
the three year time limit, or if fraud or misrepresentation is involved, he becomes subject to
reassessment, regardless of the time period involved.

If the preceding determinations indicate that the reassessment is valid and you decide to accept Mr.
Simon as a client, the following steps should be taken:

 You should have Mr. Simon file a Consent Form, T1013, with the CRA which authorizes
you to represent him in his affairs with the CRA and/or authorize you to access his file
through the online Represent a Client service.

 A notice of objection should be filed before the expiration of the 90 day time limit.

 You should begin discussions of the matter with the relevant assessor at the CRA.

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TIF Solution Two - 14

Note To Instructor These Cases have been based on examples found in IC 01-1.

Case A
In view of the business that the taxpayer is in, there was nothing in the income statement that would
have made the accountant question the validity of the information provided to him. Therefore, he could
rely on the good faith reliance exception and would not be subject to the preparer penalty.

Case B
The prospectus prepared by the company contains a false statement (overstated fair market value of the
software) that could be used for tax purposes. The company knew or would reasonably be expected to
know, but for culpable conduct, that the fair market value of the software was a false statement. Since
the company is engaged in an excluded activity, it cannot rely on the good faith reliance exception with
respect to the valuation. The CRA would consider assessing the company with third-party civil penalties
in the amount of $2,000,000 (i.e., the gross entitlements). The CRA would also consider assessing the
appraiser with third-party civil penalties. The amount of the penalty would be his gross entitlements
from the valuation activity, which is $75,000.

Case C
Although the tax return contains one or more false statements, the tax return preparer would be entitled
to the good faith defense since he relied, in good faith, on information (the financial statements that were
not obviously unreasonable) provided by another professional on behalf of the client. Therefore, he
would not be subject to the preparer penalty.
The third-party penalties may be applied to the other accountant if he knew or would be expected to
know, but for circumstances amounting to culpable conduct, that the financial statements contained false
statements.

Case D
The accountant would not be subject to the penalties for participating or acquiescing in the
understatement of a tax liability. The facts were highly suspect until the accountant asked questions to
clear up the doubt in his mind that the client was not presenting him with implausible information. The
response addressed the concern and was not inconsistent with the knowledge he possessed.

Case E
Since the tax return preparer e-filed the taxpayer’s return without obtaining the charitable donation
receipt, the CRA would consider assessing the tax return preparer with the preparer penalty. Given that
the size of the donation is so disproportionate to the taxpayer’s apparent resources as to defy credibility,
to proceed unquestioningly in this situation would show wilful blindness and thus an indifference as to
whether the ITA is complied with.

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Case F
The issue here is whether the accountant is expected to know that GST is not payable on wages, interest
expense, and zero-rated purchases. It is clear that the accountant should have known that no GST could
be claimed on these items. Given this, in filing a claim that includes a GST refund on the preceding
items, the accountant made a false statement, either knowingly, or in circumstances amounting to
culpable conduct. Consequently, the CRA would consider assessing the accountant with the third-party
civil penalty, specifically, the preparer penalty.

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Chapter Three Test Item File Solutions

TIF Solution Three - 1

1. The ability to use a bonus arrangement to defer tax on employment income is based on the fact that,
while business income is accrual based, employment income is on a cash basis. This means that the
business can deduct the bonus at the time a commitment is made to make the payment, but the
employee will not be taxed on it until it is received. If the bonus is declared in one year and paid in
the following year, this provides a one year deferral to the employee. Note, however, the bonus
must be paid within 180 days of the year end of the employer. If it is not paid within this period,
the employer will not be able to deduct the bonus until it is paid.

2. As noted in your text, the first step in making this distinction is to determine the intent of both
parties. Both the worker and the payer must be clear as to whether there is a contract of service
(employee/employer) or alternatively, a contract for services (business relationship). In many cases,
the intent may be clear. However, the worker and payer must ensure that their intent is reflected in
the actual terms and conditions of their relationship. In making this determination, the following
factors will be considered by the CRA:

Control In an employer/employee relationship, the employer usually controls, directly or

indirectly, the way the work is done and the work methods used. The employer assigns specific
tasks that define the real framework within which the work is to be done.

Ownership Of Tools And Equipment In an employer/employee relationship, the employer

usually supplies the equipment and tools required by the employee. In addition, the employer
covers the following costs related to their use: repairs, insurance, transport, rental, and
operations (e.g., fuel).

In some trades, however, it is customary for employees to supply their own tools. This is
generally the case for garage mechanics, painters, and carpenters. Similarly, employed
computer scientists, architects, and surveyors sometimes supply their own software and
instruments.

Ability To Subcontract Or Hire Assistants If the individual must personally perform the
services, he is likely to be considered an employee. Alternatively, if the individual can hire
assistants, with the payer having no control over the identity of the assistants, the individual is
likely to be considered self-employed.

Financial Risk In general, employees will not have any financial risks associated with their
work. In contrast, self-employed individuals can have risk and can incur losses. Responsibility
for fixed monthly costs is a good indicator that an individual is self-employed.

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Responsibility For Investment And Management If the individual has no capital investment
in the business and no presence in management, he is likely to be considered an employee.
Alternatively, if the individual has made an investment and is active in managing the business,
he should be considered self-employed.

Opportunity For Profit In an employer/employee relationship, the employer alone normally

assumes the risk of loss. The employer also usually covers operating costs, which may include
office expenses, employee wages and benefits, insurance premiums, and delivery and shipping
costs. The employee does not assume any financial risk, and is entitled to his full salary or
wages regardless of the financial health of the business.

Correspondingly, an employee will have little or no opportunity for profit. While there may be
productivity bonuses for exceptional work, such amounts are not generally viewed as profit.

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3. The importance of this distinction largely relates to the deductibility of expenses. The number and
types of expenses which can be deducted against employment income are very limited. In contrast,
if an individual is classified as self-employed, revenues generated will be treated as business
income, thereby opening the door to a much wider range of expense deductions. An additional
point here is that, if the individual is considered to be an employee, his employer will have to
withhold income taxes, Canada Pension Plan contributions, and Employment Insurance premiums.
This would not be the case if the individual was an independent contractor.

An independent contractor is responsible for quarterly tax instalments, if necessary, and for both the
employer’s and employee’s portions of CPP contributions. Such individuals may or may not have
to make EI contributions, depending on whether they elect to participate in this program.

4. The major items here would be:

 Using independent contractors eliminates the need for payments for CPP, EI, and payroll taxes
(where applicable).

 Independent contractors generally do not receive fringe benefits.

 Organizations are not committed to retaining independent contractors beyond the current need
for their services.

 Organizations are, in general, not legally responsible for the work of independent contractors.

5. Salary is considered to be the basic benchmark because it is fully deductible to the employer and
fully taxable to the employee. Given this, there is no tax benefit to be gained by any form of
employee compensation that has these same characteristics.

6. Examples involving tax deferral include contributions to RPPs and bonus arrangements that are paid
within 180 days of the employer’s year end. Examples involving tax avoidance include payments
for private health care, discounts on the employer’s goods or services, and non-cash gifts under
$500.

7. While there may be other possibilities, the tax planning suggestions that were included in the text
are as follows:

Require Return Of Car During extended periods of time when an employee does not use an
employer provided vehicle, the vehicle will be considered available for use unless the employer
REQUIRES it to be returned to their premises. Given this, the employer should have a policy
of requiring vehicles to be returned during periods of non-use by the employee.

Record Keeping In the absence of detailed records, an employee can be charged with the full
standby charge and 100 percent personal usage. To avoid this, it is essential that records be
kept of both employment related and personal kilometers driven.

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Leasing Vs. Buying In most cases, a lower taxable benefit will result when the employer
leases the car rather than purchases it. One adverse aspect of leasing arrangements should be
noted. Lease payments are made up of a combination of both interest and principal payments
on the car. As the taxable benefit is based on the total lease payment, the interest portion
becomes, in effect, a part of the taxable benefit.

Minimizing The Standby Charge This can be accomplished in a variety of ways including
longer lease terms, lower trade-in values for old vehicles in purchase situations, larger deposits
on leases, and the use of higher residual values in leasing arrangements. Note that refundable
deposits in excess of $1,000 on leases can reduce the deductible lease costs.

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Cars Costing More Than $30,000 With the taxable benefit to the employee based on the full
cost of the car and any portion of the cost in excess of $30,000 not being deductible to the
employer, it is difficult to imagine situations in which it would make economic sense for a
profit oriented employer to provide any employee with a luxury car. As the taxable benefit to
the employee is based on the actual cost of the car, while the deductible amount is limited to
$30,000, a situation is created in which the employee is paying taxes on an amount which can
be considerably larger than the amount that is deductible to the employer.

Employee Owned Automobile The alternative to the employer provided automobile is to

have the employer compensate the employee for using his own automobile. In many cases, this
may be preferable to providing an automobile. For example, in those situations where business
use is less than 50 percent, the provision of an automobile to an employee will result in a
benefit assessment for the full standby charge. If business use were 45 percent, for example, it
is almost certain that the amount assessed will exceed the actual benefit associated with 55
percent personal use of the vehicle. If, alternatively, the employee is compensated for using his
own personal vehicle, there may be no taxable benefit.

8. The formula requires a benefit of 2 percent of the cost of the vehicle per month of use. This benefit
continues, without regard to the length of time the car is used by the employee. At this rate, after 50
months, the taxable benefit is equal to the value of the vehicle [(2%)(50) = 100%]. If the vehicle is
used for more than 50 months, the amount of the benefit will exceed 100 percent of the cost of the
vehicle.

9. A reimbursement is an amount paid to an employee to compensate him for actual costs incurred in
performing his employment duties. The amount paid will be exactly equal to the costs incurred. In
contrast, an allowance is a payment designed to cover, in a general way, the costs of some specified
type of activity (e.g., a per diem allowance to cover food and lodging while traveling).

10. From the point of view of the employer, the full amount of any monthly allowance will be
deductible. With respect to the use of a milage allowance, there are prescribed limits on the
deduction. (These are discussed in Chapter 6.)

From the point of view of the employee, the monthly allowance will have to be included in his
employment income for the year. Given this, he can then deduct his actual costs of using his
automobile (an appropriate percentage of interest, CCA, and operating costs). Alternatively, if he
receives a per kilometer allowance, he can simply ignore it. It will not be included in the T4 issued
by his employer and, given this, he will not be able to deduct his actual costs.

11. Depending on the plan, the employer may pay all of the premiums, part of the premiums, or none of
the premiums. As long as the plan provides periodic benefits that compensate for lost employment
income, the premiums paid by the employer are not considered to be taxable benefits to the
employee regardless of the share paid.

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Amounts paid by the employee, again without regard to the share paid, are not deductible to the
employee.

If the employer has made any contribution towards the plan premiums that does not create a taxable
benefit, the full amount of any disability benefits received must be included in the income of the
employee. This amount can be reduced to the extent of the cumulative amount of premiums paid by
the employee prior to the receipt of the benefits, as well as those paid during the year the benefits
are received.

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12. The factors that would have to be considered are as follows:

 the employer’s rate of return on alternative uses for the funds

 the employer’s tax rate

 the employee’s tax rate

 the prescribed rate

 the rate available to the employee on a similar arm’s length loan

13. The taxable benefit on non-housing loans is calculated using the prescribed rate that is applicable to
each calendar quarter. The amount of the benefit is reduced by any interest paid on the loan by the
employee during the year or within 30 days of the end of the year.

14. While this treatment is very favourable for the employee, it does not appear to satisfy the tax policy
goal of fairness. Even when a stock option is not in-the-money, it clearly has value. This is based
on the fact that it allows the holder to participate in any appreciation in stock value without
investing any funds or being exposed to any downside risk. This means that, if no income inclusion
is recorded when stock options are issued to an employee, he is receiving a benefit that is not
subject to tax.

15. If the issuing corporation is a publicly traded Canadian company, the deduction is only available
when the option price is equal to or greater than the fair market value of the shares at the time the
options were issued.

If the issuing corporation is a Canadian controlled private corporation, the deduction is available if
the shares are held for two years, without regard to whether the option price was above or below the
fair market value of the shares at the time the options were issued. However, if the shares are not
held for two years, the availability of the deduction is subject to the same condition that is
applicable to public companies. That is, the option price must be equal to or greater than the fair
market value of the shares at the time they were issued.

16. ITA 8(1)(f) indicates that four conditions must be met before the deduction of expenses for
salespersons will be allowed. These are as follows:

1. The salesperson must be required by his employer to pay his own expenses. This must be
supported by form T2200 signed by the employer.

2. The salesperson must be ordinarily required to carry on his duties away from the employer’s
place of business.

3. The salesperson must not receive an expense allowance that is not included in income.

4. The salesperson must receive at least part of his remuneration in the form of commissions.

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ITA 8(1)(h) indicates that any employee can deduct travel expenses, with meals and entertainment
subject to the 50 percent limit, provided three conditions are met. These are as follows:

1. The person must be required by his employer to pay his own travel costs. This must be
supported by Form T2200 signed by the employer.

2. The person must be ordinarily required to carry on his duties away from the employer’s place
of business.

3. The person must not receive an allowance for travel costs that is not included in income.

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17. All employees who qualify to deduct work space in the home costs can deduct an appropriate
portion of:

 Maintenance or operating costs such as water and electricity

 Minor repairs

In those cases where the employee has commission income, he can also deduct an appropriate
portion of:

 Property taxes

 Insurance

Note that, under no circumstances, can an employee deduct CCA on the home, or any portion of
interest on a mortgage on the home.

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TIF Solution Three - 2

1. False. Employment income is the salary, wages, and other remuneration, including gratuities, that
are received by an individual during the year.

2. True.

3. False. Independent contractors have to make a double contribution to CPP.

4. True.

5. False. Such payments are a taxable benefit for employees.

6. True.

7. True.

8. True. Her taxable benefit from the loan is $200 for the year. Her use for only nine months is
irrelevant.

9. False. Her taxable benefit is $195 [(2%)(9/12)($10,000)] + [(2%)(3/12)($9,000)].

10. False. There would be no minimum standby charge as the company does not own the car.

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TIF Solution Three - 3

Employee vs. Self-Employed
1. B. How much work is performed at a particular site.

2. A. Veronica earns business income and Jonathon earns employment income. Veronica
will be able to deduct more expenses than Jonathon.

3. C intent, control test, ownership of tools test, opportunity for profit

Employee Benefits
4. C. $1,300 ($400 + $600 + $300)

5. A. Reimbursement of moving expenses.

6. B. Low rent housing.

7. C. A 20 percent discount on the employer’s merchandise is not considered a taxable

benefit unless the employee is permitted to purchase the item below the employer’s cost.

8. A. The allowance is not taxable to the employee.

9. A. In B, dental plan payments are not a taxable benefit. In C, subsidized meals in

employer’s facilities do not create a taxable benefit. In D, dental insurance is not a taxable
benefit.

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10. A. A dental plan plus a leased automobile that would be used only for personal travel by
the employee.

11. C. Employer reimbursement for the cost of tools required to perform work.

12. B. The Christmas gift is a near-cash gift.

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Automobile Benefits
13. D. If an employee drives an employer provided vehicle for more than 20,004 kilometers
of personal use during a year, there will be no reduction of the basic standby charge.

14. H. $3,240.

Standby charge = [(12)(2%)($20,000)(9,000/20,004)] = $2,160

Operating costs - Lesser Of:

[(9,000)($0.26)] = $2,340

[(1/2)($2,160)] = $1,080

Total of $2,160 and $1,080 = $3,240

15. C. $1,800.

Standby charge = [(2/3)(11)($500)(6,000/18,337)] = $1,200

Operating costs - Lesser Of:

[(6,000)($0.26)] = $1,560

[(1/2)($1,200)] = $600

Total of $1,200 and $600 = $1,800

16. J. $3,959.

Standby charge = [(10)(2%)($20,000)(11,000/16,670)] = $2,639

Operating costs - Lesser Of:

[(11,000)($0.26)] = $2,860

[(1/2)($2,639]) = $1,320

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Total of $2,639 and $1,320 = $3,959

17. A. $1,150.

Standby charge = [(2/3)(11)($500)(7,500/18,337)] = $1,500

Operating costs - Lesser Of:

[(7,500)($0.26)] = $1,950

[(1/2)($1,500)] = $750

Total of $1,500 and $750, less $1,100 = $1,150

18. C. The minimum taxable benefit that Mr. Brown must include in his employment income
for the use of this vehicle in 2018 is $3,401 [(2%)(12)($31,500)(9,000/20,004)], plus $1,701
[(1/2)($3,401)], a total of $5,102.

19. B. $960 [(2%)(12)($40,000)(2,000/20,004)].

20. C. Standby charge (employment related portion). Standby charge only applies when an
employee uses the employer’s automobile for personal use. It is an employment income
inclusion (not a deduction).

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Allowances And Reimbursements

21. C. Travel allowances provided by an employer are never included in an employee’s
income. If an allowance involved an unreasonable amount (i.e., amounts significantly in
excess of actual costs), some part of the allowance might be included in the employee’s
income.

22. B. $6,500 allowance for business use of employee’s automobile (10,000 km x $0.65).
“Reasonable allowance” is limited to $5,200 [(5,000 km x $0.55) + (5,000 km x $0.49)]

23. A. Housing loss reimbursement of $20,000. $2,500 of the housing loss reimbursement
would be a taxable benefit [$20,000 – 15,000) x 50%]

24. C. Reasonable vehicle allowances are not included in income.

Loans To Employees
25. B. If the proceeds from the loan are invested in income producing assets, the interest
benefit on the loan will be deductible in determining the employee’s Net Income For Tax
Purposes.

26. C. $670.68 {[$80,000][(61/365)(4% - 2%)  (184/365)(3% - 2%)]}.

27. C. $800 Tax cost of benefit of $300 [($50,000)(3% - 1%)(30%)] + interest paid of $500
[($50,000)(1%)] = $800

Employee Stock Options

28. B. If shares in a Canadian controlled private corporation are acquired through the
exercise of stock options, there will be a deduction equal to one-half of the employment income
inclusion, provided the shares were held for at least two years.

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29. C. An increase of $4,187.50. This would be calculated as follows:

Employment Income [($31.50 - $22.00)(500)] $4,750.00

Deduction Under ITA 110(1)(d) ( 2,375.00)

Taxable Capital Gain [($38.75 - $31.50)(500)(1/2)] 1,812.50

Net Addition To Taxable Income $4,187.50

30. B. The increase in Taxable Income is $3,000 [(1,000)($26 - $20) - (1/2)(1,000)($26 -

$20)] in the year of sale.

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31. D.

Employment Income [(10,000)($6 - $3)] $30,000

Deduction Under ITA 110(1)(d.1) ( 15,000)

Taxable Capital Gain [(10,000)($7 - $6)(1/2)] 5,000

Net Addition To Taxable Income $20,000

Since the Company is a Canadian controlled private corporation, this amount is taken into
income at the time the shares are disposed of. He is eligible for the stock option deduction,
even though the fair market value of the share was greater than the option price at the time of
issue, as the shares were held for at least two years.

32. C. The adjusted cost base of the shares is $60,000 ($6 per share).

33. D. An increase in employment income of $1,000 [($17 - $15)(500)]. No deduction is

available as the fair market value was greater than the option price when the options were
granted.

34. B. A taxable capital gain of $1,750 [($24 - $17)(500)(1/2)].

35. D. Increase in Net Income for Tax Purposes of $20,000; increase in Taxable Income of
$10,000. The exercise of options results in an increase in Net Employment Income of $20,000
[5,000 shares x ($79 - $75)], less the Division C deduction of $10,000 ($20,000 x 50%).

36. A. Increase in Net Income for Tax Purposes of $15,000; increase in Taxable Income of
$15,000. [ 5,000 shares x ($85 - $79) ] = $30,000 x 50% = $15,000

37. A. 100 x ($42 - $30) = $1,200 increase

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Employment Deductions
38. A. In order for an employee to deduct work space in the home costs it must be the place
where that individual principally carries on his employment duties.

39. C. $3,870 [($18,000 + $850) x 20%] + 100 = $3,870

40. D. $1,475 [($900 + 5,000) x 25%]

41. B. If John claims under ITA 8(1)(f) as a commission salesperson, the total eligible
expenses would be $16,000 (one-half of the client meals and entertainment of $14,000, plus 90
percent of the driving costs of $10,000). However, under this provision he would be limited to
his $5,000 in commission income. The alternative that would maximize his deduction would
be to use ITA 8(1)(h.1). While he could not deduct the client meals and entertainment costs
under this provision, his deduction would not be limited to his commission income. This
would allow a deduction of $9,000 (90 percent of the driving costs of $10,000).

42. D. Must receive all remuneration in commissions.

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TIF Solution Three - 4

Exam Exercise Solution Three - 1 (Bonus)
The bonus will be taxed in Ms. Connely’s hands in the year of receipt. This means that it will be
included in her 2019 tax return. With respect to Connely Ltd., the bonus is not payable until more than
180 days after the fiscal year end. As a consequence, Connely Ltd. will not be able to deduct the bonus
in the year ending August 31, 2018. It will be deducted in the year ending August 31, 2019.

Exam Exercise Solution Three - 2 (Bonus)

The bonus will be taxed in Mr. Gable’s hands in the year of receipt. This will be the taxation year
ending December 31, 2019. As it is paid within 180 days of Brock’s year end, the Company will be able
to deduct the bonus in the taxation year which ends on September 30, 2018. Note that the limit is 180
days from the fiscal year end, not the date on which the bonus was declared.

Exam Exercise Solution Three - 3 (GST On Taxable Benefits)

Mr. Lamarche’s taxable benefit would be $5,539, the $5,275 cost of the tickets, plus the additional $264
in GST.

Exam Exercise Solution Three - 4

(Taxable Benefits - Employer Owned Automobile)
Rounded to the nearest whole number, 268 days results in 9 months of availability. Further, Ms.
Nestor’s employment use is over 50 percent, entitling her to a reduction in the full standby charge.
Although she can use the alternative one-half of the standby charge calculation of the operating cost
benefit, she would not do so as it results in a higher benefit. Given these factors, the taxable benefit
would be calculated as follows:

Standby Charge [(2%)(9)($54,000 + $7,020)(5,000/15,003*)] $3,660

Operating Cost Benefit - Lesser Of:

 [($0.26)(5,000)] = $1,300

 [(1/2)($3,660)] = $1,830 1,300

Total Benefit $4,960

*[(9)(1,667)]

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Exam Exercise Solution Three - 5

(Taxable Benefits - Employer Owned Automobile)
As Mr. Rhodes’ employment related use is less than 50 percent of total usage, he must use the full
standby charge. In addition, he cannot use the alternative one-half of the standby charge calculation of
the operating cost benefit. Given this, the taxable benefit would be calculated as follows:

Standby Charge [(2%)(8)($63,000 + $3,150)] $10,584

Operating Cost Benefit [($0.26)(53,000 - 22,000)] 8,060

Total Benefit $18,644

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Exam Exercise Solution Three - 6

(Taxable Benefits - Employer Leased Automobile)
Rounded to the nearest whole number, 310 days results in 10 months of availability. As Mr. Warren’s
employment related use is more than 50 percent, he is eligible for a reduction in the full standby charge.
He is also eligible for the alternative one-half of the standby charge calculation of the operating cost
benefit. Given these factors, the taxable benefit would be calculated as follows:

Standby Charge [(2/3)($791)(10)(16,670*  16,670*)]$5,273

Operating Cost Benefit - Lesser Of:

 [($0.26)(18,000)] = $4,680

 [(1/2)($5,273)] = $2,637 2,637

Total Benefit $7,910

*[(10)(1,667)] - the numerator cannot exceed the denominator

Exam Exercise Solution Three - 7

(Taxable Benefits - Employer Leased Automobile)
As Ms. Wexler’s employment related usage is more than 50 percent, she is eligible for a reduction in the
basic standby charge. She is also eligible for the alternative one-half of the standby charge calculation
of the operating cost benefit. Given these factors, the taxable benefit would be calculated as follows:

Standby Charge

[(2/3)($728 - $50)(10)(16,670*  16,670*)] $4,520

Operating Cost Benefit - Lesser Of:

 [($0.26)(23,000)] = $5,980

 [(1/2)($4,520)] = $2,260 2,260

Total Benefit $6,780

*[(10)(1,667)] - the numerator cannot exceed the denominator

Exam Exercise Solution Three - 8 (Deductible Automobile Costs)

As the car allowance is not based on kilometers, Mr. Jackson will have to include the $4,200 allowance
that was received from his employer in his employment income. He can deduct the employment related
portion of his actual automobile costs against this amount. This would be $2,630 [($8,623)(8,150 ÷
26,720)]. The net inclusion would be $1,570 ($4,200 - $2,630).

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Exam Exercise Solution Three - 9 (Deductible Automobile Costs)

As the $6,500 allowance is not based on kilometers driven, it must be included in her income. As the
allowance is included in income, she can deduct a proportionate share of her automobile costs. This
amount would $5,345 [($12,472)(18,000 ÷ 42,000)]. Her net inclusion will be $1,155 ($6,500 - $5,345).

Exam Exercise Solution Three - 10 (Disability Insurance Benefits)

As her employer contributes to the plan, and the contributions do not create a taxable benefit, the $6,940
in benefits received during the year will be included in her employment income. This will be reduced
by the $574 ($324 + $250) in non-deductible contributions that she made during 2017 and 2018, leaving
a net inclusion of $6,366 ($6,940 - $574).

Exam Exercise Solution Three - 11 (Disability Insurance Benefits)

Because his employer contributes to the group disability plan, and the contributions do not create a
taxable benefit, the $24,000 in benefits that he receives during 2018 will be included in his income.
However, this amount will be offset by the $16,000 of contributions that he made in previous years,
leaving a net inclusion of $8,000 ($24,000 - $16,000).

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Exam Exercise Solution Three - 12 (Employee Housing Loan Benefits)

The ITA 80.4(1) benefit is calculated as follows:

The Lesser Of:

 [($135,000)(5%)(1/4) + ($135,000)(6%)(1/4)

+ ($135,000)(4%)(2/4)] = $6,413

 [($135,000)(5%)] = $6,750 $6,413

Less Interest Payment [($135,000)(3.1%)] ( 4,185)

Net Benefit $2,228

As this is a home purchase loan, the annual benefit cannot exceed the benefit that would result from
applying the 5 percent rate that was in effect when the loan was made. Note that the 5 percent rate is not
compared to the prescribed rate on a quarter-by-quarter basis, but on an annual basis. The lower figure
of $6,413 would then be reduced by the $4,185 in interest paid.

Exam Exercise Solution Three - 13 (Employee Housing Loan Benefits)

The ITA 80.4(1) benefit is calculated as follows:

The Lesser Of:

 [($210,000)(4%)(2/12) + ($210,000)(3%)(1/4)

+ ($210,000)(2%)(1/4)] = $4,025

 [($210,000)(4%)(8/12)] = $5,600 $4,025

Interest Payments Nil

Net Benefit $4,025

Exam Exercise Solution Three - 14 (Tax Planning - Loan Benefits)

In the absence of the interest free loan, the employee would borrow $240,000 at 5 percent, requiring an
annual interest payment of $12,000. The after tax cash outflow associated with the employer providing
sufficient additional salary to carry this loan would be calculated as follows:

Required Salary [$12,000 ÷ (1 - 0.44)] $21,429

Corporate Tax Savings From Deducting Salary

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[($21,429)(28%)] ( 6,000)

Employer’s After Tax Cash Flow - Additional Salary $15,429

Alternatively, if the loan is provided, the employee will have a taxable benefit of $7,200 [(3%)
($240,000)], resulting in taxes payable of $3,168 [(44%)($7,200)]. To make this situation comparable to
the straight salary alternative, the employer will have to provide the employee with both the loan amount
and sufficient additional salary to pay the taxes on the imputed interest benefit. The amount of this
additional salary would be $5,657 [$3,168 ÷ (1 - 0.44)]. The employer’s after tax cash flow associated
with providing the additional salary and the loan amount would be calculated as follows:

Required Salary [$3,168 ÷ (1 - 0.44)] $ 5,657

Corporate Tax Savings From Deducting Salary

[($5,657)(28%)] ( 1,584)

After Tax Cost Of Salary $ 4,073

Employer’s Lost Earnings [(8.2%)(1 - 0.28)($240,000)] 14,170

Employer’s After Tax Cash Flow - Loan $18,243

Given these results, providing the additional salary appears to be the better alternative.

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Exam Exercise Solution Three - 15 (Tax Planning - Loan Benefits)

In the absence of the interest free loan, John would have to borrow $350,000 at 4.5 percent, resulting in
an annual interest cost of $15,750 [(4.5%)($350,000)]. In order to pay this after tax amount, John would
need additional salary of $29,167 [($15,750 ÷ (1 - 0.46)]. The after tax cash outflow of providing this
salary is calculated as follows:

Additional Salary [($15,750 ÷ (1 - 0.46)] $29,167

Corporate Tax Savings [($29,167)(26%)] ( 7,583)

Employer’s After Tax Cash Flow - Additional Salary $21,584

If the loan is provided, John will have a taxable benefit of $7,000 [($350,000)(2%)], resulting in Tax
Payable of $3,220 [($7,000)(46%)]. In order to pay these taxes, John will need additional salary of
$5,963 [$3,220 ÷ (1 - 0.46)]. For Stern, the after tax cash outflows associated with this additional salary
and the loan would be calculated as follows:

Additional Salary [$3,220 ÷ (1 - 0.46)] $ 5,963

Corporate Tax Savings [($5,963)(26%)] ( 1,550)

After Tax Cost Of Salary $ 4,413

Employer’s Lost Earnings [(7%)(1 - 0.26)($350,000)] 18,130

Employer’s After Tax Cash Flow - Loan $22,543

Based on these results, the payment of additional salary appears to be the better alternative.

Exam Exercise Solution Three - 16 (Stock Options - Public Company)

The employment income inclusion is $22,000 [(1,000)($45 - $23)]. There would also be a deduction
under ITA 110(1)(d) equal to $11,000. However, this does not affect net employment income.

Exam Exercise Solution Three - 17 (Stock Options - CCPC)

For options to buy shares of a Canadian controlled private corporation, no employment income benefit is
included until the shares are sold. As a result, the exercise of the stock options does not affect her
employment income for 2018.

Exam Exercise Solution Three - 18 (Stock Options - Public Company)

The increase in Net Income For Tax Purposes and Taxable Income resulting from the exercise of the
options in 2017 would be calculated as follows:

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Fair Market Value At Exercise [(4,000)($82)] $328,000

Cost of Shares [(4,000)($54)] ( 216,000)

Employment Income Inclusion =

Increase In Net Income For Tax Purposes $112,000

Deduction Under ITA 110(1)(d) [(1/2)($112,000)] ( 56,000)

Increase In Taxable Income $ 56,000

When the shares are sold in 2018, the results will be as follows:

Proceeds Of Disposition [(4,000)($97)] $388,000

Adjusted Cost Base [(4,000)($82)] ( 328,000)

Capital Gain $ 60,000

Inclusion Rate 1/2

Taxable Capital Gain $ 30,000

This $30,000 taxable capital gain will be both the increase in Net Income For Tax Purposes and the
increase in Taxable Income.

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Exam Exercise Solution Three - 19 (Stock Options - CCPC)

As Mr. Savage’s employer is a Canadian controlled private corporation, the exercise of the options has
no effect on his Taxable Income in 2017.
When the shares are sold in 2018, the total increase in Net Income For Tax Purposes and Taxable
Income is calculated as follows:

Fair Market Value At Exercise [(4,000)($82)] $328,000

Cost of Shares [(4,000)($54)] ( 216,000)

Employment Income Inclusion $112,000

Proceeds Of Disposition [(4,000)($97)] $388,000

Adjusted Cost Base [(4,000)($82)] ( 328,000)

Capital Gain $ 60,000

Inclusion Rate 1/2 30,000

Increase In Net Income For Tax Purposes $142,000

Deduction Under ITA 110(1)(d) [(1/2)($112,000)] ( 56,000)

Deduction Under ITA 110(1)(d.1) N/A

Increase In Taxable Income $ 86,000

As the option price was greater than the fair market value of the shares at the time of issue, he is allowed
the deduction under ITA 110(1)(d). If this had not been the case, although Mr. Savage’s employer is a
Canadian controlled private company, he would not have been able to make this deduction under ITA
110(1)(d.1) as he did not hold the shares for the required two years.

Exam Exercise Solution Three - 20 (Stock Options - Public Company)

The effect of these transactions would be calculated as follows:

Employment Income [(1,000)($18.50 - $13.25)] $5,250

Taxable Capital Gain [(1/2)(1,000)($19.75 - $18.50)] 625

Increase In Net Income For Tax Purposes $5,875

Deduction Under ITA 110(1)(d) [(1/2)($5,250)] ( 2,625)

Increase In Taxable Income $3,250

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Exam Exercise Solution Three - 21 (Stock Options - Public Company)

The granting of the options in 2016 does not affect either Net Income For Tax Purposes or Taxable
Income.

As a public company is involved, the exercise of the options in 2017 will have the following tax
consequences:

Fair Market Value At Exercise [(2,200)($15)] $33,000

Cost Of Shares [(2,200)($10.50)] ( 23,100)

Employment Income Inclusion

(Increase In Net Income For Tax Purposes) $ 9,900

Deduction Under ITA 110(1)(d) [(1/2)($9,900)] ( 4,950)

Increase In Taxable Income $ 4,950

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When the shares are sold in 2018, the tax consequences are as follows:

Proceeds Of Disposition [(1,000)($13)] $13,000

Adjusted Cost Base [(1,000)($15)] ( 15,000)

Capital Loss ($ 2,000)

Inclusion Rate 1/2

Allowable Capital Loss ($ 1,000)

This loss can only be deducted in the determination of Net Income For Tax Purposes to the extent that
Ms. Smithers has taxable capital gains during 2018.

Note to Instructor: Depending on what has been covered in your course, students may or may
not be expected to comment on the ability to carry the capital loss back or forward as follows:

If she has taxable capital gains in the previous 3 years or any year in the future, the loss could
be carried back or carried forward and deducted in the determination of Taxable Income.

Exam Exercise Solution Three - 22 (Stock Options - CCPC)

The granting of the options in 2016 does not affect either Net Income For Tax Purposes or Taxable
Income.
As a CCPC is involved, the exercise of the options does not affect either Net Income For Tax Purposes
or Taxable Income. However, the employment income inclusion for all 625 shares is measured in this
year (see 2018 results)
When 125 of the 625 shares are sold in 2018, the tax consequences are as follows:

Deferred Employment Income:

Fair Market Value At Exercise [(125)($95)] $11,875

Cost Of Shares [(125)($92)] ( 11,500)

Employment Income Inclusion

(Increase In Net Income For Tax Purposes) $ 375

Deduction Under ITA 110(1)(d) [(1/2)($375)] ( 188)

Increase In Taxable Income $ 187

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There is also an allowable capital loss, calculated as follows:

Proceeds Of Disposition [(125)($85)] $10,625

Adjusted Cost Base [(125)($95)] ( 11,875)

Capital Loss ($ 1,250)

Inclusion Rate 1/2

Allowable Capital Loss ($ 625)

This loss can only be deducted in the determination of Net Income For Tax Purposes to the extent that
Mr. Fallow has taxable capital gains during 2018.

Note to Instructor: Depending on what has been covered in your course, students may or may
not be expected to comment on the ability to carry the capital loss back or forward as follows:

If he has taxable capital gains in the previous 3 years or any year in the future, the loss could be
carried back or carried forward and deducted in the determination of Taxable Income.

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Exam Exercise Solution Three - 23 (Commission Salesperson Expenses)

Her potential deduction is $19,900 [$6,150 + (1/2)($8,850) + $9,325]. However, this total exceeds her
commission income and cannot be deducted under ITA 8(1)(f). If she deducts under ITA 8(1)(h) there
is no limit on this total. The problem here is that she cannot deduct the advertising or entertainment
costs under this Paragraph. Further, she cannot make any deduction under ITA 8(1)(h) if she makes any
deduction under ITA 8(1)(f).
As the travel costs that are deductible under ITA 8(1)(h) exceed the ITA 8(1)(f) ceiling of $9,200 in
commission income, her maximum deduction is the $9,325 in travel costs under ITA 8(1)(h).

Exam Exercise Solution Three - 24 (Commission Salesperson Expenses)

Mr. Ho’s total potential deductions are $31,500 [$12,200 + (1/2)($6,400) + $16,100]. However, this
total exceeds his commission income and cannot be deducted under ITA 8(1)(f). While he cannot
deduct the advertising or entertainment under ITA 8(1)(h), the travel costs can be deducted without
limit. As these costs exceed Mr. Ho’s commission income, his maximum deduction is the $16,100 in
travel costs that can be deducted under ITA 8(1)(h).

Exam Exercise Solution Three - 25 (Employment Income Expenses)

As Doug Evans receives a portion of his income in the form of commissions, all of the $11,250 in listed
expenses are potentially deductible under ITA 8(1)(f) (advertising and travel) and 8(1)(j) (CCA and
interest on van). However, if he makes the deduction under ITA 8(1)(f), his expenses other than CCA
and interest on the car, are limited to $6,250, the amount of his commission income. As a result, he can
deduct $8,750 ($6,250 + $1,875 + $625).
Alternatively, he can deduct all of the expenses except the advertising and promotion costs under ITA
8(1)(h) and (h.1). As these deductions are not limited by commissions or total employment income, he
will be able to deduct a total of $10,000 ($7,500 + $1,875 + $625). Note that, if he uses ITA 8(1)(h) and
ITA 8(1)(h.1), he cannot use ITA 8(1)(f) to deduct the advertising and promotion costs of $1,250.
Therefore, his maximum deduction is $10,000 and his minimum net employment income is $57,500
($67,500 - $10,000).

Exam Exercise Solution Three - 26 (Employment Income Expenses)

As Ms. Ekart receives some of her employment income in the form of commissions, all of the $22,425
in listed expenses is potentially deductible under ITA 8(1)(f) (travel, promotion, and entertainment) and
8(1)(j) (CCA and interest on car). However, under ITA 8(1)(f), all of the expenses other than the CCA
and interest on the car are limited to her commission income of $8,400. This would result in a
maximum deduction under ITA 8(1)(f) of $12,325 ($8,400 + $2,850 + $1,075).
Alternatively, under ITA 8(1)(h) and ITA 8(1)(h.1), she can deduct the traveling expenses, but not the
promotion, advertising and entertainment. However, when the traveling expenses are added to the car
costs that are deductible under ITA 8(1)(j), her total deduction would be $14,225 ($10,300 + $2,850 +
$1,075). Using this would produce a minimum net employment income calculated as follows:

Salary $85,000

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Commissions 8,400

Deductible Expenses ($10,300 + $2,850 + $1,075) ( 14,225)

Net Employment Income $79,175

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TIF Solution Three - 5A

The correct definitions for each of the listed key terms are as follows:

A. 9

B. 5

C. 1

D. 6

E. 7

F. 3

G. 8

H. 10

The two unused definitions are as follows:

Standby Charge = 2

Taxable Allowance = 4

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TIF Solution Three - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.

The correct definitions for each of the listed key terms are as follows:

A. 11

B. 7

C. 1

D. 8

E. 9 (not 12)

F. 5 (not 14)

G. 10 (not 3)

H. 13 (not 4)

The two unused definitions are as follows:

Standby Charge = 2

Taxable Allowance = 6

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 TIF Solution One - 4

TIF Solution Three - 6

Case A
The company will deduct the bonus in the year ending August 31, 2018. Christine will include it in
income in the calendar year ending December 31, 2018.

Case B
In this case, the bonus is paid within 180 days of the company’s July 31, 2018 year end. Given this, the
company will be able to deduct the bonus in that year. However, Christine will not have to include it in
income until the calendar year ending December 31, 2019.

Case C
In this case, the bonus is not paid within 180 days of the company’s December 31, 2018 year end. This
means that the company will not be able to deduct the bonus until the taxation year ending December
31, 2019. Christine will include the bonus in income in the calendar year ending December 31, 2019.

Case D
As the bonus is not paid within three years of the end of the year in which the services were rendered,
this is a salary deferral arrangement. The company will deduct the bonus in the fiscal year ending
September 30, 2019. However, as it was earned in 2018, Christine will have to include the bonus in the
calendar year ending December 31, 2018.

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TIF Solution Three - 7

Option 1 - Employer Continues To Provide Automobile
If the employer continues to provide the car, Jason’s only cash outflow will be the taxes assessed on the
taxable benefit that results from his having the car available. This outflow under the two options would
be calculated as follows:

Case A Case B

$40,000 Cost $75,000 Cost

Standby Charge

[(2%)($40,000)(12)] $ 9,600

[(2%)($75,000)(12)] $18,000

Operating Cost Benefit [(50,000 Kilometers)($0.26)]13,000 13,000

Total Annual Benefit $22,600 $31,000

Number Of Years 2 2

Total Benefit $45,200 $62,000

John’s Marginal Tax Rate 46% 46%

Total Taxes On Taxable Benefit (Cash Outflow) $20,792 $28,520

Note that, because Jason’s use of the car is not primarily (more than 50 percent) for employment
purposes, he cannot use the alternative one-half of standby charge calculation of the operating cost
benefit.

Option 2 - Jason Purchases The Automobile

If Jason purchases the car and pays his own operating costs, the total cash outflow under both cases
would be calculated as follows:

Purchase Price $30,000

Estimated Resale Value ( 17,000)

Operating Costs [(2)(50,000 Kilometers)($0.20)] 20,000

Total Cash Outflow $33,000

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Conclusion - Case A ($40,000 Cost)

On the basis of non-discounted cash flows, the best alternative would be to have Jason’s employer
continue to provide him with the car. If the cash flows were discounted, the results would be even more
favourable for this alternative.

Conclusion - Case B ($75,000 Cost)

Despite the original cost of the car being $75,000, on the basis of non-discounted cash flows, the best
alternative would be to have Jason’s employer continue to provide him with the car.
Although the requirements of the problem ask that only the cash flows be considered, we would note
that the alternative of purchasing the car carries more uncertainty. Both the resale value and the actual
operating costs are estimates. If there was a large variation from the estimate for either or both of these
amounts, it could substantially affect the total cash outflow of the purchase alternative.

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TIF Solution Three - 8

Mr. Joseph Martin The taxable benefit to be allocated to the president of the Company would be
calculated as follows:

Standby Charge [(2/3)(7)($2,100)] $ 9,800

Operating Cost Benefit [(23,000)($0.26)] 5,980

Total Benefit $15,780

As less than 50 percent of Mr. Martin’s kilometers were employment related, he cannot reduce the
standby charge or use the alternative calculation of the operating cost benefit, based on one-half of the
standby charge, even if it was more advantageous.

Mrs. Grace Martin The taxable benefit to be allocated to the marketing vice president would be
calculated as follows:

Standby Charge [(2%)($78,000)(12)(2,000/20,004*)] $1,872

Operating Cost Benefit - Lesser Of:

 [(2,000)($0.26)] = $520

 [(1/2)($1,872)] = $936 520

Total Benefit $2,392

*[(12)(1,667)]

As more than 50 percent of Mrs. Martin’s driving was employment related, there is a reduction in the
standby charge to reflect her limited personal use of the vehicle. While Mrs. Martin would qualify for
the alternative calculation of the operating cost benefit, it would produce a larger taxable benefit in this
situation.

Mr. William Martin The taxable benefit to be allocated to the vice president of finance would be
calculated as follows:

Standby Charge [(2/3)(12)($600)] $ 4,800

Operating Cost Benefit [(32,000)($0.26)] 8,320

Reimbursement [(12)($300)] ( 3,600)

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Total Benefit $ 9,520

As less than 50 percent of the kilometers are employment related, there is no reduction in the standby
charge. In addition, the alternative calculation of the operating cost benefit cannot be used.

Mrs. Sharon Martin-Jones The taxable benefit that would be allocated to the industrial relations vice
president would be calculated as follows:

Standby Charge [(2%)($39,000)(9)(9,500/15,003*)] $4,445

Operating Cost Benefit - Lesser Of:

 [(9,500)($0.26)] = $2,470

 [(1/2)($4,445)] = $2,223 2,223

Total Benefit $6,668

*[(9)(1,667)]

As more than 50 percent of the use was employment related, there is a reduction in the standby charge.
As the car was driven more than 50 percent for employment related purposes, Mrs. Martin-Jones can
calculate the operating cost benefit as one-half of the standby charge which results in a lower benefit.

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TIF Solution Three - 9

Case A
In this Case, the taxable benefit would be calculated as follows:

Standby Charge [(2%)($42,000)(11)(4,000/18,337*)] $2,016

Operating Cost Benefit - Lesser Of:

 [(4,000)($0.26)] = $1,040

 [(1/2)($2,016)] = $1,008 1,008

Total Benefit $3,024

*[(11)(1,667)]

As Ms. Smith’s usage is more than 50 percent employment related, she can use the reduced standby
charge calculation. In addition, she can use one-half the standby charge as her operating cost benefit.

Case B
In this Case, the taxable benefit would be calculated as follows:

Standby Charge [(2%)($42,000)(10)(16,670*/16,670*)] $ 8,400

Operating Cost Benefit - Lesser Of:

 [(23,000)($0.26)] = $5,980

 [(1/2)($8,400)] = $4,200 4,200

Total Benefit $12,600

*[(10)(1,667)]

As Ms. Smith’s usage is more than 50 percent employment related, she can use the reduced standby
charge calculation. In addition, she can use one-half the standby charge as her operating cost benefit.

Case C
In this Case, the taxable benefit would be calculated as follows:
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Standby Charge [(2%)($42,000)(8)] $ 6,720

Operating Cost Benefit [(44,000)($0.26)] 11,440

Total Benefit $18,160

As Ms. Smith’s employment usage was less than 50 percent, there is no reduction in the basic standby
charge. This also means that Ms. Smith cannot elect to use the alterative calculation of the operating
costs benefit as one-half of the standby charge.

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TIF Solution Three - 10

Part A
The first year tax consequences for Fred would be that he would be assessed a taxable benefit on the
loan of $7,000 [(2%)($350,000)] for the current year. This would result in an increase in his Tax
Payable of $3,430 [(49%)($7,000)].
The cost of the loan to the company for the first year would be calculated as follows:

Lost Earnings On Funds Loaned [(10%)($350,000)] $35,000

Corporate Taxes On Imputed Earnings (At 29 Percent) ( 10,150)

Net Cost To Company - Loan $24,850

This will result in Fred having the use of $350,000 at a tax cost to himself of $3,430 and an annual cost
of $24,850 to the Company.

Part B
If instead of giving Fred the $350,000, the Company pays him the potentially lost annual earnings of
$35,000, the after tax cost to the Company will be the same, as shown in the following calculation:

Additional Salary $35,000

Savings In Corporate Taxes (At 29 Percent) ( 10,150)

Net Cost To Company - Additional Salary $24,850

Part C
Fred can borrow on a loan at a rate of interest of 4.75 percent. This means that the annual interest
payments on $350,000 would amount to $16,625 [(4.75%)($350,000)].
If he receives the additional salary, his after tax income would be as follows:

Additional Salary $35,000

Tax Payable (At 49 Percent) ( 17,150)

Net Increase In Cash $ 17,850

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Fred should accept the additional salary of $35,000 per year as it results in an annual cash inflow of
$1,225 ($35,000 - $17,150 - $16,625) after paying the tax and the mortgage interest. This compares to a
cash outflow of $3,430 if the company extends the loan to Fred.

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TIF Solution Three - 11

Part A
Mr. Lee would be assessed a taxable benefit on the loan of $10,000 [(2%)($500,000)] for the current
year. However, under ITA 80.5, this would be deemed interest paid. As he is using the funds provided
to produce income, the full amount would be deductible, resulting in no net change in his taxes.
The cost of the loan to the company for the first year would be calculated as follows:

Lost Earnings On Funds Loaned [(9%)($500,000)] $45,000

Corporate Taxes On Imputed Earnings (At 27 Percent) ( 12,150)

Net Cost To Company - Loan $32,850

This will result in Mr. Lee having the use of $500,000 at no tax cost to himself and an annual cost of
$32,850 to the Company.

Part B
If instead of giving Mr. Lee the $500,000, the Company pays him the potentially lost annual earnings of
$45,000, the after tax cost to the Company will be the same, as shown in the following calculation:

Additional Salary $45,000

Savings In Corporate Taxes (At 27 Percent) ( 12,150)

Net Cost To Company - Additional Salary $32,850

Part C
Mr. Lee can borrow on a loan at a rate of interest of 6 percent. This means that the annual interest
payments on $500,000 would amount to $30,000 and would be deductible.
If he receives the additional salary, his after tax income would be as follows:

Additional Salary $45,000

Deductible Interest On Investment Loan ( 30,000)

Increase In Net Income For Tax Purposes $15,000

Tax Payable (At 46 Percent) ( 6,900)

Net Increase In Cash $ 8,100

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Mr. Lee should accept the additional salary of $45,000 per year as it results in an annual cash increase of
$8,100.

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TIF Solution Three - 12

Case A
The required information under the assumption that Opting Inc. is a Canadian controlled private
corporation is as follows:

 Year of granting and year of exercise - No tax effect.

 Year of sale - As the option price was less than the fair market value of the shares at the time the
options were granted, no deduction is available under ITA 110(1)(d). However, Sandra held the
shares for more than two years after their acquisition and, as a consequence, she can claim a
deduction against employment income under ITA 110(1)(d.1). The tax effects would be as follows:

Fair Market Value Of Acquired Shares [($17.50)(275)] $4,812.50

Cost Of Acquired Shares [($15.00)(275)] ( 4,125.00)

Employment Income $ 687.50

Taxable Capital Gain [(275)($20.25 - $17.50)(1/2)] 378.13

Increase In Net Income For Tax Purposes $1,065.63

Deduction Under ITA 110(1)(d) Nil

Deduction Under ITA 110(1)(d.1) [(1/2)($687.50)] ( 343.75)

Increase In Taxable Income $ 721.88

Case B
The required information under the assumption that Opting Inc. is a Canadian public company is as
follows:

 Year of granting - No tax effect.

 Year of exercise - As the option price was less than the fair market value of the shares at the time
the options were issued, the ITA 110(1)(d) deduction from Taxable Income is not available. As
Opting is a public company, no deduction is available under ITA 110(1)(d.1). The tax effects
would be as follows:

Fair Market Value Of Acquired Shares [($17.50)(275)] $4,812.50

Cost Of Acquired Shares [($15.00)(275)] ( 4,125.00)

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Employment Income And

Increase In Net Income For Tax Purposes $ 687.50

Deduction Under ITA 110(1)(d) Nil

Increase In Net Income And Taxable Income $ 687.50

 Year of sale - There would an allowable capital loss calculated as follows:

Proceeds Of Disposition [(275)($16.00)] $4,400.00

Adjusted Cost Base [(275)($17.50)] ( 4,812.50)

Capital Loss $ 412.50

Inclusion Rate 1/2

Allowable Capital Loss ($ 206.25)

The effect on Net Income For Tax Purposes and Taxable Income would be nil.

Note to Instructor: Depending on what has been covered in your course, students may or may
not be expected to comment on the ability to carry the capital loss back or forward as follows:

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If she has taxable capital gains in the previous 3 years or any year in the future, the loss could
be carried back or carried forward and deducted in the determination of Taxable Income.

Case C
The required information under the assumption that Opting Inc. is a Canadian public company is as
follows:

 Year of granting - No tax effect.

 Year of exercise - The results for this year would be as follows:

Fair Market Value Of Acquired Shares [($17.50)(275)] $4,812.50

Cost Of Acquired Shares [($15.00)(275)] ( 4,125.00)

Employment Income And

Increase In Net Income For Tax Purposes $ 687.50

Deduction Under ITA 110(1)(d) [(1/2)($687.50)] ( 343.75)

Increase In Taxable Income $ 343.75

As the option price was greater than the fair market value of the shares at the time the options
were issued, the ITA 110(1)(d) deduction can be taken.

 Year of sale - There would an allowable capital loss calculated as follows:

Proceeds Of Disposition [(275)($19.75)] $5,431.25

Adjusted Cost Base [(275)($17.50)] ( 4,812.50)

Capital Gain $ 618.75

Inclusion Rate 1/2

Taxable Capital Gain $ 309.38

This would be both the increase in Net Income For Tax Purposes and the increase in Taxable
Income for the year.

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Case D
The required information under the assumption that Opting Inc. is a Canadian controlled private
corporation is as follows:

 Year of granting - No tax effect.

 Year of exercise - No tax effect.

 Year of sale - The tax effects would be as follows:

Fair Market Value Of Acquired Shares [($17.50)(275)] $4,812.50

Cost Of Acquired Shares [($15.00)(275)] ( 4,125.00)

Employment Income $ 687.50

Taxable Capital Gain [(275)($21.50 - $17.50)(1/2)] 550.00

Increase In Net Income For Tax Purposes $1,237.50

Deduction Under ITA 110(1)(d) [(1/2)($687.50)] ( 343.75)

Increase In Taxable Income $ 893.75

As the option price was greater than the fair market value of the shares at the time the options
were issued, the ITA 110(1)(d) deduction can be taken.

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TIF Solution Three - 13

Case A
The required information under the assumption that Lastech Inc. is a Canadian public company is as
follows:

 Year of granting - No tax effect.

 Year of exercise - The results for this year would be as follows:

Fair Market Value Of Acquired Shares [($25)(1,500)] $37,500

Cost Of Acquired Shares [($23)(1,500)] ( 34,500)

Employment Income And

Increase In Net Income For Tax Purposes $3,000

Deduction Under ITA 110(1)(d) [(1/2)($3,000)] ( 1,500)

Increase In Taxable Income $1,500

As the option price was greater than the fair market value of the shares at the time the options
were issued, the ITA 110(1)(d) deduction can be taken.

 Year of sale - The tax effects would be as follows:

Proceeds Of Disposition [(1,500)($28)] $42,000

Adjusted Cost Base [(1,500)($25)] ( 37,500)

Capital Gain $ 4,500

Inclusion Rate 1/2

Taxable Capital Gain $ 2,250

This $2,250 would be both the increase in Net Income For Tax Purposes and the increase in
Taxable Income for the year.

Case B
The required information under the assumption that Lastech Inc. is a Canadian public company is as
follows:

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 Year of granting - No tax effect.

 Year of exercise - As the option price was less than the fair market value of the shares at the time
the options were issued, the ITA 110(1)(d) deduction from Taxable Income is not available. The
tax effects would be as follows:

Fair Market Value Of Acquired Shares [($25)(1,500)] $37,500

Cost Of Acquired Shares [($23)(1,500)] ( 34,500)

Employment Income And

Increase In Net Income For Tax Purposes $ 3,000

Deduction Under ITA 110(1)(d) Nil

Increase In Net Income And Taxable Income $ 3,000

 Year of sale - The tax effects would be as follows:

Proceeds Of Disposition [(1,500)($28)] $42,000

Adjusted Cost Base [(1,500)($25)] ( 37,500)

Capital Gain $ 4,500

Inclusion Rate 1/2

Taxable Capital Gain $ 2,250

This $2,250 would be both the increase in Net Income For Tax Purposes and the increase in
Taxable Income for the year.

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Case C
The required information under the assumption that Lastech Inc. is a Canadian controlled private
corporation is as follows:

 Year of granting - No tax effect.

 Year of exercise - No tax effect.

 Year of sale - The tax effects would be as follows:

Fair Market Value Of Acquired Shares [($25)(1,500)] $37,500

Cost Of Acquired Shares [($23)(1,500)] ( 34,500)

Employment Income $ 3,000

Taxable Capital Gain [(1,500)($28 - $25)(1/2)] 2,250

Increase In Net Income For Tax Purposes $ 5,250

Deduction Under ITA 110(1)(d) [(1/2)($3,000)] ( 1,500)

Increase In Taxable Income $ 3,750

Case D
The required information under the assumption that Lastech Inc. is a Canadian controlled private
corporation is as follows:

 Year of granting and exercise - No tax effect.

 Year of sale - As the option price was less than the fair market value of the shares at the time the
options were granted, no deduction is available under ITA 110(1)(d). However, Ms. Black held the
shares for more than two years after their acquisition and, as a consequence, she can claim a
deduction against employment income under ITA 110(1)(d.1). The tax effects would be as follows:

Fair Market Value Of Acquired Shares [($25)(1,500)] $37,500

Cost Of Acquired Shares [($23)(1,500)] ( 34,500)

Employment Income $ 3,000

Taxable Capital Gain [(1,500)($28 - $25)(1/2)] 2,250

Increase In Net Income For Tax Purposes $5,250

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Deduction Under ITA 110(1)(d) Nil

Deduction Under ITA 110(1)(d.1) [(1/2)($3,000)] ( 1,500)

Increase In Taxable Income $3,750

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TIF Solution Three - 14

Part A
The calculations for net employment income would be as follows Offer One
Offer Two

Salary $225,000 $175,000

Commissions Nil 85,000

Hotel, Meal, And Airline Allowance (Note One) Nil N/A

Hotel, Meal, And Airline Reimbursement (Note Two) N/A N/A

Automobile Benefit (Note Three) 7,439 N/A

Automobile Allowance [(12)($1,500)] N/A 18,000

Automobile Costs [(37,000/53,000)($16,900)] N/A ( 11,798)

Loan Benefit [(2%)($200,000)] 4,000 N/A

Disability Insurance Benefit (Note Four) Nil Nil

Life Insurance Benefits (Note Four) 3,800 3,800

Advertising Expense (Note Five) Nil ( 23,000)

Net Employment Income $240,239 $247,002

Note One The $30,000 per year allowance is considered reasonable and, as a consequence, it does
not have to be included in income. In addition, it exceeds the actual costs of $26,500 ($18,000 +
$8,500). This means it would not be good tax planning to include the allowance and deduct the
actual costs.

Note Two Reimbursements have no effect on employment income. They are neither deducted nor
included in the determination of Net Employment Income.

Note Three The taxable benefit associated with the automobile provided under Offer One would
be calculated as follows:

Standby Charge [(2/3)($850 - $75)(12)(16,000 ÷ 20,004*)] $4,959

Operating Cost Benefit - Lesser Of:

[(16,000)($0.26)] = $4,160

[(1/2)($4,959)] = $2,480 2,480

Total Benefit $7,439

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* [(12)(1,667)]

Note Four The payment of disability insurance premiums by an employer does not create a taxable
benefit for employees if the plan provides periodic benefits that compensate for lost employment
income. However, the payment of life insurance premiums does create a taxable benefit.

Note Five As Ms. Arden does not receive any commissions under Offer One, she cannot deduct her
advertising costs. She can deduct the full amount under Offer Two as the $23,000 total is less than
her commissions of $85,000.

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Part B
The actual amount of annual cash to be received from the employer under the two offers would be
calculated as follows:

Offer One Offer Two

Salary $225,000 $175,000

Commissions - Estimated Nil 85,000

Hotel, Meal, And Airline Allowance 30,000 N/A

Reimbursements N/A 26,500

Automobile Allowance N/A 18,000

Total Cash $255,000 $304,500

The fact that Offer Two has significantly higher cash flows and a higher net employment income
suggests that Offer Two is preferable. A major factor in this result is that the absence of commissions in
Offer One results in the $23,000 in advertising and promotion expenses not being deductible. This
could easily be fixed at no cost to the employer by having an appropriate amount of the $30,000
allowance treated as a reimbursement of advertising and promotion expenses. This would leave the
unreimbursed hotel, meal, and airline costs which could be deducted by Ms. Arden without the presence
of commission income.
In addition, other factors that have not been considered in this simple analysis include:

 Offer One includes the provision of an automobile while Offer Two does not. This means that,
under Offer One, Ms. Arden could get rid of her personal automobile, resulting in a significant
annual savings.

 Offer Two requires using estimates of costs for her personal automobile. There is uncertainty
with respect to the amount of these costs. They could be higher or lower than estimated.

 Offer One includes a $30,000 travel allowance that would not require receipts. Offer Two will
reimburse all travel costs which would require all receipts. The additional paperwork would make
Offer Two less attractive. However, Offer Two would be more attractive if her actual travel costs
total more than $30,000. If they total less, than Offer One would allow her to keep the difference.

 Offer One includes an interest free loan that will be invested. The fact that these funds will be
invested means that there will be a deduction available to offset the $4,000 benefit on the interest
free loan. In addition, Ms. Arden’s cash flows are likely to be improved by some amount of return
on the investment of the $200,000 in loan proceeds.

 Offer Two contains an estimate of commissions. Unlike the fixed salary provided in Offer One,
there is uncertainty with respect to the amount of these commissions. They could be higher or

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lower than estimated. There could also be uncertainty related to the timing of the payment of the
commissions.

Given these latter considerations, it is difficult to come to a firm conclusion on the two offers. If the
invested funds earn a substantial return, she may be better off with Offer One. Correspondingly, it is
difficult to quantify the cash flows associated with not owning a personal automobile. In addition, there
could be a disadvantage with Offer Two if commission income did not reach the predicted level of
$85,000.

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TIF Solution Three - 15

Ms. Shirley Kantor’s net employment income for the year would be calculated as follows:

Salary $142,000

Federal And Provincial Income Tax Nil

RPP Contributions ( 3,200)

EI Premiums Nil

CPP Contributions Nil

United Way Donations Nil

Professional Dues ( 1,250)

Bonus - Item 2 25,000

Car Benefit - Item 3 5,694

Salary Advance - Item 4 50,000

Allowance For Acquiring Business Clothing - Item 6 4,800

Squash Club Membership - Item 6 2,800

Financial Advisor Fees - Item 6 1,200

Stock Option Benefit - Item 7 4,000

Computer Related Supplies - Item 8 ( 150)

Net Employment Income $230,894

Item 1 The reimbursement of moving expenses is not a taxable benefit. However, as the costs were
reimbursed, Shirley cannot deduct them.

Item 2 As employment income is determined on a cash basis, only the portion of the bonus that was
received during 2018 will be included in income.

Item 3 The taxable benefit on the car would be calculated as follows:

Standby Charge [(2%)($39,550)(12)(8,000  20,004*)] $3,796

Operating Cost Benefit - Lesser Of:

[($0.26)(8,000)] = $2,080

[(1/2)($3,796)] = $1,898 1,898

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Total Benefit $5,694

*[(12)(1,667)]

Item 4 Even though the $50,000 is earned in 2019, it is paid in 2018 and, because employment income
is on a cash basis, it must be included in income in that year.

Item 5 The use of Aeroplan points earned on employment related travel does not create a taxable
benefit.

Item 6 While employer provided specialized clothing is not a taxable benefit, regular business clothing
would not fit this description, resulting in the inclusion of this allowance in income. As the squash club
membership is not used at all for employment related activity, it would be considered a taxable benefit.
While mental or physical health counseling is not considered a taxable benefit, this is not the case with
financial counseling.

Item 7 While there is no employment income inclusion resulting from the exercise of the CCPC stock
options, there is an inclusion of $4,000 [(500)($28 - $20)] when the shares are sold. This inclusion
would be accompanied by a deduction of $2,000 [(1/2)($4,000)] in the calculation of Taxable Income.
However, the deduction does not affect the calculation of net employment income.

Item 8 While Shirley cannot deduct CCA (tax depreciation) on the computer, she can deduct the cost of
the supplies.

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TIF Solution Three - 16

For an employee who earns commissions, motor vehicle costs (other than CCA and financing costs) and
other travel costs can be deducted under either ITA 8(1)(f) or, alternatively a combination of ITA 8(1)
(h) and 8(1)(h.1). A potential problem arises in that:

 The total deducted under ITA 8(1)(f) is limited to commission income.

 A commission salesperson cannot use ITA 8(1)(f) for some costs (e.g., entertainment and
advertising costs) and use ITA 8(1)(h) and 8(1)(h.1) for his travel costs. If he uses ITA 8(1)(f), he
cannot use ITA 8(1)(h) and 8(1)(h.1).

This means that if he is deducting items like entertainment and advertising, which can only be deducted
under ITA 8(1)(f), he will have to deduct travel costs under that provision as well. This procedure may
result in exceeding the commission income limit.
In order to deal with this problem, separate calculations must be made for ITA 8(1)(f) including motor
vehicle and travel costs, and for the total of motor vehicle and travel costs under ITA 8(1)(h) and ITA
8(1)(h.1). Note that the deductions available under ITA 8(1)(i) and ITA 8(1)(j) are not affected by the
choice of ITA 8(1)(f) vs. ITA 8(1)(h) and 8(1)(h.1).
The relevant expense deduction calculations are as follows:

ITA 8(1)(f) ITA 8(1) ITA 8(1)

(Limited to $22,310) (h) and (h.1) (i) and (j)

Automobile Costs:

Operating Costs

[(38,000/45,000)($11,420)] $9,644 $9,644 -

Financing Costs

[(38,000/45,000)($2,300)] - - $1,942

CCA [(38,000/45,000)($4,500)] - - 3,800

Professional Dues - - 375

Work Space In The Home Costs:

Interest On Mortgage - - -

Property Taxes [(25%)($3,850)] 963 - -

Utilities [(25%)($1,875)] - - 469

Insurance [(25%)($960)] 240 - -

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Maintenance [(25%)($3,640)] - - 910

Travel Costs 24,600 24,600 -

Non-Deductible Meals

[(50%)($10,300)] (Note 1) ( 5,150) ( 5,150) -

Total Golf Club Fees (Note 2) Nil - -

Entertainment ($845 + $275) 1,120 - -

Non-Deductible Entertainment

[(50%)($1,120)] (Note 3) ( 560) - -

Total $30,857 $29,094 $7,496

Note 1 Mr. Robinson can deduct 50 percent of his meals while traveling for his employer. Whether
the meals are with clients or not does not affect the deductibility.

Note 2 Golf memberships are not deductible. Since the golf club is located in the city he lives in
and where his employer is located, meals with clients there would not be deductible at all as they
did not occur while Mr. Robinson was traveling for employment related activities.

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Note 3 Mr. Robinson can deduct 50 percent of the tickets he purchased as entertainment costs.
Unlike meals with clients, whether or not the client entertainment occurred while he was travelling
does not affect the deductibility. In ITA 8(1)(f) meals anywhere would be deductible (within
limitations) if it were not for ITA 8(4) which targets “meals” only as deductible under ITA 8(1)(f)
or (h) if they are incurred while away for at least 12 hours. Since the tickets are not “meals” then
that overnight restriction would not apply. Salesperson expenses are all deductible when incurred
close to home, with meals being the only exception.

The required calculation of minimum Net Employment Income would be as follows:

Salary $183,000

Commissions 22,310

Expenses ($29,094 + $7,496 - Note 4) ( 36,590)

RPP Contributions (Note 5) ( 3,750)

Awards ($550 - $500 + $200) (Note 6) 250

Stock Option Benefit (Note 7) 875

Net Employment Income $166,095

Note 4 The deduction of dues and other expenses under ITA 8(1)(i) and automobile capital costs
(CCA and financing costs) under ITA 8(1)(j) is permitted without regard to other provisions used.

The deduction for work space in the home costs has been split between ITA 8(1)(i) and (f). Since
the utilities and maintenance portions can be deducted under ITA 8(1)(i) by any employee, it is not
limited by the commission income. The insurance and property tax components are limited as they
are deducted under ITA 8(1)(f). A limitation, which is not illustrated in this problem, prevents the
deduction of work space in the home costs from creating an employment loss.

As the ITA 8(1)(f) amount is limited to the $22,310 in commission income, the total deduction
using ITA 8(1)(f), (i) and (j), is $29,806 ($22,310 + $7,496).

Using the combination of ITA 8(1)(h), (h.1), (i), and (j) produces a deduction of $36,590 ($29,094 +
$7,496). Note that when this approach is used, work space in the home costs are limited to utilities
and maintenance. Further, there is no deduction for entertainment costs. However, this approach
results in deductions totaling $6,784 ($36,590 - $29,806) more than the amount available using ITA
8(1)(f), (i), and (j) due to the effect of the commission income limit.

Note 5 The employer’s contributions to the RPP are not considered to be a taxable benefit.

Note 6 An employee can receive any number of non-cash, non-performance awards and, as long as
the total is less than $500 for the year, there is no taxable benefit. In this case, Mr. Robinson
receives non-cash awards of $550 ($375 + $175). The extra $50 ($550 - $500) will have to be
included in income. In addition, he will have to include the gift certificate for $200 as it would be

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considered a near cash award. Note that he could also have received a long-service award of up to
$500 on a tax free basis. However, it does not appear that such an award was given.

Note 7 There is an employment income inclusion on the exercise of the stock options of $875
[(250)($14.75 - $11.25)]. While there is a deduction equal to one-half of this amount available, it is
a deduction from Taxable Income and does not enter into the calculation of net employment
income. There is also a taxable capital gain on the sale of the 100 shares, but that too does not enter
into the calculation of net employment income.

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TIF Solution Three - 17

Matilda Bracken’s net employment income would be calculated as follows:

Item 1 - Signing Bonus (Note 1) $ 12,000

Item 2 - Salary Received (Note 2) 120,125

Item 2 - RPP Contributions ( 3,700)

Item 3 - Employer’s RPP Contribution (Note 3) Nil

Item 4 - Group Medical Coverage (Note 4) Nil

Item 5 - Bonus Received (Note 5) 5,300

Item 6 - Excess Gift (Note 6) 150

Item 7 - Financial Counseling (Note 7) 1,200

Item 8 - Housing Loss Reimbursement (Note 8) 17,500

Item 9 - Imputed Interest On Housing Loan (Note 9) 735

Item 10 - Stock Option Benefit (Note 10) 400

Item 11 - CFP Dues Paid (Note 11) ( 1,600)

Item 11 - Employer Reimbursement Of CFP Dues (Note 11) 800

Item 12 - Club Dues (Note 12) Nil

Item 13 - Automobile Benefit (Note 13) 8,747

Item 14 - Stationery And Supplies (Note 14) ( 147)

Item 14 - Long Distance Calls (Note 14) ( 110)

Item 14 - Workspace In The Home Costs (Note 14) ( 1,910)

Item 15 - Home Office Allowance (Note 15) 2,275

Net Employment Income $161,765

Note 1 Amounts received prior to, during or after employment are required to be included in
employment income when received.

Note 2 Salary and other forms of remuneration such as bonuses are included in income when
received regardless of when earned. While the withholdings generate a credit against Tax
Payable, CPP and EI payments are not deductible. In addition, income tax payments are not
deductible.

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Note 3 An employer’s contributions to an employee’s RPP is not a taxable benefit.

Note 4 Employer’s contributions to group health care plans are not a taxable benefit for the
employee.

Note 5 Only the amount of the bonus that was received during 2018 will be included in
Matilda’s Net Income For Tax Purposes.

Note 6 Non-cash gifts of up to $500 can be received by an employee on a tax free basis.
Amounts in excess of $500 are taxable. The excess $150 ($650 - $500) will be included in
Matilda’s net employment income.

Note 7 The provision by an employer of financial counseling services is considered to be a

taxable benefit.

Note 8 Employer-reimbursed housing losses fall into two categories – regular housing losses
and eligible housing losses. Eligible housing losses occur when there is an eligible relocation
which generally means a relocation or move the expenses of which would qualify for a moving
expense deduction had they been paid by the employee. In this case the move is an eligible
relocation meaning that the reimbursement qualifies as an eligible housing loss. The employer
reimbursed $50,000 [(50%)($100,000)]. The taxable portion of the loss reimbursement is
$17,500 [(1/2)($50,000 - $15,000)]. The remaining tax free amount of $32,500 can be
calculated as ($50,000 - $17,500) or [$15,000 + (1/2)($50,000 - $15,000)].

Note 9 The imputed interest on this loan would be $735 [($220,000)(2%)(61 ÷ 365)]. An
acceptable alternative calculation would be $733 [($220,000)(2%)(2 ÷ 12)].

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Note 10 Despite the fact that the option price was 10 percent below fair market value, the
issuance of the stock options does not create employment income. However, when she
exercises the option by purchasing shares, there is a benefit as follows:

Market Value At Exercise Date ($7,200 ÷ 90%) $8,000

Option Price ( 7,200)

Value Of Benefit (200 Shares) $ 800

Per Share Benefit ($800 ÷ 200) $4 Per Share

Since RPL is a CCPC, this benefit can be deferred until the shares are sold. As 100 shares are
sold during 2018, $400 [(100)($4 benefit per share)] of this benefit will be included in Ms.
Bracken’s 2018 net employment income.

In addition to this benefit, there is also a taxable capital gain of $50 {[1/2][$4,100 - (1/2)
($8,000)]}. However, such gains are not part of net employment income.

Note 11 Professional dues are generally deductible. However, if an employer reimburses all or
part of such dues, it creates a taxable benefit.

Note 12 While club dues cannot be deducted by an employer, they do not create a taxable
benefit for an employee, provided the membership is of benefit to the employer.

Note 13 The automobile benefit would be calculated as follows:

Standby Charge [(2%)(8)($45,200)(12,000 ÷ 13,336*)] $6,507

Operating Cost Benefit - Lesser Of:

 [($0.26)(12,000)] = $3,120

 [(1/2)($6,507) = $3,254 3,120

Total Benefit $9,627

Reimbursement To Employer [(8)($110)] ( 880)

Net Benefit $8,747

*[(8)(1,667)]

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Note 14 Based on floor space, the home office occupies 12 percent of the apartment
(150 ÷ 1,250). The work space in the home expenses that may be claimed for the period June 1
to November 30 are the following:

Rent Paid [(7)($2,200)] $15,400

Electricity Paid 350

Paint 165

Total Eligible Expenses $15,915

Home Office Use 12%

Deductible Expense $ 1,910

The stationary and supplies, as well as the business related long distance calls are deductible.
As employees cannot take CCA (tax depreciation) on office furniture or computers, there is no
deduction for the cost of these capital assets. Unless a phone is used only for employee related
activities, the monthly cost for its use is not deductible. Finally, employees cannot deduct the
cost of property insurance on a home office.

Note 15 Allowances received are included in employment income unless the allowance is
specifically excluded by ITA 6(1)(b). There is no exclusion for this allowance. The amount is
$2,275 [(7)($325)].

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TIF Solution Three - 18

Mr. Packett’s net employment income would be calculated as follows:

Gross Salary $75,000

Additions:

Bonus (Amount Received Only) $7,500

Personal Benefit On Car (Note 1) 885

Stock Option Benefit

[($34.75 - $31.00)(500)] (Note 2) 1,875

Home Purchase Loan Benefit (Note 3) 1,750

Disability Insurance Receipts (Note 4) 8,500

Tuition Fee For Medieval History Course (Note 5) 950

Fees Paid To Financial Planner (Note 6) 450

Premiums On Life Insurance (Note 7) 423 22,333

$97,333

Deductions:

RPP Contributions ($3,100)

Union Dues ( 275) ( 3,375)

Net Employment Income $93,958

Note 1 The personal benefit on the company car, taking into consideration the two months he was
in the hospital and unable to make use of the car, would be as follows:

Standby Charge [(2/3)(10)($723)(5,500/16,670)*] $1,590

Operating Cost Benefit - Lesser Of:

 [(5,500)($0.26)] = $1,430

 [(1/2)($1,590)] = $795 795

Less: Payments Withheld By Employer ( 1,500)

Taxable Benefit $ 885

*[(10)(1,667)]

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Note 2 Although Olin would qualify for the deduction of one-half of the stock option benefit under
ITA 110(1)(d), it is a deduction from Taxable Income and would not affect the calculation of net
employment income.

Note 3 The taxable benefit associated with the home purchase loan would be calculated as follows:

[($175,000)(2% - Nil)(6/12)] = $1,750

Note 4 As all of the premiums were paid by the employer and were not considered to be a taxable
benefit, benefits received under this coverage must be included in employment income.

Note 5 As it is reasonable to assume that the operations management course would primarily
benefit his employer and is not for personal interest, the fees reimbursed by his employer would not
create a taxable benefit. However, a course in medieval history does not appear to be business
related and, as a consequence, there would be a taxable benefit for the tuition paid by the employer.

Note 6 While fees paid for some types of counseling do not create a taxable benefit, counseling
related to an employee’s finances is not on the list. As a result, the reimbursement of the fees is a
taxable benefit.

Note 7 The cost of providing life insurance to employees is a taxable benefit as specified in ITA
6(4). Although premiums paid by Olin have no tax effect as they are not deductible, the employer’s
payment on his behalf is added to employment income.

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Chapter Four Test Item File Solutions

TIF Solution Four - 1

1. The reason for this approach being used is based on the fact that there are a number of items that
influence an individual’s tax obligation that are altered on the basis of the individual’s Net Income
For Tax Purposes. For example, the amount of the age tax credit is reduced by the individual’s Net
Income For Tax Purposes in excess of a specified amount (a.k.a. the threshold amount or the
income threshold). In order to ensure that income tests of this type are applied on an equitable
basis, amounts are left in Net Income For Tax Purposes even in situations where the ultimate intent
is not to assess tax on these amounts.

2. An individual’s income for the entire taxation (calendar) year, other than business income, is
subject to tax in the province in which he resides on the last day of the taxation year. Which
province assesses income tax is a very important tax planning issue. Maximum provincial rates
vary from 14.5 percent to nearly 21 percent. In addition, the value of the personal tax credits varies
between the provinces. Clearly, what province an individual is taxed in can make a great deal of
difference with respect to the amount of income taxes that will be paid.

3. A “tax deduction” is an amount subtracted in the determination of Net Income For Tax Purposes.
This reduction in Net Income For Tax Purposes will flow through to Taxable Income and reduce
Tax Payable by the amount of the deduction, multiplied by the relevant tax rate. In contrast, a “tax
credit” provides a direct reduction in the amount of Tax Payable. Because of this difference, on a
dollar-for-dollar basis, tax credits are more valuable than tax deductions.

4. The $6,986 Canada caregiver credit is available for infirm dependants who are parents,
grandparents, brothers, sisters, aunts, uncles, nieces, nephews, and children of the claimant or his
spouse or common-law partner who are over 17.

5. An individual’s spouse is a person to whom that individual is legally married. A common-law

partner is an individual who is not a spouse and who cohabits in a conjugal relationship with the
taxpayer and (a) has so cohabited with the taxpayer for a continuous period of at least one year, or
(b) is a parent of a child of whom the taxpayer is a parent. Spouses and common-law partners may
be either the same sex or of the opposite sex.

6. In order to claim this deduction, the taxpayer must be a person who is unmarried, does not have a
common-law partner, or is separated. The claim must be for an individual who is living with the
taxpayer in a self-contained domestic establishment. Further, the dependant has to be under 18 at
any time during the year, the taxpayer’s parent or grandparent, or mentally or physically infirm.
The dependant must be related by blood, marriage, common-law partnership or adoption, and must
be wholly dependent on the taxpayer for support. Note that, except in the case of the taxpayer’s
child, the dependant must be a resident of Canada.

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7. Such a taxpayer could claim the eligible dependant credit, including the extra amount for an infirm
eligible dependant.

8. Infirm children over 17 are eligible for the Canada caregiver credit based on an amount of $6,986.
The amount of this base is reduced by the child’s income in excess of $16,405. With respect to an
infirm child under 18, the base for the credit is $2,182. This base is not reduced by the infirm
child’s income.

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9. While the base for the spousal credit adds an amount for an infirm spouse, this base is reduced, on a
dollar-for-dollar basis, for the spouse’s Net Income For Tax Purposes. If the resulting credit base is
less than the Canada caregiver amount (for 2018, $6,986, reduced by the spouse’s Net Income For
Tax Purposes in excess of $16,405), an additional amount is available. The additional amount is the
difference between the income reduced base for the spousal credit and the amount that would have
been the Canada caregiver amount.

10. The three qualifying types could be selected from the following:

 periodic payments from a Registered Pension Plan (RPP);

 an annuity payment out of a Registered Retirement Savings Plan (RRSP);

 a payment out of a Registered Retirement Income Fund (RRIF);

 an annuity payment from a Deferred Profit Sharing Plan (DPSP); and

 the interest component of other annuities.

A non-qualifying type could be selected from the following:

 payments under the Old Age Security Act or Canada Pension Plan;

 payments under certain provincial pension plans;

 payments under salary deferral arrangements;

 payments under retirement compensation arrangements;

 payments under an employee benefit plan; and

 death benefits.

11. The likely reason is the belief that limiting this tax credit to the low federal rate of 15 percent would
discourage large donations by high income individuals. Stated alternatively, it appears that policy
makers believed that the use of the high 29 and 33 percent rates was necessary in order to encourage
high tax bracket individuals to continue making significant donations.

12. Any claims that are not made in the current year can be carried forward and used as the base for the
charitable donations tax credit in the subsequent five years. There is the possibility that the amount
claimed in the year of contribution could result in a tax credit that is larger than the individual’s Tax
Payable in that year. If that is the case, the extra amount claimed is simply wasted. Better tax
planning would have the taxpayer carry some amount forward to be used as the base for a credit in a
year in which he has additional Tax Payable.

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13. The base for medical expenses is reduced by the lesser of 3 percent of the taxpayer’s Net Income
For Tax Purposes and $2,302 (for 2018). If, for example, an individual had large medical costs in
the second half of 2017 and the first half of 2018, deducting the sum of these costs in the 12 month
period ending June 30, 2018 would result in only one reduction. In contrast, if the relevant amounts
were deducted in each of the two calendar years, the lesser reduction would be applied twice, once
in 2017, and again in 2018.

14. In general, the medical expense credit should be claimed by the lower income spouse. This is
because the amount of medical expenses must be reduced by the lesser of $2,302 (for 2018) and 3
percent of the individual’s income. This figure will be lower for the lower income spouse so the
medical expense credit will be larger. Exceptions to this general rule are:

 If both spouses have income such that 3 percent exceeds the $2,302 threshold, it does not
matter which spouse claims the credit.

 If the lower income spouse does not have sufficient Tax Payable to use the medical expense tax
credit, it should be claimed by the higher income spouse.

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15. It can be transferred provided the supporting person can claim the disabled person as a:

 a dependant under the eligible dependant provision [ITA 118(1)(b)];

 a dependant for purposes of the caregiver tax credit [ITA 118(1)(c.1)]; or

 a mentally or physically infirm dependant over 17 [ITA 118(1)(d)].

In addition, it can be claimed if the supporting person:

 could have claimed the eligible dependant credit, if neither the supporting person nor the
disabled dependant were married; or

 could have claimed the disabled dependant over 17, or the caregiver credit, if the dependant
had been 18 years of age or older and had no income.

16. The following types of fees are eligible for this credit:

 Tuition fees over $100 paid to a university, college, or other institution for post-secondary courses
located in Canada.

 Tuition fees paid to an institution certified by the Minister of Employment and Social
Development for a course that developed or improved skills in an occupation (the individual must
be 16 or older).

 Tuition fees paid to a university outside Canada. To qualify the course must have a minimum
duration of 3 weeks.

 For individuals who live near the U.S. border and commute, tuition fees paid to a U.S. college or
university for part-time studies.

17. The credits that can be transferred to a spouse or common-law partner are the:

 age credit,

 disability credit,

 pension income credit, and

 tuition fee credit.

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18. Non-refundable tax credits can only be used against the individual’s Tax Payable (or in some cases,
transferred to another individual). Even if the total non-refundable credits exceed Tax Payable, the
government will not provide a refund. Alternatively, if a credit is refundable, the government will
pay the individual for any amount of the credit that cannot be applied against Tax Payable. If the
individual has no Tax Payable, the entire amount of the credit will be paid to the individual.

19. For 2018, the OAS clawback claims 15 percent of each dollar of income in excess of $75,910. At
this income level, the individual is already subject to a federal marginal tax rate of 20.5 percent. In
effect, the clawback represents an additional 15 percentage points of taxation, resulting in an overall
federal rate of 35.5 percent. When combined with an average provincial rate, this pushes the overall
rate for these individuals to well over 50 percent.

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TIF Solution Four - 2

1. False. They are included in Net Income For Tax Purposes and deducted in the determination of
Taxable Income.

2. False.

Provincial income taxes are calculated as a percent of Taxable Income.

3. False.

Not all of the base figures are indexed (e.g., the pension income credit base) and the charitable
donations credit can be at 29 or 33 percent.

4. True.

While the credit is usually only available for a resident related dependant, an exception is made
for the child of an individual.

5. True.

ITA 118(8) specifically excludes Canada Pension Plan payments from eligibility for this credit.

6. True.

This will avoid double counting the 3 percent of income limit.

7. False.

The combined transfer is limited to $5,000 multiplied by the appropriate percentage.

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8. False.

She is eligible for a federal political contributions tax credit of $350 [(3/4)($400) + (1/2)
($100)].

9. False.

The federal political contributions tax credit is deductible against federal Tax Payable.

10. False.

In addition to the age requirement, there is a minimum earned income requirement.

11. False.

Any required repayment of OAS payments can be deducted in the determination of Net Income
For Tax Purposes.

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TIF Solution Four - 3

Taxable Income
1. B. A business loss incurred during the current year.

2. C. Net Income $35,000, Taxable Income $25,000.

Tax Payable
3. D. $100,842 {$93,208 + [($18,529 - $16,544) ÷ 26%]}

4. B. Income that is not taxed in a province is subject to an additional tax at the federal
level.

5. C. Total federal tax minus federal tax credits equals federal tax payable

6. C. $61,283 {$46,605 + [($10,000 - $6,991) ÷ 20.5%]}

7. D. All provinces use the same tax brackets for applying their rates.

Tax Credits
8. A. To claim the eligible dependant credit for a child, the child must be under the age of
18 at some time during the year. If the child is mentally or physically infirm, they do not have
to be under 18.

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9. C. The required amount would be calculated as follows:

15 Percent Of $200 $ 30

33 Percent Of The Lesser Of:

 $74,800 ($75,000 - $200)

 $24,158 ($230,000 - $205,842)

= [(33%)($24,158)] 7,972

29 Percent Of $50,642 [$75,000 - ($24,158 + $200)] 14,686

Total Credit $22,688

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10. A. Canada caregiver, employment credit, medical expenses, disability

11. D. Pension income amount.

12. B. They reduce tax by the same amount regardless of a taxpayer’s marginal tax rate.

13. B. It can be claimed by either spouse.

14. C. The child must be a resident of Canada.

15. C. A person may claim 75% of his or her Net Income For Tax Purposes in charitable
donations for a single year ($90,000 in this case). As none of his income is taxed at 33 percent,
this rate will not be applicable to the calculation of the charitable donations tax credit. The
donation credit is 15% of the first $200, plus 29% of the excess, for a total of $26,072.

16. C. Only expenses in excess of a specified amount are eligible for a tax credit.

17. D. All of the above.

18. C. The EI and CPP credits.

19. B. Contributions made to a candidate at the time of a federal general election are eligible.

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20. A. His father only.

21. C. Mentally infirm spouse age 65.

22. C. A healthy 67 year old grandfather.

23. C. Union Dues

24. B. Disability tax credit and Canada caregiver tax credit only.

25. D. No tax credits available. The grandmother is not supporting the child.

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26. C. ($11,809 + $2,594 + $858 + $1,195) x 15% = $2,468

27. B. $4,302 ($300 ÷ 15%) + $2,302

28. C. $308 [$2,500 – ($15,000 x 3%)] x 15%

29. D. $166 [($300 x 3/4) – [($200 x 15%) + ($100 x 29%)]

30. C. Canada Employment tax credit (must have employment income)

31. B. Age tax credit (net income is too high)

32. C. Credits related to tuition paid to a university outside of Canada cannot be transferred
to another person.

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TIF Solution Four - 4

Exam Exercise Solution Four - 1 (Calculation Of Tax Payable Before Credits)
The required Tax Payable would be calculated as follows:

Federal Tax Payable:

On First $46,605 $6,991

On Next $6,570 ($53,175 - $46,605) At 20.5 Percent 1,347

Federal Tax Payable Before Credits $8,338

Exam Exercise Solution Four - 2 (Calculation Of Tax Payable Before Credits)

The required Tax Payable would be calculated as follows:

Federal Tax Payable:

On First $93,208 $16,544

On Next $9,277 ($102,485 - $93,208) At 26 Percent 2,412

Federal Tax Payable Before Credits $18,956

Exam Exercise Solution Four - 3 (Infirm Spousal Tax Credit)

The required amount would be calculated as follows:

Basic Personal Amount $ 11,809

Spousal Including Infirm Amount

($11,809 + $2,182 - $5,800) 8,191

Credit Base $20,000

Rate 15%

Total Credits $ 3,000

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Exam Exercise Solution Four - 4 (Spousal Tax Credit)

The required amount would be calculated as follows:

Basic Personal Amount $ 11,809

Spousal ($11,809 - $8,420) 3,389

Credit Base $15,198

Rate 15%

Total Credits $ 2,280

Exam Exercise Solution Four - 5 (Canada Caregiver Tax Credit)

As his mother is not mentally or physically impaired, Gerrard would not be entitled to the Canada
caregiver credit.

Exam Exercise Solution Four - 6 (Canada Caregiver Tax Credit)

As she has a physical infirmity, Elaine’s mother would qualify for the Canada caregiver credit. The
amount would be $1,048 [(15%)($6,986)].

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Exam Exercise Solution Four - 7 (Infirm Spouse And Infirm Child)

Margo will be entitled to the spousal tax credit, including the additional amount for an infirm spouse. In
addition, she can claim the Canada caregiver credit for her 22 year old infirm daughter. The total credits
would be calculated as follows:

Spousal Including Infirm Amount

($11,809 + $2,182 - $6,600) $ 7,391

Canada Caregiver ($6,986 - Nil) 6,986

Total Base $14,377

Rate 15%

Margo’s Tax Credits Related To Spouse And Daughter $ 2,157

Exam Exercise Solution Four - 8 (Infirm Spouse And Infirm Child)

Farah will be entitled to the spousal tax credit, including the additional amount for an infirm spouse. In
addition, she can claim the Canada caregiver credit for her 26 year old infirm son. The total credits
would be calculated as follows:

Spousal Including Infirm Amount

($11,809 + $2,182 - $4,600) $ 9,391

Canada Caregiver ($6,986 - Nil) 6,986

Total Base $16,377

Rate 15%

Farah’s Tax Credits Related To Spouse And Son $ 2,457

Exam Exercise Solution Four - 9 (Infirm Eligible Dependant - Child Under 18)
Sheila would claim the Canada caregiver amount for a child under ITA 118(1)(b.1). She would also
claim the eligible dependant credit for Susan. Because she claims the Canada caregiver amount for a
child, she cannot claim the additional amount for an infirm eligible dependant. Her total credits would
be as follows:

[(15%)($2,182) + (15%)($11,809 + Nil - $3,400)] = $1,589

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Exam Exercise Solution Four - 10 (Infirm Eligible Dependant - Child Under 18)
Gloria would claim the Canada caregiver amount for a child under ITA 118(1)(b.1). She would also
claim the eligible dependant credit for Mark. Because she claims the Canada caregiver amount for a
child, she cannot claim the additional amount for an infirm eligible dependant. Her total credits would
be as follows:

[(15%)($2,182) + (15%)($11,809 + Nil)] = $2,099

Exam Exercise Solution Four - 11

(Canada Caregiver Tax Credit - Additional Amount)
The base for Toshiro’s eligible dependant credit for his infirm mother is nil ($11,809 + $2,182 -
$18,300), resulting in an eligible dependant tax credit of nil. The calculation of the Canada caregiver
amount would result in a base of $5,091 [$6,986 - ($18,300 - $16,405)]. As the eligible dependant tax
credit was nil, the additional amount is $5,091 ($5,091 - Nil), resulting in a credit of $764 [(15%)
($5,091)].

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Exam Exercise Solution Four - 12 (Multiple Credits For Dependants)

The daughter qualifies for the eligible dependant credit and the Canada caregiver tax credit. However, if
John takes the eligible dependant credit for the daughter, the Canada caregiver credit cannot be claimed
for her. Given this, the eligible dependant credit should be taken for the son. The fact that this claim
can only be made for one dependant means that the daughter is no longer eligible for this credit. Based
on this approach, John’s 2018 tax credits are as follows:

Basic Personal Amount $11,809

Eligible Dependant - Son ($11,809 - $2,100) 9,709

Canada Caregiver - Daughter 6,986

Credit Base $28,504

Rate 15%

Total Credits $ 4,276

Exam Exercise Solution Four - 13 (Multiple Credits For Dependants)

The son qualifies for the eligible dependant credit and the Canada caregiver tax credit. However, if
Ingrid takes the eligible dependant credit for the son, the Canada caregiver credit cannot be claimed for
him. Given this, the eligible dependant credit should be taken for the daughter. Based on this approach,
Ingrid’s 2018 tax credits are as follows:

Basic Personal Amount $11,809

Eligible Dependant - Daughter ($11,809 - $1,230) 10,579

Canada Caregiver - Son 6,986

Credit Base $29,374

Rate 15%

Total Credits $ 4,406

Exam Exercise Solution Four - 14 (Age Tax Credit)

Ms. Burns’ age credit would be $882 {[15%][$7,333 - (15%)($46,642 - $36,976)]}.

Exam Exercise Solution Four - 15 (Age Tax Credit)

Mr. Rose’s age credit would be $526 {[15%][$7,333 - (15%)($62,485 - $36,976)]}.

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Exam Exercise Solution Four - 16 (Adoption Expenses Tax Credit)

The adoption expenses tax credit would be calculated as follows:

Cost Of First Trip To France $ 3,850

Cost Of Second France Trip 6,280

French Orphanage Fee 1,759

Canadian Adoption Agency Fee 5,600

Legal Fees 3,250

Medical Costs (Qualify For Medical Expense Credit) Nil

Total Eligible Expenses $20,739

Since the $4,500 employer reimbursement is a taxable benefit and included in employment income, it
does not reduce the total eligible adoption expenses.
The adoption period begins at the time that an application is made for registration with an adoption
agency licensed by a provincial government. This means that all of the expenses listed in the preceding
table would be eligible expenses made during the adoption period. However, for 2018, there is an
overall limit of $15,905. Given this, the maximum credit that can be claimed is $2,386 [(15%)
($15,905)].

Exam Exercise Solution Four - 17 (Home Accessibility Tax Credit)

The addition to the truck is not a qualifying expenditure. The base for the home accessibility tax credit
is the lesser of:

 The actual qualifying home accessibility costs.

 $10,000.

The lesser of these two figures is the actual costs of $8,600, resulting in a tax credit of $1,290 [(15%)
($8,600)].

Exam Exercise Solution Four - 18 (Charitable Donations Tax Credit)

The credit base for 2018 would be limited to $52,800 [(75%)($70,400)]. However, he chooses to claim
$15,000, leaving a carry forward of $105,000 ($120,000 - $15,000). Note that, because Leon’s Taxable
Income is below the $205,842 threshold at which the 33 percent rate applies, this rate is not relevant in
the following calculation. The resulting credit would be:

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$200 At 15 Percent $ 30

$14,800 ($15,000 - $200) At 29 Percent 4,292

Total Credit $4,322

As his income for 2019 is unchanged from 2018, the limit would be the same $52,800 [(75%)($70,400)].
In general, charitable donations can be carried forward for up to 5 years. As a result, the final year to
claim any unused portion of his 2018 donation would be 2023.

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Exam Exercise Solution Four - 19

(Charitable Donations Tax Credit - Carry Forward)
The credit base for 2018 would be limited to $52,800 [(75%)($70,400)]. Note that, because Leon’s
Taxable Income is below the $205,842 threshold at which the 33 percent rate applies, this rate is not
relevant in the following calculation. The resulting credit would be:

$200 At 15 Percent $ 30

$52,600 ($52,800 - $200) At 29 Percent 15,254

Maximum Credit $15,284

In general, charitable donations can be carried forward for up to 5 years. As a result, the final year to
claim any unused portion of his 2017 donation would be 2022.

Exam Exercise Solution Four - 20 (Charitable Donations Tax Credit)

The credit base for 2018 would be limited to $62,250 [(75%)($83,000)]. However, he chooses to claim
$30,000, leaving a carry forward of $90,000 ($120,000 - $30,000). Note that, because Jack’s Taxable
Income is below the $205,842 threshold at which the 33 percent rate applies, this rate is not relevant in
the following calculation. The resulting credit would be:

$200 At 15 Percent $ 30

$29,800 ($30,000 - $200) At 29 Percent 8,642

Total Credit $8,672

As his income for 2019 is unchanged from 2018, the limit would be the same $62,250 [(75%)($83,000)].
In general, charitable donations can be carried forward for up to 5 years. As a result, the final year to
claim any unused portion of his 2018 donation would be 2023.

Exam Exercise Solution Four - 21 (Medical Expense Tax Credit)

The required calculation is as follows:

Amount B Expenses For Samuel And Spouse $2,042

Amount C

Lesser Of:

 [(3%)($125,000)] = $3,750

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 2018 Threshold Amount = $2,302 ( 2,302)

Subtotal Nil

Amount D

Son’s Medical Expenses $7,780

Reduced By The Lesser Of:

 $2,302

 [(3%)($8,675)] = $260 ( 260) 7,520

Allowable Amount Of Medical Expenses $7,520

Amount A The Appropriate Rate 15%

Medical Expense Tax Credit $1,128

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Exam Exercise Solution Four - 22 (Medical Expense Tax Credit)

The required calculation is as follows:

Amount B Expenses For Saul, His Spouse, And His Daughter $4,500

Amount C

Lesser Of:

 [(3%)($70,000)] = $2,100

 2018 Threshold Amount = $2,302 ( 2,100)

Subtotal $2,400

Amount D

Son’s Medical Expenses $6,200

Reduced By The Lesser Of:

 $2,302

 [(3%)($9,200)] = $276 ( 276) 5,924

Allowable Amount Of Medical Expenses $8,324

Amount A The Appropriate Rate 15%

Medical Expense Tax Credit $1,249

Exam Exercise Solution Four - 23 (Disability Tax Credit)

As Marie has no income, her disability credit can be transferred to Lorraine. As Marie is over 17, the
disability child supplement is not available.
In addition to the disability credit, Lorraine will be able to claim the Canada caregiver credit , as well as
a credit for all of Marie’s medical expenses.
The total credits related to Marie would be as follows:

Transfer Of Marie’s Disability Amount $ 8,235

Canada Caregiver 6,986

Marie’s Medical Expenses $9,850

Reduced By The Lesser Of:

 $2,302

 [(3%)(Nil)] Nil 9,850

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Total Credit Base $25,071

Rate 15%

Total Credits Related To Marie $ 3,761

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Exam Exercise Solution Four - 24 (Disability Tax Credit With Supplement)

Given that Suzanne’s income is less than the base for the basic personal tax credit, the disability tax
credit can be transferred to her father. In addition, because she is under 18, she is eligible for the
disability supplement. As none of her medical expenses were for attendant care, the full amount of the
supplement is available.
He will also be able to claim the Canada caregiver credit for a child under 18.
As Larry and his wife have medical expenses that exceed the income threshold, and Suzanne’s income is
not a factor since she is under 18, he can claim all of Suzanne’s medical expenses.
The total credits related to Suzanne would be calculated as follows:

Transfer Of Suzanne’s Disability $ 8,235

Disability Supplement 4,804

Canada Caregiver For A Child Under 18 2,182

Suzanne’s Medical Expenses 12,400

Total Credit Base $27,621

Rate 15%

Total Credits Related To Suzanne $ 4,143

Exam Exercise Solution Four - 25 (Education Related Tax Credits)

Mr. Balmer’s education related tax credits would be calculated as follows:

Tuition Amount:

Total $4,100

Ineligible Ancillary Fees ($415 - $250) ( 165) $3,935

Interest On Student Loan 417

Total Credit Base $4,352

Rate 15%

Total Available Credits $653

Exam Exercise Solution Four - 26 (Education Related Tax Credits)

Ms. Bucknell’s education related tax credits would be calculated as follows:

Tuition Amount:
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Total $10,400

Ineligible Ancillary Fees ($350 - $250) ( 100) $10,300

Interest On Student Loan 623

Total Credit Base $10,923

Rate 15%

Total Available Credits $ 1,638

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Exam Exercise Solution Four - 27 (Carry Forward Of Tuition Credit)

The available tuition credit for the year could be calculated as follows:

Tuition Amount $5,650

Rate 15%

Tuition Credit For The Current Year $ 848

Carry Forward Tuition Credit 525

Total Available Tuition Credits $1,373

The alternative calculation approach that is used in the tax return would be as follows:

Tuition Amount For The Current Year $5,650

Carry Forward Amount 3,500

Total Available Tuition Amounts $9,150

Rate 15%

Total Available Tuition Credit $1,373

Karl’s Tax Payable before deducting the tuition credit would be $3,426 [(15%)($34,650 - $11,809)].
This is more than sufficient to absorb the available tuition credit and, as a consequence, there would be
no carry forward.

Exam Exercise Solution Four - 28 (Transfer Of Tuition Credit)

The tuition credit for the year would be calculated as follows:

Tuition Amount $26,800

Rate 15%

Available Tuition Credit (Maximum Transfer = $750) $ 4,020

Income Tax Act Approach The $750 maximum transfer of the tuition credit must be reduced by
Betty’s Tax Payable of $497 [(15%)($15,123 - $11,809)]. This will leave a maximum transfer of $253
($750 - $497) and a carry forward credit of $3,270 ($4,020 - $497 - $253).

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Tax Return Approach The $5,000 maximum transfer of the tuition amount must be reduced by $3,314
($15,123 - $11,809), the excess of Betty’s Taxable Income over her basic personal amount. This results
in a maximum transfer of $1,686 ($5,000 - $3,314) and would leave a carry forward of $21,800
($26,800 - $3,314 - $1,686). This would give the same $3,270 [(15%)($21,800)] credit as under the
alternative calculation.

Exam Exercise Solution Four - 29 (Transfer Of Tuition Credit)

The available tuition credit for the year would be calculated as follows:

Tuition Amount $31,400

Rate 15%

Available Tuition Credit (Maximum Transfer = $750) $ 4,710

Income Tax Act Approach The $750 maximum transfer of the tuition credit must be reduced by Carl’s
Tax Payable of $51 [(15%)($12,150 - $11,809)]. This will leave a maximum transfer of $699 ($750 -
$51) and a carry forward credit of $3,960 ($4,710 - $51 - $699).

Tax Return Approach The $5,000 maximum transfer of tuition amount must be reduced by $341
($12,150 - $11,809), the excess of Carl’s Taxable Income over his basic personal amount. This results
in a maximum transfer of $4,659 ($5,000 - $341) and would leave a carry forward of $26,400 ($31,400 -
$341 - $4,659). This would give the same $3,960 [(15%)($26,400)] credit as under the alternative
calculation.

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Exam Exercise Solution Four - 30 (Transfer Of Credits From A Spouse)

Her tax credits would be calculated as follows:

Basic Personal Amount $11,809

Spousal Amount 11,809

Age [$7,333 - (15%)($53,500 - $36,976)] 4,854

Pension Income 2,000

Spousal Age Transfer 7,333

Spousal Tuition Amount - Lesser Of:

 $5,000

 $3,450 3,450

Credit Base $41,255

Rate 15%

Total Credits $ 6,188

Exam Exercise Solution Four - 31 (Transfer Of Credits From A Spouse)

John’s tax credits would be calculated as follows:

Basic Personal Amount $11,809

Spousal Amount 11,809

Age [$7,333 - (15%)($63,200 - $36,976)] 3,399

Pension Income 2,000

Spousal Age Transfer 7,333

Spousal Tuition Amount - Lesser Of:

 $5,000

 $8,200 5,000

Credit Base $41,350

Rate 15%

Total Credits $ 6,203

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Exam Exercise Solution Four - 32 (Political Contributions Tax Credit)

Mr. Dion’s $500 credit would be calculated as follows:

Contributions Credit Rate Tax Credit

First $400 3/4 $300

Next 350 1/2 175

Remaining 76 1/3 25

Maximum Credit $826 $500

Exam Exercise Solution Four - 33 (Refundable Medical Expense Supplement)

The regular medical expense credit would be calculated as follows:

Medical Expenses $10,325

Lesser Of:

 [(3%)($28,248)] = $847

 2018 Threshold Amount = $2,302 ( 847)

Allowable Amount Of Medical Expenses $ 9,478

Rate 15%

Total Credits $ 1,422

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The refundable supplement would be calculated as follows:

Lesser Of:

 $1,222 (2018 Maximum)

 [(25/15)($1,422)] = $2,370 $1,222

Reduction [(5%)($28,248 - $27,044)] ( 60)

Refundable Medical Expense Supplement $1,162

Mr. Mackey’s total Tax Payable (Refund) would be calculated as follows:

Tax Payable Before Credits [(15%)($28,248)] $4,237

Non-Refundable Credits:

Basic Personal $11,809

Common-Law Partner 11,809

Allowable Medical Expenses 9,478

Total $33,096

Rate 15% ( 4,964)

Tax Before Refundable Supplement Nil*

Refundable Supplement ( 1,162)

Tax Payable (Refund) ($1,162)

* As Tax Before Refundable Supplement can only be reduced to nil, the net result
cannot be negative for this subtotal.

Exam Exercise Solution Four - 34 (EI And OAS Clawbacks)

Mr. Clemens’ income before deducting either the EI or OAS repayment would be calculated as follows:

Net Employment Income $67,200

EI Benefits 9,460

OAS Benefits 7,000

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Income Before Deductions $83,660

Dealing first with the EI repayment, Mr. Clemens would have to repay the lesser of:

 $2,838 [(30%)($9,460)]

 $5,711 [(30%)($83,660 - $64,625)]

Using this deduction, the clawback of the OAS payments would be the lesser of:

 $7,000

 $737 [(15%)($83,660 - $2,838 - $75,910)]

As a result, his Net Income For Tax Purposes would be as follows:

Income Before Deductions $83,660

ITA 60(v.1) Deduction (EI) ( 2,838)

ITA 60(w) Deduction (OAS) ( 737)

Net Income For Tax Purposes $80,085

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Exam Exercise Solution Four - 35 (Tax Payable With OAS Clawback)

Before the deduction of any OAS repayment, Agnes had income as follows:

OAS Payments $ 7,000

CPP Payments 10,000

Investment Income 65,000

Income Before Deduction $82,000

The OAS clawback would be the lesser of:

 $7,000

 $914 [(15%)($82,000 - $75,910)]

This results in a Taxable Income of $81,086 ($82,000 - $914). Using this figure, the Tax Payable for
Agnes would be calculated as follows:

Tax On First $46,605 $ 6,991

Tax On Remaining $34,481 ($81,086 - $46,605) At 20.5 Percent 7,069

Tax Before Credits $14,060

Tax Credits (Given) ( 2,500)

Tax Payable Before Clawback $11,560

Plus: OAS Clawback 914

Total Amount Due $12,474

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TIF Solution Four - 5A

The correct definitions for each of the listed key terms are as follows:

A. 4

B. 6

C. 2

D. 8

E. 3

F. 1

G. 7

H. 13

I. 16

J. 14

K. 17

L. 10

M. 12

The four unused definitions are as follows:

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Canada Pension Plan = 9

Medical Expense Tax Credit = 5

OAS Benefits = 15

Spousal Tax Credit = 11

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TIF Solution Four - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.

The correct definitions for each of the listed key terms are as follows:

A. 5

B. 8

C. 2

D. 11

E. 3 (not 21)

F. 1

G. 9

H. 17 (not 10)

I. 20 (not 15)

J. 18

K. 22 (not 7)

L. 13 (not 4)

M. 16

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The four unused definitions are as follows:

Canada Pension Plan = 12

Medical Expense Tax Credit = 6

OAS Benefits = 19

Spousal Tax Credit = 14

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TIF Solution Four - 6

The amount of the personal tax credits would be as follows:

1. Ms. Partridge will qualify for the following tax credits:

Basic Personal Amount $11,809

Spousal ($11,809 - $4,725) 7,084

Age [$7,333 - (15%)($61,300 - $36,976)] 3,684

Pension Income 2,000

Total Credit Base $24,577

Rate 15%

Total Credits $ 3,687

Note that, because her income is below the $75,910 income threshold, there will be no
clawback of Ms. Partridge’s OAS receipts.

2. Mr. Brody will qualify for the following credits:

Basic Personal Amount $11,809

Eligible Dependant (See Note) 11,809

Total Credit Base $23,618

Rate 15%

Total Credits $ 3,543

Note The eligible dependant credit can be taken for any child. However, it should not be
claimed for the 15 year old as the amount of the credit would be reduced due to his income.

3. Ms. Lassiter will qualify for the following tax credits:

Basic Personal Amount $11,809

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Spousal ($11,809 - $1,600) 10,209

Medical Expenses (See Note) 16,164

Total Credit Base $38,182

Rate 15%

Total Credits $ 5,727

Note The claim for medical expenses is determined as follows:

Expenses For Marion, Her Spouse, And Under 18 Children

($4,240 + $3,450 + $1,860 + $2,450) $12,000

Reduced By The Lesser Of:

 [(3%)($132,450)] = $3,974

 2018 Threshold Amount = $2,302 ( 2,302)

19 Year Old’s Medical Expenses $6,720

Reduced By The Lesser Of:

 [(3%)($8,460)] = $254

 $2,302 ( 254) 6,466

Allowable Medical Expenses $16,164

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4. Ms. Archer will qualify for the following credits:

Basic Personal Amount $11,809

Spousal ($11,809 - $7,240) 4,569

Canada Caregiver - 22 Year Old Son 6,986

Total Credit Base $23,364

Rate 15%

Total Credits $ 3,505

5. Ms. Baxter will qualify for the following credits:

Basic Personal Amount $11,809

Spousal ($11,809 - $4,230) 7,579

EI (Maximum) 858

CPP (Maximum) 2,594

Canada Employment 1,195

Total Credit Base $24,035

Rate 15%

Total Credits $ 3,605

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TIF Solution Four - 7

Case 1
The solution for this Case is as follows:

Tax [(15%)($44,500)] $6,675

Basic Personal Amount ($11,809)

Spousal Including Infirm Amount

($11,809 + $2,182 - $8,880) ( 5,111)

Canada Caregiver - Additional Amount (Note) ( 1,875)

Age [$7,333 - (15%)($44,500 - $36,976)] ( 6,204)

Pension ( 2,000)

Spouse’s Age ( 7,333)

Spouse’s Disability ( 8,235)

Spouse’s Pension (= RPP Payments) ( 1,230)

Credit Base ($43,797)

Rate 15% ( 6,570)

Federal Tax Payable $ 105

Note In this Case, the base for the spousal credit is less than the regular Canada caregiver base. As
her spouse’s income is less than the income threshold for the Canada caregiver credit, she would
qualify for the full amount of the Canada caregiver credit. Given this, there is an additional amount
of $1,875 ($6,986 - $5,111) available for adding to the credit base.

The Old Age Security and Canada Pension Plan receipts are not eligible for the pension income credit,
only the Registered Pension Plan receipts are eligible. As Billy’s income is below the income threshold,
there is no reduction in his age credit.

Case 2
The solution for this Case is as follows:

Tax On First $46,605 $ 6,991

Tax On Next $39,895 ($86,500 - $46,605) At 20.5 Percent 8,178

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Federal Tax Before Credits $15,169

Basic Personal Amount ($11,809)

Eligible Dependant - Sandy ( 11,809)

Canada Caregiver For Child - Mark ( 2,182)

Credit Base ($25,800)

Rate 15% ( 3,870)

Federal Tax Payable $11,299

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Case 3
The solution for this Case can be completed as follows:

Tax On First $93,208 $16,544

Tax On Next $8,792 ($102,000 - $93,208) At 26 Percent 2,286

Federal Tax Before Credits $18,830

Basic Personal Amount ($11,809)

Eligible Dependant Including Infirm Amount - Son

($11,809 + $2,182 - $7,560) ( 6,431)

Canada Caregiver - Additional Amount (Note) ( 555)

Transfer Of Son’s Disability ( 8,235)

Credit Base ($27,030)

Rate 15% ( 4,055)

Federal Tax Payable $14,775

Note In this Case, the base for the eligible dependant credit is less than the regular Canada caregiver
base. As the son’s income is less than the income threshold for the Canada caregiver credit, he
would qualify for the full amount of the Canada caregiver credit. Given this, there is an additional
amount of $555 ($6,986 - $6,431) available for adding to the credit base.

Case 4
The solution for this Case would be as follows:

Tax On First $46,605 $ 6,991

Tax On Next $36,395 ($83,000 - $46,605) At 20.5 Percent 7,461

Federal Tax Before Credits $14,452

Basic Personal Amount ($11,809)

EI ( 858)

CPP ( 2,594)

Canada Employment ( 1,195)

Credit Base ($16,456)

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Rate 15% ( 2,468)

Charitable Donations

[(15%)($200) + (29%)($5,600 - $200)] ( 1,596)

Federal Tax Payable $10,388

Note As none of her income is taxed at 33 percent, this rate will not be applicable to the
calculation of the charitable donations tax credit.

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Case 5
The solution for this Case is as follows:

Tax On First $93,208 $16,544

Tax On Next $292 ($93,500 - $93,208) At 26 Percent 76

Federal Tax Before Credits $16,620

Basic Personal Amount ($11,809)

Spousal ($11,809 - $7,260) ( 4,549)

EI ( 858)

CPP ( 2,594)

Canada Employment ( 1,195)

Medical Expenses (See Note) ( 9,130)

Credit Base ($30,135)

Rate 15% ( 4,520)

Federal Tax Payable $12,100

Note The base for the medical expense tax credit would be calculated as follows:

Barbra And Her Partner $3,200

Reduced By The Lesser Of:

 [(3%)($93,500)] = $2,805

 2018 Threshold Amount = $2,302 ( 2,302)

Son’s Medical Expenses $8,400

Reduced By The Lesser Of:

 [(3%)($5,600)] = $168

 $2,302 ( 168) 8,232

Total Credit Base $9,130

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Case 6
The solution for this Case can be completed as follows:

Tax On First $46,605 $ 6,991

Tax On Next $37,995 ($84,600 - $46,605) At 20.5 Percent 7,789

Federal Tax Before Credits $14,780

Basic Personal Amount ($11,809)

Spousal ($11,809 - $7,200) ( 4,609)

Canada Caregiver - John’s Father (Note) ( 6,986)

Canada Caregiver - Barbra’s Father (Note) Nil

EI ( 858)

CPP ( 2,594)

Canada Employment ( 1,195)

Credit Base ($28,051)

Rate 15% ( 4,208)

Federal Tax Payable $10,572

Note Because he is infirm, John’s father qualifies for the Canada caregiver credit. However,
because he is in good health, Barbra’s father does not.

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Case 7
The solution for this Case can be completed as follows:

Tax On First $144,489 $29,877

Tax On Next $18,511 ($163,000 - $144,489) At 29 Percent 5,368

Federal Tax Before Credits $35,245

Basic Personal Amount ($11,809)

Spousal ($11,809 - $7,240) ( 4,569)

Canada Caregiver - Son ( 6,986)

EI ( 858)

CPP ( 2,594)

Canada Employment ( 1,195)

Transfer From Son (Note) ( 5,000)

Credit Base ($33,011)

Rate 15% ( 4,952)

Federal Tax Payable $30,293

Note The transfer from the son is as follows:

Tuition Fees $ 8,300

Maximum Transfer ( 5,000)

Carry Forward (For Son’s Use Only) $ 3,300

The son’s Tax Payable is completely eliminated by his basic personal credit. He can transfer a
maximum of $5,000 of his tuition amount to his mother. The remaining $3,300 can be carried
forward indefinitely, but must be used by the son.

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TIF Solution Four - 8

The amount of the personal tax credits would be as follows:

1. Mr. Hanson will qualify for the following credit:

Basic Personal Amount $11,809

Total Credit Base $11,809

Rate 15%

Total Credits $ 1,771

While his mother appears to be dependent, she is not a resident of Canada. The only non-
residents who qualify for personal credits are a spouse and children.

2. Mr. Johnson will qualify for the following credit:

Basic Personal Amount $11,809

Spousal Nil

EI (Maximum) 858

CPP (Maximum) 2,594

Canada Employment 1,195

Total Credit Base $16,456

Rate 15%

Total Credits $ 2,468

His wife’s income will have to be considered for the entire year and, with her having a total of
$30,000 ($27,500 + $2,500), the spousal credit will be eliminated.

3. Mr. Massey will qualify for the following credits:

Basic Personal Amount $11,809

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Spousal ($11,809 - $1,500) 10,309

Total Credit Base $22,118

Rate 15%

Total Credits $ 3,318

4. Mr. Jones will qualify for the following credits:

Basic Personal Amount $11,809

Spousal ($11,809 - $1,200) 10,609

Total Credit Base $22,418

Rate 15%

Total Credits $ 3,363

There is no personal tax credit available for his son.

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5. Ms. Morrison will qualify for the following credits:

Basic Personal Amount $11,809

Eligible Dependant (See Note) 11,809

Total Credit Base $23,618

Rate 15%

Total Credits $ 3,543

Note The eligible dependant credit can be taken for either child.

6. Mr. Bagley will qualify for the following credits:

Basic Personal Amount $11,809

Spousal Including Infirm Amount

($11,809 + $2,182) 13,991

Age 7,333

Pension 2,000

Spouse’s Disability 8,235

Total Credit Base $43,368

Rate 15%

Total Credits $ 6,505

As Mr. Bagley’s Net Income For Tax Purposes is less than the relevant income thresholds,
there will be no reduction in his age credit or clawback of his OAS payments.

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TIF Solution Four - 9

The federal Tax Before Credits is the same in all five of the cases in this problem. It is calculated as
follows:

Tax On First $93,208 $16,544

Tax On Next $2,792 ($96,000 - $93,208) At 26 Percent 726

Tax Before Credits $17,270

Case A
The solution to this Case can be completed as follows:

Tax Before Credits $17,270

Basic Personal Amount ($11,809)

Spousal ($11,809 - $6,750) ( 5,059)

EI ( 858)

CPP ( 2,594)

Canada Employment ( 1,195)

Transfer From Son (Note) ( 5,000)

Credit Base ($26,515)

Rate 15% ( 3,977)

Federal Tax Payable $13,293

Note: The transfer from the son is as follows:

Tuition Fees $ 9,850

Maximum Transfer ( 5,000)

Carry Forward (For Kenneth’s Use Only) $ 4,850

Kenneth’s Tax Payable is completely eliminated by his basic personal credit. He can transfer a
maximum of $5,000 of his tuition amount to his father. The remaining $4,850 can be carried
forward indefinitely, but must be used by Kenneth.
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Case B
The solution to this Case can be completed as follows:

Tax Before Credits $17,270

Basic Personal Amount ($11,809)

Eligible Dependant ( 11,809)

EI ( 858)

CPP ( 2,594)

Canada Employment ( 1,195)

Interest On Student Loan ( 1,750)

Credit Base ($30,015)

Rate 15% ( 4,502)

Federal Tax Payable $12,768

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Case C
The solution to this Case can be completed as follows:

Tax Before Credits $17,270

Basic Personal Amount ($11,809)

Spousal ($11,809 - $4,580) ( 7,229)

EI ( 858)

CPP ( 2,594)

Canada Employment ( 1,195)

Canada Caregiver (Note) Nil

Credit Base ($23,685)

Rate 15% ( 3,553)

Federal Tax Payable $13,717

Note As neither parent is mentally or physically infirm, they are not eligible for the Canada
caregiver credit.

Case D
The solution to this Case can be completed as follows:

Tax Before Credits $17,270

Basic Personal Amount ($11,809)

Spousal ($11,809 - $5,785) ( 6,024)

EI ( 858)

CPP ( 2,594)

Canada Employment ( 1,195)

Medical Expenses ($10,300)

Reduced By The Lesser Of:

[(3%)($96,000)] = $2,880

2018 Threshold Amount = $2,302 2,302 ( 7,998)

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Credit Base ($30,478)

Rate 15% ( 4,572)

Federal Tax Payable $12,698

Case E
The solution to this Case can be completed as follows:

Tax Before Credits $17,270

Basic Personal Amount ($11,809)

EI ( 858)

CPP ( 2,594)

Canada Employment ( 1,195)

Credit Base ($16,456)

Rate 15% ( 2,468)

Political Contributions Tax Credit

[(3/4)($400) + (1/2)($350) + (1/3)($450)] ( 625)

Charitable Donations [(15%)($200) + (29%)($45,000 - $200)] ( 13,022)

Federal Tax Payable $ 1,155

As none of his income is taxed at 33 percent, this rate is not applicable to the calculation of the
charitable donations tax credit.

Unused charitable donations can be carried forward for up to 5 years. By claiming $45,000 of his
donation, this leaves Wallace with $55,000 ($100,000 - $45,000) in charitable donations that can be
carried forward for 5 years.

The limitation of 75 percent of Net Income For Tax Purposes would have given Wallace a
maximum credit based on $72,000 [(75%)($96,000)] in charitable donations. He will be subject to
the 75 percent limitation of Net Income For Tax Purposes in any year he claims the charitable
donations.

Regardless of whether Wallace might be considered mentally infirm or not, the Canada caregiver
credit is not available as it can only be claimed for a dependant.

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TIF Solution Four - 10

Mr. Brooks’ minimum Net Income For Tax Purposes for the year would be calculated as follows:

Gross Salary $63,000

Additions:

Bonus (Amount Received Only) $6,500

Disability Insurance Receipts (Note 1) 4,200

Personal Benefit On Car (Note 2) 1,034

Stock Option Benefit [($28 - $23)(200)] 1,000

Housing Loan Benefit [($125,000)(2% - Nil)(3/12)] 625

Deductions:

RPP Contributions ( 2,800)

Union Dues ( 240)

Net Income For Tax Purposes $73,319

Note 1 As all of the premiums were paid by the employer and were not considered to be a taxable
benefit, benefits received under this coverage must be included in employment income.

Note 2 The personal benefit on the company car, taking into consideration the two months he was
in the hospital and unable to make use of the car, would be as follows:

Standby Charge [(2/3)(10)($678)(5,000/16,670)*] $1,356

Operating Cost Benefit - Lesser Of:

 [(5,000)($0.26)] = $1,300

 [(1/2)($1,356)] = $678 678

Less: Payments Withheld By Employer ( 1,000)

Taxable Benefit $1,034

*[(10)(1,667)]

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Taxable Income
Mr. Brooks’ Taxable Income would be calculated as follows:

Net Income For Tax Purposes $73,319

Stock Option Deduction [(1/2)($1,000)] ( 500)

Taxable Income $72,819

Tax Payable
Mr. Brooks’ federal Tax Payable (Refund) would be calculated as follows:

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Tax On First $46,605 $ 6,991

Tax On Next $26,214 ($72,819 - $46,605) At 20.5 Percent 5,374

Federal Tax Before Credits $12,365

Basic Personal Amount ($11,809)

Eligible Dependant Including Infirm Amount

($11,809 + $2,182) (Note 4) ( 13,991)

Transfer Of Harold’s Disability ( 8,235)

Harold’s Disability Supplement ( 4,804)

Canada Caregiver - Mother (Note 5) Nil

EI Premiums ( 858)

CPP Contributions ( 2,594)

Canada Employment ( 1,195)

Medical Expenses (Note 6) ( 10,590)

Tuition Fee - Unreimbursed Music Course (Note 7) ( 600)

First Time Home Buyer’s ( 5,000)

Credit Base ($59,676)

Rate 15% ( 8,951)

Charitable Donations (Note 8)

[(15%)($200) + (29%)($480 - $200)] ( 111)

Net Federal Tax $ 3,303

Federal Income Tax Withheld ( 3,000)

Federal Tax Payable $ 303

Note 4 The eligible dependant credit can be claimed for Harold, including the extra amount for an
infirm dependant.

Note 5 As she is not mentally or physically infirm, the Canada caregiver credit cannot be claimed
for Mr. Brooks’ mother. While he could claim the eligible dependant credit for his mother,
allowing the Canada caregiver to be claimed for Harold, his mother’s income would significantly
reduce the eligible dependant credit, making this an undesirable alternative.

Note 6 Allowable medical expenses are as follows:

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Mr. Brooks’ And Minor Child (Harold) Medical Expenses

($9,300 + $2,450) $11,750

Reduced By The Lesser Of:

 [(3%)($73,319)] = $2,200

 2018 Threshold Amount = $2,302 ( 2,200)

Grace’s Medical Expenses $1,265

Reduced By The Lesser Of:

 $2,302

 [(3%)($7,500)] = $225 ( 225) 1,040

Allowable Medical Expenses $10,590

Note 7 As the accounting course tuition fees were reimbursed by his employer and not included in
his employment income, there is no tuition credit for that course.

Note 8 As none of his income is taxed at 33 percent, this rate is not applicable to the calculation of
the charitable donations tax credit.

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TIF Solution Four - 11

Part A - Net Income For Tax Purposes
Marvin’s minimum Net Income For Tax Purposes would be calculated as follows:

Salary $112,468

Additions:

Bonus (Amounts Received After 2021

- Salary Deferral Arrangement) 20,000

Automobile Benefit (Note 1) 991

Stock Options (Note 2) 3,900

Gifts (Note 3) 1,800

Client Meals And Entertainment (Note 4) Nil

Interest Free Loan Benefit (Note 5) 3,000

Deductions:

RPP Contributions ( 6,800)

Professional Association Dues ( 3,400)

Net Income For Tax Purposes $131,959

Note 1 The automobile benefit would be calculated as follows:

Standby Charge [(2/3)(10)($456 - $43)(4,000 ÷ 16,670*)]$661

Operating Cost Benefit - Lesser Of:

 [(1/2)($661)] = $330

 [($0.26)(4,000)] = $1,040 330

Total Benefits $991

*[(10)(1,667)]

As Marvin’s employment related use was more than 50 percent, the reduced standby charge is
available. In addition, he can use the alternative calculation of the operating cost benefit.

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Note 2 The stock option benefit would be calculated as follows:

[(300)($85 - $72)] = $3,900

Note 3 The $1,200 Employee Of The Month Award is performance related and would be a
taxable benefit. Also a taxable benefit would be the $600 gift certificate as it is a near cash gift.
The Christmas basket is under the $500 limit and would not be a taxable benefit. The total
taxable benefit would be $1,800 ($1,200 + $600).

Note 4 Marvin’s meal and entertainment costs exceed his employer’s reimbursement by the
$1,000 that were not reimbursed. However, as he has no commission income, he cannot deduct
these out-of-pocket costs.

Note 5 The taxable benefit on the loan is calculated as follows:

[(2%)($200,000)(9/12)] = $3,000

Part B - Taxable Income

Marvin’s Taxable Income would be calculated as follows:

Net Income For Tax Purposes $131,959

Stock Option Deduction [(1/2)($3,900)] ( 1,950)

Taxable Income $130,009

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Part C - Tax Payable

Based on the Taxable Income calculated in Part B, Marvin’s Tax Payable would be calculated as
follows:

Tax On First $93,208 $16,544

Tax On Next $36,801 ($130,009 - $93,208) At 26 Percent 9,568

Federal Tax Before Credits $26,112

Basic Personal Amount ($11,809)

Spousal Including Infirm Amount

($11,809 + $2,182 - $8,460) ( 5,531)

Canada Caregiver - Additional Amount

(Note 6) ( 1,455)

Canada Caregiver - Suzanne ( 6,986)

Transfer Of Leslie’s Disability ( 8,235)

Transfer Of Samantha’s Tuition (Note 7) ( 4,009)

First-Time Home Buyers’ ( 5,000)

EI Premiums ( 858)

CPP Contributions ( 2,594)

Canada Employment ( 1,195)

Medical Expenses (Note 8) ( 17,196)

Credit Base ($64,868)

Rate 15% ( 9,730)

Charitable Donations (Note 9)

[(15%)($200) + (29%)($2,500 - $200)] ( 697)

Marvin’s Federal Tax Payable $15,685

Note 6 The base for the spousal credit is less than the Canada caregiver base. As his spouse’s
income is less than the income threshold for the Canada caregiver credit, he would qualify for the
full amount of the Canada caregiver credit. Given this, there is an additional amount of $1,455
($6,986 - $5,531) to add to the credit base.

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Note 7 Samantha will have to reduce her own Tax Payable to nil before transferring any tuition
amount. She will require $991 ($12,800 - $11,809) of the $10,300 tuition payment.

This means that her transfer will be limited to $4,009 ($5,000 - $991). This will leave Samantha
with a carry forward of $5,300 ($10,300 - $991 - $4,009).

Note 8 It would appear that the rhinoplasty surgery for Samantha is purely cosmetic in nature.
As a consequence, it is not an eligible medical expense. Sharon’s rhinoplasty surgery appears
to be medically required and would be allowable. The base for Marvin’s medical expense
credit can be calculated as follows:

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Marvin, Leslie, And Sharon

($2,200 + $3,100) $ 5,300

Reduced By The Lesser Of:

 [(3%)($131,959)] = $3,959

 2018 Threshold Amount = $2,302 ( 2,302)

Suzanne’s Medical Expenses $12,300

Reduced By The Lesser Of:

 $2,302

 [(3%)($7,250)] = $218 ( 218) 12,082

Samantha’s Allowable Medical Expenses

($16,000 - $13,500) $2,500

Reduced By The Lesser Of:

 $2,302

 [(3%)($12,800)] = $384 ( 384) 2,116

Allowable Medical Costs $17,196

Note 9 As none of his income is taxed at 33 percent, this rate is not applicable to the calculation of
the charitable donations tax credit.

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TIF Solution Four - 12

Part A
Martin’s minimum Net Income For Tax Purposes would be calculated as follows:

Salary $ 98,500

Additions:

Bonus (2018 Receipt) 3,000

Bonus (Amounts After 2021 - Salary Deferral) 3,000

Client Meals And Entertainment (Note 1) Nil

Stock Options (Note 2) 12,500

Interest Free Loan Benefit (Note 3) 1,400

Automobile Benefit (Note 4) 8,825

Gifts (Note 5) 550

Deductions:

RPP Contributions ( 4,300)

Union Dues ( 450)

Net Income For Tax Purposes $123,025

Note 1 Martin’s meal and entertainment costs exceed his employer’s reimbursement by $5,000
($12,300 - $7,300). However, as he has no commission income, he cannot deduct these out-of-
pocket costs.

Note 2 The stock option benefit would be calculated as follows:

[(500)($70 - $45)] = $12,500

Note that, because the option price was less than the fair market value of the shares at the time
the options were granted, no ITA 110(1)(d) deduction is available in the determination of
Taxable Income (Part B).

Note 3 The taxable benefit on the loan is calculated as follows:

[(1%)($280,000)(6/12)] = $1,400

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Note 4 The automobile benefit would be calculated as follows:

Standby Charge [(2%)(11)($45,200)(11,000 ÷ 18,337*)]$5,965

Operating Cost Benefit - Lesser Of:

 [(1/2)($5,965)] = $2,983

 [($0.26)(11,000)] = $2,860 2,860

Total Benefits $8,825

*[(11)(1,667)]

As Martin’s employment related use was more than 50 percent, the reduced standby charge is
available. In addition, he could use the alternative calculation of the operating cost benefit.
However, it does not provide the lower figure in this case.

Note 5 The gift certificate for $250 is taxable because it is a near-cash gift. The first $500 of
the long-service award will not be a taxable benefit. However, the excess of $300 ($800 -
$500) will be a taxable benefit. As the value of the Christmas gift basket is under $500, it will
not create a taxable benefit. The total taxable benefit for gifts is $550 ($250 + $300).

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Part B
Martin’s Taxable Income would be equal to his Net Income For Tax Purposes as there is no stock option
deduction available.

Part C
Martin’s Tax Payable would be calculated as follows:

Tax On First $93,208 $16,544

Tax On Next $29,817 ($123,025 - $93,208) At 26 Percent7,752

Federal Tax Before Credits $24,296

Basic Personal Amount ($11,809)

Spousal Including Infirm Amount

($11,809 + $2,182 - $9,400) ( 4,591)

Canada Caregiver - Additional Amount

(Note 6) ( 2,395)

Canada Caregiver - Devon ( 6,986)

Transfer Of Brian’s Disability ( 8,235)

Transfer Of Derek’s Tuition (Note 7) ( 3,309)

First Time Home Buyers (Maximum) ( 5,000)

EI Premiums ( 858)

CPP Contributions ( 2,594)

Canada Employment ( 1,195)

Medical Expenses (Note 8) ( 16,138)

Credit Base ($63,110)

Rate 15% ( 9,467)

Charitable Donations [(15%)($200)

+ (29%)($2,000 - $200)] (Note 9) ( 552)

Federal Tax Payable $14,277

Federal Tax Withheld ( 18,000)

Amount Owing (Refund) ($ 3,723)

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Note 6 The base for the spousal credit is less than the Canada caregiver base. As his spouse’s
income is less than the income threshold for the Canada caregiver credit, he would qualify for the
full amount of the Canada caregiver credit. Given this, there is an additional amount of $2,395
($6,986 - $4,591) added to the credit base.

Note 7 Derek will have to reduce his own Tax Payable to nil before transferring any tuition
amount. He will require $1,691 ($13,500 - $11,809) of this amount. This means that his
transfer will be limited to $3,309 ($5,000 - $1,691). This will leave Derek with a carry forward
of $9,300 ($14,300 - $1,691 - $3,309).

The reason for the assumption of no CPP contributions is that business income is not covered
until Chapter 6. Derek’s self-employed income would be reduced by half of the CPP paid and
his tax payable would be reduced by the other half.

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Note 8 The base for Martin’s medical expense credit can be calculated as follows:

Martin, Brian, And David

($2,200 + $1,700) $ 3,900

Reduced By The Lesser Of:

 [(3%)($123,025)] = $3,691

 2018 Threshold Amount = $2,302 ( 2,302)

Devon’s Medical Expenses $10,600

Reduced By The Lesser Of:

 $2,302

 [(3%)($5,150)] = $155 ( 155) 10,445

Derek’s Medical Expenses $4,500

Reduced By The Lesser Of:

 $2,302

 [(3%)($13,500)] = $405 ( 405) 4,095

Allowable Medical Costs $16,138

Note 9 As none of his income is taxed at 33 percent, this rate will not be applicable to the
calculation of the charitable donations tax credit.

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TIF Solution Four - 13

Part A
Ms. Dalvi’s minimum Net Income For Tax Purposes would be calculated as follows:

Salary $143,000

Additions:

Bonus [(2/3)($34,500)] 23,000

Automobile Benefit (Note 1) 6,101

Client Meals And Entertainment (Note 2) Nil

Interest Free Loan Benefit (Note 3) 1,250

Gifts (Note 4) 1,100

Stock Options (Note 5) 9,600

Deductions:

RPP Contributions ( 6,400)

Professional Association Dues ( 1,200)

Net Income For Tax Purposes $176,451

Note 1 The automobile benefit would be calculated as follows:

Standby Charge [(2/3)(11)($728 - $50)(15,000 ÷ 18,337*)] $4,067

Operating Cost Benefit - Lesser Of:

 [(1/2)($4,067)] = $2,034

 [($0.26)(15,000)] = $3,900 2,034

Total Benefits $6,101

*[(11)(1,667)]

As Ms. Dalvi’s employment related use was more than 50 percent, the reduced standby charge
is available. In addition, she can use the alternative calculation of the operating cost benefit.

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Note 2 Ms. Dalvi’s meal and entertainment costs exceed her employer’s reimbursement by
$5,300 ($14,800 - $9,500). However, as she has no commission income, she cannot deduct
these out-of-pocket costs.

Note 3 As there has been no change in the prescribed rate, the taxable benefit on the loan is
calculated as follows:

[(1%)($250,000)(6/12)] = $1,250

Note 4 The gift certificate for $400 is taxable because it is a near-cash gift. The first $500 of
the long-service award will not be a taxable benefit. However, the excess of $700 ($1,200 -
$500) will be a taxable benefit. As the value of the Christmas gift basket is under $500, it will
not create a taxable benefit. The total taxable benefit is $1,100 ($400 + $700).

Note 5 The stock option benefit would be calculated as follows:

[(1,200)($45 - $37)] = $9,600

Note that, because the option price was less than the fair market value of the shares at the time
the options were granted, no ITA 110(1)(d) deduction is available in the determination of
Taxable Income (Part B).

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Part B
Ms. Dalvi’s Taxable Income would be equal to her Net Income For Tax Purposes as there is no stock
option deduction available.

Part C
Ms. Dalvi’s Tax Payable would be calculated as follows:

Tax On First $144,489 $ 29,877

Tax On Next $31,962 ($176,451 - $144,489) At 29 Percent 9,269

Tax Before Credits $39,146

Credits:

Basic Personal Amount ($11,809)

Spousal Including Infirm Amount

($11,809 + $2,182 - $7,200) ( 6,791)

Canada Caregiver - Additional Amount

(Note 6) ( 195)

Canada Caregiver - Mary ( 6,986)

EI Premiums ( 858)

CPP Contributions ( 2,594)

Canada Employment ( 1,195)

Spouse’s Age ( 7,333)

Spouse’s Disability ( 8,235)

First Time Home Buyers’ ( 5,000)

Transfer Of Mark’s Tuition (Note 7) ( 5,000)

Medical Expenses (Note 8) ( 19,354)

Credit Base ($75,350)

Rate 15% ( 11,303)

Charitable Donations [(15%)($200)

+ (29%)($4,000 - $200)] (Note 9) ( 1,132)

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Federal Tax Payable $26,711

Federal Tax Withheld ( 29,000)

Amount Owing (Refund) ($ 2,289)

Note 6 The base for the spousal credit is less than the Canada caregiver base. As her spouse’s
income is less than the income threshold for the Canada caregiver credit, she would qualify for the
full amount of the Canada caregiver credit. Given this, there is an additional amount of $195
($6,986 - $6,791) added to the credit base.

Note 7 As Mark has no income of his own, he cannot use any of his $9,400 tuition amount.
The transfer to his mother is limited to $5,000, leaving him with a carry forward of $4,400
($9,400 - $5,000).

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Note 8 The base for Ms. Dalvi’s medical expense credit can be calculated as follows:

Ms. Dalvi, Her Spouse And Minor Child

($6,200 + $1,800) $ 8,000

Reduced By The Lesser Of:

 [(3%)($176,451)] = $5,294

 2018 Threshold Amount = $2,302 ( 2,302)

Mary’s Medical Expenses $11,300

Reduced By The Lesser Of:

 $2,302

 [(3%)($4,800)] = $144 ( 144) 11,156

Mark’s Medical Expenses $2,500

Reduced By The Lesser Of:

 $2,302

 [(3%)(Nil)] = Nil ( Nil) 2,500

Allowable Medical Costs $19,354

Note 9 As none of her income is taxed at 33 percent, this rate will not be applicable to the
calculation of the charitable donations tax credit.

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Chapter Five Test Item File Solutions

TIF Solution Five - 1

1. The basic similarity between amortization and CCA procedures is that both are directed towards
allocating the cost of a depreciable asset to periods of time subsequent to the year in which the asset
is acquired. Even here, however, we find a difference. Amortization procedures require that this
allocation period be the useful life of the asset. In contrast, CCA procedures often use periods that
are longer or shorter than the life of the asset. For example, CCA procedures allocate the cost of
some Class 12 assets to one year, even though the assets last considerably longer. Alternatively, the
period of write-off for assets subject to declining balance procedures (e.g., Class 8) have an
unlimited write off period.

The objectives of amortization and CCA procedures are different in that amortization procedures
attempt to match amortization expense with the related revenues in order to present fairly the results
of operations of the enterprise. In contrast, CCA is usually calculated in such a fashion as to
minimize Tax Payable.

As far as methods are concerned, CCA procedures are limited to the use of straight line or declining
balance methods with the added complication of the first year one-half rules. Which of these
methods is to be used is specified for various types of assets in the Income Tax Regulations. In
contrast, amortization calculations can use a much wider range of methods and, in addition, the
accountant has discretion as to the choice of methods for particular types of assets.

A final difference is in the application of the methods chosen. The CCA rules determine the
maximum amount that will be allowed as a deduction for each class. If an enterprise wishes to
minimize a business loss by taking less or no CCA in a particular period, there is no prohibition
against deducting less than the maximum CCA. In contrast, accounting amortization must
determine the amount to be deducted on a consistent basis from year to year, without being
influenced by the level of income being experienced by the enterprise.

2. The capital cost of an asset for tax purposes would, in many cases, contain all of the same costs that
were recorded for accounting purposes. However, there may be differences and some of them are
caused by the factors described below:

Automobiles Costing More Than $30,000 For tax purposes, the deductible cost of
automobiles is limited to $30,000, exclusive of GST/HST/PST. For accounting purposes, there
is no similar restriction and the capital cost would be the acquisition cost.

Government Assistance Under the provisions of ITA 13(7.1), government grants to assist in
the acquisition of capital assets must be deducted from the capital cost of the assets acquired.
Under IAS 20, Accounting For Government Grants And Disclosure Of Government

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Assistance, such assistance can either be deducted as per the tax procedures or treated as a
deferred charge.

Property Acquired In Non-Arm’s Length Transactions When an asset is acquired in a non-

arm’s length transaction, the general provisions of the Income Tax Act require that it be
recorded at its fair market value without regard to the actual transfer price used. For
accounting purposes, the transfer price would be used and, if that amount was different than the
fair market value, a significant difference between the accounting and tax values could arise.

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3. The examples that are listed in the text are as follows:

 Separate businesses must have separate Classes for each business.

 Each rental property with a cost of more than $50,000 must be allocated to a separate class.

 Each passenger vehicle with a cost in excess of $30,000 must be allocated to a separate class.

4. Mistakes in allocating assets to the appropriate CCA class can result in either the unnecessary
payment of additional tax or understatement of the tax owing. For example, if a $100,000 asset is
allocated to Class 1 (4 percent declining balance CCA) when it should have been allocated to Class
10 (30 percent declining balance CCA), the CCA deduction would be $4,000 as opposed to the
$30,000 that would have been available if the appropriate class had been used. Alternatively, an
understatement of tax owing would arise if a Class 10 asset were mistakenly added to Class 1.

5. The CCA rate applicable to a particular type of asset can be changed by either changing the rate for
the class where the type of asset is allocated, or by allocating that type of asset to a different class
that has the desired new rate. In general, the latter approach is preferable for two reasons:

 As most classes contain a variety of asset types, changing the rate for the class will change the
rate for assets other than the type on which the rate change is desired.

 Changing the rate for the class will require the new rate to be used on all of the assets in the
class, including assets that were acquired prior to the change. This type of retroactive change is
thought by many to be unfair, in that taxpayers made various economic decisions based on the
applicability of the old rate.

6. The differences are as follows:

 The addition to Class 10.1 is limited to $30,000, without regard to the actual cost of the vehicle.
There is no similar limit on Class 10 additions.

 In the year of disposal, one-half the normal CCA can be taken on Class 10.1 vehicles. Class
10 vehicles are subject to the usual disposal rules, with CCA only being available when there is
a balance remaining in the Class.

 In the year of retirement, no recapture or terminal loss can be recognized on Class 10.1
vehicles. Class 10 vehicle retirements may result in recapture or terminal losses.

7. The election could be useful if the patent is acquired near the end of its legal life. For example, if
only three years remained, the annual write off would be one-third of the cost, resulting in larger
deductions than would be the case using Class 44’s 25 percent declining balance rate.

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8. The exceptions that are listed in the text are as follows:

 All of the assets that are allocated to Class 14

 Some of the assets that are allocated to Class 12 (e.g., tools costing less than $500).

 Assets acquired from a non-arm’s length taxpayer, provided the assets were being used by that
taxpayer to produce business or property income.

9. In years in which a taxpayer deducts less than maximum CCA, the CCA that is deducted should
usually be taken from the class or classes with the lowest rates. The reason for this is that taking the
deduction from a low rate class will leave a larger balance(s) in high rate classes. As a
consequence, the application of these higher rates will result in a larger maximum CCA deduction
in future years. An exception to this rule could be appropriate if Class 10.1 is available as there is
no recapture for Class 10.1.

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10. As listed in the text, the conditions are as follows:

 The proceeds of disposition are less than the capital cost of the asset.

 There are additional assets in the CCA Class.

 There is a positive balance in the CCA Class, subsequent to the subtraction of the proceeds of
disposition. Even if the balance is negative at the time of the disposition, there will still be no
tax consequences, provided additions to the Class prior to the end of the year leave a positive
balance.

11. With respect to recapture of CCA, this will arise if there is a negative balance in a CCA class at the
end of a taxation year. Such recapture will arise whether there are still assets in the class or,
alternatively, no assets remain in the class

A terminal loss arises only when there are no assets left in a class at the end of the taxation year and
a positive UCC balance remains in that class.

12. With respect to recapture of CCA, the negative balance in the class must be added to Net Income
For Tax Purposes, In addition, it must be added to the UCC balance in order to restore it to nil at
the beginning of the next taxation year.

When there is a terminal loss, 100 percent of this balance must be subtracted from Net Income For
Tax Purposes. In addition, it must be deducted from the UCC balance in order to restore it to nil at
the beginning of the next taxation year.

13. The procedures to be used under generally accepted accounting principles are straightforward. The
net book value of the individual asset being retired is compared to the sale proceeds. If the sale
proceeds exceed the net book value, a gain is recorded. Alternatively, if the sale proceeds are less
than the net book value, a loss is included in the current year’s income.

The tax procedures involve a more complex range of outcomes. In general, the proceeds of
disposition, up to a maximum of the capital cost of the asset, will be deducted from the CCA class
for the asset involved (note that, unlike the situation in the accounting records, tax procedures
generally focus on a class of assets, rather than on individual assets). If the proceeds do not exceed
the capital cost, if the asset is not the last asset in its class, and if the deduction of the proceeds does
not create a negative balance in the class, the retirement’s only tax effect will be the reduction of
future CCA resulting from a lower UCC balance after the disposition. However, there are several
other possibilities that can be described as follows:

Proceeds Exceed Capital Cost If the proceeds exceed the capital cost of the asset, the excess will
be a capital gain, one-half of which will be a taxable capital gain.

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Last Asset In The Class If the asset retired is the last asset in the class and subsequent to the
deduction of the proceeds of sale there is still a UCC balance in the class, this amount is a terminal
loss and must be deducted in the year of the retirement.

Negative Balance In The Class If the deduction of the proceeds creates a negative balance in a
class at the end of the taxation year, regardless of whether the asset was the last asset in the class,
the deficiency is referred to as recapture of CCA. The entire amount must be included in the current
year’s Taxable Income, a process that will restore the UCC balance for the class to nil.

14. If the photocopier is allocated to either the aggregate Class 8 or a separate Class 8, it will be subject
to CCA at a 20 percent rate, even if its expected life is very short (e.g., two or three years). The
difference is that, if it is disposed of for a value that is significantly less than its cost less CCA to the
disposal date, putting the photocopier in a separate Class 8 will allow the taxpayer to deduct a
terminal loss on the disposition. Alternatively, if it is allocated to the aggregate Class 8, it is likely
that other assets will remain in the aggregate Class 8 and/or a new photocopier will be added to the
class prior to the end of the year. This means that, despite an economic loss on the disposition of
the photocopier, no terminal loss can be recognized for tax purposes.

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15. Class 14.1 was established to replace, as of January 1, 2017, a balance that was referred to as
Cumulative Eligible Capital. In general terms, it contains:

 goodwill;

 balances that were in Cumulative Eligible Capital prior to January 1, 2017; and

 property that is acquired after December 31, 2016 that would have been eligible capital
property under the old definitions (the Income Tax Act defines this item differently but this is,
in effect, the meaning of the definition).

This last item is largely intangible capital assets that have an unlimited life. Examples would
include purchased customer lists, the cost of licenses with unlimited lives, expenses of incorporation
over $3,000 and the cost of certain government rights.

16. ITA 13(4) indicates that every business will have a single goodwill property. The balance will
reflect the following additions and deductions:

Additions

 Amounts paid for goodwill acquired as part of the acquisition of all or part of a business.

 Capital receipts that do not relate to a specific property.

Deductions

 Amounts received for goodwill disposed of as part of the sale of all or part of a business.

 Capital expenditures that do not relate to a specific property.

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TIF Solution Five - 2

1. True. Capital cost allowance is analogous to the accounting term amortization and allocates the
cost of the capital asset to current and subsequent taxation years.

2. True. Undepreciated capital cost is decreased by government assistance received to acquire assets
and increased by acquisitions of depreciable assets.

3. False. The method for calculating capital cost allowance for each class is specified in the Income
Tax Regulations.

4. False. The maximum CCA for its fiscal year ending June 30 of the current year is $2,479
[($50,000)(20%)(1/2)(181/365)].

5. True. If the patent is left in Class 44, it will be subject to 25 percent declining balance CCA.
Alternatively, in Class 14, it can be written off on a straight-line basis over its legal life. If the
patent is near the end of its life, this could provide larger deductions than the 25 percent rate
applicable to Class 44.

6. False. The election should be used when the photocopiers are retired after relatively short periods
as it provides for recognition of the terminal losses which would arise in such situations.

7. True. Recapture of CCA occurs when there is a negative balance in the class at the end of the year.

8. False. Taxpayers can deduct 100 percent of terminal losses in the determination of Net Income For
Tax Purposes.

9. False. Only rental properties with a cost more than $50,000 must be allocated to a separate class.

10. False. The maximum CCA that can be deducted for tax purposes for the year is $1,500 [(1/2)
($60,000)(5%)]. The half-year rule applies to Class 14.1.

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TIF Solution Five - 3

1. B. Amortization And Capital Cost Allowance.

2. D. Class 8. At 20 percent, this Class has the lowest rate for calculating CCA.

3. B. The business will have recapture of $75,439 ($450,000 - $374,562) and a capital gain
of $281,000 ($843,000 - $562,000).

4. D. A terminal loss occurs when there are no assets left in the Class and there is a negative
balance in the Class at the end of the year.

5. F. $18,000 [20%[$80,000 + (1/2)($20,000]

6. K. $60,800 [$80,000 - $4,000 - (20%)($80,000 - $4,000)].

7. E. $13,000 [(20%)($80,000 - $15,000)].

8. J. $52,000 [$80,000 - $15,000 - (20%)($80,000 - $15,000)].

9. B. $10,000 [(20%)($80,000 - $90,000 + $60,000)].

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10. Q. Recapture of $5,000. ($80,000 – 85,000)

11. T. $10,000 terminal loss. ($80,000 – 70,000)

12. W. $5,000 taxable capital gain. ($50,000 – 40,000) x 50%

13. G. $19,000 [20%][$80,000 - $70,000 + $100,000 - (½)($100,000 - $70,000)].

14. O. $91,000 ($80,000 - $70,000 + $100,000 - $19,000 CCA).

15. C. All of the items would be included in the capital cost except C, fire and theft insurance
paid for coverage of the asset. Such amounts would be considered a deductible item in the
taxation year covered by the policy.

16. C. To minimize the subsequent year’s taxes, the business should claim maximum CCA
on Class 8 and Class 12. This will give a $5,000 unused business loss that can be carried
forward to the subsequent year.

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17. A. The maximum is limited to the lesser of cost divided by the initial lease term plus one
renewal ($45,000 ÷ 4), and cost divided by five years ($45,000 ÷ 5). The resulting $9,000 is
subject to the first year rules, giving a maximum deduction of $4,500.

18. B. $396, the franchise is Class 14 [($70,000 ÷ 15)(31/365)].

19. D. $125,000 x 4% = $5,000. The half-year rule does not apply to an acquisition from a
non-arm’s length party provided that the property was depreciable property of the prior owner
for at least 364 days prior to the transfer. As well, properties transferred between non-arm’s
length persons retain the CCA class in which they were included by the vendor.

20. B. The equipment falls under Class 8, with CCA of 20%. Taking into account the half-
year rule and the short fiscal year, the CCA is $1,336.99 [($40,000)(20%)(½)(122/365)].

21. A. Robert has recapture of $44,000 [($320,000 - $80,000) - $196,000]. The capital gain
on the sale of the total property is $200,000 ($520,000 - $320,000) which makes D wrong.

22. A. Sherry has a terminal loss of $8,000 ($168,000 - $160,000).

23. B. $1,050 ($8,000/10) + ($4,500/9 x 50%) = $1,050

24. D. $1,500 decrease

25. B. $640 ($1,600 x 55% x 50%) + ($400 x 100% x 50%) = $640

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26. A. $4,500 ($30,000 maximum x 30% x 50%) = $4,500

27. C. CCA deduction of $2,678 ($17,850 x 30% x 50%)

28. B. $12,500 ($250,000 x 4% x 50%) + ($250,000 x 6% x 50%) = $12,500

29. D. $880 Class 8 ( $600 x 20% x 50%) + Class 12 ( $350 + 470) x 100% = $880

30. C. $10,300 - 1,000 = $9,300. CCA is not deducted until the start of the following year.

31. A Recapture occurs when there is a negative UCC balance in a class at the end of the
taxation year, even if there are assets remaining in the class.

32. C. A delivery truck is leased during the year on a 3 year lease.

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33. A. $75,000/10 = $7,500 CCA annually. Pro-rate for days owned in the year: 30/365 ×
$7,500 = $616

34. D. [($12,900)(30%)(1/2)] = $1,935

35. C. [($4,000)(100%)(½)] = $2,000

36. C. [(1/2)(5%)($60,000)] = $1,500; [($60,000 - $1,500) - $60,000] = ($1,500 Recapture)

[(1/2)($82,000 - $60,000) + $1,500 Recapture] = $12,500.

37. C. The maximum CCA for the year is calculated as 5 percent of the ending balance in the
Class.

38. D. $50,000 - [(1/2)(61/365)(5%)($50,000)] = $49,791

39. A. All of the items would be added to Class 14.1 except A, the cost of fines and
penalties.

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TIF Solution Five - 4

Exam Exercise Solution Five - 1 (Segregation Into Classes)
The correct classes for each of the assets would be as follows:

Asset Class

Cash registers 8

Boats, canoes, and other vessels 7

Airplane runways 17

Passenger vehicle with a cost of $85,000* 10.1

Power operated movable equipment 38

Storage tanks for oil 6

Rental building* 1

Manufacturing and processing equipment 53

*These two assets would have to be allocated to separate classes.

Exam Exercise Solution Five - 2 (CCA Error)

The impact can be calculated as follows:

Correct CCA [($437,000)(1/2)(20%)] $43,700

CCA Taken [($437,000)(1/2)(4%)] ( 8,740)

Understatement Of CCA $34,960

Exam Exercise Solution Five - 3 (CCA Error)

The government license would be allocated to Class 14.1. The resulting overstatement can be calculated
as follows:

Correct CCA Amount [(5%)(1/2)($675,000)] $16,875

CCA Deducted [(20%)(1/2)($675,000)] ( 67,500)

Overstatement Of CCA ($50,625)

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Exam Exercise Solution Five - 4 (Class 13 And Half-Year Rule)

The required CCA calculations would be as follows:

On 2012 Improvements ($112,000 ÷ 10) $11,200

On 2018 Improvements [($41,000 ÷ 4)(1/2)] 5,125

2018 CCA $16,325

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Exam Exercise Solution Five - 5 (Class 10 And Half-Year Rule)

The maximum 2018 CCA of $139,875 and the January 1, 2019 UCC balance of $339,625 would be
calculated as follows:

January 1, 2018 UCC Balance $453,000

Add: Additions $63,200

Deduct: Proceeds Of Dispositions

(Less Than Assets’ Capital Costs) ( 36,700) 26,500

Deduct: One-Half Net Additions [(1/2)($26,500)] ( 13,250)

CCA Base $466,250

CCA [(30%)($466,250)] ( 139,875)

Add: One-Half Net Additions 13,250

January 1, 2019 UCC Balance $339,625

Exam Exercise Solution Five - 6 (Class 8 And Half-Year Rule)

The maximum 2018 CCA of $25,980 and the January 1, 2019 UCC balance of $105,320 would be
calculated as follows:

January 1, 2018 UCC Balance $128,500

Add: Additions $12,400

Deduct: Dispositions - Lesser Of:

 Cost = $9,600

 Proceeds Of Disposition = $10,200 ( 9,600) 2,800

Deduct: One-Half Net Additions [(1/2)($2,800)] ( 1,400)

CCA Base $129,900

CCA [(20%)($129,900)] ( 25,980)

Add: One-Half Net Additions 1,400

January 1, 2019 UCC Balance $105,320

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Exam Exercise Solution Five - 7 (Class 14 - No Half Year Rule)

Limited life franchises are allocated to Class 14. While the half year rule is not applicable to this Class,
CCA is based on the number of days in the year that the asset is used. In this case the maximum 2018
CCA would be $4,858 [($286,000 ÷ 5)(31 ÷ 365)]. The January 1, 2019 UCC balance would be
$281,142 ($286,000 - $4,858).

Exam Exercise Solution Five - 8 (Short Fiscal Periods)

The maximum CCA for the year is $9,432 [(30%)(1/2)($150,000)(153/365)].

Exam Exercise Solution Five - 9 (Short Fiscal Periods)

The maximum CCA for the year is $6,202 [(20%)(1/2)($92,400)(245/365)].

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Exam Exercise Solution Five - 10 (CCA And Tax Planning)

Following the general rule that, when less than the maximum CCA is to be deducted, the amounts
deducted should be taken from the Class(es) with the lowest rates, the required calculations would be as
follows:

Required Total $40,000

Maximum CCA - Class 1 [(4%)($475,000)] ($19,000)

Maximum CCA - Class 8 [(20%)($95,000)] ( 19,000) ( 38,000)

Required Balance $ 2,000

As they are both 30 percent declining balance classes, the remaining $2,000 could be taken from either
Class 10 or Class 10.1. It would be advisable to use Class 10.1, as recapture is not recorded for this
class. In addition, if the Class 10.1 vehicle is going to be disposed of in the near future, it could be
better tax planning to take the maximum CCA for Class 10.1 of $7,800 [(30%)($26,000)] and reduce the
Class 8 CCA to $13,200 ($40,000 - $7,800 - $19,000). Since there is no recapture for Class 10.1, this
could increase future deductions of the other classes. Whether this would be advantageous would
depend on the anticipated proceeds of disposition.

Exam Exercise Solution Five - 11 (CCA And Tax Planning)

Following the general rule that, when less than the maximum CCA is to be deducted, the amounts
deducted should be taken from the Class(es) with the lowest rates, the required calculations would be as
follows:

Required Total $14,000

Maximum CCA - Class 1 [(4%)($213,000)] ($8,520)

Maximum CCA - Class 8 [(20%)($16,000)] ( 3,200) ( 11,720)

Required Balance $ 2,280

The remaining $2,280 would be deducted from Class 10.

Exam Exercise Solution Five - 12 (Capital Gains On Depreciable Assets)

The only tax consequence would be a taxable capital gain of $4,500 [(1/2)($51,000 - $42,000)].

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Exam Exercise Solution Five - 13 (Recapture)

The required information would be calculated as follows:

UCC Of The Class At The Beginning Of The Year $7,423

Deduct: Dispositions During The Year - Lesser Of:

 Capital Cost = $7,500

 Proceeds Of Disposition = $7,950 ( 7,500)

Negative Ending Balance ($ 77)

Recapture Of CCA 77

January 1, 2019 UCC balance Nil

The effect would be an addition to business income of $77 in recaptured CCA. While there would also
be a taxable capital gain of $225 [(1/2)($7,950 - $7,500)], this would not be included in business
income.

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Exam Exercise Solution Five - 14 (Recapture)

The required information would be calculated as follows:

UCC Of The Class At The Beginning Of The Year $32,400

Deduct: Dispositions During The Year - Lesser Of:

 Capital Cost = $62,300

 Proceeds Of Disposition = $41,800 ( 41,800)

Negative Ending Balance ($ 9,400)

Recapture Of CCA 9,400

January 1, 2019 UCC balance Nil

The effect would be an addition to 2018 net business income of $9,400 in recaptured CCA.

Exam Exercise Solution Five - 15 (Terminal Loss)

The required information would be calculated as follows:

UCC Of The Class At The Beginning Of The Year $56,472

Deduct: Dispositions During The Year - Lesser Of:

 Capital Cost = $144,000

 Proceeds Of Disposition = $41,500 ( 41,500)

Ending Balance With No Remaining Assets $14,972

Terminal Loss ( 14,972)

January 1, 2019 UCC balance Nil

As there is a positive balance in the class at the end of the year, but no remaining assets, there would be
a terminal loss of $14,972. This loss is deducted in the calculation of net business income. As there is
no balance in Class 10 on December 31, 2018, no CCA could be taken.

Exam Exercise Solution Five - 16 (Terminal Loss)

The required information would be calculated as follows:

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UCC Of The Class At The Beginning Of The Year $ 83,400

Deduct: May 1 Disposition - Lesser Of:

 Capital Cost = $110,000

 Proceeds Of Disposition = $92,400 ( 92,400)

June 1 Acquisitions 105,000

Deduct: December 1 Disposition - Lesser Of:

 Capital Cost = $105,000

 Proceeds Of Disposition = $65,000 ( 65,000)

Ending Balance With No Remaining Assets $31,000

Terminal Loss ( 31,000)

January 1, 2019 UCC balance Nil

As there is a positive balance in the class at the end of the year, but no remaining assets, there would be
a terminal loss of $31,000. This loss is deducted in the calculation of net business income. As there is
no balance in Class 10 on December 31, 2018, no CCA could be taken.

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Exam Exercise Solution Five - 17

(Depreciable Asset Dispositions - Tax Vs, Accounting)
The accounting results would be calculated as follows:

Proceeds Of Disposition $246,000

Net Book Value ( 92,500)

Accounting Gain $153,500

For tax purposes, there would be a taxable capital gain calculated as follows:

Proceeds Of Disposition $246,000

Capital Cost ( 183,000)

Capital Gain $ 63,000

Inclusion Rate 1/2

Taxable Capital Gain $ 31,500

The capital cost of $183,000 would be subtracted from the UCC, leaving a balance of $1,465,000
($1,648,000 - $183,000).
While this disposition would reduce the maximum CCA for the current and subsequent years, there
would be no recapture (the balance in Class 8 is still positive) or terminal loss (there are still assets in
Class 8).

Exam Exercise Solution Five - 18 (Disposition Of Goodwill)

CCA on Class 14.1 for 2018 would be calculated as follows:

January 1, 2018 Balance Nil

2018 Additions ($243,000 + $317,000) $560,000

One-Half Net Additions [(1/2)($560,000)] ( 280,000)

CCA Base $280,000

2018 CCA [(5%)($280,000)] ( 14,000)

One-Half Net Additions 280,000

January 1, 2019 UCC $546,000

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Deduct: Dispositions During The Year - Lesser Of:

Capital Cost = $560,000 (See Note)

Proceeds Of Disposition

= ($187,000 + $307,000) = $487,000 ( 487,000)

UCC Subsequent to The Sales $ 59,000

Note The capital cost of the single goodwill asset is $560,000, the total of the purchased
goodwill.

There would be no immediate tax consequences resulting from the dispositions. Subsequent to the sales,
Dortran Inc. has a Class 14.1 UCC of $59,000 consisting of goodwill with a capital cost of $73,000
($560,000 - $487,000).

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Exam Exercise Solution Five - 19 (Disposition Of Goodwill)

CCA on Class 14.1 for 2018 would be calculated as follows:

January 1, 2018 Balance Nil

2018 Additions ($213,000 + $243,000) $456,000

One-Half Net Additions [(1/2)($456,000)] ( 228,000)

CCA Base $228,000

2018 CCA [(5%)($228,000)] ( 11,400)

One-Half Net Additions 228,000

January 1, 2019 UCC $444,600

Deduct: Dispositions During The Year - Lesser Of:

Capital Cost = $456,000 (See Note)

Proceeds Of Disposition

= ($165,000 + $276,000) = $441,000 ( 441,000)

UCC Subsequent to The Sales $ 3,600

Note The capital cost of the single goodwill asset is $456,000, the total of the purchased
goodwill.

There would be no immediate tax consequences resulting from the dispositions. Subsequent to the sales,
Brondor has a Class 14.1 UCC of $3,600 consisting of goodwill with a capital cost of $15,000
($456,000 - $441,000).

Exam Exercise Solution Five - 20 (Separate Class Election)

Photocopiers would be included in Class 8, a 20 percent declining balance class. The following table
compares the CCA if no election is made with the results if the separate class election is made.

No Election With Election With Election

5 Copiers 2 Copiers 3 Copiers

January Acquisitions At $5,500 $27,500 $11,000 $16,500

Dispositions At $2,000 ( 4,000) ( 4,000) N/A

Terminal Loss $ 7,000

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December Acquisitions At $6,000 12,000 $12,000

One-Half Net Additions ( 17,750) ( 6,000) ( 8,250)

Base Amount For CCA Claim $17,750 $ 6,000 $ 8,250

Class 8 CCA Rate 20% 20% 20%

CCA For 2018 $ 3,550 $ 1,200 $ 1,650

If no election is made, there will be a deduction for CCA of $3,550. Alternatively, if each machine is
allocated to a separate class, there will be a deduction for CCA of $2,850 ($1,200 + $1,650). In
addition, there will be a terminal loss of $7,000. The use of the election increases the total deductible
amount by $6,300 ($1,200 + $1,650 + $7,000 - $3,550).

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Exam Exercise Solution Five - 21 (Separate Class Election)

Photocopiers would be included in Class 8, a 20 percent declining balance class. The following table
compares the CCA if no election is made with the results if the separate class election is made.

No Election With Election

First Purchase [(3)($23,000)] $69,000 $69,000

Dispositions [(3)($2,500)] ( 7,500) ( 7,500)

Terminal Loss $61,500

November Purchase [(3)($21,500)] 64,500 $64,500

One-Half Net Additions ( 63,000) ( 32,250)

Base Amount For CCA Claim $63,000 $32,250

Class 8 CCA Rate 20% 20%

CCA For 2018 $12,600 $ 6,450

If no election is made, there will be a deduction for CCA of $12,600. Alternatively, if each machine is
allocated to a separate class, there will be a deduction for CCA of $6,450. In addition, there will be a
terminal loss of $61,500. The use of the election increases the total deductible amount by $55,350
($6,450 + $61,500 - $12,600).

Exam Exercise Solution Five - 22 (Conversion Of CEC Balances)

The maximum Class 14.1 CCA for 2017 would be calculated as follows:

CCA On Transferred CEC [(7%)($163,400)] $11,438

Addition To The Class [(5%)(1/2)($112,000)] 2,800

Maximum 2017 CCA $14,238

Exam Exercise Solution Five - 23 (Conversion Of CEC Balances)

The maximum Class 14.1 CCA for 2018 would be calculated as follows:

January 1, 2017 Class 14.1 Balance -

Transfer From CEC $48,600

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Maximum 2017 CCA [(7%)($48,600)] ( 3,402)

January 1, 2018 Class 14.1 Balance $45,198

CCA On Transferred CEC [(7%)($45,198)] $3,164

CCA Addition To The Class [(5%)(1/2)($46,000)] 1,150

Maximum 2018 CCA $4,314

Exam Exercise Solution Five - 24 (Determination Of Capital Cost)

The amount that would have been added to the CEC account in 2014 would have been $225,000 [(3/4)
($240,000 + $60,000)]. Using this information, the capital cost of the two unlimited life franchises
would be calculated as follows:

[(4/3)($180,980)] $241,307

[(4/3)($225,000 - $180,980)] 58,693

Capital Cost - Unlimited Life Franchises $300,000

Note that the capital cost is equal to the amount paid since there have been no dispositions.

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Exam Exercise Solution Five - 25 (Determination Of Capital Cost)

The amount that would have been added to the CEC account in 2015 would have been $164,250 [(3/4)
($96,000 + $123,000)]. Using this information, the capital cost of the two unlimited life franchises
would be calculated as follows:

[(4/3)($142,060)] $189,413

[(4/3)($164,250 - $142,060)] 29,587

Capital Cost - Unlimited Life Franchises $219,000

Note that the capital cost is equal to the amount paid since there have been no dispositions.

Exam Exercise Solution Five - 26 (Allocation Of Capital Cost)

The relevant calculations here are as follows:

CEC Additions [(3/4)(($175,000 + $260,000 + $141,000)]$432,000

Dispositions [(3/4)($211,000 + $315,000)] ( 394,500)

CEC Balance $ 37,500

2016 CEC Deduction [(7%)($37,500)] ( 2,625)

December 31, 2016 CEC $ 34,875

The total capital cost for the remaining asset is calculated as follows:

[(4/3)($34,875)] $46,500

[(4/3)($2,625)] 3,500

Capital Cost $50,000

There was an excess of proceeds of disposition over capital cost on the two dispositions of $91,000
[($211,000 - $175,000) + ($315,000 - $260,000)]. The amount allocated to the third franchise reflects
its $141,000 cost reduced by the gains on the other two franchises. This leaves a capital cost of $50,000
($141,000 - $91,000).

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Exam Exercise Solution Five - 27 (Allocation Of Capital Cost)

The relevant calculations here are as follows:

CEC Additions [(3/4)(($42,000 + $96,000 + $118,000)]$192,000

Dispositions [(3/4)($51,000 + $108,000)] ( 119,250)

CEC Balance $ 72,750

2016 CEC Deduction [(7%)($72,750)] ( 5,093)

December 31, 2016 CEC $ 67,657

The total capital cost for the remaining asset is calculated as follows:

[(4/3)($67,657)] $90,209

[(4/3)($5,093)] 6,791

Capital Cost $97,000

There was an excess of proceeds of disposition over capital cost on the two dispositions of

$21,000 [($51,000 - $42,000) + ($108,000 - $96,000). The amount allocated to the third franchise
reflects its $118,000 cost reduced by the gains on the other two franchises. This leaves a capital cost of
$97,000 ($118,000 - $21,000).

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TIF Solution Five - 5A

The correct definitions for each of the listed key terms are as follows:

A. 3

B. 4

C. 9

D. 5

E. 6

F. 1

G. 2

H. 7

The unused definition is as follows:

CCA = 9

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TIF Solution Five - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.

The correct definitions for each of the listed key terms are as follows:

A. 4 (not 8)

B. 6 (not 2)

C. 11

D. 7

E. 9

F. 1 (not 12)

G. 3

H. 10 (not 5)

The unused definition is as follows:

CCA = 13

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TIF Solution Five - 6

Case One
For the year ending December 31, 2018, the maximum CCA, as well as the UCC balance for January 1,
2019 for Fromor’s Class 14.1 would be as calculated as follows:

January 1, 2018 Balance Nil

2018 Additions ($127,000 + $186,000) $313,000

One-Half Net Additions [(1/2)($313,000)] ( 156,500)

CCA Base $156,500

2018 CCA [(5%)($156,500)] ( 7,825)

One-Half Net Additions 156,500

January 1, 2019 UCC $305,175

The results for 2019, including maximum CCA of $8,159, would be calculated as follows:

January 1, 2019 UCC $305,175

Disposition - Lesser Of:

Capital Cost = $313,000

Proceeds Of Disposition = $142,000 ( 142,000)

CCA Base $163,175

2019 CCA [(5%)($163,175)] ( 8,159)

January 1, 2020 UCC $155,016

There would be no immediate tax consequences resulting from the sale of goodwill, other than a
reduction in the UCC. Note that the capital cost in the calculation is of the single goodwill property.

Case Two
For the year ending December 31, 2018, the maximum CCA, as well as the UCC balance for January 1,
2019 for Fromor’s Class 14.1 would be as calculated as follows:

January 1, 2018 Balance Nil

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2018 Additions ($64,000 + $98,000) $162,000

One-Half Net Additions [(1/2)($162,000)] ( 81,000)

CCA Base $ 81,000

2018 CCA [(5%)($81,000)] ( 4,050)

One-Half Net Additions 81,000

January 1, 2019 UCC $157,950

The results for 2019 would be as follows:

January 1, 2019 UCC $157,950

Disposition - Lesser Of:

Capital Cost Of Goodwill = $64,000

Proceeds Of Disposition = $85,000 ( 64,000)

CCA Base $ 93,950

2019 CCA [(5%)($93,950)] ( 4,698)

January 1, 2020 UCC $ 89,252

While Fromor would still have a goodwill account, its capital cost would be nil.

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Proceeds Of Disposition $85,000

Capital Cost Of Goodwill ( 64,000)

Capital Gain $21,000

Inclusion Rate 1/2

Taxable Capital Gain $10,500

There would be maximum CCA of $4,698 and a taxable capital gain of $10,500 resulting in a net
increase in Net Income For Tax Purposes of $5,802.

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TIF Solution Five - 7

Note To Instructor The textbook does not cover what specific types of assets would be
allocated to Class 53, other than that they would be manufacturing and processing assets. As a
result, the problem states that the kitchen equipment is allocated to Class 8 in order to resolve
any uncertainty on this issue that might arise.

2015 Solution
The required calculations are as follows:

Class 13 Class 8 Class 10

Opening Balance Nil Nil Nil

Additions During Year $175,000 $124,000 $200,000

One-Half Net Additions ( 87,500) ( 62,000) ( 100,000)

CCA Base $ 87,500 $ 62,000 $100,000

Class 13 CCA [($87,500  10)(122/365) ( 2,925)

Class 8 CCA [(20%)($62,000)(122/365)] ( 4,145)

Class 10 CCA [(30%)($100,000)(122/365)] ( 10,027)

One-Half Net Additions 87,500 62,000 100,000

UCC - January 1, 2016 $172,075 $119,855 $189,973

As the business was established on September 1, 2015, its operations were carried out for 122 days in
2015, and only a proportionate share of the annual CCA charge may be taken. We would call your
attention to the fact that it is the length of the taxation year, not the period of ownership of the assets,
that establishes the fraction of the year for which CCA is to be recorded.

2016 Solution
The required calculations are as follows:

Class 13 Class 8 Class 10

Opening Balance $172,075 $119,855 $189,973

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Additions [(5)($27,000)] Nil Nil 135,000

Dispositions - Lesser Of:

- Capital Cost [(4)($25,000)] = $100,000

- Proceeds = $81,000 ( 81,000)

One-Half Net Additions N/A N/A ( 27,000)

CCA Base $172,075 $119,855 $216,973

Class 13 CCA ($175,000  10) ( 17,500)

Class 8 CCA [(20%)($119,855)] ( 23,971)

Class 10 CCA [(30%)($216,073)] ( 65,092)

One-Half Net Additions 27,000

UCC - January 1, 2017 $154,575 $ 95,884 $178,881

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2017 Solution
The required calculations are as follows:

Class 13 Class 8 Class 10

Opening Balance $154,575 $ 95,884 $178,881

Additions 98,000 62,000 Nil

Dispositions For Class 8 - Lesser Of:

- Capital Cost = $5,000

- Proceeds = Nil Nil

Dispositions For Class 10 - Lesser Of:

- Capital Cost [(4)($25,000) + (5)($27,000)]

= $235,000

- Proceeds = $185,000 Nil Nil ( 185,000)

One-Half Net Additions ( 49,000) ( 31,000) N/A

CCA Base $203,575 $126,884 N/A

Ending Negative Balance ($ 6,119)

Class 13 CCA -

($175,000  10) ( 17,500)

[(1/2)($98,000*  8)] ( 6,125)

Class 8 CCA [(20%)($126,884)] ( 25,377)

Class 10 Recapture 6,119

One-Half Net Additions 49,000 31,000 N/A

UCC - January 1, 2018 $228,950 $132,507 Nil

* Class 13 effectively treats each leasehold improvement as a separate property. As a result,

the half year rule is applied to the $98,000 expenditure when calculating CCA for the year.

2018 Solution
For each Class the lesser of the capital cost of the assets retired and the proceeds of disposition must be
subtracted from the relevant Class. The relevant capital costs are as follows:

Class 13 ($175,000 + $98,000) $273,000

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Class 8 ($124,000 + $62,000 - $5,000) 181,000

Class 14.1 Nil

For Class 13 and Class 8, the capital costs exceed the proceeds of disposition. For Class 14.1, the nil
cost of the single goodwill property is less than the $100,000 proceeds of disposition.
Using this information, the relevant calculations are as follows:

Class 13 Class 8 Class 14.1

UCC - January 1, 2018 $228,950 $132,507 Nil

Class 13 Proceeds Of Disposition ( 112,000)

Class 8 Proceeds Of Disposition ( 50,000)

Class 14.1 Cost Nil

Terminal Loss - 2018 $116,950 $ 82,507 Nil

With respect to the goodwill, there would be a taxable capital gain, calculated as follows:

Proceeds Of Disposition $100,000

Cost Of Single Goodwill Property Nil

Capital Gain $100,000

Inclusion Rate 1/2

Taxable Capital Gain $ 50,000

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Summary (Not Required)

Class 13 Class 8 Class 10

2015 CCA $ 2,925 $ 4,145 $10,027

2016 CCA 17,500 23,971 65,092

2017 CCA 23,625 25,377 N/A

2017 Recapture N/A N/A 6,119

2018 Terminal Loss 116,950 82,507 N/A

In addition, there is a 2018 taxable capital gain on the sale of goodwill of $50,000.

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TIF Solution Five - 8

Cumulative Eligible Capital And Class 14.1

Note To Instructors We rounded to cents rather than dollars for CEC calculations only. This
allows for a clearer picture of the application of the CEC transitional rules.

For the acquisitions prior to January 1, 2017, three-quarters of the costs of incorporation was added to
the CEC balance. It was written off on a declining balance basis at a rate of 7 percent. CEC was not
subject to the first year one-half rules. Given these facts, the required information is as follows:

CEC Balance CEC Deductions

Additions [(3/4)($25,000)] $18,750.00

2015 CEC Amount [(7%)($18,750)] ( 1,312.50) $1,312.50

CEC - January 1, 2016 $17,437.50

2016 CEC Amount [(7%)($17,437.50)] ( 1,220.63) 1,220.63

CEC - December 31, 2016 $16,216.87

The December 31, 2016 CEC balance became the January 1, 2017 UCC balance in Class 14.1. The
capital cost of this balance is calculated as follows:

[(4/3)($16,216.87)] $21,622.50

[(4/3)($1,312.50 + $1,220.63)] 3,377.50

Total Capital Cost For Class 14.1 $25,000.00

With respect to the customer list that was sold, the capital cost for this individual asset would be the
lesser of:

 The total capital cost for Class 14.1 = $25,000.00

 The expenditure that was made for the asset = Nil

The resulting Class 14.1 balance after the disposition would be as follows:

January 1, 2017 UCC Balance $16,216.87

Lesser Of:
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Proceeds Of Disposition = $50,000.00

Capital Cost = Nil Nil

Business Terminated = Terminal Loss $16,216.87

As an operating business will always have a goodwill account, even if the balance is nil, Class 14.1 will
not have a terminal loss if the business continues. However, in this case the business has been
terminated and the terminal loss can be recognized.
The additional tax consequences for Class 14.1 include a taxable capital gain, calculated as follows:

Proceeds Of Disposition $50,000.00

Adjusted Cost Base Nil

Capital Gain $50,000.00

Inclusion Rate 1/2

Taxable Capital Gain $25,000.00

Deducting the terminal loss from the taxable capital gain leaves a net inclusion for 2017 Net Income For
Tax Purposes of $8,783.13 ($25,000 - $16,216.87).

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Class 13
The leasehold improvements will be written off on a straight-line basis over the original term, plus the
term of the first renewal, a total of 10 years. Class 13 is subject to the first-year rules. Given these facts,
the required information is as follows:

Acquisitions $150,000

2015 CCA [(1/2)($150,000  10)] ( 7,500)

UCC - January 1, 2016 $142,500

2016 CCA ($150,000  10) ( 15,000)

UCC - January 1, 2017 $127,500

Disposition - Lesser Of:

 Capital Cost = $150,000

 POD = $75,000 ( 75,000)

Ending Balance With No Assets In Class = Terminal Loss$ 52,500

The $52,500 terminal loss would be deducted in the determination of 2017 Net Income For Tax
Purposes.

Class 14
The cost of the franchise will be written off on a straight-line basis over its legal life. Class 14 is not
subject to the first-year rules. However, CCA must be calculated on a pro rata, per diem basis. As the
agreement was signed on January 1, 2015, no per diem adjustment is required. Given these facts, the
required information is as follows:

Acquisitions $220,000

2015 CCA [($220,000  5)] ( 44,000)

UCC - January 1, 2016 $176,000

2016 CCA [($220,000  5)] ( 44,000)

UCC - January 1, 2017 $132,000

Disposition - Lesser Of:

Capital Cost = $220,000

POD = $200,000 ( 200,000)

Negative Ending Balance = Recapture Of CCA ($ 68,000)

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The $68,000 of recapture would be included in the 2017 Net Income For Tax Purposes.

Class 29
2015 was the last year that manufacturing equipment could be allocated to Class 29. Given this, the
manufacturing equipment will be written off on a straight-line basis at a rate of 50 percent, subject to the
first-year rules. The required calculations are as follows:

Acquisitions $262,000

2015 CCA [(1/2)(50%)($262,000)] ( 65,500)

UCC - January 1, 2016 $196,500

2016 CCA [(50%)($262,000)] ( 131,000)

UCC - January 1, 2017 $ 65,500

Disposition - Lesser Of:

Capital Cost = $262,000

POD = $186,000 ( 186,000)

Negative Ending Balance = Recapture Of CCA ($120,500)

The $120,500 of recapture would be included in the 2017 Net Income For Tax Purposes.

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Class 8
The furniture and fixtures will be written off on a declining balance basis at a rate of 20 percent. Class 8
is subject to the first-year rules. Given these facts, the required information is as follows:

Acquisitions $87,000

2015 CCA [(1/2)(20%)($87,000)] ( 8,700)

UCC - January 1, 2016 $78,300

2016 CCA [(20%)($78,300)] ( 15,660)

UCC - January 1, 2017 $62,640

Disposition - Lesser Of:

Capital Cost = $87,000

POD = $23,000 ( 23,000)

Ending Balance With No Assets = Terminal Loss $39,640

The $39,640 terminal loss would be deducted in the determination of 2017 corporate Net Income For
Tax Purposes.

Class 12
Class 12 is subject to a 100 percent write off in the year of acquisition. Small tools with a cost of less
than $500 each are not subject to the first-year rules. Given these facts, the required information is as
follows:

Acquisitions $12,000

2015 CCA [(100%)($12,000)] ( 12,000)

UCC - January 1, 2016 Nil

2016 CCA Nil

UCC - January 1, 2017 Nil

Disposition - Lesser Of:

Capital Cost = $12,000

POD = $5,000 ( 5,000)

Negative Ending Balance = Recapture Of CCA ($5,000)

The $5,000 of recapture would be included in the 2017 Net Income For Tax Purposes.

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Class 10
The delivery vans are written off on a declining balance basis at a rate of 30 percent. Class 10 is subject
to the first-year rules. Given these facts, the required information is as follows:

Acquisitions $160,000

2015 CCA [(1/2)(30%)($160,000)] ( 24,000)

UCC - January 1, 2016 $136,000

2016 CCA [(30%)($136,000)] ( 40,800)

UCC - January 1, 2017 $ 95,200

Disposition - Lesser Of:

Capital Cost = $160,000

POD = $85,000 ( 85,000)

Ending Balance With No Assets = Terminal Loss $ 10,200

The $10,200 terminal loss would be deducted in the determination of 2017 corporate Net Income For
Tax Purposes.

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Class 10.1
The BMW will be put into a separate Class 10.1, with the 2015 addition being limited to $30,000. It
will be subject to a 30 percent declining balance write off. Class 10.1 is subject to the first-year rules.
Given these facts, the required information is as follows:

Acquisitions $30,000

2015 CCA [(1/2)(30%)($30,000)] ( 4,500)

UCC - January 1, 2016 $25,500

2016 CCA [(30%)($25,500)] ( 7,650)

UCC - January 1, 2017 $17,850

2017 CCA [(1/2)(30%)($17,850)] $2,678

In Class 10.1, recapture is not recognized. This means that the $65,000 in insurance proceeds can be
ignored in calculating 2017 corporate Net Income For Tax Purposes.
Note that the taxpayer is permitted to take one-half year’s CCA in the year of disposition. Since the
Company was terminated on December 30, there is no short fiscal year to deal with.

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TIF Solution Five - 9

Sale Of Equipment
The tax consequences of the sale of equipment can be analyzed as follows:

Opening UCC Balance $ 2,100

Dispositions - Lesser Of:

 Capital Cost = $26,000

 Proceeds Of Disposition = $21,000 ( 21,000)

Negative Ending Balance ($18,900)

Recaptured CCA 18,900

January 1, 2019 UCC Balance Nil

There would be no Class 8 CCA for this year. The sale of the equipment would increase Net Income
For Tax Purposes of Vance Enterprises by $18,900.

Sale Of Buildings
The tax consequences of the sale of buildings can be analyzed as follows:

Opening UCC Balance $205,000

Dispositions - Lesser Of:

 Capital Cost = $250,000

 Proceeds Of Disposition = $262,000

($342,000 - $80,000) ( 250,000)

Negative Ending Balance ($ 45,000)

Recaptured CCA 45,000

January 1, 2019 UCC Balance Nil

The sale of the buildings would result in a taxable capital gain that would be calculated as follows:

Proceeds Of Disposition ($342,000 - $80,000) $262,000

Capital Cost ( 250,000)

Capital Gain $ 12,000

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Inclusion Rate 1/2

Taxable Capital Gain $ 6,000

There would be no Class 1 CCA for this year. The sale of the buildings would increase Net Income For
Tax Purposes of Vance Enterprises by $51,000 ($45,000 + $6,000). As the adjusted cost base of the
land is equal to the proceeds of disposition, there is no gain on the disposition of the land.

Leasehold Improvements
The leasehold improvements must be included in Class 13 and are subject to straight line write-off over
the life of the lease. However, the minimum life that may be used is five years, resulting in a 2018 CCA
deduction of $3,900 [(1/2)($39,000 ÷ 5)] and a January 1, 2019 Class 13 UCC of $35,100.

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Sale Of Automobile
The tax consequences of the sale of the automobile can be analyzed as follows:

Opening UCC Balance $10,200

Dispositions - Lesser Of:

 Capital Cost = $20,500

 Proceeds Of Disposition = $8,900 ( 8,900)

Ending Balance With No Remaining Assets $ 1,300

Terminal Loss ( 1,300)

January 1, 2019 UCC Balance Nil

Since the capital cost of the automobile is less than the prescribed limit, the automobile is not a Class
10.1 asset. This terminal loss must be deducted in the year ending December 31, 2018. As a
consequence, there will be no Class 10 CCA for the year.
In addition, Ms. Vance would have to report a taxable benefit related to the personal use of the
automobile during the year.

Sale Of Goodwill - Class 14.1

The tax consequences of the sale of the goodwill can be analyzed as follows:

January 1, 2018 Balance In Class 14.1 Nil

Disposition - Lesser Of:

Capital Cost = Nil

Proceeds Of Disposition = $110,000 Nil

December 31, 2018 And January 1, 2019 UCC BalanceNil

There would be a taxable capital gain resulting from the sale of goodwill. It would be calculated as
follow:

Proceeds Of Disposition $110,000

Capital Cost Nil

Capital Gain $110,000

Inclusion Rate 1/2

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Taxable Capital Gain $ 55,000

Summary Of CCA And UCC Results (Not Required)

The maximum CCA for the year ending December 31, 2018 and the January 1, 2019 UCC balances can
be summarized as follows:

Maximum CCA UCC

Class 8 Nil Nil

Class 1 Nil Nil

Class 13 $3,900 35,100

Class 10 Nil Nil

Class 14.1 Nil Nil

In addition, the following income effects resulted from the information provided in the problem:

Recapture On Class 8 Assets $ 18,900

Recapture On Class 1 Assets 45,000

Taxable Capital Gain On Class 1 Assets 6,000

Terminal Loss On Class 10 Assets ( 1,300)

Taxable Capital Gain On Sale Of Goodwill (Class 14.1)55,000

Total Inclusion $123,600

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TIF Solution Five - 10

The maximum CCA for the 3 years would be calculated as in the following schedules:

2016 Class 1 Class 10 Class 8

Opening Balance Nil Nil Nil

Additions

Class 1 ($326,000 - $53,000) $273,000

Class 10 [(12)($23,000)] $276,000

Class 8 $85,000

One-Half Net Additions ( 136,500) ( 138,000) ( 42,500)

CCA Base $136,500 $138,000 $42,500

Maximum CCA

Class 1 [(6%)($136,500)(245 ÷ 365)]* ( 5,497)

Class 10 [(30%)($138,000)(245 ÷ 365)] ( 27,789)

Class 8 [(20%)($42,500)(245 ÷ 365)] ( 5,705)

One-Half Net Additions 136,500 138,000 42,500

January 1, 2017 UCC $267,503 $248,211 $79,295

*As the Class 1 building is being used 100 percent for non-residential purposes and is allocated
to a separate Class 1, it would qualify for the 6 percent CCA rate.

The total maximum CCA for 2016 would be $38,991 ($5,497 + $27,789 + $5,705).

2017 Class 1 Class 10 Class 8 Class 10.1

Beginning UCC $267,503 $248,211 $79,295 Nil

Additions

Class 1 Nil

Class 10 [(5)($27,000)] 135,000

Class 8 Nil

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Class 10.1* $30,000

Class 10 Disposition - Lesser Of:

Capital Cost = $115,000

Proceeds = $80,000 Nil ( 80,000) Nil

One-Half Net Additions Nil ( 27,500) Nil ( 15,000)

CCA Base $267,503 $275,711 $79,295 $15,000

Maximum CCA

Class 1 [(6%)($267,503)] ( 16,050)

Class 10 [(30%)($275,711)] ( 82,713)

Class 8 [(20%)($79,295)] ( 15,859)

Class 10.1 [(30%)($15,000)] ( 4,500)

One-Half Net Additions 27,500 Nil 15,000

January 1, 2018 UCC $251,453 $220,498 $63,436 $25,500

*The CCA base for a Class 10.1 (luxury) car is limited to $30,000.

The total maximum CCA for 2017 would be $119,122 ($16,050 + $82,713 + $15,859 + $4,500).

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2018 Class 1 Class 10 Class 8

Beginning UCC $251,453 $220,498 $63,436

Additions Nil Nil Nil

Proceeds Of Disposition - Lesser Of:

$289,000 Vs. $273,000 ( 273,000)

$296,000 Vs. $135,500 ( 135,500)

$85,000 Vs. $12,300 ( 12,300)

Balance With No Remaining Assets ( $21,547) $ 84,998 $51,136

Class 1 Recapture 21,547

Terminal Losses ( 84,998) ( 51,136)

January 1, 2019 UCC Nil Nil Nil

With respect to the Class 10.1 vehicle, the Income Tax Regulations permit taking one-half of the regular
CCA in the year of disposition. Since the final year is not a short fiscal period, this amount would be
$3,825 [(1/2)(30%)($25,500)].
No recapture or terminal loss can be recognized with respect to Class 10.1. However, the balance would
be eliminated, leaving a January 1, 2019 UCC of nil.
The only CCA for 2018 would be the Class 10.1 CCA of $3,825 as Classes 1, 8 and 10 had no CCA for
the year. There would be recapture of $21,547 for Class 1, a terminal loss of $84,998 for Class 10 and a
$51,136 terminal loss for Class 8.
There would also be a taxable capital on the building of $8,000 [(1/2)($289,000 - $273,000)].

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TIF Solution Five - 11

Note To Instructor Although the replacement property rules (covered in Chapter 8) might be
considered relevant as a building was burned down and a new building was purchased, we have
specified that a warehouse was disposed of, and an office building was purchased, to avoid that
complication in this problem.

Class 1
As it is a new building, is going to be used 100 percent for non-residential purposes, and it has been put
in a separate Class, it is eligible for the enhanced CCA rate of 6 percent. Given this, the required
information for this Class is as follows:

January 1, 2018 UCC Nil

Additions ($623,000 - $145,000) $478,000

One-Half Net Additions ( 239,000)

Balance Subject To CCA $239,000

CCA [(6%)($239,000)] ( 14,340)

One-Half Net Additions 239,000

January 1, 2019 UCC $463,660

Class 3
The required information for this Class is as follows:

January 1, 2018 UCC $798,000

Dispositions - Lesser Of:

Capital Cost = $150,000

Proceeds Of Disposition = $185,000 ( 150,000)

Balance Subject To CCA $648,000

CCA [(5%)($648,000)] ( 32,400)

January 1, 2019 UCC $615,600

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There would also be a taxable capital gain from the disposition of $17,500 [(1/2)($185,000 - $150,000)].

Class 8
The required calculations for this class would be as follows:

January 1, 2018 UCC $346,000

Additions $105,000

Dispositions - Lesser Of:

 Capital Cost = $83,000

 Proceeds Of Disposition = $75,000 ( 75,000) 30,000

One-Half Net Additions [(1/2)($30,000)] ( 15,000)

Balance Subject To CCA $361,000

CCA [(20%)($361,000)] ( 72,200)

One-Half Net Additions 15,000

January 1, 2019 UCC Balance $303,800

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Class 10 - Vehicles
The required information for this Class would be calculated as follows:

January 1, 2018 UCC $150,000

Additions [(3)($25,000)] $75,000

Disposition of Truck - Lesser Of:

 Capital Cost = $42,000

 Proceeds Of Disposition = $18,000 ( 18,000) 57,000

One-Half Net Additions [(1/2)($57,000)] ( 28,500)

Balance Subject To CCA $178,500

CCA [(30%)($178,500)] ( 53,550)

One-Half Net Additions 28,500

January 1, 2019 UCC Balance $153,450

Class 10.1
In the case of Class 10.1, recapture is not included in income and terminal losses cannot be deducted.
However, in the year of disposition, one-half of the usual CCA can be deducted. This would be $2,678
[(1/2)(30%)($17,850)]. The January 1, 2019 UCC balance would be nil.

Class 13
The 2016 improvements are being written off over 10 years, the original term of the lease (8 years), plus
the first renewal of two years. As the Company takes maximum CCA each year, the CCA taken in 2016
and 2017 must equal 15 percent [(10%)(1/2) + 10%] of the cost of the improvements. Given this, the
January 1, 2018 UCC must equal 85 percent of the cost of the improvements. This indicates that the
cost must have been $50,000 ($42,500  85%).
Given this, the required information for this Class would be as follows:

January 1, 2018 Balance $42,500

Additions 40,000

Balance Subject To CCA $82,500

CCA:

 First Improvements ($50,000 ÷ 10) ($5,000)

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 Current Improvements
[($40,000 ÷ 8)(1/2)] ( 2,500) ( 7,500)

January 1, 2019 UCC Balance $75,000

Class 50
The required information for this Class can be calculated as follows:

January 1, 2018 Balance $23,000

Additions 18,000

One-Half Net Additions [(1/2)($18,000)] ( 9,000)

CCA Base $32,000

CCA [(55%)($32,000)] ( 17,600)

One-Half Net Additions 9,000

January 1, 2019 UCC $23,400

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Class 53
The required information for this Class would be calculated as follows:

January 1, 2018 Balance $63,000

Disposition - Lesser Of:

 Capital Cost = $84,000

 Proceeds Of Disposition = $51,000 ( 51,000)

Balance Before Terminal Loss $12,000

Terminal Loss ( 12,000)

January 1, 2019 UCC Balance Nil

After all of the assets in Class 53 have been sold there is still a $12,000 UCC balance. This results in a
terminal loss that will be deducted in full from the Net Income of Fortin Aluminum. The terminal loss
will also be deducted from the UCC balance.

Summary Of The Results (Not Required)

The maximum CCA for the year ending December 31, 2018 and the January 1, 2019 UCC balances can
be summarized as follows:

Maximum CCA UCC

Class 1 $14,340 $463,660

Class 3 32,400 615,600

Class 8 72,200 303,800

Class 10 53,550 153,450

Class 10.1 2,678 Nil

Class 13 7,500 75,000

Class 50 17,600 23,400

Class 53 Nil Nil

In addition, the following income effects resulted from the information provided in the problem:

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Taxable Capital Gain On Class 3 Building $17,500

Terminal Loss On Class 53 Assets ( 12,000)

Total Addition $ 5,500

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TIF Solution Five - 12

Part A
The required calculation of the maximum CCA for 2018 is as follows:

Class 8 (Note 1) $ 46,600

Class 10 [(30%)($152,000)] 45,600

Class 12 (Note 2) 56,000

Class 13 (Note 3) 32,000

Class 14.1 (See Note 4) 13,671

Maximum Total $193,871

Note 1 The Class 8 CCA would be calculated as follows:

Opening Balance $220,000

Additions 42,000

Proceeds Of Disposition (Less Than Cost) ( 16,000)

One-Half Net Additions [(1/2)($42,000 - $16,000)] ( 13,000)

CCA Base $233,000

CCA Rate 20%

Maximum CCA $ 46,600

Note 2 The rate for Class 12 is 100 percent. However, some additions to this Class are subject
to the half-year rules. The presence of an opening balance of $56,000 indicates that there must
have been $112,000 of costs in 2017 that were subject to this rule. Given this, the entire
balance could be deducted in 2018.

Note 3 The $272,000 balance in Class 13 is equal to 85 percent of $320,000. This means that
during the two years 2016 and 2017, 15 percent of their cost was deducted as CCA. As the
half-year rules are applicable to this Class, this represents a half year for 2016 and a full year
for 2017. Since Class 13 is a straight-line Class, this indicates that the CCA rate is 10 percent
(15% ÷ 1.5). Based on this analysis, maximum CCA for 2018 would be $32,000 [(10%)
($320,000)].

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Note 4 While the basic rate for Class 14.1 is 5 percent, a transitional provision allows the use
of 7 percent on former CEC balances that are carried forward. Given this, the maximum CCA
for this Class is $13,671 [(7%)($195,300)].

Part B
Since the Company only has Net and Taxable Income before CCA of $51,000 and the problem states
that loss carry overs should not be considered, maximum CCA would not be deducted. Only $51,000 in
CCA should be taken in order to reduce the Taxable Income to nil.
As to which balances of CCA should be reduced, the usual procedure is to deduct the required amount
from the balances with the lowest rates. By leaving the balances with higher rates untouched, larger
amounts of CCA can be deducted in later periods as required.
Taking this approach, the recommended CCA deductions would be as follows:

Class 14.1 (Maximum Available) $13,671

Class 13 (Maximum Available) 32,000

Class 8 ($51,000 - $13,671 - $32,000) 5,329

Total CCA $51,000

The deduction of this amount of CCA would serve to reduce Taxable Income to nil.

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TIF Solution Five - 13

Part A
Since there are two buildings in Class 1, the applicable rate must be 4 percent. The required calculation
of the maximum CCA is as follows:

Class 1 Class 13 Class 10

Opening Balance $462,000 $94,500 $139,000

Additions Nil Nil 76,000

Proceeds Of Disposition Nil Nil ( 58,000)

One-Half Net Additions Nil Nil ( 9,000)

CCA Base $462,000 $94,500 $148,000

CCA Rate 4% See Note 30%

Maximum CCA $ 18,480 $21,000 $ 44,400

Note CCA on Class 13 would be calculated by the dividing the cost of the leasehold
improvements by the original term of the lease, plus one renewal period. This gives $21,000
[$126,000 ÷ (4 + 2)] per year.

This gives a maximum amount for CCA of $83,880 for the taxation year ($18,480 + $21,000 +
$44,400).

Part B
Since the Company only has Net and Taxable Income before CCA of $42,000 and the problem states
that loss carry overs should not be considered, maximum CCA would not be deducted as this would
produce a loss. Only $42,000 in CCA should be taken in order to reduce the Taxable Income to nil.
With respect to the classes from which it should be taken, the usual procedure is to deduct the required
amount from the classes with the lowest rates. By leaving the classes with higher rates untouched,
larger amounts of CCA can be deducted in later periods as required.
Taking this approach, the recommended CCA deductions would be as follows:

Class 1 (Maximum Available) $18,480

Class 13 (Maximum Available) 21,000

Class 10 ($42,000 - $18,840 - $21,000) 2,520

Total CCA $42,000

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The deduction of this amount of CCA would serve to reduce Net Income For Tax Purposes and Taxable
Income to nil.
Note that if Axel plans to accept the offer to sell the building and the purchase price is more than the
Class 1 opening UCC, this could affect the choice of classes to deduct CCA from as any additional CCA
taken on Class 1 would have to be added to income as recaptured CCA when the building is sold.
If the Class 13 leasehold improvements relate to the building with the offer, it is unlikely that the offer
will contain proceeds allocated to the leasehold improvements that are more than the Class 13 opening
UCC. However, if that is the case, this too could affect the choice of classes to deduct the CCA from.

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TIF Solution Five - 14

Note To Instructor: The replacement property rules are covered in Chapter 8 and are not
taken into consideration in this problem for the building.

Class 1
The calculations related to the building that was replaced are as follows:

Opening UCC Balance $478,695

Disposition - Lesser Of:

Proceeds = $525,000 ($650,000 - $125,000)

Capital Cost = $545,000 ($625,000 - $80,000) ( 525,000)

Negative Ending Balance = Recapture Of CCA ($ 46,305)

There is also a capital gain resulting from the sale of the land. However, the requirements of the
problem are limited to CCA, recapture, and terminal losses.
Since the replacement building is new, used 100 percent for non-residential purposes and allocated to a
separate Class 1, it qualifies for an enhanced CCA rate. As it is not used for manufacturing and
processing, the enhanced rate is 6 percent. Using this rate, the CCA on the new building would be as
follows:

Opening UCC Balance Nil

Additions ($745,000 - $125,000) $620,000

One-Half Net Additions [(1/2)($620,000)] ( 310,000)

CCA Base $310,000

Rate 6%

Maximum CCA $ 18,600

Class 8
The required calculation here would be as follows:

Opening Class 8 Balance $243,000

Additions 74,000

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Disposals: Lesser Of:

Capital Cost = $56,000

Proceeds = $17,000 ( 17,000)

One-Half Net Additions [(1/2)($74,000 - $17,000)] ( 28,500)

CCA Base $271,500

Rate 20%

Maximum CCA $ 54,300

Class 10
The required calculations here would be as follows:

Opening UCC Balance And CCA Base $126,000

Rate 30%

Maximum CCA $ 37,800

Class 10.1
The Lexus would be allocated to a separate Class 10.1. The amount would be limited to $30,000,
resulting in maximum CCA of $4,500 [(1/2)(30%)($30,000)]. The kilometers driven for personal
purposes would affect the taxable benefit, but does not affect the CCA.

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Class 13
Class 13 is a straight-line class. In this case, the term of the lease and one renewal totals ten years,
resulting in a 10 year write off. The maximum CCA would be $15,000 ($150,000 ÷ 10).

Class 14
The limited life franchise would be allocated to Class 14 and amortized on a straight line basis over its
legal life. Although this franchise was purchased on August 1, this would only affect the year of
acquisition and the last year of its life. The maximum CCA would be for a complete year and would
equal $7,750 ($62,000 ÷ 8).

Class 14.1
In 2015, the cost of the unlimited life franchise was allocated to the Company’s CEC account. The
relevant calculations for 2015 and 2016 are as follows:

CEC Balance CEC Deductions

2015 Addition [(3/4)($84,000)] $63,000

CEC Amount At 7 Percent ( 4,410) $4,410

January 1, 2016 Balance $58,590

CEC Amount At 7 Percent ( 4,101) 4,101

CEC Balance - December 31, 2016

And Total CEC Deductions $54,489 $8,511

This December 31, 2016 balance will be transferred to Class 14.1, establishing the January 1, 2017 UCC
for this Class. The disposal would then be recorded as follows:

January 1, 2017 UCC $54,489

Deemed Acquisition - Lesser Of:

25% Of Proceeds Of Disposition

[(25%)($65,000)] = $16,250

25% Of Capital Cost

[(25%)($84,000)] = $21,000 16,250

Adjusted Balance $70,739

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Disposition - Lesser Of:

Capital Cost = $84,000

Proceeds Of Disposition = $65,000 ( 65,000)

December 31, 2017 UCC $ 5,739

The fact that there is a balance left in the Class after the sale of the only identifiable asset in the Class
would normally result in a terminal loss. However, for Class 14.1, this amount would be viewed as
goodwill, with amortization of the balance continuing.
As the balance relates to a pre-2017 transaction, it would be amortized for the next ten years at a rate of
7 percent, rather than the regular 5 percent rate applicable to Class 14.1. However, Class 14.1
legislation allows for the deduction of a minimum CCA amount of $500 per year with respect to pre-
2017 CEC balances carried forward. As a result, Class 14.1 CCA would be $500, the greater of:

 $402 [(7%)($5,739)]

 the minimum of $500 per year

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In terms of the economics underlying this $5,739 balance, its source can be verified as follows:

Unrecognized Loss On Disposition ($84,000 - $65,000)$19,000

Transitional Inclusion Rate 3/4

Balance $14,250

Recapture Of CEC ($4,410 + $4,101) ( 8,511)

December 31, 2017 Class 14.1 Balance $ 5,739

Summary (Required)
The total maximum CCA is calculated as follows:

Class 1 $ 18,600

Class 8 54,300

Class 10 37,800

Class 10.1 4,500

Class 13 15,000

Class 14 7,750

Class 14.1 500

Total CCA $138,450

In addition, there is Class 1 recapture of $46,305.

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Chapter Six Test Item File Solutions

TIF Solution Six - 1

1. The major types of income that make up Net Income For Tax Purposes are:

 Employment Income

 Business Income

 Property Income

 Capital Gains.

2. For assets used in a business, the income produced while they are being held would be classified as
business income. When they are sold, the result would be a capital gain or capital loss, provided
they are non-depreciable. In the case of depreciable assets, the results could be a capital gain,
recapture, or a terminal loss.

For assets acquired as investments, the income while they are held would be property income,
including rents, interest, and dividends. When they are sold, the result would be a capital gain or
capital loss, provided they are non-depreciable. In the case of depreciable assets, the results could
be a capital gain, recapture, or a terminal loss.

For assets acquired for resale, there would generally be no income while they are held. However,
when they are sold the result would be business income or loss.

3. The sale of inventory results in business income or loss, whereas the sale of non-depreciable capital
property results in a capital gain or capital loss. (Subdivision b vs. c). With respect to the sale of
inventories, 100 percent of any gain or loss will be included in, or deducted from, Net Income For
Tax Purposes. In contrast, only one-half of any gain or loss on the sale of a non-depreciable capital
asset will be included in, or deducted, from Net Income For Tax Purposes. The other important
difference is that, while a loss on the sale of inventories can be deducted against any type of
income, an allowable capital loss on the sale of a capital asset can only be deducted against taxable
capital gains.

4. There are many items that could be listed here. The required four could be selected from
differences:

 between CCA and amortization expense,

 in the treatment of warranty costs,

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 in the treatment of pension costs,

 in the treatment of business meals and entertainment,

 in the treatment of capital gains,

 in the treatment of automobile costs, and

 in the treatment of scientific research and experimental development costs.

At a more conceptual level, there are also differences in the treatment of unreasonable
expenditures and non-arms’ length transactions.

5. The text lists four areas of difference. Any two of the following would serve to answer the
question.

 CCA Calculations When property income is being earned, the deduction of capital cost
allowance (CCA) cannot be used to create or increase a net loss for the period. In addition,
when property income is being earned by individuals, there is no requirement for a pro rata
CCA reduction to reflect a short fiscal period. If business income is being earned, CCA
can be used to create a loss. However, CCA deductions must be prorated for short fiscal
periods.

 Attribution Rules When property income is being earned, the income attribution rules
(see Chapter 9) are applicable. This is not the case when business income is being earned.

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 Earned Income Calculations Property income is not included in the determination of

earned income, either with respect to RRSP contributions or the limit on child care cost
deductions. Business income is included in these figures.

 Expense Deductions Certain expenses can be deducted against business income, but not
property income. An example of this would be travel costs. In contrast, for individuals,
there is a deduction for foreign taxes on property income in excess of 15 percent that is not
available against foreign business income.

6. It is important because only one-half of capital gains is included income and only one-half of capital
losses is deductible from income. For business income or loss, 100 percent is included or deducted.
Also important is the fact that capital losses can only be deducted against capital gains. In contrast,
business losses can be used to reduce other sources of income.

7. The required four items could be selected from the following criteria that are listed in the text:

 Intent to sell or hold to produce income.

 Length of ownership.

 Number and frequency of transactions.

 Relationship to the taxpayer’s business.

 Supplemental work on the property.

 Nature of the assets.

 Objectives declared in articles of incorporation.

8. For income tax purposes, assets are allocated to classes where specified rates are applied, using
either declining balance or straight-line procedures. This procedure establish the maximum
deduction. However, the taxpayer can deduct any amount from nil to this maximum amount.
Further, there is no requirement that the portion to be deducted be established in a consistent
manner from year-to-year.

For accounting purposes, each individual asset is generally accounted for. While the accountant can
choose from a variety of methods for calculating the amount of amortization, once a method is
selected, it must be followed consistently from year-to-year. In addition, the full amount that results
from the application of the selected method must be deducted. Deducting a lesser amount would
not be acceptable under GAAP.

9. A current year reserve is a deduction in the calculation of net business income. As this system is
applied in tax work, only those reserves that are specified in the Income Tax Act can be deducted in
the calculation of net business income. The other aspect of the system is that any reserve that is

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deducted in the determination of net business income in the current tax year, must be added back to
net business income in the following year.

10. Although there are other reserves in the Income Tax Act, the three reserves that are given attention
in the text are:

 reserve for doubtful debts;

 reserve for undelivered goods and services; and

 reserve for unpaid amounts.

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11. Under GAAP, the bad debt expense for the current year is determined by estimating the amount of
year end receivables that are expected to be uncollectible. The expense for the current year will be
equal to this amount, plus any debit balance left in the allowance for bad debts at the end of the year
or, alternatively, less any credit balance in the allowance for bad debts at the end of the year.

Under the Income Tax Act, the deduction for bad debts will be determined as follows:

 Add the actual amount of accounts that were written off during the current period.

 Add the reserve that reflects the estimate of end of period accounts that are expected to be
uncollectible.

 Subtract the reserve that was deducted at the end of the previous period.

12. As described in the text, the constraints are as follows:

 ITA 20(1)(n) indicates that no reserve can be deducted unless at least some part of the proceeds
will not be received until at least two years after the date the property is sold (this two year
requirement does not apply to sales of real property inventory).

 ITA 20(8) specifies that no reserve can be deducted in a year, for any type of property, if the
sale took place more than 36 months before the end of that year. In addition, the reserve is not
available if the purchaser is a corporation controlled by the seller, or a partnership in which the
seller has a majority interest.

13. Some of the items that might be listed here include:

 Must be incurred to produce income.

 No capital expenditures.

 No personal living expenditures.

 No recreational facilities or club dues.

 No political contributions.

 No expenses of a personal services business.

 No interest or property taxes on vacant land.

 No soft costs.

 No prepaid expenses.

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14. If the land is being used to produce income, interest costs and property taxes associated with its
ownership are fully deductible. For example, the land on which a factory building is situated is
clearly being used to produce income and, as a consequence, the related interest and property taxes
would be fully deductible.

If, however, the land is vacant, interest and property taxes can only be deducted to the extent that
the land produces net revenues. For example, if the vacant land is only being used for a parking lot,
the interest and property taxes could be deducted to the extent of the net revenues from the parking
activity.

To the extent that interest and property taxes cannot be deducted, they can be added to the adjusted
cost base of the land.

A special rule applies to real estate companies whose principal business is leasing, rental or sale, or
the development of land. They are permitted to deduct a base level amount, defined as interest at
the prescribed rate on a $1 million principal amount.

15. All employees can deduct a pro rata share of maintenance and utilities. In addition, employees who
receive a portion of their income in the form of sales commissions can deduct a pro rata share of
property taxes and house insurance. The self-employed individual can deduct all of the preceding
items and, in addition, can deduct a pro rata share of both mortgage interest and capital cost
allowance.

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16. The general rule is that expenditures made in foreign print or foreign broadcast media where the
advertising message is directed primarily at the Canadian market cannot be deducted. This
restriction does not apply where such foreign media expenditures are focused on non-Canadian
markets.

There is an exception to this general rule for foreign periodicals only. Canadian businesses can
deduct 100 percent of advertising costs in these publications, without regard to whether it is directed
at the Canadian market, provided 80 percent or more of its non-advertising content is original
editorial content. If the periodical cannot meet the 80 percent criteria, only 50 percent of such
advertising costs will be deductible.

17. A typical example of the application of ITA 67 would be a payment to a non-arm’s length party that
could not be justified by the services rendered by that person. For example, the owner of a business
paying a $100,000 salary to a spouse or child who does no work in the business.

18. The text describes the following exceptions, any three of which would satisfy the requirements of
the question:

 Long-haul truck drivers can deduct more than 80 percent of these costs.

 The costs incurred by hotels and restaurants in providing meals and entertainment to their
clients are fully deductible.

 Meals and entertainment expenses relating to a fund raising event for a registered charity are
fully deductible.

 Where the taxpayer is compensated by someone else for the cost of food, beverages, or
entertainment, the amounts will be fully deductible against this compensation.

 When amounts are paid for meals or entertainment for employees and, either the payments
create a taxable benefit for the employee, or the amounts do not create a taxable benefit
because they are being provided at a remote work location, the amounts are fully deductible to
the employer.

 When amounts are incurred by an employer for food, beverages, or entertainment that is
generally available to all individuals employed by the taxpayer, the amounts are fully
deductible. (Maximum of six such special events per year.)

 Meals included in the price of airline, bus, and rail tickets are viewed by the government as
immaterial. The food component of the ticket price is deemed to be nil.

19. There are two limits. CCA is limited to a maximum capital cost of $30,000. In addition, if the
automobile is financed, interest costs are limited to $10 per day.

20. For tax purposes, inventories can be valued at either market or, alternatively, lower of cost and
market.

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21. For accounting purposes, estimated warranty costs can be recognized as a liability, with the
recorded amount being charged to expense. In general, for tax purposes, warranty costs must be
recognized on a cash basis. Estimated amounts cannot be deducted for tax purposes.

22. For income tax purposes, discounts on issued debt obligations cannot be amortized during the
period that the bonds are outstanding. This means that deductible interest is based only on cash
amounts of interest paid. However, when the bonds mature, the full maturity amount, including 100
percent of the discount, must be paid, resulting in a loss equal to the amount paid at maturity, less
the original issue proceeds. If the bonds are issued for not less than 97 percent of their maturity
amount and, if the effective yield is not more than 4/3 of the coupon rate, the full amount of the loss
can be deducted when the maturity amount is paid. If these conditions are not met, the loss at
maturity is treated in the same manner as a capital loss, with only one-half of the payment being
deductible.

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23. The Income Tax Act identifies three categories of farmers. These categories and the required
treatment of losses for farmers that fall into each category are as follows:

Hobby Farmers These are individuals who farm on a part-time basis, but have no reasonable
expectation of a profit. None of their losses are deductible.

Full Time Farmers These are individuals who farm on a full-time basis. The full amount of
their losses can be deducted against any other source of income. This category does not
preclude the taxpayer having one or more other sources of income, provided these sources are
subordinate to farming.

Part-Time Farmers As described in ITA 31, these are farmers whose chief source of income
is neither farming nor a combination of farming and some other source of income that is a
subordinate source of income. They would also have to have a reasonable expectation of profit
from farming. For farmers falling into this category the amount of farm losses that can be
deducted against other sources of income is limited to $2,500, plus one-half of the next
$30,000. This means the maximum deduction, based on a loss of $32,500, is $17,500. Losses
that cannot be deducted in the current year can be carried over to previous or subsequent years
to the extent of farm income in those years.

24. The sale of the assets of a business in its entirety is a capital transaction. This means that any gains
and losses from the sale of the assets will, in the absence of a special provision, be treated as capital
gains and losses. As there is no possibility of a gain on the sale of accounts receivable, this means
that any loss that arises will, in the absence of the ITA 22 election, be treated as a capital loss. This
is unfortunate in that only one-half of such losses will be deductible.

With respect to the purchaser of the receivables, he would be unable to claim any reserves for
doubtful debts or deduct any amounts written off as bad debts with respect to those receivables. If
the amount actually collected differs from the purchaser’s cost, the difference will be treated as a
capital gain or loss.

Fortunately, the ITA 22 election allows the sale of accounts receivable to be treated as a business
transaction, resulting in full deductibility for any loss that arises on the disposition. The election
also means that, for the purchaser, any difference between the cost of the receivables and the
amount collected will be treated as fully deductible or taxable business income. Note, however, that
a joint election must be filed by both the purchaser and the vendor. ITA 22 does not automatically
apply.

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TIF Solution Six - 2

1. False.

There are a number of differences between the business income and property income rules.

2. True.

While taxpayers cannot deduct losses on personal use property, any gains will be subject to tax.

3. False.

The deduction of CCA cannot be used to create a property income loss. It can be used to create
a business loss.

4. False.

The fact that an asset is held for a long period of time would indicate that any gain on its
disposition should be treated as a capital gain.

5. True.

6. False.

While they cannot be deducted for tax purposes, they can be deducted under GAAP.

7. False.

A reserve can only be deducted for tax purposes if it is specified in the Income Tax Act.

8. True.

While the procedures are somewhat different, the results are the same.

9. False.

If the home office is the individual’s principal place of business, it does not have to be used
exclusively to produce income.

10. True.

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The specific provision in ITA 20(1)(aa) overrides the more general provision in ITA 18(1)(b)
which prohibits the deduction of capital expenditures.

11. False.

For the hobby farmer, no losses are deductible.

12. True.

Inventories can be valued at aggregate market, which can mean replacement cost or net
realizable value.

13. False.

The gain will be treated as business income without any election being made by the taxpayer.

14. True.

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TIF Solution Six - 3

Business Vs. Property Vs. Capital Gains
1. C. A capital gain of $3,000 and business income of $20,600.

2. C. Profit from the sale of inventory items

3. D. A net Business Loss of $7,000 [($45,000 - ($2,000 + $50,000)] x 100% = $7,000

4. B. Business income is not subject to the income attribution rules.

5. E. Whether the transaction resulted in a gain or loss.

6. C. Jerry has business income of $26,350.

7. A. In determining whether a disposition is capital or business in nature, the number and

frequency of transactions is taken into account.

8. B. business income. The intent at the time of acquisition was to earn a profit on the
subdivision and resale of the land.

Inclusions And Reserves

9. D. As long as some part of the proceeds for goods sold is not collectible until future
periods, a reserve for uncollected amounts can be deducted. This is not correct in that there are
restrictions on when such reserves can be used.

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10. D. Included in income when the cash is received. However, the business will be able to
deduct a reserve for goods or services to be delivered in the future.

11. B. $30,000 + 500 – 200 = $30,300

12. C. $13,000 ($12,000 - $12,500 + $1,500 - $14,000)

13. E. None of the above. No reserve is allowable under ITA 20(1)(n) as the entire proceeds
are due within two years after the sale.

Limitations On Deductions
14. B. $9,906 [(30%)($11,662) + $950 + $6,500][38,000 ÷ 42,000].

15. D. Parking fines incurred by delivery vehicles making deliveries in congested areas.

16. D. Both A and B.

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17. C. $33,000 ($25,000 + $8,000).

18. D. Jon can deduct a pro rata share of operating costs, utilities, property taxes, mortgage
interest and CCA.

19. A. Business deduction of $4,318 [($7,200 + 1,000 +1,300) x 10,000/22,000]; and a

taxable benefit of $0 Note: D would be the correct answer if the business was incorporated
and owned the car.

20. A. $18,800 [($30,000)(85%)(30%) + (365)($10) + $7,500]

21. A. A speeding ticket received by a truck delivering goods for resale.

22. D $4,835

House insurance $ 880

House utilities 2,600

House repairs and maintenance 3,000

Mortgage interest 5,700

Property tax 1,600

Total $13,780

Percentage (800 ÷ 3,000) 26-2/3%

Deductible portion $3,675

Business liability insurance 400

Office supplies 760

Total $4,835

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23. C. Kyle can deduct the $650 of property taxes paid and $850 of the interest paid. He can
only deduct interest and property tax on the vacant land up to the $1,500 in rent received.

24. A. $40,000 – 33,000 +1,200 – 2,300 = $5,900 net income before home expenses (can’t
create a loss)

25. D. [($23,700 - $4,100) x 50% ] + (4,100 x 100%) = $13,900

26. B. $9,733 + ($75 x 12) + $1600 + $420 = $12,653

Lease payments – least of:

a) Actual lease payments ($950 -75) x 12 = $10,500

b) Basic formula ($800 x 365/30) = $9,733

c) Anti Avoidance formula [$10,500 x $30,000/(.85 x 38,000)] = $9,752

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Specific Deductions
27. C. Cost of sales can be determined using inventory valuation based on either replacement
cost or net realizable value.

28. A. Last-In, First-Out.

29. A. This $11,000 would have to be written off over five years on a straight-line basis.

30. C. $15 late payment interest charged by utility company

31. D. Reasonable salary paid to a relative

32. B. $24,000 - accounting gain (10,000–500) + taxable capital gain (2,000 x 50%) =
$15,500

33. A. $12,200 + ($28,000 /10) – [ ($28,000 – 2,100)(15%) ] = $11,115

34. C. ($500 + 750) – [( 3 + 5) x ($50 x 50%) = $1,050 limit is 2 conventions, $50/day

deemed meals x 50%

35. B. Financing costs may be deducted on a straight-line basis over a five-year period.
However, if the debt is repaid in full without any new debt being incurred, the undeducted
balance of financing costs may be deducted immediately.

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36. D. $85,000 ($50,000 + $30,000 + $5,000). The salaries cannot be deducted because they
are not paid within 180 days of the Company’s year end.

37. D. $100,000 + $7,000 + $6,000 - $10,000 = $103,000

Taxation Year
38. C. Jon can choose any date for his year end. However, if Jon chooses a non-calendar
year end he will have to adjust his income by an amount referred to as “additional business
income”.

Special Business Income Situations

39. B. $4,550 [$6,800 - (1/2)($23,000 - $118,500)]

40. B. $2,500 + [(1/2)($9,500 - $2,500)] = $6,000

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TIF Solution Six - 4

Exam Exercise Solution Six - 1 (Business Vs. Property Income)
While only a single transaction is involved, this could be considered an adventure or concern in the
nature of trade. However, Martin does not have any plans to acquire additional rights, nor does he
appear to have any intention of selling the rights that he has purchased. This strongly suggests that this
is not an adventure or concern in the nature of trade. This would lead to the conclusion that the royalties
he receives should be treated as property income, rather than business income. This being the case, any
gain or loss on the disposition of these rights would be treated as a capital gain or loss.

Exam Exercise Solution Six - 2 (Business Income Vs. Capital Gains)

Provided that he can demonstrate that his intent was to operate the building as a rental property, the gain
should qualify as a capital gain. The fact that the offer was unsolicited would support this conclusion.

Exam Exercise Solution Six - 3 (Business Income Vs. Capital Gains)

As holding the internet domain names does not produce any income, they cannot be classified as capital
assets. This means that the gains resulting from their sale would have to be considered business income
which would not be eligible for capital gains treatment.

Exam Exercise Solution Six - 4 (Bad Debts And Reserve For Doubtful Debts)
The net decrease for the year will be $4,300 calculated as follows:

Add: 2017 Reserve For Tax Purposes $3,400

Deduct:

2018 Actual Write-Offs ($3,600)

2018 Reserve For Tax Purposes ( 4,100) ( 7,700)

2018 Net Deduction For Tax Purposes ($4,300)

Exam Exercise Solution Six - 5 (Bad Debts And Reserve For Doubtful Debts)
The net decrease will be $10,956 calculated as follows:

Add: 2017 Reserve For Tax Purposes $12,300

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Deduct:

2018 Actual Write-Offs ($13,000)

2018 Reserve For Tax Purposes

[(4%)($256,400)] ( 10,256) ( 23,256)

2018 Net Deduction For Tax Purposes ($10,956)

Exam Exercise Solution Six - 6

(Reserve For Doubtful Debts And Undelivered Services)
The amount to be included in net business income would be calculated as follows:

Cash Sales $71,200

Accounts Receivable 22,450

Reserve For Undelivered Services ( 7,100)

Reserve For Doubtful Accounts ( 650)

Total Increase $85,900

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Exam Exercise Solution Six - 7

(Reserve For Doubtful Debts And Undelivered Services)
The amount to be included in net business income would be calculated as follows:

Cash Sales $123,000

Sales On Account 46,000

Reserve For Undelivered Services ( 9,500)

Reserve For Doubtful Accounts ( 4,000)

Total Increase $155,500

Exam Exercise Solution Six - 8 (Reserve For Unpaid Amounts)

As some of the proceeds are not receivable for more than 2 years, a reserve can be deducted under ITA
20(1)(n). The maximum reserve, based on the gross profit of $216,000, and the net business income, for
each of the 5 years would be as follows:

Income Proceeds Rec’d

2018 Reserve = [(100%)($216,000)] = $216,000 Nil Nil

2019 Reserve = [(75%)($216,000)] = $162,000 $ 54,000 $107,000

2020 Reserve = [(50%)($216,000)] = $108,000 54,000 107,000

2021 Reserve = Nil (36 Months From Sale Date) 108,000 107,000

2022 Reserve = Nil (All Proceeds Received) Nil 107,000

Totals $216,000 $428,000

As December 31, 2021 is more than 36 months after the sale was made, no reserve can be deducted for
2021 or 2022. Note that the technically correct calculation of income involves adding back the previous
year’s reserve and deducting the new reserve. For example, the calculation for 2020 involves adding
back the 2019 reserve of $162,000 and deducting the new reserve of $108,000.

Exam Exercise Solution Six - 9 (Reserve For Unpaid Amounts)

As some of the proceeds are not receivable for more than 2 years, a reserve can be deducted under ITA
20(1)(n). Based on the gross profit of $62,000 ($125,000 - $63,000), the maximum reserve for each of
the 4 years, as well as amounts to be included in income in each year, is as follows:

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Income Proceeds Rec’d

2018 Reserve = [(60%)($62,000)] = $37,200 $24,800 $ 50,000

2019 Reserve = [(40%)($62,000)] = $24,800 12,400 25,000

2020 Reserve = [(20%)($62,000)] = $12,400 12,400 25,000

2021 Reserve = Nil (All Proceeds Received) 12,400 25,000

Totals $62,000 $125,000

The 3 year time limit is not relevant as all of the proceeds are received within the fourth year. Note that
the technically correct calculation of income involves adding back the previous year’s reserve and
deducting the new reserve. For example, the calculation for 2020 involves adding back the 2019 reserve
of $24,800 and deducting the new reserve of $12,400.

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Exam Exercise Solution Six - 10 (Interest In Thin Capitalizations)

As Mr. Roundtree owns 29 percent of the common shares, he is clearly a specified shareholder under
ITA 18(5). His relevant equity balance would be $1,359,000 [(29%)($2,100,000) + (100%)($750,000)].
Given this, the disallowed interest would be calculated as follows:

Total Interest Paid To Mr. Roundtree [(7%)($5,250,000)]$367,500

Maximum Deductible Interest [(7%)(1.5)($1,359,000)]( 142,695)

Disallowed Interest $224,805

Exam Exercise Solution Six - 11 (Interest In Thin Capitalizations)

As Ms. Bergeron owns 40 percent of the common shares, she is clearly a specified shareholder under
ITA 18(5). Her relevant equity balance would be $1,560,000 [$1,000,000 + (100%)($560,000)]. Given
this, the disallowed interest would be calculated as follows:

Total Interest Paid To Ms. Bergeron [(9%)(1/2)($9,100,000)] $409,500

Maximum Deductible Interest [(9%)(1.5)($1,560,000)]( 210,600)

Disallowed Interest $198,900

Exam Exercise Solution Six - 12 (Work Space In The Home Costs)

The following home work space costs would be deductible in each of the three scenarios:

Part A Part B Part C

Utilities $3,200 $ 3,200 $ 3,200

Maintenance And Repairs 3,800 3,800 3,800

Property Taxes Nil 6,400 6,400

House Insurance Nil 1,800 1,800

Interest On Mortgage Nil Nil 6,200

House CCA Nil Nil 15,000

Subtotal $7,000 $15,200 $36,400

Percentage 30% 30% 30%

Subtotal $2,100 $ 4,560 $10,920

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Monthly Phone [(40%)($480)] Nil Nil 192

Employment/Business Related

Long Distance Charges (100%) 780 780 780

Internet Service Fees [(40%)($675)] Nil Nil 270

Maximum Deduction $2,880 $ 5,340 $12,262

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Exam Exercise Solution Six - 13 (Work Space In The Home Costs)

The following work space in home costs would be deductible in each of the three scenarios:

Part A Part B Part C

Utilities $2,500 $ 2,500 $ 2,500

Maintenance And Repairs 3,100 3,100 3,100

Property Taxes Nil 5,400 5,400

House Insurance Nil 1,300 1,300

Interest On Mortgage Nil Nil 4,600

House CCA Nil Nil 12,000

Subtotal $5,600 $12,300 $28,900

Percentage 18% 18% 18%

Subtotal $1,008 $ 2,214 $5,202

Home Telephone (See Note) Nil Nil Nil

Phone Line To Home Work Space (100%) 480 480 480

Employment/Business Related

Long Distance Charges (100%) 560 560 560

Internet Service Fees [(30%)($720)] Nil Nil 216

Maximum Deduction $2,048 $ 3,254 $6,458

Note With a separate phone line to the home work space the cost of which is fully deductible,
it can be assumed that the home phone is not used for employment/business purposes.

Exam Exercise Solution Six - 14 (Automobile Ownership Costs)

The base amount for the CCA calculation is limited to the Class 10.1 maximum of $30,000. As a result,
the amounts that can be deducted by Mr. Roddle in his tax return are as follows:

Capital Cost Allowance [(30%)(1/2)($30,000)] $4,500

Interest Costs - Lesser Of:

 Amount Paid = $1,575

 [($10)(92 Days)] = $920 920

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Total Deduction $5,420

Exam Exercise Solution Six - 15 (Automobile Ownership Costs)

The base amount for the CCA calculation is limited to the Class 10.1 maximum of $30,000. As a result,
the amounts that can be deducted by Ms. Bouclair in her tax return are as follows:

Capital Cost Allowance [(30%)(1/2)($30,000)] $4,500

Interest Costs - Lesser Of:

 Amount Paid = $2,000

 [($10)(122 Days)] = $1,220 1,220

Total Deduction $5,720

Exam Exercise Solution Six - 16 (Automobile Leasing Costs)

The amount she can deduct is limited to $1,148, the least of:

 $1,724 [($862)(2)];

 $1,627 [($800)(61/30)]; and

 $1,148 {[$1,724][$30,000 ÷ (85%)($53,000)]}.

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Exam Exercise Solution Six - 17 (Automobile Leasing Costs)

The amount he can deduct is limited to $2,306, the least of:

 $3,985 [($797)(5)];

 $4,080 [($800)(153/30)]; and

 $2,306 {[$3,985][$30,000 ÷ (85%)($61,000)]}

Exam Exercise Solution Six - 18 (Leases: Tax Vs. GAAP)

For tax purposes, the lease would be treated as an operating lease, with the deduction being based only
on the lease payments. Under GAAP, the lease would have to be treated as a purchase and capitalized.
This is because during the lease term the lease transfers “substantially all of the benefits and risks of
ownership related to the leased property from the lessor to the lessee”. This means that the accounting
deductions would be for amortization on the capitalized asset and interest costs on the associated
liability.

Exam Exercise Solution Six - 19 (Inventory Valuation)

The following calculations will be used in this solution.

Fair Market Value (Using Replacement Cost) [($24.00)(7,800)] $187,200

Fair Market Value (Using Net Realizable Value) [(80%)($31.00)(7,800)]$193,440

FIFO Cost [(5,300)($25.00) + (7,800 - 5,300)($21.00)] $185,000

Average Cost [($23.89*)(7,800)] $186,342

*Average per unit cost of $23.89 ($587,400 ÷ 24,600) calculated as follows:

Price Units Total

$23.00 7,500 $172,500

$28.00 5,000 140,000

$21.00 6,800 142,800

$25.00 5,300 132,500

Totals 24,600 $587,800

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For tax purposes, the inventory value can be determined by any of the following methods.

 Fair Market Value (Using Replacement Cost)= $187,200

 Fair Market Value (Using Net Realizable Value) = $193,440

 Lower of $185,000 Cost (FIFO) or $187,200 Market (Replacement Cost) = $185,000

 Lower of $185,000 Cost (FIFO) or $193,440 Market (Net Realizable Value) = $185,000

 Lower of $186,342 Cost (Average Cost) or $187,200 Market (Replacement Cost) = $186,342

 Lower Of $186,342 Cost (Average Cost) or $193,440 Market (Net Realizable Value) = $186,342

Exam Exercise Solution Six - 20 (Additional Business Income)

Ms. Gabor’s additional business income for 2018 will be $14,131 [($23,500)(92 Days ÷ 153 Days)].
The 92 days is for the period October 1 through December 31. The 153 days is for the period May 1
through September 30. The total business income that Ms. Gabor will have to report for 2018 is
$37,631 ($23,500 + $14,131).

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Exam Exercise Solution Six - 21

(Professional Income - Billed Basis Of Recognition)
Joan’s 2018 net business income inclusion would be calculated as follows:

January 1, 2018 Unbilled Work In Process [(100%)($41,400)] $ 41,400

Billings For Work Done In 2018 171,300

December 2018 Unbilled Work In Process

[(20%)($206,350 - $171,300)] 7,010

Total 2018 Income Inclusion $219,710

Exam Exercise Solution Six - 22

(Professional Income - Billed Basis Of Recognition)
Jonathan’s 2018 net business income inclusion would be calculated as follows:

January 1, 2018 Unbilled Work In Process [(100%)($23,800)] $ 23,800

Billings For Work Done In 2018 156,300

December 2018 Unbilled Work In Process

[(20%)($187,200 - $156,300)] 6,180

Total 2018 Income Inclusion $186,280

Exam Exercise Solution Six - 23 (ITA 22 Election On Receivables)

The tax effect would be a net deduction of $610 [$4,800 - ($87,560 - $82,150)].

Exam Exercise Solution Six - 24 (ITA 22 Election On Receivables)

If we assume that there is no election under ITA 22, Ms. Besson will have to include the $4,200 reserve
in income. This will be partially offset by the deduction of an allowable capital loss of $1,600 [(1/2)
($68,500 - $65,300)]. Assuming Ms. Besson has taxable capital gains against which the $1,600 loss can
be deducted, the transaction will result in a net inclusion in income of $2,600 ($4,200 - $1,600).
Alternatively, if the ITA 22 election is jointly made, she will still have to include the $4,200 reserve in
business income. However, in this case, the inclusion will be offset by a business income deduction of
$3,200 ($68,500 - $65,300). In this case the net addition will be $1,000 ($4,200 - $3,200).

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TIF Solution Six - 5A

The correct definitions for each of the listed key terms are as follows:

A. 9

B. 8

C. 10

D. 1

E. 4

F. 11

G. 7

H. 3

The three unused definitions are as follows:

Cash Basis = 2

Taxation Year = 5

Business = 6

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TIF Solution Six - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.
The correct definitions for each of the listed key terms are as follows:

A. 12

B. 11 (not 4)

C. 14 (not 13)

D. 1 (not 3)

E. 6 (not 10)

F. 15

G. 9

H. 5

The three unused definitions are as follows:

Cash Basis = 2

Taxation Year = 7

Business = 8

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TIF Solution Six - 6

The results for the 2 years would be as follows:

2018 2019

Cash Sales ($259,000 - $88,000) $171,000

Cash Sales ($360,000 - $72,000) $288,000

Sales On Account 88,000 72,000

Reserve For Doubtful Debts:

Add Prior Year Reserve Nil 7,000

Deduct Current Year Reserve ( 7,000) ( 9,500)

Deduct Actual Write-Offs Nil ( 6,500)

Advances From Customers 27,000 21,000

Reserve For Undelivered Merchandise:

Add Prior Year Reserve Nil 27,000

Deduct Current Year Reserve ( 27,000) ( 21,000)

Gross Profit On Sale Of Unused Materials 15,000 Nil

Reserve For Unpaid Amounts:

Add Prior Year Reserve 9,677

Deduct Current Year Reserve*

{[$15,000][($62,000 - $22,000)  $62,000]} ( 9,677)

{[$15,000][($62,000 - $42,000)  $62,000]} ( 4,839)

Net Effect $257,323 $382,838

*As some of the proceeds on the sale of unused materials are not due until two years after the date
of the sale, a reserve for unpaid amounts can be deducted. The three year time limit is not relevant
as the full balance is paid off prior to the end of that period.

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TIF Solution Six - 7

Part A
Under ITA 18(12), the following conditions must be satisfied in order for expenses related to work
space in a self-contained domestic establishment to be deductible:

 the work space is either the individual’s principal place of business; or

 the work space is used exclusively for the purpose of earning income from business and is used
on a regular and continuous basis for meeting clients, customers, or patients of the individual in
respect of the business.

With respect to Mr. Larson’s mail order business, the allocated space in his home would appear to be his
principal place of business. This means that he would be able to deduct work space in home costs in
determining his net business income.

Part B
The calculation of the minimum net business income to be reported in Mr. Larson’s personal tax return
is as follows:

Revenues $182,000

Expenses Other Than Home Work Space Costs:

Cost Of Merchandise Sold ($98,000)

Packaging Materials ( 2,400)

Shipping Costs ( 4,600)

Miscellaneous Office Supplies ( 560)

Telephone ( 1,100)

Printing Of Posters And Brochures ( 420)

CCA (Note 1) ( 2,321) ( 109,401)

Income Before Home Work Space Costs $ 72,599

Less: Home Work Space Costs (Note 2) ( 4,332)

Net Business Income $ 68,267

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Note 1 Maximum CCA amounts on the assets of the business (not including CCA on the
house) for the short fiscal year would be calculated as follows (alternative calculations shown
in the two columns):

Short Fiscal Year

100% (335/365)

Class 8 [($18,500)(1/2)(20%)] $1,850 $1,698

Class 50 [($1,430)(1/2)(55%)] 393 361

Class 12 [($570)(1/2)(100%)] 285 262

Total $2,528

Short Fiscal Year Factor 335/365

Maximum CCA* $2,320 $2,321

*The $1 difference in the two amounts is due to rounding difference in the calculations.

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Note 2 The work space in home costs would be calculated as follows:

Utilities For Home (Heat, Light, And Water) $ 3,200

Mortgage Interest Paid 10,100

House Insurance 500

Property Taxes 4,300

Repairs And Maintenance For Home 2,600

Total $20,700

Class 1 CCA [($426,000 - $150,000)(1/2)(4%)] 5,520

Total Costs For The Home $26,220

Percentage Of Floor Space 18%

Subtotal $ 4,720

Short Fiscal Year Factor 335/365

Deductible Home Work Space Costs $ 4,332

Part C
There are two issues that should be discussed with Mr. Larson.

 As this problem asks for “minimum” net business income, CCA must be deducted on Mr.
Larson’s home. The problem with this is that, if he takes CCA, it could jeopardize the principal
residence exemption on this property, resulting in the payment of taxes on a portion of the taxable
capital gain that might arise on any future sale of the property, assuming real estate prices are
increasing. This is discussed in more detail in Chapter 8.

 Although it is not relevant for this year, Mr. Larson should be aware that the deduction of work
space in home costs cannot be used to create a loss in the future. However, any amount not
deductible because it is greater than his income can be deducted in any subsequent year provided
there is sufficient income from the same business in that year. This provides for an unlimited carry
forward of unused work space in home costs (see IT-514, Work Space in Home Expenses).

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TIF Solution Six - 8

Part A
The tax consequences resulting from the sale of the Honda can be calculated as follows:

January 1, 2018 UCC $24,650

Disposition - Lesser Of:

Capital Cost = $29,000

Proceeds Of Disposition = $25,000 ( 25,000)

Negative Ending Balance ($ 350)

Recapture Of CCA 350

UCC - December 31, 2018 Nil

The $350 of recapture would be included in Maxine’s net business income for 2018. No CCA would be
deducted for Class 10. Note that, because the BMW cost more than $30,000, it would be allocated to a
separate Class 10.1. This means that its acquisition would not eliminate the recapture in Class 10.
The maximum CCA deduction on the BMW would be calculated as follows:

Capital Cost (Limited To $30,000) $30,000

One-Half Net Additions ( 15,000)

Balance For CCA Purposes $15,000

Rate 30%

Maximum CCA $ 4,500

The net effect on income due to the two automobiles would be as follows:

Recapture Inclusion $ 350

CCA ( 4,500)

Operating Costs (Fully Deductible) ( 12,300)

Decrease In Net Income For Tax Purposes ($16,450)

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Part B
Because the Honda was used primarily (more than 50 percent) for employment purposes, it is eligible
for the reduced standby charge and the alternative operating cost benefit calculation. This is not the case
with the BMW sedan.
The minimum total benefit on the two vehicles would be calculated as follows:

Standby Charge:

Honda [(2%)($29,000)(6)(8,000 ÷ 10,002*)] $ 2,783

BMW - No Reduction [(2%)($105,000)(6)] 12,600

Total Standby Charge $15,383

Operating Cost Benefit For Honda - Lesser Of:

 [($2,783)(1/2)] = $1,392

 [(8,000)($0.26)] = $2,080 $1,392

Operating Cost Benefit For BMW

[(19,000)($0.26)] 4,940 6,332

Minimum Total Benefit $21,715

*[(6)(1,667)]

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TIF Solution Six - 9

Market Determination - Two Possible Values
For tax purposes, the business can measure market using either replacement cost or net realizable value.
These values would be as follows:

Replacement Cost [($16.75)(5,000)] $83,750

Net Realizable Value [($18.30)(5,000)] $91,500

While it is not an acceptable practice under GAAP, the CRA will accept the use of market values,
without regard to their relationship to cost.

Cost Determination - Two Possible Values

In the determination of cost, taxpayers are permitted to use specific identification (this would not appear
to be practical here), a First In, First Out (FIFO) assumption, or Average Cost.
Using the First In, First Out method, the appropriate value for the ending inventory would be determined
as follows:

1,500 Units At $16.50 $24,750

3,200 Units At $21.42 68,544

300 Units At $20.25 6,075

5,000 Units At FIFO Cost $99,369

Based on average cost, the ending inventory value would be calculated as follows:

Number Of Units 5,000

Average Cost [($297,644 ÷ 15,300)] 19.45

5,000 Units At Average Cost $97,250

Lower Of Cost And Market - Four Possible Values

For tax purposes, the possible values here would be as follows:

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Lower Of Replacement Cost And FIFO Cost $83,750

Lower Of Replacement Cost And Average Cost 83,750

Lower Of Net Realizable Value And FIFO Cost 91,500

Lower Of Net Realizable Value And Average Cost 91,500

For accounting purposes, only the last two values would be acceptable.

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TIF Solution Six - 10

1. Costs of obtaining financing are generally deductible, and consequently the payment to the
Brazilian consultant would be deductible. However, as a financing cost, it would have to be
deducted over five years at a rate of $240 per year.

2. Donations to registered Canadian charities can be deducted in the calculation of a corporation’s

Taxable Income. However, such contributions are not deductible in the calculation of Net Income
For Tax Purposes. As business income is a component of Net Income For Tax Purposes, the
contributions cannot be deducted at this stage.

3. The cost of the option on the land is a capital expenditure and cannot be deducted in the calculation
of business income. As a capital expenditure, it will be added to the cost of any land acquired or,
alternatively, if the option expires without an acquisition of land, the $2,500 will likely be
considered a capital loss.

4. Under ITA 20(1)(b), the first $3,000 of costs incurred in the incorporation of a corporation can be
deducted. The remaining $4,500 ($7,500 - $3,000) will be added to Class 14.1. As these costs are
not related to a specific asset, they will become part of the Company’s goodwill balance.

5. The cost of the franchise cannot be deducted during the current period. It is a capital expenditure
that will be added to Class 14 and written off by the straight-line method over its 10 year life.

6. The landscaping costs are fully deductible as incurred. With respect to the cost of cancelling the
lease, these amounts can only be deducted on a pro rata basis over the remaining term of the lease.
The cost of the parking lot is a capital cost that will be added to Class 17 (miscellaneous assets
including parking lots) and written off at a rate of 8 percent of the declining balance.

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TIF Solution Six - 11

The required calculations would be as follows:

Net Business Income For Tax Purposes $401,300

Item 1 - Maximum CCA (Note 1) 42,100

Item 1 - GAAP Amortization (Note 1) ( 36,400)

Item 2 - Landscaping Costs (Note 2) 12,000

Item 3 - Web Site Maintenance (Note 3) Nil

Item 4 - Class 8 Sale (Note 4) 1,600

Item 5 - U.S. Advertising (Note 5) ( 5,500)

Item 6 - Business Meals And Entertainment (Note 6) ( 6,000)

Item 7 - Theft (Note 7) Nil

Item 8 - Class 10 Sale (Note 8) 4,159

Item 8 - Class 10 Sale (Note 8) ( 8,552)

Item 9 - Donations (Note 9) ( 4,200)

Item 10 - Soccer Uniforms (Note 10) Nil

Item 11 - Ending Inventories (Note 11) ( 5,000)

GAAP Based Net Income $395,507

Note 1 The net adjustment is $5,700 added back.

Note 2 While landscaping costs can be deducted for tax purposes, if they have a life that
extends beyond the current year, they must be treated as an asset under GAAP.

Note 3 It would appear that the costs of these services is reasonable. Given this, they can be
deducted under both tax procedures and GAAP. No adjustment is required in determining
GAAP based net income.

Note 4 For tax purposes, the $14,200 proceeds of disposition would be subtracted from Class
8. As there are still assets in the Class, as well as a positive balance in the Class at the end of
the year, there are no tax consequences resulting from the disposition. However, under GAAP,
a gain of $1,600 ($14,200 - $12,600) would have been recognized.

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Note 5 While these costs could not be deducted for tax purposes, they would be deducted
under GAAP.

Note 6 The $6,000 that was deducted for tax purposes would be one-half of the total of
$12,000. Under GAAP, the remaining $6,000 can also be deducted.

Note 7 The stolen $4,300 can be deducted under both tax procedures and GAAP. No
adjustment would be required in determining GAAP based net income.

Note 8 When the $15,000 proceeds of disposition is subtracted from Class 10 a balance of
$4,159 ($19,159 - $15,000) remains in the Class. As there are no assets left in the Class, the
tax figure was reduced by a terminal loss of $4,159. This must be added back. In contrast,
under GAAP, the loss was $8,552 ($23,552 - $15,000). This must be deducted in place of the
tax loss of $4,159.

Note 9 While charitable contributions cannot be deducted in determining net business income
for tax purposes, they can be deducted under GAAP.

Note 10 The cost of the soccer uniforms would be a legitimate deduction for both tax and
GAAP purposes. No adjustment is required in determining GAAP based net income.

Note 11 While market is an acceptable basis for inventory valuation using tax procedures,
GAAP requires the use of lower-of-cost-or-market. Using this figure would reduce ending
inventory values. This would increase GAAP based cost of sales and decrease GAAP based
Net Income by $5,000 ($123,000 - $118,000).

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TIF Solution Six - 12

The minimum net business income of Fairway Distribution would be calculated as follows:

Accounting Income As Reported $273,000

Additions:

Item 2 - Amortization 78,500

Item 3 - Cost Of Advertising In Foreign Newspaper (Note 1) 3,500

Item 3 - Donations To Charities (Note 2) 1,260

Item 3 - Cost Of Real Estate Appraisal (Note 3) 1,470

Item 3 - Cost Of Landscaping (Note 4) 5,260

Item 3 - Mrs. Fairway’s Management Fee (Note 5) 123,000

Subtotal $485,990

Deductions:

Item 1 - Bad Debt Expense Adjustment (Note 6) ( 4,200)

Item 2 - CCA (Given) ( 123,600)

Net Business Income $358,190

Note 1 In general, the cost of advertising in foreign media that is directed towards Canadian
markets cannot be deducted for tax purposes. While there is an exception for foreign periodicals, it
does not apply to foreign newspapers.

Note 2 Donations to charities cannot be deducted in the calculation of net business income. They
will be the basis for a tax credit in the calculation of Tax Payable for Mr. Fairway.

Note 3 The cost of appraising a capital asset for purposes of sale is not deductible. Rather, it is an
addition to the capital cost of the appraised asset.

Note 4 While landscaping costs related to business properties are deductible when incurred, the
cost of improving non-business personal use property would not be.

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Note 5 ITA 67 requires that business expenses be “reasonable in the circumstances”. As Mrs.
Fairway does not appear to do any work for the business, it would be difficult to view her
management fee as reasonable. As a consequence, it would not be deductible.

Note 6 For tax purposes, the bad debt adjustment would be calculated as follows:

Last Year’s Reserve $15,000

Actual Write-Offs ( 17,500)

This Year’s Reserve ( 19,200)

Total Deduction For Tax Purposes ($21,700)

Accounting Deduction (Actual Write-Offs) 17,500

Bad Debt Expense Adjustment ($ 4,200)

As $4,200 ($21,700 - $17,500) more than the amount that was written off for accounting purposes
can be deducted for tax purposes, an adjustment is required. Note that the accounting procedures
that were used in this case are not consistent with GAAP.

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TIF Solution Six - 13

The calculation of Markham Ltd.’s Net Income For Tax Purposes would be as follows:

Accounting Net Income $147,000

Additions:

Amortization Expense (Income Statement) 156,000

Income Tax Expense (Income Statement) 129,000

Item 2 - Non-Deductible Meals And Entertainment

(50% of $15,000) 7,500

Item 3 - Golf Club Membership Fees 3,400

Item 4 - Contributions To Registered Charities 3,700

Item 5 - Bond Discount Amortization 2,500

Item 7 - Articles Of Incorporation Amendment Costs 6,000

Item 8 - Taxable Capital Gain On Sale Of Building

[(1/2)($562,000 - $500,000)] 31,000

Item 8 - Gain on Land ($50,000 - $50,000) Nil

Item 8 - Accounting Loss On Class 10 Assets 15,000

Item 9 - Interest On Late Income Tax Instalments 500

Subtotal $501,600

Deductions:

Item 1 - Landscaping Costs ( 6,000)

Item 8 - Accounting Gain On Sale Of Building

($562,000 - $457,000) (Land ACB = $50,000) ( 105,000)

Capital Cost Allowance (Note One) ( 157,388)

Item 8 - Terminal Loss (Note One) ( 8,000)

Net Income For Tax Purposes $225,212

Note One Maximum CCA and other related inclusions and deductions can be calculated as
follows:

Class 1

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January 1, 2018 Class 1 Balance $400,000

Addition ($683,000 - $60,000) $623,000

Disposition - Lesser Of:

 Proceeds = $562,000

 Capital Cost = $500,000 ( 500,000) 123,000

One-Half Net Additions ( 61,500)

CCA Base $461,500

CCA At 4 Percent ( 18,460)

One-Half Net Additions 61,500

January 1, 2019 UCC Balance $504,540

Class 8

January 1, 2018 Class 8 Balance $575,000

Additions 126,000

One-Half Net Additions ( 63,000)

CCA Base $638,000

CCA At 20 Percent ( 127,600)

One-Half Net Additions 63,000

January 1, 2019 UCC Balance $573,400

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Class 10

January 1, 2018 Class 10 Balance $45,000

Disposition - Lesser Of:

 Proceeds = $37,000

 Capital Cost = $93,000 ( 37,000)

Balance After Disposition $ 8,000

Terminal Loss ( 8,000)

January 1, 2019 UCC Balance Nil

Class 13

January 1, 2018 Class 13 Balance $68,000

2018 CCA:

2016 Expenditures ($50,000  10 Years) ( 5,000)

2017 Expenditures ($27,000  9 Years) ( 3,000)

January 1, 2019 UCC Balance $60,000

Class 14.1

On December 31, 2016, the Company’s CEC balance is calculated as follows:

2016 Additions [(3/4)($70,000)] $52,500

2016 CEC Amount At 7 Percent ( 3,675)

December 31, 2016 Balance $48,825

This balance will become the January 1, 2017 UCC for Class 14.1. Given this, the relevant
calculations for 2017 are as follows:

January 1, 2017 Class 14.1 Balance $48,825

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CCA - [(7%)($48,825)] ( 3,418)

January 1, 2018 UCC Balance $45,407

The required calculations for 2018 are as follows:

January 1, 2018 Class 14.1 Balance $45,407

2018 Addition 6,000

CCA

[(7%)($45,407)] ($3,178)

[(5%)(1/2)($6,000)] ( 150) ( 3,328)

January 1, 2019 UCC Balance $48,079

Summary Of CCA Results (Not Required) The maximum 2018 CCA and January 1, 2019 UCC
balances can be summarized as follows:

Class Maximum CCA UCC

Class 1 $ 18,460 $ 504,540

Class 8 127,600 573,400

Class 10 (Terminal Loss = $8,000) Nil Nil

Class 13 8,000 60,000

Class 14.1 3,328 48,079

Total $157,388

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Other Notes

 While there is a specific prohibition against the deduction of interest on late income tax
instalments, there is no equivalent restriction on interest due to late municipal taxes, and it would
appear that these amounts are deductible.

 As the old building is not a rental property, the new building can be added to the same Class 1
that contained the old building. If this were not the case, this transaction would have resulted in
recapture of CCA on the disposition of the old building.

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TIF Solution Six - 14

Carol’s minimum net business income can be calculated as follows:

Carol Basque

Statement Of Business Income

For Year Ending December 31, 2018

Total Revenue $297,800

Vehicle Operating Costs

[($6,150)(38,000 ÷ 41,000)] ($ 5,700)

Building Operating Costs ( 27,300)

Payments To Assistants

(Payment To Daughter Is Deductible) ( 46,100)

Miscellaneous Office Costs ( 13,600)

Business Meals [(50%)($15,500)] ( 7,750)

CCA (Note) ( 50,755) ( 151,205)

Net Business Income $146,595

Note The total CCA deductible would be as follows:

Class 1 [(6%)($447,831)] $26,870

Class 8 (Calculation Follows) 15,432

Class 50 [(1/2)(55%)($1,250)] 344

Class 12 [(1/2)(100%)(1,475)] 738

Class 10.1 (Calculation Follows) 2,678

Class 10 [(1/2)(30%)($28,000)(38,000 ÷ 41,000)] 3,893

Class 14.1 [(1/2)(5%)($32,000)] 800

Total CCA $50,755

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Class 1 As the building is used 100 percent for non-residential purposes, it is eligible for the
enhanced rate of 6 percent.

Class 8 The required calculations are as follows:

Opening Balance $38,160

Additions $78,000

Disposal - Lesser Of:

 Proceeds = Nil

 Cost = $53,000 Nil 78,000

One-Half Net Additions [(1/2)($78,000)] ( 39,000)

CCA Base $77,160

Rate 20%

Class 8 CCA $15,432

The proceeds of disposition were nil as the property was worthless given the extent to which it
was damaged.

Class 10.1 As the Lexus cost over $30,000, it was allocated to a separate Class 10.1. While
neither terminal losses or recapture of CCA can be recognized on the disposition of the Lexus,
Carol will be allowed to take one-half year’s CCA. This amount would be $2,678 [(1/2)(30%)
($17,850)].

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TIF Solution Six - 15

The required calculations would be as follows:

Accounting Income (Loss)

Before Taxes And Amortization Expense ($113,000)

Additions:

Item 2 - Property Taxes On Fishing Lodge 1,100

Item 3 - Contributions To Charities (Note 1) 13,700

Item 6 - Lease Cancellation Payment (Note 2) 17,000

Item 8 - Insurance Premium (Note 3) 9,500

Item 12 - Renovation Costs (Note 4) 153,000

Item 13 - Wife’s Convention Expenses 1,900

Item 14 - Bond Discount Amortization 950

Item 15 - Cost Of Amending Articles (Note 5) 3,600

Item 16 - Non-Deductible Portion Of

Meals And Entertainment [(50%)($12,500)] 6,250

Net Business Income (Before CCA and CEC Deductions) $ 94,000

Note 1 The contributions to registered charities will be deductible in the computation of Taxable
Income, but not in the computation of income from a business. Charitable contributions are a
deduction for corporations, although they are eligible for tax credit treatment for individuals.

Note 2 ITA 20(1)(z) requires that lease cancellation payments be amortized over the term of the
lease remaining immediately before cancellation. The amount to be deducted is a pro rata
calculation based on the number of days remaining subsequent to the cancellation. As the
cancellation occurred on December 31, 2018, none of the amount would be deductible during the
current year. The $17,000 would be deducted over the 7 years that would have remained of the
lease term, at the rate of $2,429 per year. The fact that $5,000 of the amount had not been paid as
of December 31, 2018 is not relevant.

Note 3 Life insurance premiums where the employer is the beneficiary are not considered to be
incurred for the purpose of earning income and are therefore not deductible except where they are
required by a creditor in relation to financing.

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Note 4 These amounts serve to extend the life of the relevant asset and should be treated as capital
expenditures. When they are added to the relevant UCC balances, they would result in increased
CCA. However, the problem indicates that you do not have to consider CCA or CEC amounts.

Note 5 The payment to amend the articles of incorporation would added to Class 14.1. While the
Company would be able to deduct CCA for this Class, you have been instructed to ignore such
deductions in this problem.

Other Items Further explanation related to the items not included in the preceding calculation of Net
Income For Tax Purposes are as follows:

Item 1 If the damages relate to a transaction that produces business income, they are considered a
business expense.

Item 4 Landscaping costs are fully deductible under ITA 20(1)(aa).

Item 5 Losses of this type, unless they result from the activity of senior officers or shareholders,
are considered to be deductible as a normal cost of doing business.

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Item 7 The bonus to the president would be deductible in 2018.

Item 9 Such appraisal costs are considered to be deductible as a normal cost of doing business.

Item 10 The $51,000 in management bonuses would be deductible in 2018. The 2017 bonuses
would require no adjustments.

Item 11 The bad debts would be fully deductible.

Item 13 The $3,300 in costs associated with the president attending the convention would be
deductible.

Item 15 Both the costs of defending against the breach of contract action, as well as the costs
related to the income tax reassessment, would be fully deductible.

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TIF Solution Six - 16

Part A - No Election
If the ITA 22 election is not made, the tax consequences for Gail Gates would be as follows:

Add: 2017 Reserve For Doubtful Debts $15,000

2018 Income Inclusion $15,000

While Gail has an allowable capital loss of $7,000 [(1/2)($263,000 - $249,000)], she will not be able to
deduct this amount as she has had no capital gains in the previous three years and does not expect to
have any in the current or subsequent years.
If the ITA 22 election is not made, the tax consequences to Mandy Portals would be as follows:

Proceeds Of Disposition (Amount Collected) $251,000

Adjusted Cost Base ( 249,000)

Capital Gain $ 2,000

Inclusion Rate 1/2

2018 Income Inclusion $ 1,000

Part A - Election
If the ITA 22 election is made, the tax consequences for Gail would be as follows:

Add: 2017 Reserve For Doubtful Debts $15,000

Deduct: Business Loss ($263,000 - $249,000) ( 14,000)

2018 Income Inclusion $ 1,000

If the ITA 22 election is made, the tax consequences to Mandy would be as follows:

Add: Face Value - Price Paid ($263,000 - $249,000) $14,000

Deduct: Actual Write-Offs ($263,000 - $251,000) ( 12,000)

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2018 Income Inclusion $ 2,000

Part B
For Gail Gates, the ITA 22 election is clearly desirable, converting a $15,000 income inclusion into a
$1,000 inclusion.
For Mandy Portals, the fact that actual collections ($251,000) exceed the estimated value of the
Accounts Receivable on the date of the sale ($249,000), means that the ITA 22 election would not be
desirable. It would double her income inclusion from $1,000 to $2,000.

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TIF Solution Six - 17

Net Employment Income
The Net Employment Income component of Net Income For Tax Purposes would be calculated as
follows:

Salary $143,000

Additions

Commissions 18,500

Automobile Benefit (Note 1) 9,000

Stock Option Benefit [(2,000)($32 - $25)] 14,000

Gifts (Note 2) 400

Travel Allowance (Note 3) Nil

Music Course Tuition Benefit (Note 4) 600

Deductions

RPP Contributions ( 4,200)

Union Dues ( 625)

Net Employment Income $180,675

Note 1 The automobile benefit would be calculated as follows:

Standby Charge [(2%)($40,000)(10)(15,000 ÷ 16,667)]$ 7,200

Operating Cost Benefit - Lesser Of:

 [($0.26)(15,000)] = $3,900

 ($7,200 ÷ 2) = $3,600 3,600

Total Benefit Before Repayment $10,800

Repayment ( 1,800)

Automobile Benefit $ 9,000

Note 2 The gift certificate of $300 would be considered a near cash gift and would have to be
included in net employment income. In addition, the $100 excess of the value of the watch
over $500 would have to be included. This gives a total inclusion of $400.

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Note 3 As the travel allowance (12 @ $600 = $7,200) appears to be reasonable given her
actual costs ($4,200 + $2,900 = $7,100) it does not have to be included in Jamine’s income.
Given her allowance is greater than her actual costs, this would be advisable. As a result, she
cannot deduct the actual travel costs incurred.

Note 4 Tuition for the negotiating skills course would appear to be employment related and, as
a consequence, the reimbursement for it would not be included in Jamine’s employment
income.

Taxable Capital Gain

When the 1,000 shares acquired with options are sold, there would be a taxable capital gain calculated as
follows:

Proceeds Of Disposition [(1,000)($32)] $32,000

Adjusted Cost Base [(1,000)($25)] ( 25,000)

Capital Gain $ 7,000

Inclusion Rate 1/2

Taxable Capital Gain $ 3,500

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Net Business Income

The Net Business Income component of Net Income For Tax Purposes would be calculated as follows:

Amounts Billed $63,450

Unbilled Work In Progress (Note 5) 5,055

Total Inclusions $68,505

Deductions:

Office Rent (12 Months At $750) ($9,000)

CCA (Note 6) ( 4,130)

Part Time Office Help ( 6,340)

Office Supplies ( 623)

Web Hosting Fee ( 240)

Cell Phone Charges ( 462)

Meals And Entertainment [(1/2)($4,340)] ( 2,170) ( 22,965)

Net Business Income $45,540

Note 5 Since Jamine is a management consultant, she was not able to use the billed basis of
income recognition. This means that she is not eligible for the transitional provision related to
the billed basis and must include 100 percent of her unbilled work in progress in her income.

Note 6 Maximum CCA would be calculated as follows:

Class 13 [(1/2)($18,000 ÷ 5*)] $1,800

Class 8 [(1/2)(20%)($16,300)] 1,630

Class 50 [(1/2)(55%)($1,230)] 338

Class 12 [(1/2)(100%)($723)] 362

Total $4,130

*With respect to the Class 13 amount, this is a straight line Class and it is subject to the half
year rules. While the term of the lease is only 3 years, the deductible amount is the lesser of the
capital cost divided by the term of the lease and one-fifth of the capital cost. In this case, the
deduction is limited to one-half of one-fifth of the capital cost.

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Net Income For Tax Purposes And Taxable Income

Jamine has Net Income For Tax Purposes and Taxable Income as follows:

Net Employment Income $180,675

Taxable Capital Gain 3,500

Net Business Income 45,540

Net Income For Tax Purposes $229,715

Stock Option Deduction (Note 7) Nil

Taxable Income $229,715

Note 7 When the options were granted, the option price of $25 was below the market price of
$27. Given this, the ITA 110(1)(d) deduction is not available. As Dominion Steel is a publicly
traded company, the ITA 110(1)(d.1) deduction cannot be used.

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Federal Tax Payable

The required calculations are as follows:

Tax On First $205,842 $47,670

Tax On Next $23,873 ($229,715 - $205,842) At 33 Percent 7,878

Tax Before Credits $55,548

Tax Credits:

Basic Personal Amount ($11,809)

Spouse ($11,809 - $5,650) ( 6,159)

EI Premiums ( 858)

CPP Contributions ( 2,594)

Canada Employment ( 1,195)

Jamine’s Tuition Credit (Note 8) ( 600)

Transfer Of Isabella’s Tuition - Lesser Of:

Absolute Limit Of $5,000

Actual Tuition Of $10,200 ( 5,000)

Medical Expenses (Note 9) ( 13,583)

Total Credit Base ($41,798)

Rate 15% ( 6,270)

Charitable Donations (Note 10) ( 674)

Political Contributions [(3/4)($400) - (1/2)($50)] ( 325)

Federal Tax Payable $48,279

Note 8 As Jamine included the reimbursement of the music course in her employment income as a
taxable benefit, she can claim the tuition fee credit.

Note 9 The amount of medical expenses that can be included is calculated as follows:

Medical Expenses For:

Jamine $3,200

Raul ($7,800 - $4,800) 3,000

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Diego 2,450 $ 8,650

Lesser Of:

 [(3%)($229,715)] = $6,891

 2018 Threshold Amount = $2,302 ( 2,302)

Balance Before Dependants 18 And Over $ 6,348

Isabella’s Medical Expenses $7,235

Reduced By The Lesser Of:

 $2,302

 [(3%)(Nil)] = Nil Nil 7,235

Total Medical Expense Claim $13,583

Note 10 The charitable donations tax credit would be calculated as follows:

15% Of $200 $ 30

33% Of The Lesser Of:

$2,150 - $200 = $1,950

$229,715 - $205,842 = $23,873 644

29% Of [$2,150 - ($200 + $1,950)] Nil

Total Credit $674

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TIF Solution Six - 18

Part A(1) - Minimum Net Income For Tax Purposes
Net Employment Income
Net Employment Income would be calculated as follows:

Base Salary $50,000

Commission Income

[(1.5%)($2,800,000 + $200,000 - $300,000)] 40,500

Group Term Life Insurance Premium [($5)($50,000 ÷ $1,000)] 250

Award ($900 – $500) 400

Eligible Housing Loss [(1/2)($20,000 – $15,000)] 2,500

Stock Option Benefit [(3,000)($20 – $17)] 9,000

Interest Benefit On Employee Loan [(1%)(3,000)($17)(334/365)] 467

Standby Charge [(2/3)($450)(12)(8,000 ÷ 20,004)] 1,440

Operating Cost Benefit (See Part B) - Lesser Of:

 [(8,000)($0.26)] = $2,080

 [(1/2)($1,440)] = $720 720

RPP Contributions ( 3,000)

Salesperson Expenses (Note 1) ( 6,966)

Professional Membership Dues ( 1,400)

Net Employment Income $93,911

Note 1 Salesperson expenses would be calculated as follows:

Automobile expenses [($5,400)(27,000 ÷ 35,000)] $4,166

Meals and entertainment [(50%)($2,600)] 1,300

Hotels 1,500

Total Expenses (Less Than Commissions) $6,966

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Net Business Income

Net Business Income would be calculated as follows:

Revenues $40,000

Supplies Used ($1,600 + $12,000 - $900) ( 12,700)

Business Telephone ( 800)

Work Space In The Home Expenses (Note 2) ( 5,000)

Automobile Operating Expenses (100 percent) ( 3,000)

CCA (Note 3) ( 6,690)

Net Business Income $11,810

Note 2 Work space in the home expenses would be calculated as follows:

Utilities $ 5,400

Property Taxes 3,800

Maintenance 1,600

Insurance 1,900

Mortgage Interest 12,300

Total House Expenses $25,000

Business Use Of Residence 20%

Work Space In The Home Expenses $ 5,000

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Note 3 The CCA would be calculated as follows:

Class 8

Opening UCC $3,100

One-Half Additions [(1/2)($2,200)] 1,100

Balance $4,200

Rate 20% $ 840

Class 10.1- Old Car

[($9,000)(30%)(1/2)] (Note 4) $1,350

Class 10.1- New Car In Separate Class

[($30,000)(30%)(1/2)] 4,500 5,850

Total CCA $6,690

Note 4 The recapture rules do not apply to Class 10.1. Also with respect to Class 10.1, in the
year of disposition, the taxpayer is entitled to claim one-half of the normal CCA on the opening
class balance.

Taxable Capital Gains

The taxable capital gain on the sale of the option shares would be calculated as follows:

Proceeds Of Disposition [($22)(2,000)] $44,000

Adjusted Cost Base [($20)(2,000)] ( 40,000)

Capital Gain $4,000

Inclusion Rate 1/2

Taxable Capital Gain $2,000

Minimum Net Income For Tax Purposes

Minimum Net Income For Tax Purposes would be calculated as follows:

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Net Employment Income $ 93,911

Net Business Income 11,810

Taxable Capital Gain On Shares 2,000

Interest Expense (Note 5) ( 467)

Net Income For Tax Purposes $107,254

Note 5 As the loan was used for investment purposes, the employment income interest benefit
of $467, which is deemed to be interest paid by virtue of ITA 80.5, would be deductible by
virtue of ITA 20(1)(c).

Part A(2) - Minimum Taxable Income

Minimum Taxable Income would be calculated as follows:

Net Income For Tax Purposes $107,254

Stock Option Deduction [(1/2)(($9,000)] ( 4,500)

Taxable Income $102,754

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Part A(3) - Minimum Federal Tax Payable

Minimum Federal Tax Payable would be calculated as follows:

Tax On First $93,208 $16,544

Tax On Next $9,546 [(26%)($102,754 - $93,208)] 2,482

Tax Before Credits $19,026

Tax Credits:

Basic Personal Amount ($11,809)

Eligible Dependant (Ryan) ( 11,809)

CPP( 2,594)

EI ( 858)

Canada Employment ( 1,195)

Transfer Of Tuition - Lesser Of:

 Absolute Limit Of $5,000

 Actual Tuition Of $1,600 ( 1,600)

Medical Expenses (Note 6) ( 1,698)

Subtotal ($31,563)

Rate 15% ( 4,734)

Charitable Donations (Note 7)

[(15%)($200) + (29%)($1,600 – $200)] ( 436)

Federal Tax Payable $13,856

Federal Taxes Deducted At Source ( 15,000)

Federal Tax Owing (Refund) ($ 1,144)

Note 6 The base for the medical expense credit is calculated as follows:

Premiums Paid On Dental And Health Plan $1,500

Ryan’s Orthodontic Work $5,000

Employer Reimbursement (50%) ( 2,500) 2,500

Total Eligible Expenses $4,000

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Reduced By The Lesser Of:

 [(3%)($107,254)] = $3,218

 $2,302 ( 2,302)

Base For Medical Expense Credit $1,698

Note 7 As none of her income is taxed at 33 percent, this rate will not be applicable to the
calculation of the charitable donations tax credit.

Part B - Tax Planning Advice

The following points are relevant here:

Car Insurance As her employer pays the insurance cost portion of her operating expenses, the
usual operating cost benefit is applicable, despite the fact that Joan pays all the other operating
costs. If alternatively, this was treated as a taxable allowance, the $720 operating cost benefit
would be eliminated. The net effect of this change would be as follows:

Elimination Of Operating Cost Benefit ($ 720)

Taxable Allowance Received 2,200

Deduction Of Insurance Costs [($2,200)(27,000 ÷ 35,000)] ( 1,697)

Decrease In Employment Income ($ 217)

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Compensation For Daughter Joan should pay Julie a reasonable salary for her services to the
business. Since Julie’s net income is currently reported as $7,200, a salary payment of up to
$5,804 ($11,809 + $1,195 - $7,200) would not attract any federal tax as her basic personal
amount of $11,809 and Canada employment amount of $1,195 would offset the tax. Although
Julie would have a tuition tax credit to offset more income, this would mean the credit could
not be transferred to Joan.

The payment of salary would be deductible to Joan, but would attract some employer EI
premiums as well as some CPP premiums for Joan and Julie if the salary exceeds the CPP
threshold of $3,500.

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Chapter Seven Test Item File Solutions

TIF Solution Seven - 1

1. The required two differences can be selected from the following differences which were described
in the text:

 When some types of property income are being earned, the deduction of capital cost allowance
(CCA) cannot be used to create or increase a net loss for the period.

 When property income is being earned by individuals, there is no requirement for a pro rata CCA
reduction to reflect a short fiscal period.

 When property income is being earned, the income attribution rules (see Chapter 9) are
applicable. This is not the case when business income is being earned.

 Certain expenses can be deducted against business income, but not property income. These
include write-offs of cumulative eligible capital and convention expenses. In contrast, for
individuals, there is a deduction for foreign taxes on property income in excess of 15 percent that is
not available against foreign business income.

2. While other situations could be mentioned, the ones that are listed in the text are as follows:

 Interest related to the acquisition of items for personal consumption (e.g., a loan to purchase a sail
boat).

 Interest related to the acquisition of assets which produce income that is only partially taxed (e.g.,
capital gains).

 Interest related to the acquisition of assets which produce income that will not be taxed until a
subsequent taxation year (e.g., gains on investments in land).

3. As discussed in Income Tax Folio S3-F6-C1, for an amount to be characterized as interest, three
characteristics must be present:

 The payment must accrue on a continuous basis.

 It must be calculated with reference to a principal sum.

 It must be compensation for the use of that principal sum.

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Dividend payments are also compensation for the use of a principal sum and, in some cases
(preferred shares), they are calculated with reference to some stated amount. Given this, the
most reliable distinguishing feature is that dividends do not accrue on a continuous basis. They
arise only when they are declared by the management of the company.

4. These rules were created to deal with situations where an investment which has been financed with
debt is sold for proceeds that are less than the debt. If all of the proceeds are used to pay off the
related debt, a debt balance will remain. In the absence of special rules, interest on this remaining
debt would not be deductible because it cannot be linked to an income producing asset. However,
ITA 20.1(1) indicates that the remaining debt is deemed to be used for income producing purposes,
thereby allowing the taxpayer to deduct the interest on this balance.

5. If the debt issuer is in the money lending business, the premium will have to be taken into income
when the bonds are issued. For most other issuers, the premium will be treated as a tax free capital
receipt, with no further tax consequences at the maturity of the bond. If, however, it appears that
the bonds were deliberately priced to create a premium, the premium will have to be amortized as a
reduction in interest expense over the life of the bonds.

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6. Over the life of the bond, no recognition is given to the fact that the bond sold at a discount. The
amount of interest that will be deducted will be based entirely on the coupon or stated rate. When
the bonds are paid off at maturity, the difference between the discounted value and the maturity
amount will be deductible as a loss. Provided the bonds are sold for not less than 97 percent of their
face value and have an effective yield that does not exceed 4/3 of the stated yield, the loss will be a
fully deductible business loss. Otherwise, it must be treated as a capital loss, only one-half of which
is deductible against taxable capital gains.

7. Corporations are required to recognize revenue on a full accrual basis, including all amounts
receivable at the end of a taxation year. In contrast, individuals can use either cash or accrual
accounting. However, either method is limited by the requirement under ITA 12(4) that interest be
recognized on each anniversary date of the debt instrument. This, in effect, is a modified version of
accrual accounting.

8. While the purchaser must include all of the income received in his Net Income For Tax Purposes,
he can then deduct the amount that was accrued at the date of purchase. While the question does
not require this, we would note that the seller of the debt must include the same amount in his Net
Income For Tax Purposes.

9. The goal here is to ensure that the individual is not able to escape recapture when he disposes of the
property. Rental properties often have a fair market value that exceeds their UCC. If each such
asset is in a separate CCA class, when the asset is sold and the proceeds of disposition are
subtracted from the UCC, the result will be a negative balance that must be taken into income. If
the property was not allocated to a separate CCA class, this result could be avoided by simply
acquiring another rental property and adding its cost to the CCA class. As recapture only arises if
there is a negative balance at the end of the period, there would be no recapture if this addition
eliminates the deficit in the CCA class.

10. The concept of integration is the idea that an individual should pay the same amount of taxes on a
given income source, without regard to whether it is received directly and taxed only once or,
alternatively, channeled through a corporation. In this latter case, the income would be taxed twice
— once at the corporate level and again in the hands of the individual. If integration works, the
amount of taxes that would be paid by the individual receiving the income directly would be the
same as the combined corporate and personal taxes that would be assessed if a corporation was
used.

11. For eligible dividends, the gross up and tax credit procedures require that the dividends received be
grossed up by 38 percent. The federal credit against tax payable is calculated as 6/11 of the amount
of the gross up.

For non-eligible dividends, the procedures require that the dividends received be grossed up by 17
percent. The federal credit against tax payable is calculated as 21/29 of the amount of the gross up.

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12. The adjusted cost base of income trust units at the time they are acquired is equal to their cost. As
the units are held by the investor there are two types of adjustments to this value:

 The adjusted cost base will be reduced by any return of capital that is included in the
distributions that are received by the investor.

 In those cases where the investor has chosen to reinvest distributions, the adjusted cost
base will be increased by the amounts reinvested. As new units will be issued, this
addition, when combined with the new total units, will create a new average cost for
individual units.

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13. If the mutual fund is organized as a corporation, all of its distributions will be taxed as dividends.
With the exception of capital dividends, they will be grossed up and will generate a dividend tax
credit. In most cases they will be eligible dividends.

If the mutual fund is organized as a trust, its distributions will consist of the same types of income
that were earned by the trust (eligible dividends, non-eligible dividends, capital gains, and foreign
interest and dividend income). Some part of the distributions may also be a return of capital.

14. A stock dividend occurs when a corporation undertakes a pro rata distribution of shares to its
existing shareholders without receiving any consideration in return.

To the extent that the corporation has increased its paid up capital, it will be subject to tax as either
an eligible or non-eligible dividend, subject to the usual gross up and tax credit procedures.

With respect to the adjusted cost base of the investor’s holding of shares, the amount that is taxed
will be added to this value.

15. Tax legislation currently provides that only one-half of capital gains are to be included in Net
Income For Tax Purposes. When a corporation recognizes a capital gain, only one-half is taxed at
the corporate level. In the absence of a special provision, when the untaxed one-half is paid out as a
dividend, it would be subject to tax. However, there is a special provision which allows capital
dividends to be received on a tax free basis.

16. The full amount withheld will be added back in the determination of Taxable Income. Any amount
that is withheld in excess of 15 percent will be deducted in the determination of Taxable Income.
The amount withheld, to a maximum of 15 percent of the amount of foreign non-business income,
will be applied as a credit against Canadian Tax Payable.

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TIF Solution Seven - 2

1. True.

Corporations must use the full accrual approach.

2. False.

When an issuer deliberately prices a bond issue to create a premium, IT-533 requires that this
premium be amortized as a reduction in the deductible amount of interest.

3. True.

IT Folio S3-F6-C1 makes it clear that the indirect use of the money is not relevant to the
question of deductibility.

4. False.

IT Folio S3-F6-C1 indicates that there is a presumption that common shares will pay dividends
unless the securities have contractual terms that make such payments impossible.

5. False.

He can claim a rental loss in the current year of $800. The loss cannot be increased with CCA.

6. True.

All of these calculations will produce the correct result.

7. False.

The return of capital is subtracted from the adjusted cost base of the units.

8. True

While mutual funds are usually organized as trusts, they can also be organized as corporations.

9. True.

Even though no assets are received, investors will have to pay taxes on stock dividends equal to
the increase in the PUC of the shares issued on the stock dividend.

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10. False.

The full pre-tax amount must be included in the Net Income For Tax Purposes of the Canadian
resident. The amount withheld will be treated as a credit against Tax Payable or a
combination of credit and deduction.

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TIF Solution Seven - 3

Interest Deductibility And Interest Inclusion
1. B. Net Property Loss of $155 [(500)($0.50)(138%) - ($10,000)(5%)]

2. C. If an individual borrows $100,000 to invest in securities and the securities are later
sold for $60,000, interest on the $100,000 will continue to be fully deductible provided the
$60,000 is immediately invested in other securities.

3. B. Net Property Income of $666 ($966* – 300).

*Dividend Income (2,000 x $0.35) = $700 x 138% = $966.

4. A. $2,352. [(50%)(1,000)($15 – $10) - $148*]

*Interest Expense = $10,148 – 10,000 = $148

[Calculated as: $10,000 x 6% x 90/365 = $147.95]

5. D. Net Property Loss of $102. ($100 x 138%) = $138 – $240 interest

6. D. Interest paid on funds borrowed to make interest-free loans to employees is not

deductible.

7i.

A. The accrual method.

7ii.

D. The receivable method.

7iii.

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E. Not allowed method ($1,200 interest would have to be accrued by the September 30, 2017
anniversary of the loan).

7iv.

E. Not allowed method (interest would have to be accrued on the September 30, 2017 anniversary
of the loan).

8. C. The corporation will be able to deduct interest of $100,000 in each of the years 1
through 10 and will have a capital loss in year 10 of $100,000, only one-half of which will be
deductible.

9. D. The corporation will be able to deduct interest of $100,000 in each of the years 1
through 10 and there will be no tax consequences at maturity.

10. B. $0 in 2018 and $1,000 in 2019 ($20,000 x 5% = $1,000).

11. C. It must be paid on a regular, periodic basis.

12. D. Jon will have to recognize nil in 2018 and $12,000 in 2019.

13. A. Individuals must accrue interest using the cash basis.

14. A. Provided the issuer is not in the business of lending money, issuing debt securities at a
premium will normally reduce the after-tax cost of financing for the issuer.

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Rental Income
15. D. If a new rental property is acquired, put into a separate CCA class, and is used more
than 90 percent for non-residential purposes, it is eligible for an enhanced CCA rate of 10
percent.

16. B. $16,000 ($43,000 - $27,000).

17. B. Short fiscal period rule (only required for Business Income).

18. A. Cost of a new refrigerator (must be capitalized).

19. D. $500 for his labour (50 hours @ minimum wage of $10 per hour).

20. A. $4,660 ($11,200 – 6,000 – 540)

Calculations:

Rental revenue: [($1,400)(8) = $11,200

CCA: [(1/2)($300,000(4%)] = $6,000

21. B. 2018: [(1/2)($200,000)(4%)] = $4,000, UCC = $200,000 - $4,000 = $196,000

2019: $196,000 x 4% = $7,840, Rental income = $8,000 - $7,840 = $160

Dividend Income

22. B. All taxable dividends paid by Canadian controlled private corporations are non-
eligible dividends.

23. C. Nil [(138%)($23,000)(15%) - (38%)($23,000)(6/11)]

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24. D. Capital Dividends. (Capital Dividends are non-taxable and do not generate a dividend
tax credit.)

25. B. The federal dividend tax credit is equal to 6/11 of the gross up on eligible dividends
received.

26. C. Federal Tax Payable = Federal tax on grossed-up dividends minus the dividend tax
credit.

27. D. $2,800 [($800)(138%) + ($600)(116%) + ($900 ÷ 90%)]

28. B. $256 [($900)(38%)(6/11) + ($600)(16%)(8/11)]

29. C. $5,066.

Taxes on the grossed up eligible dividends

[(138%)($16,000)(29% + 17.5%)] $10,267

Dividend tax credit [(38%)($16,000)(6/11 + 31%)] ( 5,201)

Net Taxes $ 5,066

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30. D. $22,080 [(2%)($800,000)(138%)].

Mutual Funds And Income Trusts

31. C. Business income received by an income trust will be distributed to investors as
business income.

32. B. Increase of $560 [(500)($1.12)]

33. B. $1,128 [($1,200)(50%)(138%) + ( $1,200)(50%)(50%)]

34. C. Income earned by the trust is not subject to income tax within the trust if it is
distributed to the unitholders.

35. A. $58.21 [($720,000 + $60,000 - $18,000) ÷ (12,000 + 1,090.91)]

Foreign Source Income

36. D. Pearlene will have foreign source net business income of $15,000 and a credit against
Tax Payable of $3,000. [(€10,000)($1.50)] = $15,000; [(€2,000)($1.50)] = $3,000

37. B. An increase in taxable income of $5,000 and a foreign tax credit of $500

38. B. $1,500 ($1,275 ÷ 85%) or 1,000 @ $1.50

39. B. $6,275 [(29%)($50,000 - $2,500) - $7,500]. The credit is limited to $7,500, 15

percent of the foreign non-business income. The remaining $2,500 of the withholding is used
as a deduction from Net Income For Tax Purposes.
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40. A. $100 of interest income from Canadian bonds

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TIF Solution Seven - 4

Exam Exercise Solution Seven - 1 (Discount Bonds)

Tax Consequences The tax consequences would be as follows:

Annual Deduction - 2018 Through 2023 [($1,250,000)(2%)] $25,000

Maturity Amount $1,250,000

Proceeds Of Sale ( 1,150,000)

2023 Loss $ 100,000

Inclusion Rate 1/2

Allowable Amount (See Note) $ 50,000

NOTE As the bonds were sold for less than 97 percent of their maturity amount and, in
addition, the effective rate of 3.5 percent is more than four-thirds of the coupon rate [(2%)(4/3)
= 2.7%], only one-half of the $100,000 loss, or $50,000 would be deductible. The total
deduction for the 6 year period would be $200,000 [($25,000)(6) + $50,000].

Accounting Consequences The accounting consequences would be as follows:

Annual Interest Payment [($1,250,000)(2%)] $25,000

Discount Amortization ($100,000 ÷ 6) 16,667

Annual Interest Expense - 2018 Through 2023 $41,667

Payment of the maturity amount in 2023 would have no tax consequences. Note that the total for the 6
year period would be $250,000 [(6)($41,667)], $50,000 more than could be deducted for tax purposes.

Exam Exercise Solution Seven - 2 (Discount Bonds)

Tax Consequences The tax consequences would be as follows:

Annual Deduction - 2018 Through 2020 [($800,000)(3%)] $24,000

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Maturity Amount $800,000

Proceeds Of Sale ( 770,000)

2020 Loss $ 30,000

Inclusion Rate 1/2

Allowable Amount (See Note) $ 15,000

NOTE As the bonds are sold for less than 97 percent of their maturity value, only one-half of
this loss would be deductible. The yield test cannot be applied as the problem does not give the
effective yield on the bonds. The total deduction for the 3 year period would be $87,000 [(3)
($24,000) + $15,000].

Accounting Consequences The accounting consequences would be as follows:

Annual Interest Payment [($800,000)(3%)] $24,000

Discount Amortization ($30,000 ÷3) 10,000

Annual Interest Expense - 2018 Through 2020 $34,000

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Payment of the maturity amount in 2020 would have no tax consequences. The total deduction for the 3
year period would be $102,000 [(3)($34,000)], $15,000 more than could be deducted for tax purposes.

Exam Exercise Solution Seven - 3 (Premium Bonds)

The tax consequences under each of the three assumptions would be as follows:

Money Lender In this case, there would be an income inclusion of $250,000 ($1,750,000 -
$1,500,000) in the current year. The interest deduction for the year would be $210,000 [(14%)
($1,500,000)].

No Deliberate Premium In this case, the premium would have no immediate tax consequences
and there would be no tax consequences when the bonds mature. The interest deduction for the
year would be $210,000 [(14%)($1,500,000)]. Given that the bonds are paid off for less than the
proceeds from their issuance, this result provides the issuer of the bonds with a tax free capital
receipt of $250,000.

Deliberate Premium In this case, the premium would be amortized at the rate of $31,250 per year
($250,000 ÷ 8). This means the interest deduction for the year would be $178,750 ($210,000 -
$31,250).

Exam Exercise Solution Seven - 4 (Premium Bonds)

The tax consequences under each of the three assumptions would be as follows:

Money Lender In this case, there would be an income inclusion of $300,000 ($1,200,000 -
$900,000) in 2018. The interest deduction for the year would be $108,000 [(12%)($900,000)].

No Deliberate Premium In this case, the premium would have no immediate tax consequences
and there would be no tax consequences when the bonds mature. The interest deduction for the
year would be $108,000 [(12%)($900,000)]. Given that the bonds are paid off for less than the
proceeds from their issuance, this result provides the issuer of the bonds with a tax free capital
receipt of $300,000.

Deliberate Premium In this case, the premium would be amortized at the rate of $60,000 per year
($300,000 ÷ 5). This means the interest deduction for the year would be $48,000 ($108,000 -
$60,000).

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Exam Exercise Solution Seven - 5 (Annual Accrual Rules)

The total interest to be recorded on the instrument will be $33,600 [($80,000)(7%)(6 years)]. It will be
allocated as follows:

Year Interest Paid Interest Reported

2018 Nil Nil

2019 Nil $ 5,600

2020 Nil 5,600

2021 $18,200 7,000

2022 Nil 4,200

2023 Nil 5,600

2024 15,400 5,600

Total $33,600 $33,600

2018 As no anniversary date occurred and no interest was received during 2018, no interest will have to
be included in Mr. Leiner’s 2018 tax return.
2019 The first anniversary date occurs on May 31 and this requires the recognition of $5,600 [(7%)
($80,000)] of interest.

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2020 The second anniversary date occurs and this requires the recognition of an additional $5,600 of
interest.
2021 The third anniversary date requires the recognition of $5,600 and, in addition, an $18,200 [(7%)
($80,000)(3.25 Years)] payment is received. As $16,800 [(3)($5,600)] of this amount has been accrued
on the three anniversary dates, only $1,400 of this amount will be added to income. This gives a total
for the year 2021 of $7,000 ($5,600 + $1,400).
2022 The anniversary date will require recognition of $5,600. However, only $4,200 of this amount
will be included as $1,400 was recognized in 2021.
2023 $5,600 will be recognized on the anniversary date.
2024 A payment of $15,400 [(2.75)($5,600)] will be received. As $9,800 ($4,200 + $5,600) of the
amount received has been recorded on the two anniversary dates, the total for 2024 will be $5,600
($15,400 - $9,800).

Exam Exercise Solution Seven - 6 (Annual Accrual Rules)

The total interest to be recorded on the instrument will be $10,000 [($50,000)(5%)(4 years)]. It will be
allocated as follows:

Year Interest Paid Interest Reported

2018 Nil Nil

2019 Nil $ 2,500

2020 $ 6,250 3,750

2021 Nil 1,250

2022 3,750 2,500

Total $10,000 $10,000

2018 As there is no anniversary date and no interest was received, no interest will have to be included
in Ms. Lox’s 2018 tax return.
2019 The first anniversary date occurs on March 31 of this year and requires the recognition of $2,500
[(5%)($50,000)] of interest in Ms. Lox’s tax return.
2020 The second anniversary date occurs on March 31 of this year and requires the recognition of
$2,500 [(5%)($50,000)] of interest in Ms. Lox’s tax return. In addition, on September 30 of this year, an
interest payment of $6,250 [(5%)($50,000)(2.5)] is received. As $5,000 of this amount has been
recognized on anniversary dates, only an additional $1,250 ($6,250 - $5,000) must be recognized
because of the payment. This gives a total of $3,750 ($2,500 + $1,250) to be included in Ms. Lox’s
2020 tax return.
2021 The third anniversary date occurs on March 31 of this year and requires recognition of an
additional $2,500 [(5%)($50,000)]. However, $1,250 of this amount was recognized in 2020, leaving
only $1,250 to be included in Ms. Lox’s 2021 return.
2022 The fourth anniversary date occurs on March 31 of this year and requires recognition of an
additional $2,500 [(5%)($50,000)] of interest in Ms. Lox’s tax return. In addition, a payment of $3,750
[(5%)($50,000)(1.5)] is received. As $1,250 of this amount has been recognized in 2021 and the

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remaining $2,500 must be recognized because of the fourth anniversary date, this payment does not
require the recognition of any additional amounts of interest.

Exam Exercise Solution Seven - 7 (Accrued Interest At Transfer)

Mrs. White will have to include the full $4,000 received. However, under ITA 20(14) she is eligible for
a deduction of $1,326 [($2,000)(120/181)], reflecting the interest that was accrued on the bonds at the
time of her purchase. The net amount that will be included in her tax return is $2,674 ($4,000 - $1,326).

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Exam Exercise Solution Seven - 8 (Accrued Interest At Transfer)

During 2018, Mr. Wexler will receive interest of $5,000 [(5%)($100,000)]. However, under ITA 20(14)
he can deduct the $1,243 [($2,500)(90/181)] of interest that was accrued when the bonds were acquired
on April 1, 2018. The net amount that will be included in his tax return is $3,757 ($5,000 - $1,243).

Exam Exercise Solution Seven - 9 (Rental Income)

Net rental income for Mr. Bodvin will be calculated as follows:

Rents $32,000

Rental Expenses Other Than CCA ( 27,500)

Rental Income Before CCA $ 4,500

CCA (See Note) ( 4,500)

Net Rental Income Nil

Note Maximum CCA would be $6,660 [(1/2)(4%)($423,000 - $132,000 + $42,000)].

However, the maximum CCA that he can deduct will be limited to his net rental income before
CCA of $4,500.

Exam Exercise Solution Seven - 10 (Rental Income)

Net rental income for Ms. Baxter will be calculated as follows:

Rents $29,000

Rental Expenses Other Than CCA And Painting ( 20,100)

Painting ( 3,500)

Rental Income Before CCA $ 5,400

CCA (See Note) ( 5,400)

Net Rental Income Nil

Note Maximum CCA would be $5,800 [(1/2)(4%)($385,000 - $95,000). However, the

maximum CCA that can be deducted is limited to her net rental income before CCA of $5,400.

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Exam Exercise Solution Seven - 11 (Eligible Dividend Income)

Eligible Dividends Received $23,500

Gross Up (38%) 8,930

Taxable Dividends $32,430

Combined Federal/Provincial Tax Rate (29% + 14%) 43%

Tax Before Credit $13,945

Dividend Tax Credit [(6/11 + 25%)(38%)($23,500)] ( 7,103)

Tax Payable $ 6,842

The after tax retention is $16,658 ($23,500 - $6,842). Note that to calculate this amount, the taxes are
deducted from the dividends received and not the grossed up taxable dividends.

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Exam Exercise Solution Seven - 12 (Eligible Dividend Income)

Eligible Dividends Received $10,200

Gross Up (38%) 3,876

Taxable Dividends $14,076

Combined Federal/Provincial Tax Rate (33% + 16%) 49%

Tax Before Credit $ 6,897

Dividend Tax Credit [(6/11 + 29%)(38%)($10,200)] ( 3,238)

Tax Payable $ 3,659

The after tax retention is $6,541 ($10,200 - $3,659). Note that to calculate this amount, the taxes are
deducted from the dividends received and not the grossed up taxable dividends.

Exam Exercise Solution Seven - 13 (Non-Eligible Dividend Income)

Federal and provincial Tax Payable on these dividends would be calculated as follows:

Non-Eligible Dividends Received $5,600

Gross Up (16%) 896

Taxable Dividends $6,496

Combined Federal/Provincial Tax Rate (26% + 10%) 36%

Tax Before Credit $2,339

Dividend Tax Credit [(8/11 + 38%)(16%)($5,600)] ( 992)

Tax Payable $1,347

The after tax retention is $4,253 ($5,600 - $1,347). Note that to calculate this amount, the taxes are
deducted from the dividends received and not the grossed up taxable dividends.

Exam Exercise Solution Seven - 14 (Non-Eligible Dividend Income)

Federal and provincial Tax Payable on these dividends would be calculated as follows:

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Non-Eligible Dividends Received $14,200

Gross Up (16%) 2,272

Taxable Dividends $16,472

Combined Federal/Provincial Tax Rate (26% + 7%) 33%

Tax Before Credit $ 5,436

Dividend Tax Credit [(8/11 + 25%)(16%)($14,200)] ( 2,220)

Tax Payable $ 3,216

The after tax retention is $10,984 ($14,200 - $3,216). Note that to calculate this amount, the taxes are
deducted from the dividends received and not the grossed up taxable dividends.

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Exam Exercise Solution Seven - 15 (Income Trust Distributions)

Jeanine will include an additional $3,230 [(1,700)($1.90)] in Net Income For Tax Purposes. The
adjusted cost base calculations are as follows:

Original Investment - Purchase Cost $62,900

Reinvestment Of Distribution [(1,700)($2.75)] 4,675

Tax Free Return Of Capital [(1,700)($0.85)] ( 1,445)

Adjusted Cost Base $66,130

Original Investment - Number Of Units 1,700

Reinvestment Of Distribution ($4,675 ÷ $32) 146

Number Of Units 1,846

This will result in an average cost of $35.82 ($66,130 ÷ 1,846) per unit.

Exam Exercise Solution Seven - 16 (Income Trust Distributions)

Jerry will include an additional $1,250 [(2,500)($0.50)] in Net Income For Tax Purposes. The adjusted
cost base calculations are as follows:

Original Investment - Purchase Cost $30,000

Reinvestment Of Distribution [(2,500)($1.50)] 3,750

Tax Free Return Of Capital [(2,500)($1.00)] ( 2,500)

Adjusted Cost Base $31,250

Original Investment - Number Of Units 2,500

Reinvestment Of Distribution ($3,750 ÷ $12.50) 300

Number Of Units 2,800

This will result in an average cost of $11.16 ($31,250 ÷ 2,800) per unit.

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Exam Exercise Solution Seven - 17 (Mutual Fund Distributions)

Given the purchase price per unit is $10.40, the reinvestment will result in Mr. Bordy receiving 57.12
($594 ÷ $10.40) additional units. This will leave him holding 2,257.12 units with an adjusted cost base
of $18,524 ($17,930 + $594). His adjusted cost base per unit after the reinvestment is $8.21 ($18,524 ÷
2,257.12).

Exam Exercise Solution Seven - 18 (Mutual Fund Distributions)

The amount of the distribution would be $1,530 [(3,400)($0.45)]. Reinvestment of this amount at $5.10
per unit would result in Ariel receiving 300 additional units. Given this, her adjusted cost base per unit
would be $5.01 [($17,000 + $1,530) ÷ (3,400 + 300)].

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Exam Exercise Solution Seven - 19 (Stock Dividends)

The required calculations would be as follows:

Original Shares Held [(5%)(4,500,000)] 225,000

Stock Dividend Percentage 6%

New Shares Acquired 13,500

Per Share Addition To Paid Up Capital $ 21

Eligible Stock Dividend Received $283,500

Gross Up At 38 Percent 107,730

Taxable Eligible Dividend $391,230

There would be a federal dividend tax credit of $58,726 [(6/11)(38%)($283,500)]. The $283,500 stock
dividend would be added to the $4,275,000 [($19)(225,000)] original cost of the shares.
The adjusted cost base per share would be calculated as follows:

[($4,275,000 + $283,500) ÷ (225,000 + 13,500)] = $19.11

Exam Exercise Solution Seven - 20 (Stock Dividends)

The required calculations would be as follows:

Original Shares Held [(8%)(1,800,000)] 144,000

Stock Dividend Percentage 8%

New Shares Acquired 11,520

Per Share Addition To Paid Up Capital $ 12

Stock Dividend Received $138,240

Gross Up At 38 Percent 52,531

Taxable Eligible Dividend $190,771

There would be a federal dividend tax credit of $28,653 [(6/11)(38%)($138,240)]. The $138,240 stock
dividend would be added to the $1,584,000 [($11)(144,000)] original cost of the shares.
The adjusted cost base per share would be calculated as follows:

[($1,584,000 + $138,240) ÷ (144,000 + 11,520)] = $11.07

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Exam Exercise Solution Seven - 21 (Foreign Source Income)

Part A If the foreign source income is non-business income, the credit against Tax Payable is limited to
15 percent of the foreign non-business income. Given this, the required calculations would be as
follows:

Amount Received $21,060

Withholdings [(22%)($27,000)] 5,940

Inclusion For Foreign Non-Business Income $27,000

Deduction [(22% - 15%)($27,000)] ( 1,890)

Increase In Taxable Income $25,110

Federal Tax Rate 33%

Tax Payable Before Credit $ 8,286

Foreign Tax Credit [(15%)($27,000)] ( 4,050)

Federal Tax Payable $ 4,236

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Part B If the foreign source income is business income, the full amount of the withholdings can be used
as a credit against Tax Payable. Given this, the required calculations are as follows:

Amount Received $21,060

Withholdings [(22%)($27,000)] 5,940

Increase In Taxable Income $27,000

Federal Tax Rate 33%

Tax Payable Before Credit $ 8,910

Foreign Tax Credit (Amount Withheld) ( 5,940)

Federal Tax Payable $ 2,970

Exam Exercise Solution Seven - 22 (Foreign Source Income)

Part A If the foreign source income is non-business income, the credit against Tax Payable is limited to
15 percent of the foreign non-business income. In this case the withholding is at a rate of 20 percent
[($34,000 - $27,200)  $34,000]. Given this, the required calculations would be as follows:

Amount Received $27,200

Withholdings [(20%)($34,000)] 6,800

Inclusion For Foreign Non-Business Income $34,000

Deduction [(20% - 15%)($34,000)] ( 1,700)

Increase In Taxable Income $32,300

Federal Tax Rate 33%

Tax Payable Before Credit $ 10,659

Foreign Tax Credit [(15%)($34,000)] ( 5,100)

Federal Tax Payable $ 5,559

Part B If the foreign source income is business income, the full amount of the withholdings can be used
as a credit against Tax Payable. Given this, the required calculations are as follows:

Amount Received $27,200

Withholdings [(20%)($34,000)] 6,800

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Increase In Taxable Income $34,000

Federal Tax Rate 33%

Tax Payable Before Credit $ 11,220

Foreign Tax Credit (Amount Withheld) ( 6,800)

Federal Tax Payable $ 4,420

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TIF Solution Seven - 5A

The correct definitions for each of the listed key terms are as follows:

A. 7

B. 1

C. 4

D. 8

E. 3

F. 5

G. 9

H. 6

The two unused definitions are as follows:

Non-Eligible Dividends = 2

Interest Income = 10

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TIF Solution Seven - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.
The correct definitions for each of the listed key terms listed below.

A. 9 (not 7)

B. 1

C. 5

D. 11

E. 4

F. 6 (not 3)

G. 12

H. 8 (not 13)

The three unused definitions are as follows:

Non-Eligible Dividends = 2

Foreign Taxes Paid Credit = 10

Interest Income = 14

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TIF Solution Seven - 6

Case A
The interest would be deductible as the direct use of the borrowed funds was to acquire the publicly
traded securities which would (or should) produce income.

Case B
Since the proceeds exceed the borrowings, Mr. Tulee has complete flexibility with respect to linking, as
long as the amount linked is less than or equal to the cost of the property. Any allocation totaling
$50,000 would be acceptable.

Case C
Under ITA 20.1 (the disappearing source rules), the $220,000 balance will be deemed to be used to
produce income. Therefore, she can continue to deduct the interest.

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TIF Solution Seven - 7

Note To Instructor The value of the land for the properties that have been sold has been
ignored in this problem to focus on the rental income issues.

Net Rental Income

For the four properties, CCA and other information related to disposals, would be calculated as follows:

124 Glengarry 436 Rankin

Avenue Avenue

January 1, 2018 UCC $563,086 Nil

Additions 63,000 $947,000

One Half Net Additions:

[(1/2)($63,000)] ( 31,500)

[(1/2)($947,000)] ( 473,500)

CCA Base $594,586 $473,500

Rate 5% 4%

Maximum CCA $ 29,729 $ 18,940

4251 Oak 1322 Curry

Street Avenue

January 1, 2018 UCC $411,845 $213,018

Dispositions - Lesser Of:

$456,000 Cost And $523,000 POD ( 456,000)

$246,000 Cost And $185,000 POD ( 185,000)

Subtotal ($ 44,155) $ 28,018

Recapture (Note 1) 44,155

Terminal Loss (Note 2) ( 28,018)

CCA Base Nil Nil

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Note 1 As each rental property with a cost in excess of $50,000 must be allocated to a separate
CCA Class, the negative balance for the 4251 Oak Street property must be included in income
as recapture.

Note 2 As no assets remain in the separate class for 1322 Curry Avenue, the positive balance
that remains can be deducted as a terminal loss.

The terminal loss for Class 8 would be calculated as follows:

January 1, 2018 UCC $3,598

Disposition - Lesser Of:

 Cost = $23,000

 Proceeds Of Disposition = Nil Nil

Balance With No Remaining Assets In The Class $3,598

Terminal Loss On Class 8 Assets ( 3,598)

CCA Base Nil

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The calculation of net rental income would be as follows:

Income (Loss) Before CCA

124 Glengarry Avenue $ 8,600

4251 Oak Street 11,760

1322 Curry Avenue ( 2,190)

436 Rankin Avenue 4,495

Recapture 44,155

Terminal Loss On Class 1 ( 28,018)

Terminal Loss On Class 8 ( 3,598)

Income Before CCA $35,204

CCA (Note 3) ( 35,204)

Net Rental Income Nil

Note 3 Maximum available CCA is $48,669 ($29,729 + $18,940). However, as CCA cannot
be used to create a net rental loss, the CCA deduction is limited to $35,204, the net rental
income before CCA.

With respect to the question of the Class from which this amount will be deducted, when CCA is not
maximized, the general rule is to deduct the amount taken from the Class with the lowest rate. This
would suggest deducting $18,940 from the Class 1 UCC balance for 436 Rankin Avenue, and the
remaining $16,264 ($35,204 - $18,940) from the 124 Glengarry Avenue Class 3 UCC balance.
If Ms. Roberts had any plans to sell 436 Rankin in the near future, it might be more beneficial to
consider taking the maximum CCA on the 124 Glengarry Avenue building instead.

Taxable Capital Gain

While the net rental income is nil, there would be a taxable capital gain of $33,500 [(1/2)($523,000 -
$456,000)] on the disposition of the 4251 Oak Street building.
Note that the building at 1322 Curry Avenue is a depreciable property and its sale cannot create a capital
loss. The difference between its capital cost of $246,000 and the proceeds of disposition of $185,000
has been written off through CCA and the terminal loss arising from its sale.

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TIF Solution Seven - 8

2017
The maximum CCA for 2017 would be calculated as follows:

Class 1 Class 8

Addition $690,000 $43,000

One-Half Net Additions ( 345,000) ( 21,500)

CCA Base $345,000 $21,500

Maximum CCA:

[(4%)($345,000)] ( 13,800)

[(20%)($21,500)] ( 4,300)

Add: One-Half Net Additions 345,000 21,500

January 1, 2018 UCC $676,200 $38,700

Net Rental Income for 2017 would be calculated as follows:

Rental Revenue $63,600

Expenses Other Than CCA ( 23,400)

Income Before CCA $40,200

Class 1 CCA ( 13,800)

Class 8 CCA ( 4,300)

Net Rental Income $ 22,100

Note that when an individual uses assets to produce property income (e.g., rental income), the full
calendar year is considered to be the taxation year of the individual. This means that the short fiscal
period rules are not applicable to Mr. Thorne.

2018
The terminal loss for Class 8 would be calculated as follows:

January 1, 2018 UCC $38,700

Disposition - Lesser Of:

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 Cost = $43,000

 Proceeds Of Disposition = $31,000 ( 31,000)

Balance With No Remaining Assets In The Class $ 7,700

Terminal Loss ( 7,700)

January 1, 2019 UCC - Class 8 Nil

The terminal loss will be deducted from the Class 8 UCC leaving a January 1, 2019 balance of nil.
The maximum CCA for 2018 would be $27,048 [(4%)($676,200)]. However, as the deduction of CCA
cannot be used to create a loss, the actual amount deducted would be limited to $17,400, as shown in the
calculation of Net Rental Income:

Rental Revenue $54,500

Expenses Other Than CCA And Terminal Loss ( 29,400)

Terminal Loss On Class 8 Assets ( 7,700)

Income Before CCA $17,400

CCA (Limited To Income Before CCA) ( 17,400)

Net Rental Income Nil

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The January 1, 2019 UCC of the Class 1 building would be calculated as follows:

January 1, 2018 UCC $676,200

2018 CCA Deducted ( 17,400)

January 1, 2019 UCC - Class 1 $658,800

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TIF Solution Seven - 9

2017
The maximum CCA for 2017 would be calculated as follows:

Class 1 Class 8

Addition $255,000 $12,800

One-Half Net Additions ( 127,500) ( 6,400)

CCA Base $127,500 $ 6,400

Maximum CCA:

[(4%)($127,500)] ( 5,100)

[(20%)($6,400)] ( 1,280)

Add: One-Half Net Additions 127,500 6,400

January 1, 2018 UCC $249,900 $11,520

Net Rental Income for 2017 would be calculated as follows:

Rental Revenue $26,000

Expenses Other Than CCA ( 10,900)

Income Before CCA $15,100

Class 1 CCA ( 5,100)

Class 8 CCA ( 1,280)

Net Rental Income $ 8,720

Note that when an individual uses assets to produce property income (e.g., rental income), the full
calendar year is considered to be the taxation year of the individual. This means that the short fiscal
period rules are not applicable to Mr. Taylor.

2018
The terminal loss for Class 8 would be calculated as follows:

January 1, 2018 UCC $11,520

Disposition - Lesser Of:

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 Cost = $12,800

 Proceeds Of Disposition = $10,400 ( 10,400)

Balance Before Terminal Loss $ 1,120

Terminal Loss ( 1,120)

January 1, 2019 UCC - Class 8 Nil

The terminal loss will be deducted from the Class 8 UCC leaving a January 1, 2019 balance of nil.

The maximum CCA for 2018 would be $9,996 [(4%)($249,900)]. However, as the deduction of CCA
cannot be used to create a loss, the actual amount deducted would be limited to $9,100, as shown in the
calculation of Net Rental Income:

Rental Revenue $28,400

Expenses Other Than CCA And Terminal Loss ( 18,180)

Terminal Loss On Class 8 Assets ( 1,120)

Income Before CCA $ 9,100

CCA (Limited To Income Before CCA) ( 9,100)

Net Rental Income Nil

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The January 1, 2019 UCC of the Class 1 building would be calculated as follows:

January 1, 2018 UCC $249,900

2018 CCA Deducted ( 9,100)

January 1, 2019 UCC - Class 1 $240,800

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TIF Solution Seven - 10

Part A
The combined tax rates for the three sisters are 23 percent (15% + 8%), 32.5 percent (20.5% + 12%),
and 53 percent (33% + 20%). Given these rates, the after tax returns on the bonds would be calculated
as follows:

Betty (23%) Barbra (32.5%) Becky (53%)

Interest [(5%)($20,000)] $1,000 $1,000 $1,000

Federal/Provincial Tax Payable

At 23, 32.5, And 53 Percent ( 230) ( 325) ( 530)

After Tax Return - Interest $ 770 $ 675 $ 470

Part B
The after tax returns resulting from an investment in the preferred stock begins with the calculation of
the federal and provincial Tax Payable:

Betty (23%) Barbra (32.5%) Becky (53%)

Dividends [($20,000/$25)($1.50)] $1,200 $1,200 $1,200

Gross Up Of 38 Percent 456 456 456

Taxable Dividend $1,656 $1,656 $1,656

Combined Rate (See Part A) 23% 32.5% 53%

Tax Before Dividend Tax Credit $ 381 $ 538 $ 878

Dividend Tax Credit

[(6/11 + 27%)($456)] ( 372) ( 372) ( 372)

Tax Payable $ 9 $ 166 $ 506

Based on the preceding calculation of combined Tax Payable, the after tax returns on the preferred
shares are calculated as follows:

Betty (23%) Barbra (32.5%) Becky (53%)

Dividends Received $1,200 $1,200 $1,200

Tax Payable ( 9) ( 166) ( 506)

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After Tax Return - Dividends $1,191 $1,034 $ 694

Comparison
A comparison of the after tax rates of return can be made as follows:

Betty (23%) Barbra (32.5%) Becky (53%)

After Tax Dividends $1,191 $1,034 $694

After Tax Interest ( 770) ( 675) ( 470)

Advantage Of Preferred Stock $ 421 $ 359 $224

Recommendation
As would be expected, the preferred stock offers higher after tax returns for each of the three sisters.
However, you should also advise them that the preferred shares have a greater level of risk. As the
preferred shares are not cumulative, there is the possibility that not all of the scheduled dividends will
actually be paid. In addition, the fair market value of the shares can vary which could result in proceeds
of disposition that could be more or less than $25 per share at the time of sale.

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TIF Solution Seven - 11

The major considerations in deciding between the two alternative investment strategies are the after tax
return and the certainty of the related cash flows.

Guaranteed Investment Certificate As long as the certificate is purchased from a financial

institution that is guaranteed by the federal government, there is virtually no risk that the
principal or interest could be lost. Your combined federal and provincial tax rate for interest is
44 percent (29% + 15%). Based on this, the after tax retention on this investment would be as
follows:

Interest [(3%)($250,000)] $7,500

Tax Payable [(44%)($7,500)] ( 3,300)

After Tax Return $4,200

Common Stock Purchase If you invest the $250,000 in common stock, you will acquire
2,000 shares ($250,000 ÷ $125). With the dividend at $6.00 per share, the total eligible
dividend will be $12,000. However, there is no guarantee that the stock will pay a dividend of
$6.00 per share during the year. There is the possibility that more or less than $6.00 per share
will be paid. In addition, the estimated market price of at least $135 on December 31, 2018 is
also not certain. The price on that date could be higher or lower.

Assuming that the stock does pay $12,000 in dividends and you sell the shares for $135 per
share on December 31, 2018, your after tax return on the investment is as follows:

Dividends Received $12,000

Gross Up [(38%)($12,000)] 4,560

Taxable Dividends $16,560

Taxable Capital Gain [(1/2)(2,000)($135 - $125)] 10,000

Taxable Income $26,560

Tax Rate (29% + 15%) 44%

Tax Payable Before Dividend Tax Credit $11,686

Dividend Tax Credit [(6/11 + 30%)($4,560)] ( 3,855)

Tax Payable $ 7,831

Dividends Received $12,000

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Capital Gain (100%) 20,000

Tax Payable ( 7,831)

After Tax Return $24,169

Conclusion Based purely on after tax returns, the common stock purchase is preferable as it provides an
additional $19,969 ($24,169 - $4,200). However, as previously indicated, the common stock involves
more risk and uncertainty. You will have to make a decision as to whether the additional $19,969
warrants the assumption of additional risk. Other factors which may influence your decision are as
follows:

 The funds are locked into the investment certificate and can only be withdrawn prior to maturity
at a severe interest penalty, if at all.

 The investment in common stock would give you more flexibility if you should require some of
the funds before the end of the year. All or some portion of the stockholding could be sold during
the year.

 Any dividends that are paid will be available for your use as at the payment date. The interest
will not be available to you until maturity.

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TIF Solution Seven - 12

Analysis
The major considerations in deciding between the two alternative investment strategies are the after tax
return and the certainty of the related cash flows.

Income Trust Units The cash flows associated with investments in trust units are not
guaranteed. However, the distributions made by these trusts tend to be fairly stable and, in
general, involve less risk than dividends on common shares. Your investment of $450,000 will
result in you owning 30,000 shares ($450,000  15).

As the monthly distribution includes $0.025 as a return of capital, you will only be taxed on
$0.030 of the monthly distribution. Based on this, your Tax Payable will be calculated as
follows:

Taxable Income [(12)($0.030)(30,000)] $10,800

Tax Rate (Given) 34%

Tax Payable $ 3,672

When you sell the shares at $15 per unit, there will be additional taxes as follows:

Proceeds Of Disposition [($15)(30,000)] $450,000

Adjusted Cost Base:

Original Cost $450,000

Less Tax Free Return Of Capital

[(12)($0.025)(30,000)] ( 9,000) ( 441,000)

Capital Gain (= Return Of Capital) $ 9,000

Inclusion Rate 1/2

Taxable Capital Gain $ 4,500

Tax Rate 34%

Tax Payable $ 1,530

Your after tax return would be calculated as follows:

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Trust Distributions [(12)($0.055)(30,000)] $19,800

Tax Payable ($3,672 + $1,530) ( 5,202)

After Tax Retention - Income Trust $14,598

Common Stock Purchase If you invest the $450,000 in the common stock, you will acquire
3,750 shares ($450,000 ÷ $120). The anticipated taxable income from these shares for the year
is calculated as follows:

Eligible Dividends [($1.75)(3,750)] $ 6,563

Gross Up [(38%)($6,563)] 2,494

Taxable Capital Gain [(1/2)(3,750)($124 - $120)] 7,500

Taxable Income $16,557

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Based on this figure, your Tax Payable would be calculated as follows:

Taxable Income $16,557

Tax Rate 34%

Tax Payable Before Credits $5,629

Dividend Tax Credit [(6/11 + 36%)($2,494)] ( 2,258)

Tax Payable $3,371

Your after tax return would be calculated as follows:

Eligible Dividends Received $ 6,563

Capital Gain (100%) 15,000

Pre Tax Cash Flow $21,563

Tax Payable ( 3,371)

After Tax Retention - Common Stock $18,192

Conclusion
Using your estimates for investment returns, the better investment, based purely on after tax returns, is
the common stock purchase. It provides an additional $3,594 ($18,192 - $14,598). However, the
common stock investment involves more risk and uncertainty.
You will have to make a decision as to whether the additional $3,594 warrants the assumption of
additional risk.

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TIF Solution Seven - 13

Taxable Income And Tax Payable
The amount of taxable income and tax payable resulting from the investments would be calculated as
follows:

Public Company Shares

Eligible Dividends [($1.10)(5,000)] $ 5,500

Gross Up [($5,500)(38%)] 2,090 $ 7,590

Taxable Capital Gain

[(1/2)(5,000)($22 - $20)] 5,000 $12,590

CCPC Shares

Non-Eligible Dividends [($5.00)(1,250)] $ 6,250

Gross Up [($6,250)(16%)] 1,000 7,250

Income Trust Units

Distribution [($0.90)(12,500)] $11,250

Return Of Capital [($0.40)(12,500)] ( 5,000) 6,250

Mutual Fund Units

Capital Gain [(1/2)($0.60)(4,000)] $ 1,200

Eligible Dividends [($0.80)(4,000)] $ 3,200

Gross Up [($3,200)(38%)] 1,216 4,416

Property Income [($0.35)(4,000)] 1,400 7,016

Foreign Term Deposit

Foreign Interest [(€8,000)($1.45)] $11,600

Excess Withholding - See Note

[(20% - 15%)(€8,000)($1.45)] ( 580) 11,020

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Taxable Income $44,126

Tax Rate (29% + 16%) 45%

Tax Before Credits $19,857

Dividend Tax Credit - Eligible Dividends

[(6/11 + 30%)(38%)($5,500 + $3,200)] ( 2,795)

Dividend Tax Credit - Non-Eligible Dividends

[(8/11 + 25%)(16%)($6,250)] ( 977)

Foreign Tax Credit [(15%)(€8,000)($1.45)] - See Note ( 1,740)

Tax Payable $14,345

Note - Foreign Source Property Income As required, 100 percent of the foreign interest is
included in Net Income For Tax Purposes. However, for individuals, the credit against Tax Payable
that is provided under ITA 126(1) is limited to a maximum of 15 percent of the foreign source non-
business income. Since the withheld amount exceeds 15 percent, the excess is deducted and does
not qualify for treatment as a foreign tax credit.

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Adjusted Cost Base - RioKan Income Trust

The investment of the $11,250 [($0.90)(12,500)] distribution will result in an additional 1,285.71
($11,250  $8.75) units, for a total of 13,785.71 (12,500 + 1,285.71) units. The adjusted cost base of
all of the units would be calculated as follows:

Original Units [($8.00)(12,500)] $100,000

Reinvestment In New Shares [($0.90)(12,500)] 11,250

Return Of Capital [($0.40)(12,500)] ( 5,000)

Total Adjusted Cost Base $106,250

Based on this, the adjusted cost base per unit would be calculated as follows:

$106,250  13,785.71 = $7.71

Adjusted Cost Base - Fidel Large Cap Mutual Fund

The investment of the $7,000 [($1.75)(4,000)] distribution at $26.50 per unit will result in an additional
264.15 ($7,000  $26.50) units, for a total of 4,264.15 units. The total adjusted cost base of these
units would be $107,000 [(4,000)($25) + $7,000). Given this, the adjusted cost base per unit would be
calculated as follows:

$107,000  4,264.15 = $25.09

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TIF Solution Seven - 14

Ms. Smursch’s minimum Net Income For Tax Purposes would be calculated as follows:

Income From A Business Or Profession:

Billable Hours (Given) $345,000

January 1, 2018 Unbilled Work In Progress 23,000

December 31, 2018 Unbilled

Work In Progress (Note 1) ( 11,200)

Office Supplies And Office Expenses ( 23,000)

Rent ( 60,000)

Meals And Entertainment [(1/2)($18,000)] ( 9,000)

Convention Expenses (Note 2) ( 2,400) $262,400

Property Income:

Income From Income Trust [($3.50 - $1.50)(2,500)] 5,000

Taxable Capital Gain (Note 3) 8,417

Minimum Net Income For Tax Purposes $275,817

Note 1 As Sara is a professional accountant she is eligible for the use of the billed basis of
recognition. However, as noted in the text, this provision is being phased out over 5 years at
the rate of 20 percent per year. For 2018, she must take into income 20 percent of her
December 31, 2018 unbilled WIP. That gives her a WIP deduction of $11,200 [(100% - 20%)
($14,000)].

Note 2 Unless the scope of Ms. Smursch’s business is likely to extend to this activity in the
Middle East, the costs of the Beirut convention cannot be deducted.

Note 3 The adjusted cost base of the Realty Income Trust units would be calculated as follows:

Original Cost [(2,500)($43.00] $107,500

Reinvestment Of Distribution [(2,500)($3.50)] 8,750

Tax Free Return Of Capital [(2,500)($1.50)] ( 3,750)

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Adjusted Cost Base $112,500

The taxable capital gain on the disposition of all the units would be calculated as follows:

Proceeds Of Disposition $129,333

Adjusted Cost Base ( 112,500)

Capital Gain $ 16,833

Inclusion Rate 1/2

Taxable Capital Gain $ 8,417

The distribution reinvestment resulted in 194.44 addition shares ($8,750  $45). However,

this number is irrelevant as all of the units were sold.

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TIF Solution Seven - 15

Part A - Net Income For Tax Purposes
Employment Income
Christopher’s net employment income would be calculated as follows:

Salary $67,460

Additions:

Travel Allowances (Note 1)

Hotels And Food Nil

Use Of Personal Automobile 5,200

Interest Free Loan Benefit [(1%)($20,000)] 200

Deductions:

Hotels And Food (Note 1) Nil

Automobile Costs (Note 2) ( 7,680)

RPP Contributions ( 4,200)

Net Employment Income $60,980

Note 1 Given his actual costs, the allowance for hotels and food seems reasonable. This
means it does not have to be included in income. However, this will prevent Christopher from
deducting his actual costs. With respect to the allowance for personal use of his automobile, it
is not based on kilometers driven and this means it cannot be considered “reasonable”. It must
be included in income.

Note 2 His deductible automobile costs would be calculated as follows:

Operating Costs $4,900

CCA On Class 10.1 [(1/2)(30%)($30,000)] 4,500

Interest On Loan [(1%)($20,000)] 200

Total Automobile Costs $9,600

Employment Related Percentage (25,600  32,000) 80%

Total Deductible Costs $7,680

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The luxury car rules limit the capital cost of the car to $30,000 for vehicles purchased during
2017. Also note that the $200 of imputed interest on the car loan is deemed to be interest paid
for purposes of determining motor vehicle costs under ITA 8(1)(j).

Net Property Income

Christopher’s net property income would be calculated as follows:

Public Company Eligible Dividends $23,000

Gross Up [(38%)($23,000)] 8,740

Non-Eligible Dividends - Private Company 15,000

Gross Up [(16%)($15,000)] 2,400

Foreign Preferred Shares Dividends [(100%)(US$1,800)(C$1.35)] 2,430

Gross Up N/A

Mutual Fund Eligible Dividends 9,000

Gross Up [(38%)($9,000)] 3,420

Mutual Fund Interest Income 5,250

Less Interest On Loan For Investments [(2.5%)($200,000)(3/12)] ( 1,250)

Net Property Income $67,990

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The interest on the home mortgage taken out to purchase the house is not deductible as the funds were
not used to produce income. However, when the original loan was repaid and the house remortgaged,
the direct use of the funds was to produce income from investments. As a result, the interest is
deductible.

Taxable Capital Gains

Christopher has taxable capital gains from the mutual fund distribution as follows:

Mutual Fund Taxable Capital Gains [(1/2)($20,000)] $10,000

Net Income For Tax Purposes

Christopher’s Net Income For Tax Purposes can be calculated as follows:

Net Employment Income $ 60,980

Net Property Income 67,990

Taxable Capital Gains 10,000

Net Income For Tax Purposes $138,970

Part B - Taxable Income

As Christopher has no deductions in the determination of Taxable Income, his Taxable Income will be
equal to his Net Income For Tax Purposes of $138,970.

Part C - Tax Payable

Christopher’s Tax Payable would be calculated as follows:

Tax On First $93,208 $16,544

Tax On Next $45,762 ($138,970 - $93,208) At 26 Percent11,898

Tax Before Credits $28,442

Tax Credits:

Basic Personal Amount ($11,809)

Spousal ($11,809 - $8,200) ( 3,609)

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Volunteer Firefighters ( 3,000)

First Time Home Buyers ( 5,000)

Canada Caregiver For Jason ( 6,986)

Medical Expenses (Note 3) ( 21,453)

Home Accessibility Credit (Note 4) ( 10,000)

EI Premiums ( 858)

CPP Contributions ( 2,594)

Canada Employment ( 1,195)

Credit Base ($66,504)

Rate 15% ( 9,976)

Charitable Donations (Note 5)

[(15%)($200) + (29%)($3,200 - $200)] ( 900)

Dividend Tax Credits:

Eligible Dividends [(6/11)(38%)($23,000 + $9,000)]( 6,633)

Non-Eligible Dividends [(8/11)(16%)($15,000)] ( 1,745)

Foreign Tax Credit [(10%)(US$1,800)(C$1.35)] ( 243)

Federal Tax Payable $ 8,945

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Note 3 The amount for medical expenses would be calculated as follows:

Christopher And Kathy ($1,525 + $1,342 + $2,450) $ 5,317

Reduced By The Lesser Of:

 [(3%)($138,970)] = $4,169

 2018 Threshold Amount = $2,302 ( 2,302)

Jason’s Medical Expenses

($12,000 + $3,300 + $3,420) $18,720

Reduced By The Lesser Of:

 [(3%)($9,400)] = $282

 $2,302 ( 282) 18,438

Allowable Medical Costs $21,453

The home modifications were made to allow Jason, who is confined to a wheelchair, to be more
mobile within the home. As a result, the costs are allowable medical costs. As indicated in
Note 4, $10,000 of this amount can be used again in the base for the home accessibility credit.

The fees for hair replacement and teeth whitening are not allowable medical costs.

Note 4 The home accessibility tax credit base is equal to the lesser of the actual costs of
$12,000 and an unindexed amount of $10,000. Also note that, despite the fact that the full
$12,000 was used in the base for the medical expense credit, $10,000 of this amount can be
used again in the base for the home accessibility credit.

Note 5 As none of his income is taxed at 33 percent, this rate will not be applicable to the
calculation of the charitable donations tax credit.

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TIF Solution Seven - 16

Employment Income
Jeremy’s net employment income would be calculated as follows:

Gross Wages $74,000

RPP Contributions ( 5,600)

Union Dues ( 896)

Net Employment Income $67,504

Property Income
Jeremy’s property income would be calculated as follows:

Eligible Dividends Received $8,600

Gross Up Of Eligible Dividends (38%) 3,268

Non-Eligible Dividends Received 6,400

Gross Up Of Non-Eligible Dividends (16%) 1,024

Foreign Dividends Before Withholding ($13,600 ÷ 85%)16,000

Interest 3,420

Property Income $38,712

Net Business Income

Jeremy’s net business income would be calculated as follows:

Net Cash Flow $187,000

Principal Payments On Car Loan ($14,400 - $5,100) 9,300

Non-Deductible Interest [($5,100 - (365)($10 Daily Maximum)] 1,450

December 31 Receivables 26,700

January 1 Billed Receivables ( 23,200)

December 31 Work In Process (Note 1) 31,300

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January 1 Work In Process ( 28,900)

December 31 Accounts Payable ( 14,200)

January 1 Accounts Payable 15,600

Subtotal $205,050

CCA ($22,430 + $4,493 + $4,500) (Note 2) ( 31,423)

Car Operating Costs (Already Deducted) Nil

Net Business Income $173,627

Note 1 Since Jeremy is a management consultant, he was not able to use the billed basis of
income recognition. This means that he is not eligible for the transitional provision related to
the billed basis and must include 100 percent of his unbilled work in progress in his income.

Note 2 The CCA would be calculated as follows:

Class 1 CCA

January 1, 2018 UCC $342,837

Additions (Improvements) 62,000

One-Half Net Additions ( 31,000)

Base For CCA $373,837

Rate 6%

CCA $ 22,430

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As the building was acquired new and was used 100 percent for non-residential purposes, it is
eligible for the 6 percent CCA rate. The fact that it was the only building owned by the
business would result in it automatically being allocated to a separate class, but it must remain
in a separate Class 1 to continue to qualify for the 6 percent rate.

Class 8 CCA

January 1, 2018 UCC $10,564

Additions 47,000

Disposals - Lesser Of:

 Proceeds Of Disposition = $23,200

 Capital Cost = $25,000 ( 23,200)

One-Half Net Additions [(1/2)($47,000 - $23,200)] ( 11,900)

Base For CCA $22,464

Rate 20%

CCA $ 4,493

Class 10.1 CCA

As the cost of the car exceeds $30,000, the addition to Class 10.1 is limited to this value. The
maximum deduction for 2018 would be $4,500 [(30%)(1/2)($30,000)].

Net Income For Tax Purposes And Taxable Income

There are no Taxable Income deductions available. As a consequence, Taxable Income is equal to Net
Income For Tax Purposes.

Net Employment Income $ 67,504

Property Income 38,712

Net Business Income 173,627

Pension Income 32,500

Net Income For Tax Purposes And Taxable Income $312,343

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Tax Payable
Tax Payable would be calculated as follows:

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Tax On First $205,842 $47,670

Tax On Next $106,501 ($312,343 - $205,842) At 33 Percent 35,145

Tax Before Credits $82,815

Tax Credits:

Basic Personal Amount (Jeremy) ($11,809)

Spouse ($11,809 - $8,400) ( 3,409)

Canada Caregiver - Sarah ( 6,986)

Jeremy’s Age Credit [$7,333 - (15%)($312,343 - $36,976) Nil

Jeremy’s Pension Credit ( 2,000)

EI ( 858)

CPP ( 2,594)

Canada Employment ( 1,195)

Transfer Of Spouse’s Age Credit

[$7,333 - (15%)($8,400 - $36,976) ( 7,333)

Transfer Of Spouse’s Pension Credit ( 2,000)

Transfer Of Sarah’s Disability Credit ( 8,235)

Transfer Of Samantha’s Tuition Credit (Note 5) ( 5,000)

Medical Expenses (Note 6) ( 14,598)

Total Credit Base ($66,017)

Rate 15% ( 9,903)

Charitable Donations (Note 7) ( 756)

Dividend Tax Credit On:

Eligible Dividends [(6/11)(38%)($8,600)] ( 1,783)

Non-Eligible Dividends [(8/11)(16%)($6,400)] ( 745)

Foreign Tax Credit - Amount Withheld [(15%)($16,000)] ( 2,400)

Federal Tax Payable $67,228

Note 5 Samantha’s child support received is not included in her Net Income For Tax Purposes.
Given this, Samantha has Net Income For Tax Purposes of nil and would qualify as a dependant of
Jeremy’s. Even though she lives with Jeremy, he cannot claim the Canada caregiver tax credit for
her or her children as they are not mentally or physically infirm.

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The maximum transfer of the tuition credit would be the lesser of:

 The actual tuition of $16,400.

 The absolute maximum of $5,000.

Note 6 The claim for medical expenses is determined as follows:

Medical Expenses Of Jeremy And Sandra ($4,000 + $1,700) $ 5,700

Reduced By The Lesser Of:

 [(3%)($312,343)] = $9,370

 2018 Threshold Amount = $2,302 ( 2,302)

Balance Before Dependants 18 And Over $ 3,398

Sarah’s Medical Expenses $9,400

Reduced By The Lesser Of:

 $2,302

 [(3%)(Nil)] = Nil Nil 9,400

Samantha’s Medical Expenses $ 1,800

Reduced By The Lesser Of:

 $2,302

 [(3%)(Nil)] = Nil Nil 1,800

Total Medical Expense Claim $14,598

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Note 7 Jeremy’s charitable donations tax credit would be calculated as follows:

15 Percent Of $200 $ 30

33 Percent Of The Lesser Of:

($2,400 - $200) = $2,200

$312,343 - $205,842 = $106,501 726

29 Percent Of [($2,400 - ($200 + $2,200)] Nil

Total Credit $756

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Chapter Eight Test Item File Solutions

TIF Solution Eight - 1

1. One explanation that is mentioned in the text is that such gains are incidental to the main activities
of the business. However, the most important explanation is that these gains cannot be distributed
to investors. Since they result from the disposition of assets that are required in the operations of
the business, the funds resulting from their sale must be reinvested in the business in order to
continue operations. Other possible factors that relate to all taxpayers are that such gains may only
reflect the inflation in the prices of assets and the requirement that the gains be taxed favourably in
order that Canada remain internationally competitive.

2. Possible answers here would include:

 Sale of the capital asset. The proceeds of disposition here would be the sales price.

 Expropriation by a government body. The proceeds of disposition here would be the amount of
compensation paid by the government body.

 Destruction through fire, flood, or other natural disasters. The proceeds of disposition here
would be any insurance payments received.

 Loss through theft. The proceeds of disposition here may be nil. However, if there is insurance
coverage, any amount paid by the insurer would be the proceeds of disposition.

 Deemed dispositions. The deemed proceeds of disposition here would be the amount specified
in the Income Tax Act.

3. Government assistance for the acquisition of capital assets must be deducted from the adjusted cost
base of the asset acquired. This is, in general, consistent with the accounting treatment of
government assistance for the acquisition of capital assets.

4. A superficial loss is one that results from the sale of a capital asset that is reacquired within 30 days
before, or 30 days after, the disposition. Such losses cannot be deducted at the time of the
disposition. However, they are added to the adjusted cost base of the reacquired asset, thereby
reducing any future gain on the disposition of that asset.

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5. The taxpayer subtracts the sum of the adjusted cost base plus selling costs, from the proceeds of
disposition. The result is then multiplied by one-half resulting in a taxable capital gain (positive
amounts) or an allowable capital loss (negative amount).

6. The adjusted cost base would be based on the average cost of the entire holding of the identical
properties.

7. The maximum amount of the reserve in each year is the lesser of two figures. The first is the capital
gain multiplied by the ratio of the proceeds not yet collected to the total proceeds of disposition.
The second is the capital gain multiplied by a percentage which is 20 percent of the gain multiplied
by, 4 less the number of preceding taxation years ending after the disposition.

8. For tax purposes, warranty costs related to the sale of capital assets can only be deducted when
costs are actually incurred. If no costs are incurred in the year of sale, no costs can be deducted
against any income that arises in that period. When actual costs are incurred, they are treated as a
capital loss. This means that only one-half of the costs can be deducted. In addition, such losses
can only be deducted to the extent of capital gains, either in the period of incurrence or in a carry
over period.

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In contrast, for accounting purposes, the enterprise must deduct the estimated cost of providing the
warranty in the year in which the asset is sold. When actual costs are incurred, they are charged to
the allowance that was established in the year of sale. If the actual costs are higher of lower than
the estimate, there will be an adjustment which will be charged to income in the year that the
warranty stops being applicable.

9. When a combination of land and buildings is sold, there will often be a capital gain on the land
component, only one-half of which will be included in the selling taxpayer’s Net Income For Tax
Purposes. If the fair market value of the building is less than its UCC balance and the building is
the last asset in its class, there will be a terminal loss on the building. This terminal loss will be 100
percent deductible and can be used to offset the one-half of the capital gain on the land that was
included in the taxpayer’s Net Income For Tax Purposes. This will, of course, tempt taxpayers to
allocate a larger amount of the total proceeds to the land and a correspondingly smaller amount of
the total proceeds to the building. The special rule in ITA 13(21.1)(a) increases the building
proceeds to the point where any terminal loss will either be eliminated, or reduced to the point that
it does not offset any capital gain on the land.

10. While gains on personal use property are taxable, losses cannot be deducted. In addition, a special
rule specifies that each property will have a minimum proceeds of disposition of $1,000 and a
minimum adjusted cost base of $1,000. The treatment of listed personal property differs in that
losses can be deducted. However, they can only be deducted against gains on listed personal
property, not against other types of income including capital gains on other types of property.
Listed personal property is also subject to the same rules as other personal use property with
respect to minimum amounts for proceeds of disposition and adjusted cost base.

11. The enterprise will have a deductible loss of $4,000 [(€100,000)($0.04)]. The accounting treatment
will not differ from the tax treatment.

12. If the option is exercised, its cost will be added to the adjusted cost base of the land. Alternatively,
if it expires, its cost will be treated as a capital loss, one-half of which will be deductible only
against taxable capital gains.

13. If the fair market value of the personal use property exceeds its original cost, there will be a capital
gain resulting from the deemed disposition/reacquisition. As a capital gain is involved, only one-
half of the gain would be taxable. Given this, it would not be appropriate to allow this amount to be
fully deductible as CCA. As a consequence, the deductible amount only includes one-half of the
difference between the fair market value of the asset and its cost.

14. This result can be avoided by electing under ITA 45(2) not to have a change in use. If this election
is made, there will be no deemed disposition/reacquisition. In addition, the taxpayer can continue
designating the property as his principal residence for up to four years after the change in use. The
disadvantage of this election is that the taxpayer will not be able to claim CCA against the net rental
income that is received.

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15. When an individual converts a principal residence to a rental property it is a change in use and, in
the absence of an election, it is treated as a deemed disposition/reacquisition at fair market value.
However, if the individual makes an election under ITA 45(2), he will be deemed not to have
disposed of the property and it will continue to be eligible for the principal residence exemption.
For up to four years, the property can continue to be designated as a principal residence for
purposes of claiming the exemption. However, if the individual deducts CCA against his rental
income, the election is rescinded. If the individual leaves the residence because of an employer
required move, the election can be extended without limit, but the individual must return to that
residence while still with the same employer.

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16. The exceptions that are listed in the text are:

 Real property situated in Canada.

 Property belonging to a business that is carrying on business through a permanent

establishment in Canada.

 Excluded rights and interests (largely retirement savings balances).

17. An eligible small business corporation is a Canadian controlled private corporation that has
substantially all (meaning more than 90 percent) of the fair market value of its assets devoted
principally to an active business carried on primarily (meaning more than 50 percent) in Canada.
The corporation’s qualifying assets include its holdings of shares or debt in other eligible small
business corporations. To be eligible for the ITA 44.1 provisions, the small business corporation
and corporations related to it cannot have assets with a carrying value in excess of $50 million.
Shares or debt of related corporations are not counted when determining the $50 million limit on
assets.

18. Most business properties are insured for their replacement cost. When a property is destroyed by a
natural disaster, it is a disposition with the insurance payments constituting the proceeds of
disposition. As will often be the case, if the insurance proceeds exceed the cost of the destroyed
property, the result will be a taxable capital gain. In addition, the required deduction from the
relevant UCC classes may create one or more negative UCC balances. If the property is not
replaced prior to the end of the taxation year, these negative balances will become recapture. Both
the taxable capital gains and the recapture must be included in Net Income For Tax Purposes and, in
the absence of the replacement property rules, could not be reversed.

19. There are two differences. The first difference relates to the type of property that is eligible. The
rules apply to involuntary dispositions where capital property is lost, stolen, destroyed, or
expropriated, without regard to its type. If the disposition is voluntary, only real property is
eligible.

The second difference relates to the timing of the replacement. For involuntary dispositions, the
taxpayer has to replace the property within two years after the proceeds of disposition become
receivable. When the disposition is voluntary, the time period is limited to one year.

20. The unique tax planning feature that is available with capital gains and capital losses is that they can
usually be recognized for tax purposes at the discretion of the taxpayer. This results from the fact
that they are recognized when there is a disposition and, in most circumstances, the taxpayer
decides when a disposition will occur.

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TIF Solution Eight - 2

1. True. The gains may reflect higher prices for the assets the business needs.

2. True. Note that it would also be a superficial loss if an identical asset was acquired 30 days prior to
the disposition.

3. False. The adjusted cost base of the shares would be equal to their average cost of $21.43 {[(250)
($20) + (100)($25)] ÷ 350}. This means that the allowable capital loss would be $321.50 [($15.00 -
$21.43)(100)(1/2)].

4. False. The reserve cannot be more than 80 percent of the total gain.

5. False. Capital gains on a principal residence are taxable, but there is a formula available to reduce
or eliminate the capital gain.

6. True. While losses on personal use property can, in general, not be deducted, an exception is made
for those items that are listed personal property.

7(a).

False. There is no capital gain on the transaction, since both the adjusted cost base and the proceeds
of disposition are less than $1,000.

7(b).

False. There is no allowable capital loss on the sale of personal use property.

7(c).

True. The taxable capital gain on the transaction is $250, one-half of the $1,500 proceeds less the
deemed cost of $1,000.

8. True. There will always be a deemed disposition/reacquisition when there is a change in use.

9. False. There is a deemed disposition/reacquisition of most capital property, but there are types of
property that are exempt.

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10. False. The requirement for active business income is 90 percent or more.

11. True. If it were a voluntary disposition, replacement would have to occur within one year.

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TIF Solution Eight - 3

General Rules
1. C. The lifetime capital gains deduction reduces the amount of capital gains included in
Net Income For Tax Purposes.

2. C. The favourable taxation of capital gains is designed to partially compensate businesses

for the effects of inflation.

3. D. Amounts paid to PD Company on the sale of inventories.

4. B. The tax treatment of gifts is different when the gift is made to a non-arm’s length party
rather than to an arm’s length party.

5. B. CCA taken in previous years.

6. C. Since Carine’s primary intent was to use the land in her business, the gain is a capital
gain.

Superficial Losses
7. B. $20,000. The calculations are as follows:

November 12 Sale

Proceeds Of Disposition [(100)($120)] $12,000

Adjusted Cost Base [(100)($220)] ( 22,000)

Capital Loss ($10,000)

Disallowed Portion [($10,000)(80 ÷ 100)] 8,000

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Allowed Portion ($ 2,000)

Cost Of 130 Shares

November 18 Purchase [(80)($100)] $ 8,000

Disallowed Loss 8,000

December 22 Purchase [(50)($80)] 4,000

Adjusted Cost Base $20,000

8. C. $275 for 2017, $90 for 2018

Smoke shares: 100 x ($28.00 – 22.50) = $550 x 50% = $275

2017 Mirrors shares: 100 x ($25.00 – 24.00) = $100 superficial loss

2018 Mirrors shares: (100 x $26.00) – [ (100 x $23.20) + $100 superficial loss ] = $180 x 50% = $90

Detailed Application Of The Rules

9. D. If a portion of a property is sold, the adjusted cost base must be determined using the
fair market value of the portion sold as a fraction of the total fair market value of the property.

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10. C. When there is a partial disposition of land that is held as a capital asset, the adjusted
cost base must be based on a proportionate share of the total area of the land. Proportionate
allocation would not be appropriate if there are variances in the quality of the land (e.g., one
part was a swamp that could not be used).

Capital Gains Reserves

11. D. Any capital gains reserve that is deducted in the current taxation year must be added
back to income in the subsequent taxation year.

12. B. $156,250 - The maximum reserve that can be claimed is the lesser of:

 [($400,000 - $150,000)($250,000/$400,000)] = $156,250

 [($400,000 - $150,000)(20%)(4 - 0)] = $200,000

13. B. $78,125 - The maximum reserve that can be claimed is the lesser of:

 [($400,000 - $150,000)($125,000/$400,000)] = $78,125

 [($400,000 - $150,000)(20%)(4 - 1)] = $150,000

14. C. $12,000 - The maximum reserve that can be claimed is the lesser of:

 [($300,000 - $170,000 - $10,000)($280,000/$300,000)] = $112,000

 [($300,000 - $170,000 - $10,000)(20%)(4 - 0)] = $96,000

Taxable capital gain = [(1/2)($120,000 - $96,000)] = $12,000

15. A. $400,000 - $160,000 = $240,000. [(1/2)($240,000 - $180,000)] = $30,000

 (300,000/400,000)($240,000) = $180,000

 (80%)($240,000) = $192,000

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Special Rules For The Sale Of Real Property

16. B. A capital gain of $50,000 and a terminal loss of nil. The deemed proceeds for the
building would be calculated as follows:

The Lesser Of:

The FMV of the land and building $950,000

Reduced By The Lesser Of:

 The ACB of the land = $250,000

 The FMV of the land = $350,000 ( 250,000) $700,000

The Greater Of:

 The FMV of the building = $600,000

 The Lesser Of:

The cost of the building = $800,000

The UCC of the building = $650,000 $650,000

Based on this, the deemed proceeds for the land would be $300,000 ($950,000 - $650,000),
resulting in a capital gain of $50,000 ($300,000 - $250,000). The terminal loss on the building
would be reduced to Nil ($650,000 - $650,000).

17. C. There is a capital gain on the land and a terminal loss on the building

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Principal Residence Rules

18. D. If an individual owns only one real property, it is not necessary to file the Form
T2091, Designation Of A Property As A Principal Residence By An Individual, in order to
claim the principal residence exemption.

19. B. $2,500 taxable capital gain on Home B.

Home B owned 4 years (2015 to 2018)

 2015 and 2016 designated to Home A

 2017 and 2018 can be used for Home B

In the following formula, A is the number of years the property is designated a principal
residence and B is the number of years the property was owned after 1971.

Exempt portion of gain = {[Total capital gain][(1 + A) ÷ B]}

= [$200,000 - $180,000][(1 + 2)/4] = $15,000

Taxable capital gain = [(1/2)($20,000 - $15,000)] = $2,500

20. A. 2014 should be allocated to the cabin. Annual gain for the cabin is $6,000 ($30,000 /
5 years) which is greater than the annual gain for the chalet which is $5,000 ($30,000 / 6 years).

21. A. If a taxpayer owns two residences, and both are sold in the same year, the principal
residence formula will eliminate the capital gain on only one of the residences.

Personal Use Property

22. A. Losses on the disposition of personal use property can be deducted to the extent of
gains on the disposition of personal use property.

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23. C. $650 [(1/2)($1,500 - $200)]

The net capital gain on listed personal property consisted of a $1,500 gain ($2,500 - $1,000) on
the painting and a $200 loss ($1,000 - $1,200) on the stamp collection. There is no net capital
gain on the personal use property as the outboard motor gain is eliminated by the $1,000 rule
and the loss on the desk is not deductible.

24. C. $350 [($1,200 – 1,000) + (1,800 – 1,200) + (1,000 – 1,100)] x 50% = $350

25. C. An antique chair.

Foreign Currency
26. D. $1,360.

The effect can be calculated as follows:

Proceeds Of Disposition [(1,000)(FC12)($1.46)] $17,520

Adjusted Cost Base [(1,000)(FC10)($1.48)] ( 14,800)

Capital Gain $ 2,720

Inclusion Rate 1/2

Taxable Capital Gain $ 1,360

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27. B. When a Canadian corporation issues foreign currency debt, a gain or loss will only be
recognized when the debt is repaid.

Options
28. A. If the option expires, Crystal will have a business loss of $5,000.

29. B. If Nigel sells the option for $700, he will have an allowable capital loss of $150 [(1/2)
($1,000 - $700)].

Change In Use
30. A. $16,000.

The maximum CCA is calculated as follows:

Opening UCC Nil

Addition

Cost ($850,000 - $400,000) $450,000

Bump Up [(1/2)($1,100,000 - $400,000)] 350,000 $800,000

One-Half Net Additions ( 400,000)

Base For CCA $400,000

Rate 4%

Maximum CCA $ 16,000

31. B. $6,800 {[4%][1/2][$230,000 + (1/2)($450,000 - $230,000)]}

32. B. $8,750. Taxable capital gain on entire property: ($215,000 – 180,000) x 50% (one
unit) = $17,500 x 50% = $8,750

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33. B. $900. Deemed Cost [($80,000 x 50%) = $40,000] + Bump-up [($100,000 – 80,000) x
50% x 50% = $5,000]=$45,000. $45,000 x 50% (half year rule) x 4% = $900

34. C. The capital cost for CCA purposes will be $125,000. Since it is for personal use, there
will be no CCA deducted.

35. B. $1,000,000 + (1/2)($1,400,000 - $1,000,000) = $1,200,000.

Change In Use - Principal Residence Elections

36. B $16,667.

The total gain on property is $150,000 ($500,000 - $350,000). Rochelle can designate the property as
her principal residence for the 3 years 2010 through 2012. In addition, she can elect to not have a
deemed change in use for an additional 4 years, bringing the total to 7. Given that her total ownership
period was 9 years, the exempt portion of the gain would be calculated as follows:

[$150,000][(7 + 1) ÷ 9] = $133,333

Based on this, Rochelle would have to recognize a gain of $16,667.

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37. B. Susan must recognize a capital gain for tax purposes of $50,000 at January 1, 2018.
Since she took CCA, the election is not available to her.

38. B. When Ms. Boisvert moved, she filed an election to be deemed not to have converted
the property to earning business or property income. As a result, she could claim no CCA on
the property, but she is able to designate it her principal residence for years in which she did
not reside there. This is limited to four years when the residence is vacated due to a transfer by
one’s employer and the house is not reoccupied after that employment ceases.

In the following formula, A is the number of years the property is designated a principal
residence and B is the number of years the property was owned after 1971.

Exempt portion of gain = {[Total capital gain][(1 + A) ÷ B]}

= [$72,000][(1 + 12 + 4) ÷ 24] = $51,000

Minimum capital gain = ($72,000 - $51,000) = $21,000

Note that the election could have been extended for more than four years if Ms. Boisvert had
returned to live in the property, prior to leaving the employer who required her to move.

Departures From Canada

39. D. Nil

As both the residence and the apartment building are Taxable Canadian Property, no deemed disposition
is required.

40. B. Land and building that is being used as a rental property.

41. D. House in Ontario.

Deferral Provisions On Small Business Investments

42. B. The use of the deferral provision will not affect the adjusted cost base of the
replacement shares.

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43. A. $680.

Deferred 2018 capital gain = $400 [(100)($32 - $28)].

ACB of Mouse shares = $2,800 [(80)($40) - $400].

Capital gain = $1,360 [(80)($52) - $2,800]. The taxable amount = $680 [(1/2)($1,360)].

Deferral Provisions On Replacement Property

44. C. $1,398,539.

When the insurance proceeds were received in 2017, the Company would have to record a $150,000
($1,650,000 - $1,500,000) capital gain, as well as recapture of $251,461 ($1,500,000 - $1,248,539). As
the replacement cost of the new building exceeded the insurance proceeds, both of these amounts can be
eliminated through an amended return. This will result in an addition to the UCC balance of $1,398,539
($1,800,000 - $150,000 - $251,461).

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45. A. The 2018 taxable capital gain is $250 and the deemed capital cost of the new
equipment is $10,000

Taxable Capital Gain:

Lesser of a) $12,000 – 10,000 = $2,000

b) $12,000 – 11,500 = $500

x 50% = $250

Reversed Capital Gain = $2,000 – 500 = $1,500

Deemed Capital Cost = $11,500 – 1,500 = $10,000

46. D. Provided the replacement cost of the property is less than the proceeds of disposition,
100 percent of any recapture recognized as a result of an involuntary disposition can be
reversed.

47. D. A warehouse was sold in December, 2016 with half the proceeds received at the time
of sale and half of the proceeds receivable on January 1, 2018. A new warehouse was
purchased in June, 2018.

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TIF Solution Eight - 4

Exam Exercise Solution Eight - 1 (Government Assistance)
The capital cost of this Class 1 asset would be $2,725,000 ($4,200,000 - $375,000 - $1,100,000). Given
this, the maximum CCA in this first year would be $54,500 [(1/2)($2,725,000)(4%)]. As the property is
not new, it does not qualify for the enhanced CCA rates.

Exam Exercise Solution Eight - 2 (Government Assistance)

The capital cost of this Class 1 asset would be $2,100,000 ($2,600,000 - $500,000). Based on this, the
maximum CCA in 2018 would be $42,000 [(4%)(1/2)($2,100,000)]. As the property is not new, it does
not qualify for the enhanced CCA rates.

Exam Exercise Solution Eight - 3 (Superficial Loss)

The allowed portion of the loss would be calculated as follows:

Proceeds Of Disposition [(750)($13.75)] $10,313

Adjusted Cost Base [(750)($21.50)] ( 16,125)

Total Capital Loss ($ 5,812)

Disallowed Portion [(400)($21.50 - $13.75)] 3,100

Adjusted Capital Loss ($ 2,712)

Inclusion Rate 1/2

Allowable Capital Loss ($ 1,356)

The adjusted cost base of the acquired shares would be calculated as follows:

Purchase Price [(400)($12.15)] $4,860

Disallowed Loss [(400)($21.50 - $13.75)] 3,100

Adjusted Cost Base $7,960

Exam Exercise Solution Eight - 4 (Superficial Loss)

The allowed portion of the loss would be calculated as follows:

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Proceeds Of Disposition [(1,000)($5)] $ 5,000

Adjusted Cost Base [(800)($10) + (200)($12)]* ( 10,400)

Total Capital Loss ($ 5,400)

Disallowed Portion [(200)($10.40* - $5)] 1,080

Adjusted Capital Loss ($ 4,320)

Inclusion Rate 1/2

Allowable Capital Loss ($ 2,160)

*Adjusted cost base of $10.40 ($10,400 ÷ 1,000) per share

The adjusted cost base of the acquired shares would be calculated as follows:

Purchase Price [(200)($1)] $ 200

Disallowed Loss [(200)($10.40 - $5)] 1,080

Adjusted Cost Base $1,280

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Exam Exercise Solution Eight - 5 (Capital Gain On Depreciable Assets)

The required adjustments would be as follows:

Add:

Taxable Capital Gain [(1/2)($126,000 - $111,000)]$ 7,500

Recapture ($111,000 - $103,000) 8,000

Deduct:

Accounting Gain ($126,000 - $93,000) ( 33,000)

Net Adjustment ($17,500)

Exam Exercise Solution Eight - 6 (Identical Properties)

The relevant average cost calculations are as follows:

Acquisition Date Shares Cost Average

Or Sale Date Purchased (Sold) Per Share Total Cost Cost/Share

January 15, 2017 Purchase 700 $22.75 $15,925

March 12, 2017 Purchase 410 25.50 10,455

Subtotal 1,110 $26,380 $23.77

September 15, 2017 Sale ( 250) $23.77 ( 5,943)

Subtotal 860 $20,437

February 14, 2018 Purchase 925 $28.25 26,131

Subtotal 1,785 $46,568 $26.09

October 1, 2018 Sale ( 410) $26.09 ( 10,697)

End Of Year Balances 1,375 $35,871

Mr. Park’s taxable capital gain for 2017 is calculated as follows:

Proceeds Of Disposition [($26.45)(250)] $6,613

Adjusted Cost Base [($23.77)(250)] ( 5,943)

Capital Gain $ 670

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Inclusion Rate 1/2

Taxable Capital Gain $ 335

Mr. Park’s taxable capital gain for 2018 is calculated as follows:

Proceeds Of Disposition [($30.75)(410)] $12,608

Adjusted Cost Base [($26.09)(410)] ( 10,697)

Capital Gain $ 1,911

Inclusion Rate 1/2

Taxable Capital Gain $ 956

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Exam Exercise Solution Eight - 7 (Identical Properties)

The relevant average cost calculations are as follows:

Acquisition Date Shares Cost Average

Or Sale Date Purchased (Sold) Per Share Total Cost Cost/Share

January 2017 Purchase 300 $4.75 $ 1,425

July 2017 Purchase 200 5.25 1,050

Subtotal 500 $2,475 $4.95

November 2017 Sale ( 250) $4.95 ( 1,238)

Subtotal 250 $ 1,237

July 2018 Purchase 400 $5.50 2,200

Subtotal 650 $3,437 $5.29

December 2018 Sale ( 150) $5.29 ( 794)

End Of Year Balances 500 $2,643

Ms. Lane’s taxable capital gain for 2017 is calculated as follows:

Proceeds Of Disposition [($5.40)(250)] $1,350

Adjusted Cost Base [($4.95)(250)] ( 1,238)

Capital Gain $ 112

Inclusion Rate 1/2

Taxable Capital Gain $ 56

Ms. Lane’s taxable capital gain for 2018 is calculated as follows:

Proceeds Of Disposition [($4.80)(150)] $720

Adjusted Cost Base [($5.29)(150)] ( 794)

Capital Gain ($ 74)

Inclusion Rate 1/2

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Taxable Capital Gain (Allowable Capital Loss) ($ 37)

Exam Exercise Solution Eight - 8 (Warranties On Capital Assets)

For 2017, there will be a taxable capital gain of $26,500 [(1/2)($279,000 - $226,000)]. During 2018,
there will be an allowable capital loss of $2,200 [(1/2)($4,400)]. This allowable capital loss will only be
deductible in 2018 against 2018 taxable capital gains. Any loss that cannot be deducted in the current
year is subject to the carry over provisions described in Chapter 11.

Exam Exercise Solution Eight - 9 (Warranties On Capital Assets)

In 2017, there will be a taxable capital gain of $28,000 [(1/2)($182,000 - $126,000)]. When the
warranty costs are incurred in 2018, there will be an allowable capital loss of $1,200 [(1/2)($2,400)].
Any loss that cannot be deducted in the current year is subject to the carry over provisions described in
Chapter 11.

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Exam Exercise Solution Eight - 10 (Capital Gains Reserve)

The capital gain on the property would be $59,800 ($172,300 - $112,500). As $139,300 ($172,300 -
$33,000) of the proceeds remain uncollected, the maximum reserve is the lesser of:

[($59,800)($139,300 ÷ $172,300)] $48,347

[($59,800)(20%)(4 - 0)] $47,840

The addition to her Net Income For Tax Purposes is $5,980 [(1/2)($59,800 - $47,840)].

Exam Exercise Solution Eight - 11 (Capital Gains Reserve)

The capital gain on the property would be $18,100 ($105,300 - $87,200).
At the end of 2017, the balance owing would be $100,000 ($105,300 - $5,300). Based on this, the 2017
reserve is the lesser of:

[($18,100)($100,000 ÷ $105,300) $17,189

[($18,100)(20%)(4 - 0)] $14,480

This means that the Net Income For Tax Purposes inclusion for 2017 would be $1,810 [(1/2)($18,100 -
$14,480)].
At the end of 2018, the balance owing would be $50,000 ($100,000 - $50,000). Based on this, the 2018
reserve is the lesser of:

[($18,100)($50,000 ÷ $105,300) $ 8,594

[($18,100)(20%)(4 - 1)] $10,860

The capital gain for 2018 would be calculated as follows:

2017 Reserve $14,480

2018 Reserve ( 8,594)

2018 Capital Gain $ 5,886

The Net Income For Tax Purposes inclusion for 2018 would be $2,943 [(1/2)($5,886)].

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At the end of 2019, all of the proceeds have been collected. Given this, no reserve can be deducted.
However, the 2018 reserve will have to be added back to income, resulting in a Net Income For Tax
Purposes inclusion of $4,297 [(1/2)($8,594)].

Exam Exercise Solution Eight - 12 (Bad Debts On Capital Assets)

For 2017, there will be an allowable capital loss of $8,000 [(1/2)($115,000 - $131,000)]. For 2018,
there will be an allowable capital loss of $16,500 [(1/2)(Nil - $33,000)]. Both of these allowable capital
losses will only be deductible against taxable capital gains.

Exam Exercise Solution Eight - 13 (Bad Debts On Capital Assets)

For 2017, there will be a taxable capital gain of $15,500 [(1/2)($213,000 - $182,000)]. In 2018, the
uncollectible balance will create an allowable capital loss of $75,000 [(1/2)($150,000)]. He will be able
to deduct this amount in 2018, to the extent of any taxable capital gains that are realized in that year. If
the loss cannot be used in the current year, at least $15,500 can be carried back to 2017 and deducted
against the taxable capital gain realized in that year (assuming he had no capital losses that year.) Any
unused amount can be carried forward without time limit.

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Exam Exercise Solution Eight - 14 (Special Rules For Sale Of Real Property)
In the absence of the special rules related to the sale of real property, there would be taxable capital gain
of $10,000 [(1/2)($120,000 - $100,000)], and a terminal loss on the building of $3,000 [($350,000 -
$7,000) - $340,000]. However, in these circumstances, ITA 13(21.1)(a) would require a deemed
proceeds for the building to be calculated as follows:

The Lesser Of:

The FMV of the land and building $460,000

Reduced By The Lesser Of:

 The ACB of the land = $100,000

 The FMV of the land = $120,000 ( 100,000) $360,000

The Greater Of:

 The FMV of the building = $340,000

 The Lesser Of:

The cost of the building = $350,000

The UCC of the building = $343,000 $343,000

With the deemed proceeds for the building at $343,000, the terminal loss on the building would be
reduced to nil [($350,000 - $7,000) - $343,000]. With the addition of $3,000 to the building proceeds,
the land proceeds would be reduced to $117,000, thereby reducing the taxable capital gain to $8,500
[(1/2)($117,000 - $100,000)].

Exam Exercise Solution Eight - 15 (Sale Of Principal Residence)

The capital gain on each of the two properties is as follows:

House Cottage

Sales Price $263,000 $197,000

Adjusted Cost Base ( 186,000) ( 105,000)

Capital Gain $ 77,000 $ 92,000

Annual Gain - House ($77,000 ÷ 12) $6,417

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Annual Gain - Cottage ($92,000 ÷ 9) $10,222

Given these amounts, the years 2011 through 2018 should be allocated to the cottage and the years 2007
through 2010 for the house. This gives the following gain reductions for the two properties:

Cottage {[$92,000][(8 + 1) ÷ 9]} $92,000

City Home {[$77,000][(4 + 1) ÷ 12]} $32,083

This will leave a minimum capital gain on the sale of the two properties of $44,917 ($92,000 - $92,000
+ $77,000 - $32,083).

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Exam Exercise Solution Eight - 16 (Sale Of Principal Residence)

The total capital gain on the two properties can be calculated as follows:

City Home Chalet

Sales Price $214,000 $122,000

Adjusted Cost Base ( 172,000) ( 89,000)

Sales Commission At 6 Percent ( 12,840) ( 7,320)

Capital Gain $ 29,160 $ 25,680

Annual Gain - City Home ($29,160 ÷ 14) $2,083

Annual Gain - Chalet ($25,680 ÷ 8) $3,210

Given these amounts, the years 2012 through 2018 should be allocated to the chalet. This leaves the
years 2005 through 2011 for the Vernon house. This gives the following gain reductions for the two
properties:

Chalet {[$25,680][(7 + 1) ÷ 8]} $25,680

City Home {[$29,160][(7 + 1) ÷ 14]} $16,663

This will leave a minimum capital gain of $12,497 ($25,680 - $25,680 + $29,160 - $16,663).

Exam Exercise Solution Eight - 17 (Personal Use Property)

The tax consequences would be as follows:

Personal Use Property

Gain On Collector Car ($61,000 - $45,000) $ 16,000

Loss On Antique Furniture (Personal Use Property)Nil

Listed Personal Property

Gain On Marble Sculpture

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($13,000 - $1,000 floor) $12,000

Loss On Stamp Collection

(See Note) ( 12,000) Nil

Capital Gain $16,000

Inclusion Rate 1/2

Net Taxable Capital Gain $ 8,000

Note The adjusted cost base of the marble sculpture is deemed to be $1,000 using the $1,000
floor rule. While there is a loss of $24,500 ($50,500 - $26,000), on the coin collection, it can
only be deducted to the extent of the $12,000 capital gain on the sale of the sculpture because it
is listed personal property. The balance of $12,500 ($24,500 - $12,000) can be carried back 3
years and forward 7 years.

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Exam Exercise Solution Eight - 18 (Personal Use Property)

The results would be as follows:

Personal Use Property

Gain On Sailboat ($56,000 - $42,000) $14,000

Loss On Antique Sports Car (Personal Use Property)Nil

Listed Personal Property

Gain On Group Of Seven Painting

($145,000 - $142,000) $3,000

Loss On Coin Collection (See Note) ( 3,000) Nil

Capital Gain $14,000

Inclusion Rate 1/2

Net Taxable Capital Gain $ 7,000

Note While there is a loss of $6,500 ($11,500 - $18,000), on the coin collection, it can only be
deducted to the extent of the $3,000 capital gain on the sale of the painting. The balance of
$3,500 ($6,500 - $3,000) can be carried back 3 years and forward 7 years.

Exam Exercise Solution Eight - 19 (Foreign Currency Gains And Losses)

The taxable capital gain on the sale is calculated as follows:

Proceeds Of Disposition [(300)(B$85)(C$0.72)] $18,360

Adjusted Cost Base [(B$15,300)(C$0.70)] ( 10,710)

Capital Gain $ 7,650

Inclusion Rate 1/2

Taxable Capital Gain $ 3,825

None of this gain qualifies under ITA 39(2), so there would be no $200 exemption.

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Exam Exercise Solution Eight - 20 (Foreign Currency Gains And Losses)

At the time of the January sale, Mr. Steller will have a taxable capital gain, calculated as follows:

Proceeds Of Disposition [(500)(£32)($1.60)] $25,600

Adjusted Cost Base [(500)(£20)($1.80)] ( 18,000)

Capital Gain $ 7,600

Inclusion Rate 1/2

Taxable Capital Gain $ 3,800

When the currency is converted in December, Mr. Steller will have a taxable capital gain calculated as
follows:

Proceeds Of Conversion [(500)(£32)($1.70)] $27,200

Adjusted Cost Base Of Currency [(500)(£32)($1.60)] ( 25,600)

Foreign Exchange Gain $ 1,600

Exclusion (Permitted To Individuals) ( 200)

Foreign Exchange Gain Subject To Tax $ 1,400

Inclusion Rate 1/2

Foreign Exchange Taxable Capital Gain $ 700

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Exam Exercise Solution Eight - 21 (Change In Use - CCA On Rental Property)

The required calculations are as follows:

Cost Of Building ($142,000 - $22,000) $120,000

FMV At Change In Use

($242,000 - $22,000) $220,000

Cost ( 120,000)

Gain $100,000

Bump Up 1/2 50,000

Subtotal $170,000

One-Half Net Additions ( 85,000)

Base For CCA $ 85,000

Rate 4%

Maximum CCA $ 3,400

As this is less than the $4,800 in net rental income, this full amount can be deducted. The first year rules
are applicable as the property was not used to produce business or property income prior to the change
in use. However, the short fiscal period rules do not apply to an individual earning property (rental)
income.

Exam Exercise Solution Eight - 22 (Change In Use - ACB, UCC And CCA)
There would be a taxable capital gain resulting from the change in use as follows:

Deemed Proceeds Of Disposition ($136,400 - $20,000)$116,400

Adjusted Cost Base ($57,000 - $20,000) ( 37,000)

Capital Gain $ 79,400

Inclusion Rate 1/2

Taxable Capital Gain $ 39,700

Cost Of Building ($57,000 - $20,000) $37,000

FMV At Change In Use

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($136,400 - $20,000) $116,400

Cost ( 37,000)

Gain $79,400

Bump Up 1/2 39,700

Subtotal $76,700

One-Half Net Additions ( 38,350)

Base For CCA $38,350

Rate 4%

Maximum 2018 CCA $ 1,534

January 1, 2019 UCC ($76,700 - $1,534) $75,166

Exam Exercise Solution Eight - 23 (Emigration)

There would be a deemed disposition on his departure, leaving him liable for the taxes on a $13,000
[(1/2)($56,000 - $30,000)] taxable capital gain.

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Exam Exercise Solution Eight - 24 (Emigration)

There would be a deemed disposition on her departure, leaving her liable for the taxes on a $3,500 [(1/2)
($52,000 - $45,000)] taxable capital gain.

Exam Exercise Solution Eight - 25 (Deferral Of Small Business Gains)

The capital gain is $500,000 ($1,100,000 - $600,000). As the $940,000 cost of the replacement shares is
less than the $1,100,000 proceeds of disposition, the permitted deferral is calculated as follows:

[($500,000)($940,000 ÷ $1,100,000)] = $427,273

This leaves the adjusted cost base of the Quint Ltd. shares at $512,727 ($940,000 - $427,273).

Exam Exercise Solution Eight - 26 (Deferral Of Small Business Gains)

The required calculations are as follows:

Capital Gain ($985,000 - $895,000) $90,000

Maximum Deferral [($90,000)($800,000 ÷ $985,000)] $73,096

This reduction will be allocated to the two investments as follows:

Barby Shares Ken Shares

Cost Of Investments $200,000 $600,000

Deferral:

[($73,096)($200,000 ÷ $800,000)] ( 18,274)

[($73,096)($600,000 ÷ $800,000)] ( 54,822)

Adjusted Cost Base $181,726 $545,178

Exam Exercise Solution Eight - 27 (Involuntary Dispositions)

As the replacement of the building did not occur until 2018, there will be a taxable capital gain and
recapture in 2017:

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Insurance Proceeds $1,000,000

Capital Cost ( 815,000)

Capital Gain $ 185,000

Inclusion Rate 1/2

Taxable Capital Gain $ 92,500

UCC $648,275

Disposition - Lesser Of:

Capital Cost = $815,000

POD = $1,000,000 ( 815,000)

Negative Ending Balance = Recapture ($166,725)

Using the ITA 44(1) election, the amended capital gain for 2017 will be nil, the lesser of:

 The reported gain of $185,000

 Nil - The excess of the proceeds of disposition over the cost of the new Building.

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With the ITA 13(4) election, the amended 2017 recapture is as follows:

January 1, 2017 UCC $648,275

Deduction:

Lesser Of:

 Proceeds Of Disposition = $1,000,000

 Capital Cost = $815,000 $815,000

Reduced By The Lesser Of:

 Normal Recapture = $166,725

 Replacement Cost = $1,075,000 ( 166,725) ( 648,275)

Amended 2017 Recapture Nil

These amended figures will be reflected in the values for the new building as follows:

Cost Of New Building $1,075,000

Capital Gain Deferred By Election ( 185,000)

Deemed Capital Cost $ 890,000

Recapture Deferred By Election ( 166,725)

UCC - December 31, 2018 $ 723,275

These amounts are $75,000 more than the old capital cost and UCC. This reflects the $75,000
($1,075,000 - $1,000,000) over and above the insurance proceeds that the Company spent on replacing
the building.

Exam Exercise Solution Eight - 28 (Involuntary Dispositions)

The results in 2017 would be as follows:

Proceeds Of Insurance $20,000

Capital Cost ( 18,000)

Capital Gain $ 2,000

Inclusion Rate 1/2

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Taxable Capital Gain $ 1,000

January 1, 2017 UCC $12,000

Lesser Of:

Capital Cost Of $18,000

Proceeds Of Disposition Of $20,000 ( 18,000)

Negative Ending Balance = Recapture ($ 6,000)

Using the ITA 44(1) election, the amended capital gain for 2017 will be nil, the lesser of:

 The reported gain of $2,000

 Nil - The excess of the proceeds of disposition over the cost of the new equipment.

With the ITA 13(4) election, the amended 2017 recapture is as follows:

January 1, 2017 UCC $12,000

Deduction:

Lesser Of:

 Proceeds Of Disposition = $20,000

 Capital Cost = $18,000 $18,000

Reduced By The Lesser Of:

 Normal Recapture = $6,000

 Replacement Cost = $20,000 ( 6,000) ( 12,000)

Amended 2017 Recapture Nil

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Subsequent to the application of these elections, the tax values for the equipment would be as follows:

Cost Of New Equipment $20,000

Capital Gain Deferred By Election ( 2,000)

Deemed Capital Cost Of New Equipment $18,000

Recapture Deferred By Election ( 6,000)

UCC At December 31, 2018 $12,000

Exam Exercise Solution Eight - 29 (Voluntary Dispositions)

There is no capital gain as the proceeds of disposition equal the total cost of the property. However, as
the replacement did not occur until 2018, there will be recapture of CCA in 2017 calculated as follows:

UCC $ 250,000

Lesser Of:

Capital Cost = $1,100,000

Proceeds Of Disposition = $1,100,000 ( 1,100,000)

Negative Ending Balance = Recapture Of CCA ($ 850,000)

Using the ITA 13(4) election in 2018, the amended 2017 recapture can be calculated as follows:

January 1, 2017 UCC $250,000

Deduction:

Lesser Of:

 Proceeds Of Disposition = $1,100,000

 Capital Cost = $1,100,000 $1,100,000

Reduced By The Lesser Of:

 Normal Recapture = $850,000

 Replacement Cost = $1,400,000 ( 850,000) ( 250,000)

Amended 2017 Recapture Nil

This will result in tax values for the new building and 2018 CCA as follows:

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Capital Cost $1,400,000

Recapture Reversal ( 850,000)

UCC $ 550,000

One-Half Net Additions [(1/2)($550,000)] ( 275,000)

CCA Base $ 275,000

Rate 4%

2018 CCA $ 11,000

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TIF Solution Eight - 5A

The correct definitions for each of the listed key terms are as follows:

A. 1

B. 9

C. 3

D. 4

E. 10

F. 7

G. 8

H. 2

The two unused definitions are as follows:

Disposition = 5

Personal Use Property = 6

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TIF Solution Eight - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.
The correct definitions for each of the listed key terms listed below.

A. 1 (not 5)

B. 13

C. 3

D. 6 (not 11)

E. 14 (not 10)

F. 9

G. 12 (not 4)

H. 2

The two unused definitions are as follows:

Disposition = 7

Personal Use Property = 8

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Part A
The total cost of the 1,222 shares remaining on December 31, 2018 would be $17,077. This is
calculated in the following table:

Shares Cost Average

Acquisition Or Sale Date Purchased (Sold) Per Share Total Cost Cost/Share

March 2012 650 $11.00 $ 7,150

September, 2013 922 13.00 11,986

May, 2015 480 17.00 8,160

Subtotal 2,052 $27,296 $13.30

November, 2015 Sale ( 610) $13.30 ( 8,113)

July, 2018 240 18.00 4,320

Subtotal 1,682 $23,503 $13.97

October, 2018 ( 460) $13.97 ( 6,426)

December 31, 2018 Balances 1,222 $17,077

Part B
The average cost of the shares sold during July, 2018 would be calculated as follows:

April, 2017 Purchase [(2,200)($12)] $26,400

December, 2017 Purchase [(1,450)($17)] 24,650

Total Cost $51,050

Average Cost ($51,050 ÷ 3,650) $13.99

Given this average cost, the taxable capital gain on the July, 2018 sale of shares would be calculated as
follows:

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Proceeds [(2,840)($22)] $62,480.00

Cost [(2,840)($13.99)] ( 39,731.60)

Capital Gain $22,748.40

Inclusion Rate 1/2

Taxable Capital Gain $11,374.20

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TIF Solution Eight - 7

2018 Results
For this year, Ms. Houde will have a taxable capital gain calculated as follows:

Proceeds Of Disposition $6,000,000

Adjusted Cost Base ( 3,500,000)

Capital Gain $2,500,000

Inclusion Rate 1/2

Taxable Capital Gain $1,250,000

As no provision can be made for the provided warranty and Ms. Houde has chosen not to use a reserve,
this full amount will have to be included in her Net Income For Tax Purposes.

2019 Results
During this year, Ms. Houde will have to include the $250,000 [(5%)($6,000,000 - $1,000,000)] of
interest in her Net Income For Tax Purposes.
Receipt of the 2019 principal payment has no tax consequences.
The $400,000 payment to the developer will result in a $200,000 [(1/2)($400,000)] allowable capital
loss. If she has no other capital losses during 2019, this amount can be carried back to be used against
taxable capital gains in the previous 3 years, including any unused balance of the $1,250,000 taxable
capital gain that was recognized on the original sale.
Any loss that is not carried back can be carried forward indefinitely and applied against future capital
gains. (Loss carry overs are covered in Chapter 11.)

2020 Results
During this year, the only tax effect will be the inclusion of the $200,000 [(5%($6,000,000 - $1,000,000
- $1,000,000)] of interest received in her Net Income For Tax Purposes.

2021 Results
At the beginning of 2021, the balance of the loan is $4,000,000. With only $1,000,000 of this being
recovered from the bankruptcy, Ms. Houde will have a 2021 allowable capital loss of $1,500,000 [(1/2)
($4,000,000 - $1,000,000)]. If she has other capital gains in 2021, this can be applied to reduce these
amounts. If not, the $1,500,000 can be carried back to be used against taxable capital gains in the
previous 3 years, including any unused balance of the $1,250,000 taxable capital gain that was
recognized on the original sale.
Any loss that is not carried back can be carried forward indefinitely and applied against future capital
gains. (Loss carry overs are covered in Chapter 11.)

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Net Effect
Ms. Houde has collected only $3,000,000 of the total principal amount. In addition, this amount has
been reduced to $2,600,000 by the required warranty payment. If she had originally sold the property
for this amount, she would have had an allowable capital loss of $450,000 [(1/2)($2,600,000 -
$3,500,000)]. Note that this is the same amount that has resulted from the preceding transactions:

2018 Taxable Capital Gain $1,250,000

2019 Allowable Capital Loss ( 200,000)

2021 Allowable Capital Loss ( 1,500,000)

Net Tax Effect Of Sale ($ 450,000)

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TIF Solution Eight - 8

Basic Alternatives
The basic issue here is whether the profit resulting from the sale is business income or, alternatively, a
capital gain. The basic criteria in making this distinction is the intent of the taxpayer at the time the
asset is acquired. Was it being acquired to produce income or, alternatively, was it being acquired for
resale at a profit? Additional criteria (most of which are relevant to this solution) that can be used in
determining intent are as follows:

 length of ownership period

 number and/or frequency of such transactions

 relationship to the taxpayer’s business

 supplemental work on the property

 nature of the asset

 objectives stated in the articles of incorporation

Business Income Approach

CL did no work on the land, did not receive income from the land, and the length of the ownership
period was relatively short. Casper also informed the property manager of the industrial park that he
might be interested in selling some of the land.
This would suggest business income treatment. Also supporting this view is the fact that Casper
believed, at the time of purchase, that the land could be resold at a profit. The addition to Net Income
For Tax Purposes in 2018 resulting from business income treatment would be as follows:

Proceeds Of Disposition $4,300,000

Cost [($11,800,000)(10  40)] ( 2,950,000)

Addition To Net Income For Tax Purposes $1,350,000

The reserve available under ITA 20(1)(n) is only available on business income, i.e., property sold during
the ordinary course of business. Since CL provides moving services and does not sell land as its
business, the company would not be eligible for this reserve. Business income reserves are covered in
Chapter 6.

Capital Gains Approach

The fact that the original intent was to move the company’s operation to this site would suggest capital
gains treatment. In addition, the offer was unsolicited, the land sale appears to be the only one that CL
has made and CL’s business is not land development or real estate.
It would appear that the arguments for capital gains treatment are stronger than those for business
income treatment. However, this situation could change if CL sells more pieces of land in the near
future as that would make this sale one of several and more indicative of business income.

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The minimum addition to Net Income For Tax Purposes in 2018 resulting from capital gains treatment
would be as follows:

Proceeds Of Disposition $4,300,000

Adjusted Cost Base [($11,800,000)(10  40)] ( 2,950,000)

Total Capital Gain $1,350,000

Less Reserve - Lesser Of:

 [($1,350,000)($2,800,000  $4,300,000)] = $879,070

 [($1,350,000)(20%)(4 - 0)] = $1,080,000 ( 879,070)

Capital Gain $ 470,930

Inclusion Rate 1/2

Addition To Net Income For Tax Purposes $ 235,465

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While additional income would have to be recognized in 2019 to 2022 under this approach, the total
amount would only be $675,000, one-half of the amount to be recognized under the business income
approach. In addition, the capital gains approach provides significant tax deferral through the use of a
capital gains reserve.

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The capital gain on the two tracts of land would be calculated as follows:

Tract A Tract B

Proceeds Of Disposition $127,000 $106,000

Adjusted Cost Base ( 71,000) ( 87,000)

Capital Gain $ 56,000 $ 19,000

2018 Solution
At the end of 2018, the proceeds not due for Tract A is $110,000 ($127,000 - $17,000). The
corresponding figure for Tract B is $74,000 ($106,000 - $32,000).
The minimum taxable capital gain to be included in Ms. Helm’s income for 2018 would be calculated as
follows:

Tract A Tract B

Total Capital Gain $ 56,000 $ 19,000

Maximum Reserve For 2018:

Tract A - Lesser Of:

[($56,000)($110,000 ÷ $127,000)] = $48,504

[($56,000)(20%)(4)] = $44,800 ( 44,800)

Tract B - Lesser Of:

[($19,000)($74,000 ÷ $106,000)] = $13,264

[($19,000)(20%)(4)] = $15,200 ( 13,264)

Subtotal $ 11,200 $ 5,736

Inclusion Rate 1/2 1/2

2018 Inclusion $ 5,600 $ 2,868

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2019 Solution
At the end of 2019, the proceeds not due for Tract A is $85,000 ($110,000 - $25,000). The proceeds not
due for Tract B are not changed from 2018.
The minimum taxable capital gain to be included in Ms. Helm’s income for 2019 would be calculated as
follows:

Tract A Tract B

2018 Reserve Added Back $ 44,800 $ 13,264

2019 Reserve:

Tract A - Lesser Of:

[($56,000)($85,000 ÷ $127,000)] = $37,480

[($56,000)(20%)(3)] = $33,600 ( 33,600)

Tract B - Lesser Of:

[($19,000)($74,000 ÷ $106,000)] = $13,264

[($19,000)(20%)(3)] = $11,400 ( 11,400)

Subtotal $ 11,200 $ 1,864

Inclusion Rate 1/2 1/2

2019 Inclusion $ 5,600 $ 932

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TIF Solution Eight - 10

Capital Gain
The taxable capital gain on the disposition would be calculated as follows:

Proceeds Of Disposition $895,000

Adjusted Cost Base ( 135,000)

Selling Costs [(4%)($895,000)] ( 35,800)

Capital Gain $724,200

Inclusion Rate 1/2

Taxable Capital Gain $362,100

Reserve Limits
Under ITA 40(1)(a)(iii), the amount that can be deducted as a capital gains reserve is equal to the lesser
of:

 [(Capital Gain)(Proceeds Not Yet Due ÷ Total Proceeds)]

 [(Capital Gain)(20%)(4 - Number Of Preceding Years Ending After Disposition)]

The second part of this formula serves to require that at least 20 percent of the gain be recognized in the
year of disposition and each subsequent year, without regard to the pattern of cash collected.

Part A
The reserve percentage under the two components of ITA 40(1)(a)(iii) would be as follows:

Proceeds 20 Percent

Year Not Yet Due Formula

2018 90% 80%

2019 80% 60%

2020 70% 40%

2021 60% 20%

2022 50% Nil

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In this case, the formula calculation provides the lowest figure in each of the 5 years. Using this as the
basis for the reserve will result in the recognition of $144,840 [(20%)($724,200)] of the gain in each of
the five years. The taxable amount in each year will be $72,420, for a total of $362,100 over the five
years 2018 through 2022.

Part B
In this case, the reserve percentage components would be as follows:

Proceeds 20 Percent

Year Not Yet Due Formula

2018 50% 80%

2019 40% 60%

2020 30% 40%

2021 20% 20%

2022 10% Nil

For the years 2018 through 2020, the proceeds not yet due calculation provides the lowest figure. Based
on this, the minimum reserve for the three years would be calculated as follows:

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 2018 [($724,200)(50%)] = $362,100

 2019 [($724,200)(40%)] = $289,680

 2020 [($724,200)(30%)] = $217,260

2018 2019 2020

Capital Gain $724,200 N/A N/A

Previous Year’s Reserve $362,100 $289,680

New Reserve ( 362,100) ( 289,680) ( 217,260)

Capital Gain $362,100 $ 72,420 $72,420

Inclusion Rate 1/2 1/2 1/2

Taxable Capital Gain $181,050 $ 36,210 $36,210

For the year 2021, both components of the ITA 40(1)(a)(iii) have the same percentage.

2020 Reserve Added To Income $217,260

2021 Reserve [($724,200)(20%)] ( 144,840)

Capital Gain $ 72,420

Inclusion Rate 1/2

Taxable Capital Gain For 2021 $ 36,210

For the year 2022, the 20 percent formula provides the lower percentage.

2021 Reserve Added To Income $144,840

2022 Reserve [($724,200)(0%)] Nil

Capital Gain $144,840

Inclusion Rate 1/2

Taxable Capital Gain For 2022 $ 72,420

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As shown in the following table, at this point the entire $362,100 taxable capital gain has been
recognized:

Year Gain Recognized

2018 $181,050

2019 36,210

2020 36,210

2021 36,210

2022 72,420

Total $362,100

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TIF Solution Eight - 11

As the ownership period varies for the two properties, the total gains must be converted to annual
amounts. The Kelowna home was owned for 20 years (1999 through 2018) and the Ottawa home was
owned for 12 years (2007 through 2018).
Given this, the annual gains are as follows:

Kelowna Home Ottawa Home

Proceeds Of Disposition $897,000 $534,000

Adjusted Cost Base ( 623,000) ( 426,000)

Total Capital Gain $274,000 $108,000

Divided By Years Owned 20 12

Annual Gains $ 13,700 $ 9,000

As the annual gain is larger on the Kelowna home, qualifying years should be designated to that
property first. Because of the plus one in the exemption formula, it will only take 19 years to
completely eliminate the gain on this property. This leaves 1 year to be designated to the Ottawa home.

The required calculations would be as follows:

Kelowna Home Ottawa Home

Total Capital Gain $274,000 $108,000

Exemption:

Kelowna Home (1999 to 2017)

{[$274,000][(19 + 1) ÷ 20]} ( 274,000)

Ottawa Home (2018)

{[$108,000][(1 + 1) ÷ 12]} ( 18,000)

Capital Gain Nil $ 90,000

Inclusion Rate N/A 1/2

Taxable Capital Gain Nil $ 45,000

This gives a total taxable capital gain on the two properties of $45,000.

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TIF Solution Eight - 12

Classification Of Property
All of the items sold are personal use property. However, if they can be classified as “listed personal
property”, their tax treatment will be different. Under ITA 54, listed personal property consists of the
following items.

(i) print, etching, drawing, painting, sculpture, or other similar work of art,

(ii) jewelry,

(iii) rare folio, rare manuscript, or rare book,

(iv) stamp, or

(v) coin.

The Paul Borduas painting, as well as the Hemingway first edition clearly fall into the listed personal
property classification. The Bentley and the Chris Craft clearly do not.
The classification of the fountain pen collection is not clear. The issue is whether a pen can be
considered jewelry (and not a writing implement) as there are fountain pens that cost as much as
$100,000 and are made from precious metals and stones.
The dictionary definition of jewel includes “a precious possession”. However, the definition of jewelry
is more narrow, referring to “ornaments for personal adornment”. Whether something that is displayed
on one’s desk would be considered personal adornment would be debatable, but the fact that Mr.
Howard always “wears” the pens prominently would favour the jewelry classification.
In the solution which follows, we have classified the pens as jewelry. However, we recognize that this
classification could be subject to challenge.

Effect On Net Income For Tax Purposes

The overall amount to be included in Net Income For Tax Purposes can be calculated as follows:

Personal Use Property (Note 1)

Gain On Antique Boat ($62,000 - $45,000) $17,000

Loss On Bentley Nil $17,000

Listed Personal Property

Gain On First Edition ($31,000 - $12,000) $19,000

Gain On Painting ($132,000 - $128,000) 4,000

Total Listed Personal Property Gains $23,000

Loss On Pens (Note 2) ( 23,000) Nil

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Net Capital Gains $17,000

Inclusion Rate 1/2

Addition To Net Income For Tax Purposes $ 8,500

Note 1 Unless an item of personal use property can be classified as listed personal property, losses
on its disposition cannot be deducted. However, gains on such property are taxable, without regard
to the classification.

Note 2 The total loss on the pen collection is $29,000 ($13,000 - $42,000). However, the current
year deduction is limited to the $23,000 in gains on listed personal property. The remaining $6,000
($29,000 - $23,000) can be carried back 3 years and forward 7 years to be applied against gains on
listed personal property that have occurred in previous years or may occur in subsequent years.

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TIF Solution Eight - 13

2016 Results
The purchase of shares with newly acquired Swiss Francs will have no effect on Net Income For Tax
Purposes in this year.

2017 Results
The total dividend received is SF5,500 [(5,000)(SF1.10)]. This amount will be converted to $7,425
[(SF5,500)($1.35)] and included in Mr. Franklin’s 2017 Net Income For Tax Purposes. Since
Matterhorn is not a taxable Canadian corporation, its dividends are not eligible for the gross up and tax
credit procedures.

2018 Results
The taxable capital gain on the sale of securities would be calculated as follows:

SF Amount Rate Translated

Proceeds Of Disposition [(5,000)(SF23)] SF115,000 $1.38 $158,700

Adjusted Cost Base [(5,000)(SF25)] (SF125,000) $1.25 ( 156,250)

Capital Gain On Sale Of Securities (SF 10,000) $ 2,450

Inclusion Rate 1/2

Taxable Capital Gain $ 1,225

At the time of conversion, Mr. Franklin will have SF5,500 from the 2017 dividend, plus SF115,000
from the 2018 sale of shares, a total of SF120,500. A capital loss will result from their conversion,
calculated as follows:

Proceeds Of Conversion [(SF120,500)($1.34)] $161,470

Adjusted Cost Base

Dividend Proceeds [(SF5,500)($1.35)] $ 7,425

Share Proceeds [(SF115,000)($1.38)] 158,700 ( 166,125)

Capital Gain (Loss) On Foreign Exchange ($ 4,655)

ITA 39(1.1) Reduction Of Capital Loss 200

Net Capital Loss ($ 4,455)

Inclusion Rate 1/2

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Allowable Capital Loss ($ 2,228)

The net allowable capital loss of $1,003 ( $2,228 - $1,225) can only be deducted in 2018 to the extent
that Mr. Franklin has taxable capital gains in that year. If all or part of it cannot be currently used, the
unused portion can be carried back 3 years and forward without limit, to be applied against taxable
capital gains in those years.
Note that because Mr. Franklin is an individual, the ITA 39(1.1) deduction of $200 reduces the capital
loss on the foreign exchange conversion.

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TIF Solution Eight - 14

Case A
In this Case, the Federal Court Trials Division decided that the profit on the sale of the apartment
building was a capital gain. They based their decision largely on the fact that it appeared that the Intent
of the taxpayer was to operate the apartment building as an income producing property.

Case B
In this Case, the Minister Of National Revenue argued that because of the Frequency Of Transactions,
the taxpayer was in the business of buying and selling cars and, as a consequence, profits on the sale of
cars should be treated as business income. However, the taxpayer was successful in refuting the
Minister’s view by arguing that the Nature Of The Transaction was such that the assets should be
viewed as capital assets and any resulting profits as capital gains.

Case C
The gains on the various sales of residential property were ruled to be business income. The primary
consideration in this Case seemed to be the Relation Of The Transactions To The Regular Business
of the taxpayer. The work that was done on the residential properties was so closely related to the
normal business activities of the interior designer that they should be considered as part of the income
from that business.

Case D
The Tax Appeals Board concluded that the amounts involved were business income rather than capital
gains. The Nature Of The Transaction seemed to be the primary consideration in this Case. The
Board indicated that the transaction was no more than an ingeniously contrived scheme to pay sums of
money for another ten years in return for the right to fill the doctors’ prescriptions. Therefore, the
amounts constituted income from their profession.

Case E
Here again, the Tax Appeals Board concluded that the amounts involved were not capital gains. In this
Case, primary emphasis was placed on the fact that the Company’s Charter was not limited to dairy
farming, but allowed them to undertake such real estate transactions.

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Case F
The profits on trading in racehorses were ruled as business income. The primary point made was the
Relation Of The Transactions To The Regular Business of the taxpayer. There was also mention of
the Frequency Of The Transactions.

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TIF Solution Eight - 15

2016 Results
During 2016, 80 percent of the property is used for income producing purposes. Based on this the
maximum CCA that can be deducted for this year is calculated as follows:

Capital Cost [(80%)($500,000)] $400,000

One-Half Net Additions ( 200,000)

CCA Base $200,000

Maximum CCA [(4%)($200,000)] ( 8,000)

One-Half Net Additions 200,000

UCC - January 1, 2017 $392,000

There are no additional tax consequences during this year.

2017 Results - Business To Personal Use

On January 1, 2017, there would be a deemed disposition/acquisition of 20 percent of the total property.
This would result in a taxable capital gain on the land calculated as follows:

Proceeds Of Disposition [(20%)($230,000)] $46,000

Adjusted Cost Base [(20%)($225,000)] ( 45,000)

Capital Gain $ 1,000

Inclusion Rate 1/2

Taxable Capital Gain On Land $ 500

There would also be taxable capital gain on the building, calculated as follows:

Proceeds Of Disposition [(20%)($585,000) $117,000

Adjusted Cost Base [(20%)($500,000)] ( 100,000)

Capital Gain $ 17,000

Inclusion Rate 1/2

Taxable Capital Gain $ 8,500

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The maximum CCA for 2017 would be calculated as follows:

Opening UCC $392,000

Disposition: Lesser Of:

Capital Cost [(20%)($500,000)] = $100,000

Proceeds Of Disposition

[(20%)($585,000) = $117,000 ( 100,000)

CCA Base $292,000

Maximum CCA [(4%)($292,000)] ( 11,680)

UCC - January 1, 2018 $280,320

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2018 Results - Personal To Business Use

On January 1, 2018, there would be a deemed disposition/acquisition of 40 percent of the total property.
This would result in a taxable capital gain on the land, calculated as follows:

Proceeds Of Disposition [(40%)($245,000)] $98,000

Adjusted Cost Base:

[(20%)($225,000)] ($45,000)

[(20%)($230,000)] ( 46,000) ( 91,000)

Capital Gain $ 7,000

Inclusion Rate 1/2

Taxable Capital Gain On Land $ 3,500

There would also be a taxable capital gain on the building, calculated as follows:

Proceeds Of Disposition [(40%)($630,000)] $252,000

Adjusted Cost Base:

[(20%)($500,000)] ($100,000)

[(20%)($585,000)] ( 117,000) ( 217,000)

Capital Gain $ 35,000

Inclusion Rate 1/2

Taxable Capital Gain $ 17,500

With respect to maximum CCA, this change in use involves a deemed disposition/acquisition from
personal use to business use. In addition, the fair market value of the building is greater than her cost.
Given this, the UCC will be limited to her cost plus one-half of the difference between fair market value
and cost. This amount would be $17,500, as calculated in the preceding table as the taxable capital gain.
Maximum CCA for would be calculated as follows:

Opening UCC $280,320

Deemed Acquisition Cost

[(20%)($500,000)] $100,000

[(20%)($585,000)] 117,000

Bump Up 17,500 234,500

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One-Half Net Additions ( 117,250)

CCA Base $397,570

Maximum CCA [(4%)($397,570)] ( 15,903)

Add: One-Half Net Additions 117,250

UCC - January 1, 2019 $498,917

Note To Instructors
We have asked students to ignore the principal residence exemption as the focus of the problem is on
change in use. The textbook states that if there is non-residential use of a principal residence, the CRA
will not apply the partial disposition rules so long as the income use is ancillary to the main use as a
principal residence, there is no structural change to the property, and no CCA is claimed.
CCA was claimed on the 20 percent that went from business to principal residence back to business and
the textbook does not specifically cover the effect of this CCA issue or a property where the principal
residence portion is originally a small percentage of the total, on the principal residence exemption.
The fact that the business had claimed CCA on the 20 percent portion that was subsequently added to
the personal portion when the business use dropped from 80 percent to 60 percent would not cause any
adjustment to the principal residence. From a tax policy point of view, a change from personal use to
business use is a concern since the personal use disposition results in capital gains with the added cost
potentially being fully deductible as CCA. This is the reason why the change of use rules only allow half
the increase in value to be added to cost. This issue does not arise, however when the property is
converted from an income use to a personal use.
If the principal residence exemption was considered, when the 40 percent principal residence portion is
changed to business use in 2018, that event would cause a disposition of a principal residence which
would then be eligible for the principal residence exemption. As a result, there would be no net capital
gain for 2018.

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TIF Solution Eight - 16

Ms. Doan’s taxable capital gain on deemed dispositions resulting from her departure from Canada
would be calculated as follows:

ABC Ltd. Shares ($86,000 - $42,000) $44,000

Vacant Land (Note 1) N/A

Power Corporation Shares ($72,000 - $38,000) 34,000

TD Bank Shares ($72,000 - $84,000) ( 12,000)

Sailboat (Note 2) N/A

Oil Painting ($11,000 - $5,000) 6,000

Stamp Collection (Note 3) ( 6,000)

Capital Gain $66,000

Inclusion Rate 1/2

Taxable Capital Gain On Departure $33,000

Note 1 Real property is exempted from the ITA 128.1(4)(b) deemed disposition requirement.
However, as it is taxable Canadian property, a later sale of this land will attract Canadian
income taxes, even though Ms. Doan is no longer a Canadian resident.

Note 2 Losses on personal use property are not deductible.

Note 3 Both the oil painting and the stamp collection are listed personal property. While there
is a $9,000 ($12,000 - $3,000) loss on the stamp collection, it can only be deducted to the
extent of the $6,000 gain on the oil painting. However, the remaining $3,000 ($9,000 - $6,000)
can be carried back 3 years to be applied against any gains on listed personal property that
occurred in those years. Although it can also be carried forward for up to 7 years, it is unlikely
that Ms. Doan will have listed personal property in Canada once she becomes a non-resident.

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TIF Solution Eight - 17

First Sale
Since Ms. Tosh has held the Tech Ltd. common shares for more than 185 days, it is a qualifying
disposition. Since the Small Oil common shares were purchased immediately, they can be designated as
replacement shares.
Preferred shares cannot be designated as replacement shares. As a result, the Small Bank Inc. shares do
not qualify as replacement shares.
The capital gain on the Tech Ltd. disposition is $700,000 ($4,200,000 - $3,500,000). As the cost of
replacement shares is only $3,800,000, the permitted deferral is limited as per the following calculation:

[($700,000)($3,800,000  $4,200,000)] = $633,333 Deferral

Given this, the adjusted cost base of the Small Oil shares would be calculated as follows:

Unadjusted Cost $3,800,000

Deferral Amount ( 633,333)

Adjusted Cost Base Of Small Oil Shares $3,166,667

Second Sale
Since Ms. Tosh has held the Future Inc. common shares for more than 185 days, it is a qualifying
disposition. Since the eligible small business corporation common shares were purchased in the current
year, they can be designated as replacement shares.
The capital gain on the disposition of Future Inc. shares is $1,800,000 ($5,600,000 - $3,800,000). Of the
$5,600,000 in proceeds, only $5,200,000 ($2,400,000 + $2,800,000) was invested in replacement shares.
This means that the permitted deferral will be limited as per the following calculation:

[($1,800,000)($5,200,000  $5,600,000)] = $1,671,429 Deferral

Using this information, the adjusted cost base of the newly acquired shares would be calculated as
follows:

Sombra Shares Ziff Shares

Purchase Price $2,400,000 $2,800,000

Deferral:

[($1,671,429)($2,400,000 ÷ $5,200,000)] ( 771,429)

[($1,671,429)($2,800,000 ÷ $5,200,000)] ( 900,000)

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Adjusted Cost Base $1,628,571 $1,900,000

Net Taxable Capital Gain

If Ms. Tosh does not purchase any other replacements shares within 120 days of December 31, 2018, the
two sales would result in a taxable capital gain, calculated as follows:

Total Gain Deferral Net Gain

Tech Ltd. Shares $ 700,000 $ 633,333 $ 66,667

Future Inc. Shares 1,800,000 1,671,429 128,571

Totals $2,500,000 $2,304,762 $195,238

Inclusion Rate 1/2

Net Taxable Capital Gain $ 97,619

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Advice
If Ms. Tosh invests in any eligible small business corporation common shares, including her brother’s
company’s, within 120 days of December 31, 2018, she can designate up to $800,000 as replacement
shares. She would then be able to defer more or all of the capital gain on the two sales of shares.
If she wants to invest in her brother’s company after the 120 days has passed, she should review her
other investments to determine if she can use the deferral provisions on small business investments to
her advantage to obtain the $1,000,000.
There is the question of whether Ms. Tosh should invest in her brother’s new company, but that would
involve an analysis that goes beyond the scope of the material in the text.

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TIF Solution Eight - 18

Part A
The 2018 tax consequences would be as follows:

Land The Company would have a taxable capital gain on the Land calculated as follows:

Proceeds Of Disposition $1,500,000

Adjusted Cost Base ( 430,000)

Capital Gain $1,070,000

Inclusion Rate 1/2

Taxable Capital Gain $ 535,000

Building The Company would have a taxable capital gain and recapture calculated as follows:

Proceeds Of Disposition $3,300,000

Capital Cost ( 3,100,000)

Capital Gain $ 200,000

Inclusion Rate 1/2

Taxable Capital Gain $ 100,000

Opening UCC $1,286,690

Deduct Disposition - Lesser Of:

Capital Cost = $3,100,000

Proceeds Of Disposition = $3,300,000 ( 3,100,000)

Negative Closing UCC Balance = Recapture ($1,813,310)

Recapture (Included In Income) 1,813,310

UCC - January 1, 2019 Nil

Equipment The Company would have recapture calculated as follows:

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Opening UCC $285,371

Deduct Disposition - Lesser Of:

Capital Cost = $670,000

Proceeds Of Disposition = $523,000 ( 523,000)

Negative Closing UCC Balance = Recapture ($237,629)

Recapture (Included In Income) 237,629

UCC - January 1, 2019 Nil

Part B
Land With respect to the Land, the capital gain resulting from the use of the ITA 44(1) election would
be the lesser of:

 $1,070,000 (regular capital gain); and

 $700,000 (the excess of the $1,500,000 proceeds of disposition for the old land over the
$800,000 cost of the replacement land).

The taxable amount would be $350,000 [(1/2)($700,000)] and this would be included in the revised
2018 Net Income For Tax Purposes. The original gain of $535,000 [(1/2)($1,070,000)] would be
eliminated in the revised return.
If the ITA 44(1) election is used in 2019, the deemed adjusted cost base of the replacement land would
be calculated as follows:

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Actual Cost $800,000

Capital Gain Reversed By Election ($1,070,000 - $700,000) ( 370,000)

Deemed Adjusted Cost Base Of Replacement Land $430,000

Note that the deemed adjusted cost base of the replacement land has been reduced to the adjusted cost
base of the old land.

Building If the ITA 44(1) election is used in 2019, the amended 2018 capital gain would be nil, the
lesser of:

 $200,000 (regular capital gain); and

 Nil (reflecting the fact that there was no excess of the $3,300,000 proceeds of disposition for the
old building over the $3,500,000 cost of the replacement building).

Using this election will reduce the deemed capital cost for the building as follows:

Actual Cost $3,500,000

Capital Gain Reversed By Election ( 200,000)

Deemed Capital Cost Of Replacement Building $3,300,000

If the ITA 13(4) election is used in 2019, the amended 2018 recapture would be calculated as follows:

January 1, 2018 UCC Balance $1,286,690

Deduction:

Lesser Of:

Proceeds Of Disposition = $3,300,000

Capital Cost = $3,100,000 ($3,100,000)

Reduced By The Lesser Of:

Normal Recapture = $1,813,310

Replacement Cost = $3,500,000 1,813,310 (1,286,690)

Recapture Of 2018 CCA (Amended) Nil

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These new nil figures for the capital gain and the recapture on the disposition of the old building will
replace the old figures of $200,000 and $1,813,300 that were included in the original 2018 return.

If both elections are used in 2019, the UCC of the replacement building is calculated as follows:

Deemed Capital Cost $3,300,000

Recapture Reversed By Election ( 1,813,310)

UCC - Replacement Building $1,486,690

Note that the $1,486,690 UCC for the new building is equal to the UCC of the old building
($1,286,690), plus the additional $200,000 ($3,500,000 - $3,300,000) in funds required for its
acquisition.

Equipment As this is a voluntary disposition, the ITA 13(4) and 44(1) elections can only be used on
real property (land and buildings). They cannot be used on the equipment and, as a consequence, the
$237,629 in recapture will not be altered in the amended return. As the elections cannot be used, both
the capital cost and the UCC of the new equipment will be $723,000.

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Part C
The Election The ITA 44(6) election applies when there is a disposition involving a combination of
part land and part building. If, for either of the assets, the proceeds of disposition exceed the adjusted
cost base, the election allows the transfer of all or part of that excess to the other asset.
As will be demonstrated in this problem, this can provide some relief when ITA 44(1) and ITA 13(4)
fail to eliminate all of the capital gains arising on one part of the disposition of the old property. ITA
44(1) fully eliminated the capital gain on the building. However, a $700,000 capital gain remained on
the land. This would suggest that it could be advantageous to transfer some of the proceeds of
disposition from the land to the building.
The excess of the proceeds of disposition of the old land over the cost of the replacement land was
$700,000 ($1,500,000 - $800,000). This is the amount of transfer that would be required to eliminate
the capital gain on the land. However, the excess of the cost of the replacement building over the old
building’s proceeds of disposition is only $200,000 ($3,500,000 - $3,300,000). If a transfer in excess of
this amount is made, any reduction in the capital gain on the land will be matched by an increased
capital gain on the building.
Applying ITA 44(6) in an optimal manner will result in the following adjusted proceeds of disposition:

Land Building

Actual Proceeds Of Disposition $1,500,000 $3,300,000

Optimal Transfer Land To Building ( 200,000) 200,000

Adjusted Proceeds Of Disposition $1,300,000 $3,500,000

Application To Land If both ITA 44(1) and ITA 44(6) are applied, the resulting capital gain on the
land will be calculated as the lesser of:

 $870,000 ($1,300,000 - $430,000); and

 $500,000 (the excess of the $1,300,000 adjusted proceeds of disposition for the old land over the
$800,000 cost of the replacement land).

This is a reduction of $200,000 ($700,000 - $500,000) from the amount that was calculated when only
ITA 44(1) was applied. However, the adjusted cost base of the land would be unchanged by the use of
ITA 44(6):

Actual Cost $800,000

Capital Gain Reversed By Election ($870,000 - $500,000)( 370,000)

Deemed Adjusted Cost Base Of Replacement Land $430,000

Application To Building With the proceeds of disposition transfer limited to $200,000, the capital gain
on the building is still nil. Specifically, the gain will be the lesser of:

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 $400,000 ($3,500,000 - $3,100,000); and

 Nil (reflecting the fact that there was no excess of the $3,500,000 adjusted proceeds of disposition
for the old building over the $3,500,000 cost of the replacement building).

However, the capital cost and UCC of the building will be reduced by the application of ITA 44(6):

Actual Cost $3,500,000

Capital Gain Reversed By The Two Elections ( 400,000)

Deemed Capital Cost $3,100,000

Recapture Reversed By Election ( 1,813,310)

UCC - Replacement Building $1,286,690

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The UCC of the replacement building is now equal to the UCC of the old building.

Comparison The table which follows compares the results of using only ITA 44(1) and ITA 13(4) with
the results that arise when the ITA 44(6) election is also used.

No ITA 44(6) With ITA 44(6)

Capital Gains

Land $700,000 $500,000

Building Nil Nil

Replacement Property

Adjusted Cost Base Of Land $ 430,000 $ 430,000

Capital Cost Of Building 3,300,000 3,100,000

UCC 1,486,690 1,286,690

As you can see in the table, the use of ITA 44(6) has reduced the capital gain on the land by $200,000.
However, it has done so at the cost of reducing the capital cost and UCC of the replacement building.
There is a tax cost associated with this trade off in that only one-half of the capital gain would have
been taxed in the current year, whereas the future CCA that has been lost would be fully deductible.

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TIF Solution Eight - 19

Part A
The 2018 tax consequences of the involuntary disposition would include both taxable capital gains and
recapture. The amounts would be calculated as follows:

Land Building

Proceeds Of Disposition:

Sale Price Of Land $200,000

Insurance Proceeds For Building $1,000,000

Adjusted Cost Base/Capital Cost ( 150,000) ( 750,000)

Capital Gain $ 50,000 $ 250,000

Inclusion Rate 1/2 1/2

Taxable Capital Gain $ 25,000 $ 125,000

January 1, 2018 UCC Balance $ 425,000

Lesser Of:

 Cost = $750,000

 Proceeds Of Disposition = $1,000,000 ( 750,000)

December 31 UCC Balance ($ 325,000)

Recapture 325,000

January 1, 2019 UCC Nil

For 2018, there is no CCA claim. Instead, there is $325,000 in recaptured CCA that must be taken into
income.
As a result of this involuntary disposition, Winding will have an addition to their 2018 Net Income For
Tax Purposes of $475,000 ($25,000 + $125,000 + $325,000).

Part B
After the land and building are replaced in 2019, an election can be made under ITA 44(1), and an
amended return can be filed for 2018. In the amended return, the capital gains will be nil, the lesser of
the amounts calculated in Part A and the following:
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Land Building

Proceeds Of Disposition $200,000 $1,000,000

Less: Cost Of Replacement Property ( 300,000) ( 1,100,000)

Excess, If Any Nil Nil

The reversed amounts will have to be removed from the capital costs of the new assets, resulting in the
following revised capital cost values:

New Land New Building

Capital Cost $300,000 $1,100,000

Capital Gain Reversed By Election ( 50,000) ( 250,000)

Deemed Capital Cost $250,000 $ 850,000

These values can also be calculated by taking the old capital costs of $150,000 and $750,000, and
adding the additional funds required to replace the old assets ($100,000 for the land and $100,000 for
the building).

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An election can also be made under ITA 13(4) to amend the 2018 recapture. The calculation would be
as follows:

January 1, 2018 UCC Balance $425,000

Deduction:

Lesser Of:

Proceeds Of Disposition = $1,000,000

Capital Cost = $750,000 $750,000

Reduced By The Lesser Of:

Normal Recapture = $325,000

Replacement Cost = $1,100,000 ( 325,000) ( 425,000)

Recapture Of 2018 CCA (Amended) Nil

The UCC of the new building will be adjusted for this change as follows:

Deemed Capital Cost Of Building

(See Preceding Calculation) $ 850,000

Recapture Reversed - ITA 13(4) Election ( 325,000)

UCC $ 525,000

This $525,000 can also be calculated as the old UCC of $425,000, plus the $100,000 ($1,100,000 -
$1,000,000) in funds invested by Winding in excess of the insurance proceeds.

Part C
The CCA claim for 2019 would be calculated as follows:

Opening UCC Balance Nil

Addition of New Building UCC $525,000

One-Half Net Additions ( 262,500)

CCA Base $262,500

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Rate For Class 1 4%

CCA For 2019 $ 10,500

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TIF Solution Eight - 20

Part A
The 2018 tax consequences of the involuntary disposition would include both taxable capital gains and
recapture. The amounts would be calculated as follows:

Land Building

Proceeds Of Disposition:

Sale Price Of Land $250,000

Insurance Proceeds For Building $1,250,000

Adjusted Cost Base/Capital Cost ( 140,000) ( 750,000)

Capital Gain $110,000 $ 500,000

Inclusion Rate 1/2 1/2

Taxable Capital Gain $ 55,000 $ 250,000

July 1, 2017 UCC Balance $ 599,298

Lesser Of:

 Cost = $750,000

 Proceeds Of Disposition = $1,250,000 ( 750,000)

June 30 UCC Balance ($ 150,702)

Recapture 150,702

July 1, 2018 UCC Nil

For the fiscal year ending June 30, 2018, there is no CCA claim. Instead, there is $150,702 in
recaptured CCA that must be taken into income.
As a result of this involuntary disposition, Wilson will have an addition to 2018 Net Income For Tax
Purposes of $455,702 ($55,000 + $250,000 + $150,702).

Part B
After the land and building are replaced in the fiscal year ending June 30, 2019, an election can be made
under ITA 44(1), and an amended return can be filed for 2018. In the amended return, the capital gains
will be nil, the lesser of the amounts calculated in Part A and the following:
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Land Building

Proceeds Of Disposition $250,000 $1,250,000

Less: Cost Of Replacement Property ( 300,000) ( 1,300,000)

Excess, If Any Nil Nil

The reversed amounts will have to be removed from the capital costs of the new assets, resulting in the
following revised capital cost values:

New Land New Building

Cost $300,000 $1,300,000

Capital Gain Reversed By Election ( 110,000) ( 500,000)

Deemed Cost $190,000 $ 800,000

These values can also be calculated by taking the old capital costs of $140,000 and $750,000, and
adding the additional funds required to replace the old assets ($50,000 for the land and $50,000 for the
building).

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An election can also be made under ITA 13(4) to amend the 2018 recapture to nil. The calculation
would be as follows:

July 1, 2017 UCC Balance $599,298

Deduction:

Lesser Of:

Proceeds Of Disposition = $1,250,000

Capital Cost = $750,000 $750,000

Reduced By The Lesser Of:

Normal Recapture = $150,702

Replacement Cost = $1,300,000 ( 150,702) ( 599,298)

Recapture Of 2018 CCA (Amended) Nil

The UCC of the new building will be adjusted for this change as follows:

Deemed Capital Cost Of Building

(See Preceding Calculation) $ 800,000

Recapture Reversed - ITA 13(4) Election ( 150,702)

UCC $ 649,298

This $649,298 can also be calculated as the old UCC of $599,298, plus the $50,000 ($1,300,000 -
$1,250,000) in funds invested by Wilson in excess of the insurance proceeds.

Part C
The CCA claim for the fiscal year ending June 30, 2019 would be calculated as follows:

Opening UCC Balance Nil

Addition of New Building UCC $649,298

One-Half Net Additions ( 324,649)

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CCA Base $324,649

Enhanced Rate For New Class 1

Non-Residential Buildings 6%

CCA For 2019 $ 19,479

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TIF Solution Eight - 21

1. The described treatment is not correct. While Mr. Acker has not sold any property, a part of his
building has undergone a change in use from a rental property to a personal use property. As a
consequence, there will be a deemed disposition at fair market value for that portion of the building
that he is occupying. Any resulting capital gain or loss will have to be reflected in his current tax
return. If he had not taken CCA on the property, he could have filed an election to postpone the
recognition of the capital gain until he sells the property.

2. This interpretation is not correct. No recognition can be given to the estimated cost of the warranty
prior to the provision of the warranty services. As a consequence, a capital gain of $33,000 will
have to be recognized. However, when the warranty services are provided, the costs of providing
the services can be treated as capital losses.

3. The described treatment is correct. Losses on the sale of personal use property such as the table are
not deductible. The gain on the painting is not taxable as both the adjusted cost base and the
proceeds are less than $1,000.

4. The described treatment is the appropriate one.

Proceeds Of Disposition ($11,600 - $200) $11,400

Adjusted Cost Base ($11,200 - $800) ( 10,400)

Capital Gain $ 1,000

Inclusion Rate 1/2

Taxable Capital Gain $ 500

5. The described treatment is the appropriate one.

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TIF Solution Eight - 22

Employment Income
Anita’s commission income of $36,000 is large enough not to limit the deduction of her employment
related expenses. The required calculations here would be as follows:

Salary $142,000

Additions

Bonus (Note 1) Nil

Commissions 36,000

Taxable Benefit - Employer Paid Life Insurance Premium 1,100

Expense Allowance [(12)($2,500)] 30,000

Stock Option Benefit [(1,500)($41 - $32)] 13,500

Disability Insurance Benefits (Note 2) 5,500

Deductions:

RPP Contributions ( 5,900)

Professional Association Dues ( 1,500)

Home Office Expenses (Note 3) ( 2,040)

Automobile Costs

CCA (Note 4) ( 5,814)

Operating Costs [(80%)($5,400)] ( 4,320)

Hotel Costs ( 6,300)

Airline And Other Transportation ( 12,300)

Client Meals And Entertainment [(1/2)($8,400)] ( 4,200)

Net Employment Income $185,726

Note 1 As the bonus is paid more than 180 days after the employer’s year end, the employer
will not be able to deduct the accrual in 2018. This, however, does not change Anita’s tax
position. She will not have to include the bonus in income until 2019.

Note 2 While Anita must include the $6,000 [(3)($2,000)] in benefits received, she can
deducted the $500 ($240 + $260) in premiums that she has paid for the plan.

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Note 3 As Anita has commission income, she can deduct 20 percent of all of the costs except
the mortgage interest. This will provide a deduction of $2,040 [(20%)($1,800 + $7,200 +
$1,200)].

Note 4 The 2018 CCA would be based on a UCC calculated as though 100 percent of the
available CCA had been taken in 2017. The 100 percent CCA for 2017 would be $4,275 [(1/2)
(30%)($28,500)]. Using this figure, the deductible 2018 CCA would be $5,814 [(80%)(30%)
($28,500 - $4,275)].

Property Income
The required calculations here would be as follows:

Eligible Dividends $ 2,200

Gross Up On Eligible Dividends [(38%)($2,200)] 836

Income Trust Distribution [(1,500)($2)] 3,000

Net Rental Income (Note 5) 22,875

Net Property Income $28,911

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Note 5 As the change in use is from personal to business, the base for calculating CCA would
be as follows:

Cost Of Sailboat $123,000

Fair Market Value At Change In Use $147,000

Cost ( 123,000)

Increase In Value (Bump Up) $ 24,000

Inclusion Factor 1/2 12,000

Cost For UCC And CCA Purposes $135,000

One-Half Net Additions ( 67,500)

CCA Base $ 67,500

Rate For Class 7 15%

CCA (No Part Year Proration) $ 10,125

Using this CCA figure, net rental income would be $22,875 ($46,000 - $13,000 - $10,125). Note that if
Anita were to offer substantial services besides the boat rental, such as providing meals and a crew for
the sailboat, this would be considered business, not property income. In that case, the CCA would be
prorated for the short fiscal year.

Net Taxable Capital Gains

The required calculations here would be as follows:

Land Sale ($220,000 - $85,000) $135,000

Reserve For Land Sale (Note 6) ( 104,318) $30,682

Sailboat Change In Use ($147,000 - $123,000) 24,000

Capital Income Trust (Note 7) 6,240

Antique Clock ($5,000 - $1,000 Floor) (Note 8) 4,000

Total Capital Gains $64,922

Capital Loss On Stock Option Shares [(1,500)($41 - $31)]( 15,000)

Net Taxable Capital Gains $49,922

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Inclusion Rate 1/2

Net Taxable Capital Gains $24,961

Note 6 The total proceeds of disposition for the land would be $220,000 [$50,000 + (10)
($17,000)]. Given this, the gain on the land would be $135,000 ($220,000 - $85,000). The
maximum reserve would be $104,318, the lesser of:

 $104,318 [($135,000)($170,000 ÷ $220,000)]

 $108,000 [($135,000)(20%)(4 - 0)]

Note 7 The $3,000 income trust distribution was used to acquire 120 additional units
($3,000 ÷ $25). Using this figure, the capital gain calculation would be as follows:

Proceeds Of Disposition [(1,500 + 120)($27)] $43,740

Adjusted Cost Base [(1,500)($23) + $3,000] ( 37,500)

Capital Gain $ 6,240

Note 8 Since the clock had an adjusted cost base of $300, its deemed adjusted cost base is
$1,000.

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Net And Taxable Income

The required calculations here would be as follows:

Net Employment Income $185,726

Net Property Income 28,911

Net Taxable Capital Gains 24,961

Net Income For Tax Purposes $239,598

Stock Option Deduction (Note 9) Nil

Taxable Income $239,598

Note 9 As the option price was less than fair market value when the options were granted, no
ITA 110(1)(d) deduction is available.

Federal Tax Payable

The required calculations here would be as follows:

Tax On First $205,842 $47,670

Tax On Next $33,756 ($239,598 - $205,842) At 33 Percent 11,139

Tax Before Credits $58,809

Tax Credits:

Basic Personal Amount ($11,809)

Common-Law Partner (Note 10) ( 5,809)

Canada Caregiver For Child - Lex ( 2,182)

Transfer Of Lex’s Disability ( 8,235)

Disability Supplement ( 4,804)

Transfer Of Tuition Credit (Note 11) ( 5,000)

Medical Expenses (Note 12) ( 17,298)

EI ( 858)

CPP ( 2,594)

Canada Employment Credit ( 1,195)

Total Credit Base ($59,784)

Rate 15% ( 8,968)

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Subtotal $49,841

Charitable Donations Credit (Note 13) ( 1,152)

Dividend Tax Credit [(6/11)($836)] ( 456)

Federal Tax Payable $48,233

Note 10 Only the taxable spousal support payments of $6,000 [(12)($500)] are included in
Peaches’ income. This gives a credit base of $5,809 ($11,809 - $6,000).

Note 11 The transfer of Peaches’ tuition credit would be $5,000, the lesser of:

$5,000

$9,400

Note 12 The base for the medical expense tax credit would be calculated as follows:

Total Medical Expenses $19,600

Lesser Of:

 [(3%)($239,598)] = $7,188

 2018 Threshold Amount = $2,302 ( 2,302)

Medical Expense Tax Credit Base $17,298

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Note 13 The charitable donations tax credit would be calculated as follows:

15 Percent Of $200 $ 30

33 Percent Of The Lesser Of:

$3,400 ($3,600 - $200)

$33,756 ($239,598 - $205,842) 1,122

29 Percent Of Nil [$3,600 - ($200 + $3,400)] Nil

Total Credit $1,152

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TIF Solution Eight - 22

Employment Income
Joan’s commission income of $46,000 is large enough not to limit the deduction of her employment
related expenses. The required calculations here would be as follows:

Salary $122,000

Additions

Commissions 46,000

Expense Allowance [(12)($1,500)] 18,000

Stock Option Benefit [(2,000)($32 - $20)] 24,000

Deductions:

RPP Contributions ( 2,700)

Professional Association Dues ( 1,500)

Home Office Expenses (Note 1) ( 1,193)

Automobile Costs

CCA (Note 2) ( 4,514)

Operating Costs [(60%)($4,200)] ( 2,520)

Hotel Costs ( 5,500)

Airline And Other Transportation ( 7,600)

Business Meals And Entertainment [(1/2)($6,400)] ( 3,200)

Net Employment Income $181,273

Note 1 As Joan has commission income, she can deduct 15 percent of all of the costs except
the mortgage interest. This will provide a deduction of $1,193 [(15%)($2,200 + $4,800 +
$950)].

Note 2 The 2018 CCA would be based on a UCC calculated as though 100 percent of the
available CCA had been taken in 2017. The 100 percent CCA for 2017 would be $4,425 [(1/2)
(30%)($29,500)]. Using this figure, the deductible 2018 CCA would be $4,514 [(60%)(30%)
($29,500 - $4,425)].

Property Income
The required calculations here would be as follows:

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Eligible Dividends $ 2,350

Gross Up On Eligible Dividends [(38%)($2,350)] 893

Income Trust Distribution [(1,000)($1.00)] 1,000

Net Rental Income (Note 3) 6,450

Net Property Income $10,693

Note 3 As the change in use is from personal to business, the base for calculating CCA would
be as follows:

Cost Of Building ($75,000 - $20,000) $55,000

Fair Market Value At Change In Use

($250,000 - $50,000) $200,000

Cost ( 55,000)

Increase In Value $145,000

Inclusion Factor 1/2 72,500

Cost For UCC And CCA Purposes $127,500

One-Half Net Additions ( 63,750)

CCA Base $ 63,750

Rate For Class 1 4%

CCA $ 2,550

Using this CCA figure, net rental income would be $6,450 ($9,000 - $2,550).

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Net Taxable Capital Gains

The required calculations here would be as follows:

Stock Option Shares [(2,000)($35 - $32)] $ 6,000

Torstar Income Trust (Note 4) 4,143

Land Sale ($375,000 - $125,000) $250,000

Reserve For Land Sale (Note 5) ( 183,333) 66,667

Painting ($22,000 - $2,000) 20,000

Change In Use:

Cottage - Land ($50,000 - $20,000) $ 30,000

Cottage - Building ($200,000 - $55,000) 145,000 175,000

Net Capital Gains $271,810

Inclusion Rate 1/2

Net Taxable Capital Gains $135,905

Note 4 The $1,000 income trust distribution was used to acquire 71.43 additional units
($1,000 ÷ $14). Using this figure, the capital gain calculation would be as follows:

Proceeds Of Disposition [(1,071.43)($16)] $17,143

Adjusted Cost Base [(1,000)($12) + $1,000)] ( 13,000)

Capital Gain $ 4,143

Note 5 The gain on the land would be $250,000 ($375,000 - $125,000). The maximum
reserve would be $183,333, the lesser of:

 $183,333 [($250,000)($275,000 ÷ $375,000)]

 $200,000 [($250,000)(20%)(4 - 0)]

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Net And Taxable Income

The required calculations here would be as follows:

Net Employment Income $181,273

Net Property Income 10,693

Net Taxable Capital Gains 135,905

Net Income For Tax Purposes $327,871

Stock Option Deduction [(1/2)($24,000)] ( 12,000)

Taxable Income $315,871

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Federal Tax Payable

The required calculations here would be as follows:

Tax On First $205,842 $47,670

Tax On Next $110,029 ($315,871 - $205,842) At 33 Percent 36,310

Tax Before Credits $83,980

Tax Credits:

Basic Personal Amount ($11,809)

Spouse ($11,809 - $8,400) ( 3,409)

Canada Caregiver For Child - Anna ( 2,182)

Transfer Of Anna’s Disability ( 8,235)

Disability Supplement ( 4,804)

Transfer Of Tuition - Lesser Of:

 Absolute Limit Of $5,000

 Actual Tuition Of $11,500 ( 5,000)

Medical Expenses (Note 6) ( 16,898)

EI ( 858)

CPP( 2,594)

Canada Employment Credit ( 1,195)

Total Credit Base ($56,984)

Rate 15% ( 8,548)

Subtotal $75,432

Charitable Donations Credit (Note 7) ( 723)

Dividend Tax Credit [(6/11)($893)] ( 487)

Federal Tax Payable $74,222

Note 6 The base for the medical expense tax credit would be calculated as follows:

Total Medical Expenses $19,200

Reduced By The Lesser Of:

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 [(3%)($327,871)] = $9,836

 2018 Threshold Amount = $2,302 ( 2,302)

Medical Expense Tax Credit Base $16,898

Note 7 The charitable donations tax credit would be calculated as follows:

15 Percent Of $200 $ 30

33 Percent Of The Lesser Of:

$2,300 - $200 = $2,100

$315,871 - $205,842 = $110,029 693

29 Percent Of Nil [$2,300 - ($200 + $2,100)] Nil

Total Credit $723

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Chapter Nine Test Item File Solutions

TIF Solution Nine - 1

1. A retiring allowance is an amount received, either on, or after retirement in recognition of long
service or, alternatively, an amount received in respect of a loss of employment. The full amount of
such allowances must be included in income in the year that it is received. While this is not part of
the answer to the question as stated, you might note that, within specified limits, all or part of the
allowance may be transferred to an RRSP and deducted in the calculation of Net Income For Tax
Purposes.

2. A death benefit is the total of all amounts received by a taxpayer in a taxation year on or after the
death of an employee in recognition of the employee’s service in an office or employment. The
definition of this benefit is stated in such a way that it does not include the first $10,000 of such
payments. This means that they can, in effect, be received tax free.

3. In general, there is 100 percent exemption of scholarships and prizes that are received in connection
with:

 an education program that qualifies for the education tax credit; and

 an elementary or secondary school education program.

However, there are a number of exceptions to this exemption:

 At the post-secondary level, the exemption will only be available to the extent it relates to a
college or CEGEP diploma, or a bachelor, masters or doctoral degree. This means it will not be
available for most post-doctoral fellowships.

 Again, at the post-secondary level, the exemption will only be available in situations where it is
reasonable to conclude that the scholarship was received to support the taxpayer’s enrolment in
a post-secondary program.

 With respect to scholarships received in connection with part-time enrollment, except in cases
where the need to enroll on a part time basis is related to a physical or mental impairment, the
exemption will be limited to the amount of tuition paid, plus costs of program-related materials.

4. They are included in Net Income For Tax Purposes because that figure is used in a variety of
eligibility tests. For example, to get the full tax credit for an infirm dependant over 17, the
dependant’s income must be less than a threshold amount. Since the policy is to reduce this credit
in proportion to the dependant’s income in excess of that amount, it is important that all types of
income be included in the Net Income For Tax Purposes calculation. To accomplish this goal,

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social assistance and workers’ compensation payments are included in the calculation of Net
Income For Tax Purposes and then deducted in the calculation of Taxable Income.

5. Deductibility of moving expenses is available to three categories of taxpayers. They are as follows:

 Taxpayers who move to a new work location (a new work location may not involve a new
employer), either as:

 employees,

 independent contractors, or

 after ceasing to be a full time student at a post-secondary institution.

 Taxpayers who move in order to commence full time attendance at a post-secondary institution
and receive income from the educational institution that increases their Net Income For Tax
Purposes.

 An unemployed taxpayer who moves to a new location in Canada to take up employment at that
new location.

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6. An employer can compensate an employee for a loss on the sale of a home that was sold because of
a required move. However, the tax free amount of compensation is limited to the first $15,000, plus
one-half of any compensation in excess of $15,000. This means that one-half of any amount of
compensation in excess of $15,000 will be treated as a taxable benefit to the employee.

7. An eligible child is defined in ITA 63(3) to include a child of the taxpayer, his spouse or common-
law partner, or a child who is dependent on the taxpayer or his spouse or common-law partner and
whose income does not exceed the basic personal credit amount . In addition, the child must be
under 16 years of age at some time during the year or dependent on the taxpayer or his spouse by
reason of physical or mental infirmity.

8. The objective of providing the disability supports deduction is to assist individuals with the extra
costs that a disabled person incurs when trying to attend school or work. Examples of such costs
that are cited in the text are as follows:

 sign-language interpretation services, a teletypewriter or similar device;

 a Braille printer;

 an optical scanner, an electronic speech synthesizer;

 note-taking services, voice recognition software, tutoring services; and

 talking textbooks.

9. When there is a significant disparity in the incomes of a couple, pension income splitting is usually
desirable. However, if the disparity is not very significant, pension income splitting may not be
attractive. Factors that have to be considered include loss of the transferee’s age credit or a
decrease in the medical expenses credit. The OAS clawback may also be involved in the analysis.
Making a decision in this area requires a case-by-case analysis.

10. The specific conditions that must be met are set out in IT Folio S1-F3-C3 as follows:

 the amount is paid as alimony or an allowance for the maintenance of the spouse or common-
law partner, or former spouse or common-law partner;

 the spouses or common-law partners, or former spouses or common-law partners, are living
apart at the time the payment is made and throughout the remainder of the year, and were
separated pursuant to a divorce, judicial separation, or written separation agreement;

 the amount is paid pursuant to a decree, order, or judgment of a competent tribunal or pursuant
to a written agreement;

 the recipient has discretionary use of the amount; and

 the amount is payable on a periodic basis.

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11. The answer here depends on how the annuity was acquired. If it was purchased with tax deferred
funds (e.g., funds from an RRSP), the full amount of the annuity payment will be included in Net
Income For Tax Purposes and there will be no offsetting deduction.

Alternatively, if the annuity was purchased with after tax funds (e.g., funds from a bank account),
the full amount of the payment will still be included in income. However, there will be an
offsetting deduction to reflect the fact that part of the payment is a return of capital. The amount of
the deduction will be based on the cost of the annuity, divided by total payments to be received
under the annuity, with this fraction multiplied by the individual annuity payment.

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12. The major advantages would include:

 The fact that making contributions results in additional contributions being made by the
government in the form of Canada Education Savings Grants.

 The fact that earnings on the invested contributions are not taxed as they accrue, providing for
tax free compounding while the funds are in the plan.

 The fact that these plans allow parents to allocate income to their children without triggering
the income attribution rules.

 The probability that the funds will be received by an eligible student either with no taxes being
assessed or, at worst, with taxes being assessed at the lowest federal rate.

Note that, while having an RESP can result in eligibility for Canada Learning Bonds contributions,
this is not part of the answer to this question because these contributions are not dependent on
others making a contribution to the RESP.

13. In the Canada Learning Bonds program, the government will make contributions to an RESP for a
child whose family qualifies for the National Child Benefit supplement. The contributions will be
made in each year that the child’s family qualifies for the supplement, beginning with the year that
the child is born and ending in the year that the child reaches age 15. The first payment will be for
$500, plus an additional $25 to help defray the costs of establishing an RESP for the child.
Subsequent payments will be for $100 in each year that the family qualifies. Unlike Canada
Education Savings Grants, there is no requirement for contributions to be made in order for the
RESP to receive the Canada Learning Bonds contributions.

14. There are several major advantages to the use of TFSAs:

 Earnings in the plan accumulate on a tax free basis.

 Withdrawals from the plan are not subject to tax.

 Amounts earned in the plan are not subject to the income attribution rules.

 Reductions in contribution room related to withdrawals are replaced in the following

taxation year.

15. If an individual’s spouse or common-law partner is designated as a successor holder, their TFSA
can be transferred into the hands of this beneficiary as an ongoing TFSA. It can either be
maintained by the individual as a separate TFSA or, alternatively, rolled over into their TFSA
without being treated as a contribution. Income on the assets contained in the bequeathed TFSA
will continue to accumulate on a tax free basis.

If the decedent’s TFSA is transferred to any other beneficiary, that individual can use the funds in
the plan at the time of the transferor’s death without tax consequences. However, any amounts

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received in excess of the fair market value of the assets in the plan at the time of the transferor’s
death will be subject to tax.

16. A transfer below fair market value would produce a reduced capital gain (increased capital loss) for
the transferor. In the absence of ITA 69, the transferee would have a reduced adjusted cost base for
the asset, resulting in an increased capital gain (reduced capital loss) for the transferee. The most
logical reason for such a transfer would be that the transferor is in a higher tax bracket than the
transferee.

17. The consideration should either be equal to the fair market value of the transferred property or nil
(i.e., gift the property). If the transfer is made for consideration in excess of fair market value, the
transferee’s adjusted cost base will be limited to fair market value, resulting in the potential for
double taxation of the difference between the fair market value and the transfer price. If the transfer
is made for consideration that is less than fair market value, the transferor’s proceeds will be
deemed to be fair market value, again resulting in the potential for double taxation of the difference
between the transfer price and the fair market value of the property.

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18. Unless an election is made, a transfer to a spouse or common-law partner will be recorded at tax
values. For non-depreciable property, this will be the adjusted cost base of the property. For
depreciable property, this will be the UCC of the property. The original capital cost will also be
retained by the transferee with the difference between this and the UCC being considered to be
deemed CCA. In these circumstances, there will be no tax consequences for the transferor at the
time of transfer. The transferor can elect out of this treatment in his tax return by including any
gain, loss, or recapture that would result if the transfer were made at fair market value.

19. From the point of view of the transferor, the excess of the fair market value of the asset over its
capital cost will be classified as a capital gain, only one-half of which is taxable. If the transferee
was allowed to treat the full fair market value as its capital cost, this excess would become fully
deductible CCA. To prevent this from happening, the transferee is only allowed to include one-half
of the excess in his capital cost, resulting in its deduction being equal to the transferor’s taxable
gain.

20. There is a deemed disposition of all of an individual’s capital property at death. The results of these
dispositions can be described as follows:

Capital Property Other Than Depreciable Property The deceased taxpayer is deemed to
have disposed of the property at fair market value immediately before his death. The person
receiving the property is deemed to have acquired the property at this time, at a value equal to
its fair market value.

Depreciable Property The basic rules for this type of property are the same. That is, there is
a deemed disposition of the property by the deceased taxpayer at fair market value, combined
with an acquisition of the property at the same value by the beneficiary. When the capital cost
of the property for the deceased taxpayer exceeds its fair market value, the beneficiary is
required to retain the original capital cost, with the difference being treated as deemed CCA.

21. The two basic rollovers that are available when an individual dies can be described as follows:

Rollover To Spouse, Common-Law Partner, Or Spousal Trust This rollover allows the
deceased’s capital property to be transferred at tax values (UCC or adjusted cost base). It
applies automatically unless the representatives of the deceased elect out of its provisions.

Rollover Of Farm Or Fishing Property This rollover allows a farming or fishing property
owned by the deceased to be transferred to a child or grandchild at tax values. This election
applies automatically unless the representatives of the deceased elect out of its provisions.

22. When there is a transfer of a capital property to a spouse or common-law partner, income attribution
will be applicable in the following circumstances:

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1. The income from the transferred property is property income. Income attribution is not
applicable to business income.

2. The transferor does not elect out of ITA 73(1). This would result in income attribution without
regard to the consideration given for the property by the transferee.

3. If the transferor elects out of ITA 73(1), income attribution will still apply unless the transferee
provides consideration for the property that is equal to the fair market value of the property
received.

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23. If he gives the shares to his spouse and does not elect out of ITA 73(1), the shares will be
transferred at their tax costs and there will be no tax consequences at the time of transfer. However,
both dividends and any capital gain or loss resulting from a subsequent sale by the spouse will be
attributed back to him.

Alternatively, if the shares are gifted to the daughter, the transfer will take place at fair market
value, resulting in a capital gain or loss at that time. Until the daughter reaches 18 years of age, any
dividends paid on the shares will be attributed back to her father. However, if the daughter sells the
shares, any resulting gain or loss (based on the fair market value at the time of transfer) will be
taxed in the hands of the daughter.

24. There are a number of items listed in the text that could be mentioned here:

 Contributing to an RESP for his child.

 Contributing to a spousal RRSP.

 Contributing to a TFSA for his spouse.

 Contributing to a TFSA for his child once the child is 18 years of age.

 Since business income is being earned in the family unit, pay reasonable salaries to family
members for activities that can be justified as business related.

 If pension income is received, make use of the pension splitting provisions.

 Giving assets with anticipated capital gains to the child rather than the spouse.

 Loans at the prescribed rate if safe investments with higher returns are available.

 Segregating funds from sources to which the income attribution rules do not apply (i.e. gifts
and inheritances).

 Keeping records which detail that the lower income family members’ funds are being used for
investment purposes, rather than for non-deductible expenditures such as household expenses.

 Allowing family members to invest at the inception of any new business.

Other factors might also be mentioned.

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TIF Solution Nine - 2

1. False.

She must include only $15,000 ($25,000 - $10,000) in income in the year of receipt.

2. True.

While the entire amount must be included, a deduction is available for eligible amounts that are
transferred to an RRSP.

3(i).

True.

His airfare from Prince George to Red Deer is a deductible moving cost.

3(ii).

True.

The $750 is a deductible moving cost.

3(iii).

True.

The total $1,800 in legal fees is a deductible moving cost.

3(iv).

False.

The $2,000 is not a deductible moving cost.

3(v).

True.

The $5,000 in real estate fees paid to sell their Prince George house is a deductible moving
cost.

3(vi).

False.

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There is an unlimited carry forward for unused moving costs.

4. False. Sarah can deduct a maximum of $5,333 [(2/3)($8,000)].

5. False.

An eligible child does not have to be under 16 at some time during the year if he or she is
dependent on the taxpayer or his spouse or common-law partner by reason of physical or
mental infirmity.

6. True.

Imprisonment of the lower income spouse is one of the situations in which the higher income
spouse is allowed to deduct child care costs.

7. True.

The payments will be taxed in Jim’s hands and will be deductible from Shirley’s income. As
there are no children, the amounts paid are spousal support.

8. True.

If after tax funds are used, the capital element of the annuity payment can be deducted from the
amount received. Alternatively, if RRSP funds are used, the entire annuity payment will
be subject to tax, with no offsetting deduction for a capital element.

9. True.

10. True.

While contributions are not deductible, earnings resulting from the investment of these
contributions are not subject to tax until the funds are withdrawn from the plan.

11. False.

There is no annual limit. Contributions are limited by contribution room.

12. False.

There is no tax on income withdrawn from a TFSA.

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13. False. Rollover is a term that refers to a transfer of assets on a tax free basis, without regard to
whether the transfer was between parties dealing at arm’s length.

14. True. The term arm’s length can apply to transactions involving trusts, corporations, and
individuals.

15. True. Johan’s gain will be $1,000. However, his brother’s adjusted cost base will be limited by
ITA 69 to $1,500.

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16. False. There will be no capital gain.

17. False. If the beneficiary is a spouse or common-law partner, the disposition will be at tax values
rather than fair market value.

18(a).

True. If she bequeaths all of her assets to a spousal trust, her Taxable Income at death is nil.

18(b).

False. If she bequeaths all of her assets to her daughter, Christine, her Taxable Income at death
arising from the dispositions totals $38,875. This is comprised of a taxable capital gain of
$4,500 [(1/2)($20,000 - $11,000)] on the stocks, a taxable capital gain on the building of
$5,625 [(1/2)($110,000 - $98,750)], and recapture of $28,750 ($98,750 - $70,000) on the
building.

18(c).

True. Christine’s Taxable Income arising from the sale is a taxable capital gain of $7,500 [(1/2)
($125,000 - $110,000)]. Christine’s adjusted cost base for the building is $110,000, the fair
market value at the time of her mother’s death.

19. False.

Any dividends declared on the securities will not be attributed to the father because his
daughter is older than 17.

20. False.

There is no income attribution for capital gains that are realized on assets that have been
transferred to related minors.

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TIF Solution Nine - 3

Other Inclusions – Subdivision d Inclusions
1. A. The $10,000 exclusion from income of a death benefit must be claimed by a spouse.

2. C. While a deduction can be made for transfers to an RRSP, 100 percent of the retiring
allowance has to be included in income.

3. C. Workers’ compensation payments.

CPP Payments Deduction

4. B. Both his Net Income For Tax Purposes and his Taxable Income will be reduced by
$2,594. Note that [(15%)($5,188)] = $778 (Answer D).

5. B. $1,064 [($2,594)(15%) + ($2,594)(26%)]

Moving Costs Deduction

6. D. The costs of selling a residence where the taxpayer lived prior to the relocation is
always deductible.

7. C. The claim can only be made against employment income earned at the new location.

8. A. $8,800 [$5,000 + $2,000 + $750 + (15/30)($2,100)]. Legal fees are not deductible as
Mr. Kumar did not own a house prior to moving; house hunting trips are not deductible; costs
for temporary accommodation are limited to 15 days.

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9. A. $8,500 ($102,000 ÷ 12). The deduction is limited to the income earned at the new
location.

10. B. $16,300 ($1,200 + $12,000 + $100 + $200 + $2,800).

Child Care Costs

11. B. Amounts paid to a person under the age of 18 are never deductible. Deduction is
permitted provided the person is not related to the taxpayer.

12. C. John’s claim is limited to $1,600 [($200)(2)(4 months)]. Since Alexandria’s

attendance is part-time, the sum of the Periodic Amounts is multiplied by the number of months
of part-time attendance, not weeks.

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13. B. $19,000 [$8,000 + $11,000]. Hinda cannot be claimed as he is not an eligible child
due to his income level.

Disability Supports Deduction

14. D. This deduction is available to individuals who do not qualify for the disability tax
credit.

15. A. The deduction is limited to individuals who qualify for the disability tax credit.

16. C. $22,000 [($25,000 - $10,000 - $5,000) + $12,000]

Pension Income Splitting

17. B. If an individual and his spouse are in different tax brackets, pension income splitting
will always reduce their combined federal Tax Payable.

18. C. $36,500 [(1/2)($65,000) + $4,000]

19. D. $42,200 ($35,000 + $7,200). Neither CPP received nor RRSP withdrawals when
under 65 can be split.

Spousal And Child Support

20. C The recipient of child support payments will not be able to claim the tax credit for an
eligible dependant.

21. D. None of the above.

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22. D. $2,200 [($4,000 - $1,800)]. Deductible spousal support is limited to the $4,000
amount paid, less the required $1,800 for child support.

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Income From Annuities

23. B. If the taxpayer uses funds from his savings account to purchase an annuity, the taxable
amount of any payment is reduced by the capital element that is included in the payment.

24. B. $772 [$5,772 – ($25,000 ÷ $28,860)($5,772)]

Registered Savings Plans

25. B. Withdrawals from either plan will be received tax free.

26. C. There is no limit on the amount of annual contributions that can be made. The limit is
on the total amount that can be contributed for each beneficiary.

27. A. Contributions to the plan are deductible.

28. D. Withdrawals of accumulated account earnings will be subject to tax.

29. C. Ms. Eli should invest in the TFSA.

30. C. The contributions are tax deductible up to a maximum of $5,500 for 2018.

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Non-Arm’s Length Transactions

31. C. When there is a non-arm’s length transfer of a capital property that has a fair market
value that is less than the transferor’s capital cost, the transferee’s new capital cost is deemed to
be equal to the transferor’s old capital cost.

32. D. John will have a taxable capital gain of $35,000 and the adjusted cost base of the land
to his son will be $250,000.

33. C. John will have a taxable capital gain of $35,000 and the adjusted cost base of the land
to his son will be $320,000.

34. D. Nil

35. A. $57,500. Taxable capital gain = ($240,000 – 225,000) x 50% = $7,500

Recapture = $175,000 – $225,000 = $50,000

$7,500 + 50,000 = $57,500

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36. D. She has some unused capital losses.

37. A. $2,000 for Sonya and $750 for her sister. ($18 – 10) x 500 x 50% =$2,000, ($18 – 15)
x 500 x 50% = $750

38. B. Hugo has a terminal loss of $3,000 and his son has recapture of CCA of $1,000. Since
it is a non-arms’ length sale to Hugo’s son at a value that is less than Hugo’s capital cost, ITA
13(7)(e) deems the son’s new capital cost to be equal to the transferor’s old capital cost.

Death Of A Taxpayer
39. A. Recapture of $20,000 for Lance and the capital cost of the asset to Paul will be
$150,000.

40. C. In recording the deemed disposition that occurs when an individual dies, the proceeds
of disposition will always be the fair market value of the property. This is not correct in that
the proceeds of disposition on a transfer to a spouse will be the deceased’s tax values.

41. C. If her daughter later sells the property for $100,000, she will have a capital gain of
$10,000. As the daughter will retain Erica’s original capital cost, the $10,000 will have to be
treated as recapture.

42. A. Capital property that is bequeathed to a spouse is transferred on a rollover basis.

43. C. Any assets transferred to a spouse on death are automatically rolled over with no tax
consequences. The automobile is personal use property so the loss is not deductible. The only
asset that will affect the final return is the building.

Recapture = $30,000, taxable capital gain = [(1/2)($220,000 - $100,000)] = $60,000. Total =

$90,000.

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44. C. The transfer of an unincorporated business to a spouse. The transferor does not elect
out of ITA 73(1).

45. C. $240 (compound interest does not attribute).

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46. C. A growth fund that invests in corporations with a history of paying minimal dividends
and earns its income primarily in the form of capital gains.

47. D. William’s Net Income For Tax Purposes is $1,288.

Taxable Capital Gain On Disposition Of Global Inc.

[($2,500 - $200)(1/2)] $1,150

Allowable Capital Loss On Gift - TriStar Limited Nil

Attribution Of Dividend 138

William’s Net Income For Tax Purposes $1,288

48. D. Hans must elect out of the ITA 73 rollover, Olga must pay consideration equal to fair
market value, and the loan must bear interest to be paid within 30 days of the end of each year.
Attribution can be avoided as long as the interest rate is at least equal to the prescribed rate.

49. D. Carmen faces a tax liability of $2,574 as a result of her capital gains.

50. A. The gift is to Sandy’s long-time business partner.

51. A. Pere will claim the dividends on his tax return and Fils will claim the capital gain on
his tax return.

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TIF Solution Nine - 4

Exam Exercise Solution Nine - 1 (Moving Expenses)
The analysis here is as follows:

Payment From Employer $6,000

Acquisition Cost Of New House ( 3,250)

House Hunting Trip ( 650)

Balance $2,100

Moving Costs ( 8,300)

Lease Penalty ( 1,200)

Available Deduction ($7,400)

Income At New Location = Maximum Deduction 6,625

Carry Forward ($ 775)

Since he did not own a house in Halifax, he cannot deduct the $3,250 in costs associated with acquiring
the new home in Moncton. Further, there is no provision for deducting the $650 cost of the house
hunting trip to Moncton. However, these amounts can be paid for by his employer without creating a
taxable benefit.
The maximum moving expense deduction is limited to $6,625, the 2018 income at the new location.
The remaining $775 can be carried forward and deducted against income earned at the new location in a
subsequent year.

Exam Exercise Solution Nine - 2 (Moving Expenses)

The analysis here is as follows:

Payment From Employer $ 7,000

House Hunting Trip ( 950)

Balance $ 6,050

Cost Of Selling Windsor House ( 7,200)

Moving Costs ( 12,600)

Available Deduction ($13,750)

Income At New Location [(2)($54,000 ÷ 12)] 9,000

Carry Forward ($ 4,750)

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There is no provision for deducting the $950 cost of the house hunting trip to Toronto. However, this
amount can be paid for by her employer without creating a taxable benefit.
The maximum deduction is limited to $9,000, the income earned at the new location. The remaining
$4,750 can be carried forward and deducted against income earned at the new location in a subsequent
year.

Exam Exercise Solution Nine - 3 (Child Care Expenses)

As Mr. Renaud is the low income spouse, he will have to take the deduction for child care costs. The
deduction will be the least of the following amounts:

 The actual costs of $11,200.

 The annual limit of $18,000 [(1)($8,000) + (2)($5,000)].

 $8,000 [(2/3)($12,000)]

The least of these three amounts is $8,000.

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Exam Exercise Solution Nine - 4 (Child Care Expenses)

As the 18 year old child has a physical infirmity, he is an eligible child for purposes of deducting child
care costs. While child care costs are normally deducted by the lower income spouse, the higher income
spouse can make the deduction during periods when the lower income spouse is in prison. The amount
that can be deducted, however, is limited to $175 per week in the case of the four year old and $100 per
week for the other children. Given this, Mr. Anders’ deduction is limited as shown in the following
calculation:

Mr. Anders Mrs. Anders

Actual Payments [(50)($190)] $ 9,500 $ 9,500

Annual Expense Limit [(1)($8,000) + (2)($5,000)] $18,000 $18,000

2/3 Of Earned Income

[(2/3)($69,000)] $46,000

[(2/3)($18,000)] $12,000

Periodic Expense Limit [(6)($200)(1) + (6)($125)(2)] $ 2,700 N/A

The least of the amounts for Mr. Anders is $2,700. The least of the amounts for Mrs. Anders is $9,500.
Mrs. Anders’ deduction would be reduced by the $2,700 deducted by Mr. Anders, leaving her with a
deduction of $6,800 ($9,500 - $2,700).

Exam Exercise Solution Nine - 5 (Disability Supports Deduction)

As Lara is not eligible for the disability tax credit, she will deduct the cost of full time attendant care
under ITA 64. When combined with the other disability support costs and the reimbursement, the
qualifying costs total $41,000 ($32,000 + $17,000 - $8,000). As this is less than her income from
employment, she will be able to deduct the full amount of these costs as her disability supports
deduction.

Exam Exercise Solution Nine - 6 (Pension Income Splitting)

In the absence of pension income splitting, Janice would have Tax Payable of nil [(15%)($7,000) -
(15%)($11,809)]. Jerry’s Net Income For Tax Purposes, before any OAS clawback, would be $95,000
($88,000 + $7,000). There would be an OAS clawback of $2,864 [(15%)($95,000 - $75,910)], leaving
Jerry with a Net and Taxable Income of $92,136 ($95,000 - $2,864). Based on this figure, his Amount
Owing would be calculated as follows:

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Tax Of First $46,605 $ 6,991

Tax On Next $45,531 ($92,136 - $46,605) At 20.5% 9.334

Total Before Credits $16,325

Credits:

Basic Personal ($11,809)

Spousal ($11,809 - $7,000) ( 4,809)

Age [$7,333 - (15%)($92,136 - $36,976) Nil

Pension ( 2,000)

Spouse’s Age ( 7,333)

Total ($25,951)

Rate 15% ( 3,893)

Federal Tax Payable $12,432

OAS Clawback 2,864

Total Amount Owing $15,296

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If maximum pension splitting is used, it will give both Jerry and Janice Net and Taxable Income of
$51,000 [($88,000 ÷ 2) + $7,000]. Since this is below the income threshold, there will be no clawback
of OAS for Jerry or Janice. Based on these figures, the Amount Owing for both Jerry or Janice would
be the same and calculated as follows:

Tax On First $46,605 $6,991

Tax On Next $4,395 ($51,000 - $46,605) At 20.5% 901

Tax Before Credits $7,892

Credits:

Basic Personal ($11,809)

Age [$7,333 - (15%)($51,000 - $36,976) ( 5,229)

Pension ( 2,000)

Total ($19,038)

Rate 15% ( 2,856)

Federal Tax Payable $ 5,036

OAS Clawback Nil

Total Amount Owing For Each $ 5,036

With pension income splitting, the total amount owing by Jerry and Janice would be $10,072 [(2)
($5,036)]. This is an improvement of $5,224 over the $15,296 that Jerry would have paid without
income splitting. Further savings would be available at the provincial level.

Exam Exercise Solution Nine - 7 (Support Payments)

The total required child support is $8,400 [(7 Months)($1,200)] and Shannon’s payments will be
allocated to this requirement first. This means that $8,400 of her payments will not be deductible to her
or taxable to Leon. The remaining $1,100 ($9,500 - $8,400) will be considered a payment towards
spousal support and will be deductible to Shannon and taxable to Leon.

Exam Exercise Solution Nine - 8 (Support Payments)

The required payments for 2018 child support were $12,000 [(12)($1,000)]. Of Barry’s total payment of
$14,000, this $12,000 amount must be classified as child support, with the $2,000 balance being
classified as spousal support. As only spousal support payments are deductible, Barry’s 2018 deduction
is limited to $2,000. Similarly, only spousal support payments are taxable to the recipient. This means
that Mandy will only have to include $2,000 in her 2018 income.

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Exam Exercise Solution Nine - 9 (Annuity Payments)

A total of $12,060 [(3)($4,020)] in payments will be received from this annuity. The $4,020 will be
included in her annual tax return. However, because the annuity was purchased with after tax funds, she
is eligible for a deduction equal to $3,333 [($10,000 ÷ $12,060)($4,020)]. As a result, Ms. Brock’s Net
Income For Tax Purposes will increase by $687 ($4,020 - $3,333) each year.

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Exam Exercise Solution Nine - 10 (Annuity Payments)

Sal will receive total payments of $3,000 [(3)($1,000)]. For 2018, the $1,000 payment received will be
included in his Net Income For Tax Purposes. However, because the annuity was purchased with after
tax funds, he is entitled to a deduction of $891 [($1,000)($2,673 ÷ $3,000)]. The net increase in Net
Income For Tax Purposes will be $109 ($1,000 - $891).

Exam Exercise Solution Nine - 11 (Canada Education Savings Grants)

The total 2017 contributions to Marco’s RESP are $1,400 ($1,000 + $400). As this is within the $2,500
limit for contribution eligible for CESGs, the 2017 CESG would be $380 {[(40%)($500)] + [(20%)
($1,400 - $500)]}.
For 2018, contributions to Marco’s RESP total $4,100 ($2,200 + $1,900). However, at this point, the
plan has accumulated only $5,000 [(2)($2,500)] in room for contributions eligible for CESGs. As
$1,400 of this was used in 2017, only $3,600 remains for use in 2018. Given this, the 2018 CESG
amount would be $820 {[(40%)($500)] + [(20%)($3,600 - $500)]}.

Exam Exercise Solution Nine - 12 (Inadequate Consideration)

As the transfer is for $130,000, a value that is less than the fair market value of $175,000, ITA 69 deems
the proceeds of disposition to be the fair market value. This means that Ms. Lox has a taxable capital
gain of $12,500 [(1/2)($175,000 - $150,000)].
When her father sells the securities for $175,000, his adjusted cost base will be the $130,000 that he
paid. This will result in a taxable capital gain of $22,500 [(1/2)($175,000 - $130,000).

Exam Exercise Solution Nine - 13 (Inadequate Consideration)

Ms. Lox will have a taxable capital gain of $30,000 [(1/2)($210,000 - $150,000)]. This is based on the
actual proceeds of disposition.
As the transfer is for $210,000, a value that is more than the fair market value of $175,000, ITA 69
limits the father’s adjusted cost base to the fair market value. This means that when he sells the
securities for $175,000, he would have no gain or loss.

Exam Exercise Solution Nine - 14

(Inter Vivos Transfers To A Common-Law Partner)
The tax consequences for Marilyn and Ellen in each of the two years would be as follows:

2018 For Marilyn There would be no tax consequences for Marilyn.

2019 For Marilyn When Ellen sells the land, the taxable capital gain of $52,500 [(1/2)
($190,000 - $85,000)] would be attributed back to Marilyn.

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2018 For Ellen The $8,500 in income from the parking lot operation would be included in
Ellen’s Net Income For Tax Purposes. As this is business income, there would be no
attribution.

2019 For Ellen As the taxable capital gain is attributed to Marilyn, there would be no tax
consequences for Ellen.

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Exam Exercise Solution Nine - 15 (Transfer Of Depreciable Asset To A Spouse)

ITA 73(1) Applies If Mr. Lionel does not elect out of ITA 73(1), the property will be transferred at the
UCC of $107,000. There would be no tax consequences at the time of transfer.
While the spouse would receive the property with a UCC of $107,000, the capital cost of $160,000
would be retained, with the difference being considered deemed CCA. The $200,000 proceeds of
disposition do not affect these results.
Elect Out Of ITA 73(1) Mr. Lionel can elect out of ITA 73(1) by including in his income a taxable
capital gain of $20,000 [(1/2)($200,000 - $160,000)], as well as recapture of $53,000 ($160,000 -
$107,000).
For capital gains purposes, the capital cost to the spouse would be $200,000. However, for CCA and
recapture calculations, ITA 13(7)(e) would deem the capital cost to the spouse to be $180,000 [$160,000
+ (1/2)($200,000 - $160,000)].

Exam Exercise Solution Nine - 16

(Non-Arm’s Length Transfer Of Depreciable Property)
Mr. Low When Mr. Low sells the asset for $132,000, the only tax consequence will be recapture of
$68,500 ($63,500 - $132,000).
Mr. Low’s Father As the transfer value is below the transferor’s capital cost, ITA 13(7)(e) will deem
the capital cost to Mr. Low’s father to be equal to the old capital cost of $145,000, with the $13,000
excess over the transfer value of $132,000, being deemed CCA. This means that when Mr. Low’s father
sells the asset for $135,000, he will subtract the lesser of the $135,000 proceeds of disposition and the
$145,000 deemed capital cost from the UCC of $132,000. The result will be recapture of $3,000
($132,000 - $135,000).

Exam Exercise Solution Nine - 17

(Non-Arm’s Length Transfer Of Depreciable Property)
John Travis When John sells the asset for $295,000, the only tax consequence will be recapture of
$50,000 ($245,000 - $295,000).
John’s Brother The transfer value ($295,000) is below the capital cost to John ($350,000). Given this
ITA 13(7)(e) will deem the capital cost to the brother to be equal to John’s capital cost, with the $55,000
($350,000 - $295,000) excess of the transfer value being treated as deemed CCA. This means that,
when the brother sells the asset for $315,000, he will subtract the lesser of the $315,000 proceeds of
disposition and the deemed capital cost of $350,000 from the UCC of $295,000. This will result in
recapture of $20,000 ($295,000 - $315,000).

Exam Exercise Solution Nine - 18

(Inter Vivos Farm Property Transfer To A Child)
With respect to the land, the $300,000 paid is between the $271,000 adjusted cost base floor and the
$365,000 fair market value ceiling. Therefore, the proceeds of disposition would be $300,000, resulting
in a taxable capital gain for Mrs. Wong of $14,500 [(1/2)($300,000 - $271,000)]. The $300,000 would
also be the adjusted cost base for her son.

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With respect to the barn, as there was no consideration given, the transfer would take place at the UCC
floor of $90,000. There would be no tax consequences for Mrs. Wong. With respect to her son, he
would assume a UCC value of $90,000. However, the old capital cost of $120,000 would be retained,
with the $30,000 difference being treated as deemed CCA.

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Exam Exercise Solution Nine - 19

(Inter Vivos Farm Property Transfer To A Child)
The $470,000 that was paid for the land is between the $435,000 adjusted cost base floor and the
$584,000 fair market value ceiling. This means that the proceeds of disposition would be $470,000,
resulting in a taxable capital gain for Martin of $17,500 [(1/2)($470,000 - $435,000)]. The adjusted cost
base for the son would also be $470,000.
As no consideration was provided for the barn, the transfer would take place at the UCC floor of
$140,000. For Martin, there would be no tax consequences. With respect to the son, he would assume
the UCC value of $140,000 and the $165,000 capital cost would be retained, with the $25,000 difference
being treated as deemed CCA.

Exam Exercise Solution Nine - 20 (Transfers On Death)

With respect to the transfer to Linda, it would be transferred at its UCC of $74,000 [(1/2)($148,000)].
This would result in no tax consequences on Mr. Norten’s final tax return and would give Linda a UCC
for the asset of $74,000. However, she would retain the old capital cost of $180,000 with the difference
between the two values being treated as deemed CCA.
The transfer to his daughter, Mary, would take place at the fair market value of $122,000. This means
that the proceeds of disposition for the two backhoes would be $196,000 ($74,000 + $122,000). Given
this, recapture of $48,000 ($148,000 - $196,000) would be included in Mr. Norten’s final tax return.
Mary would also retain her father’s original capital cost of $180,000, but her UCC for the backhoe
would be $122,000 with the difference between the two values being treated as deemed CCA.

Exam Exercise Solution Nine - 21 (Transfers On Death)

The transfer to Nancy’s spouse Mark would take place at the UCC value of $52,000 [(1/2)($104,000)].
This would result in no tax consequences for Nancy’s final tax return. With respect to Mark’s tax
values, his UCC would $52,000. However, he would retain Nancy’s capital cost of $125,000 with the
difference between the two values being treated as deemed CCA.
In the case of the transfer to Nick, it would take place at the fair market value of $86,000. This means
that the proceeds of disposition for the two assets would be $138,000 ($52,000 + $86,000). This would
result in recapture of $34,000 ($104,000 - $138,000) being included in Nancy’s final tax return. As was
the case with the transfer to Mark, Nick would retain Nancy’s capital cost of $125,000 with the
difference between the two values being treated as deemed CCA.

Exam Exercise Solution Nine - 22 (Income Attribution - Spouse)

ITA 73(1) provides for a tax free rollover of capital property to a spouse. The tax consequences for Mr.
and Mrs. Blue for the two years can be outlined as follows:

 2017 for Mr. Blue - none.

 2017 for Mrs. Blue - none.

 2018 for Mr. Blue - none.

 2018 for Mrs. Blue - Total income of $10,468. She would have taxable dividends of $4,968 and a
taxable capital gain of $5,500 [(1/2)($53,000 - $42,000)] attributed to her.

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Exam Exercise Solution Nine - 23 (Income Attribution - Spouse)

ITA 73(1) provides for a tax free rollover of capital property to a spouse. The tax consequences for Mr.
and Mrs. London for the two years can be outlined as follows:

 2017 for Mrs. London - none.

 2017 for Mr. London - none.

 2018 for Mrs. London - none.

 2018 for Mr. London - total income of $11,993. He would have taxable dividends of $2,843 and
a taxable capital gain of $9,150 [(1/2)($39,800 - $21,500)] attributed to him.

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Exam Exercise Solution Nine - 24 (Income Attribution - Spouse)

The tax consequences for Charlotte and Michael for each of the two years are as follows:

 2017 for Charlotte - Electing out of ITA 73(1) will require Charlotte to record a taxable capital
gain of $6,000 [(1/2)($35,000 - $23,000)].

 2017 for Michael - none.

 2018 for Charlotte - Since Michael did not pay the fair market value, taxable dividends of $2,484
[(138%)($1,800)] will be attributed to Charlotte. In addition, a taxable capital gain of $3,500 [(1/2)
($42,000 - $35,000)] will be attributed to her.

 2018 for Michael - none.

Exam Exercise Solution Nine - 25 (Income Attribution - Related Minor)

There is no provision for a tax free transfer of shares to a child. The tax consequences for Tom and
Patrick London for the two years can be outlined as follows:

 2017 for Patrick - none.

 2017 for Tom - a taxable capital gain of $6,850 [(1/2)($35,200 - $21,500)].

 2018 for Patrick - a taxable capital gain of $2,300 [(1/2)($39,800 - $35,200)].

 2018 for Tom - taxable dividends of $2,843 attributed to him.

Exam Exercise Solution Nine - 26 (Income Attribution - Related Minor)

There is no provision for a tax free transfer of shares to a child. Given this, the tax consequences for
Charlotte and Vanessa for each of the two years are as follows:

 2017 for Charlotte - a taxable capital gain of $6,000 [(1/2)($35,000 - $23,000)].

 2017 for Vanessa - none.

 2018 for Charlotte - Taxable dividends of $2,484 [(138%)($1,800)] will be attributed to Charlotte.

 2018 for Vanessa - a taxable capital gain of $3,500 [(1/2)($42,000 - $35,000)].

Exam Exercise Solution Nine - 27

(Income Attribution - Spouse And Related Minor)
The tax consequences are as follows:

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2017

 Mr. Cleroux has a taxable capital gain of $10,200 [(1/2)(400)($156 - $105)].

 His son has no tax consequences.

 His wife has no tax consequences.

2018

 Mr. Cleroux has taxable dividends of $6,210 [(400 + 600)($4.50)(138%)] attributed to him from
his son and wife.

 Mr. Cleroux has a taxable capital gain of $11,100 [(1/2)(600)($142 - $105)] attributed to him
from his wife.

 His son has an allowable capital loss of $2,800 [(1/2)(400)($142 - $156)].

 His wife has no tax consequences.

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Exam Exercise Solution Nine - 28 (Income Attribution - Use Of Loans)

Since Mrs. Lafarge does not elect out of ITA 73(1) by including a gain in her 2017 tax return, there will
be no tax consequences for either Mr. or Mrs. Lafarge in 2017. In addition, because the transfer is a tax
free rollover, the adjusted cost base of the bonds to Mr. Lafarge will be $119,000.
As the loan did not bear interest at market rates, all of the 2018 interest income on the bonds will be
attributed to Mrs. Lafarge. In addition to the interest of $5,600, there would be a taxable capital gain of
$7,500 [(1/2)($134,000 - $119,000)], which would also be attributed to Mrs. Lafarge. The total addition
to Mrs. Lafarge’s income for 2018 is $13,100 ($5,600 + $7,500). There will be no tax consequences for
Mr. Lafarge in 2018.

Exam Exercise Solution Nine - 29 (Income Attribution - Use Of Loans)

The tax consequences for John and Julie in each of the two years are as follows:

 2017 for John - John will elect out of ITA 73(1) by recording a taxable capital gain of $2,500
[(1/2)($210,000 - $205,000)].

 2017 for Julie - None.

 2018 for John - The $11,000 of interest will be attributed to John. In addition, he will have a
taxable capital gain of $3,000 [(1/2)($216,000 - $210,000)]. While Julie provided John with a note,
the fact that it did not bear interest means that income attribution still applies.

 2018 for Julie - None.

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TIF Solution Nine - 5A

The correct definitions for each of the listed key terms are as follows:

A. 3

B. 7

C. 8

D. 4

E. 9

F. 6

G. 2

H. 5

The two unused definitions are as follows:

Spousal Support = 1

Income Splitting = 10

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TIF Solution Nine - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.

The correct definitions for each of the listed key terms are as follows:

A. 5

B. 10

C. 11

D. 6 (not 12)

E. 13 (not 1)

F. 8

G. 3 (not 4)

H. 7

The three unused definitions are as follows:

Spousal Support = 2

Death Benefit = 9

Income Splitting = 14

584 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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585 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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TIF Solution Nine - 6

ITA 56(1)(a)(iii) requires the inclusion of death benefits in income in the year in which they are
received. However, ITA 248 defines these benefits in a manner that allows the exclusion of the first
$10,000 of a death benefit paid to a surviving spouse.
As a consequence, none of the $6,000 payment that was received during 2018 will be included in Mr.
Long’s 2018 Net Income For Tax Purposes, and only $2,000 ($6,000 + $6,000 - $10,000) will be
taxable in 2019.
After the first $10,000 in death benefits is received tax free, any subsequent death benefits received will
be fully taxable to Mr. Long.

586 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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TIF Solution Nine - 7

Deductible Moving Costs
Costs for food and lodging at or near an old or new residence are limited to a maximum period of 15
days. Note that the 9 days spent travelling to Vancouver are not included in the 15 day total. Since the
daily costs for her Montreal stay are higher than those for her Vancouver stay, she claims the 15 day
maximum at the Montreal rate.
The deductible moving expenses can be calculated as follows:

House Hunting Trip Hotel And Food (Not Deductible)Nil

Real Estate Commission - Montreal Home $27,500

Legal Fees - Montreal Home 800

Other Montreal Home Costs (Not Deductible) Nil

Storage Costs 2,200

Moving Company Charges 10,200

Hotel In Montreal (15 Nights At $350) 5,250

Food - Maximum (15 Days At $51 Flat Rate) 765

Expenses Of Travel To Vancouver:

Gas (Using Simplified Method) Nil

Quebec Vehicle Rate

[(4,558 @ $0.505) $2,302

Hotel (9 Nights - Total) 1,575

Food (9 Days At $51 Flat Rate) 459 4,336

Vancouver Hotel Nil

Moving Expense Deductions Available $51,051

Part A - Costs Paid By Vancouver Office

Moving costs can only be deducted against “income earned at the new work location”. This raises the
question as to whether the $60,000 that was provided to cover moving costs would be considered to be
“earned at the new location”. It would be our view that since it was paid by the Vancouver office
subsequent to Michelle commencing work at that location, it would qualify.

Salary At New Location (One Month @ $15,000) $15,000

General Moving Allowance 20,000

Compensation For Loss On Montreal Residence (Note 1)30,000

587 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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Payment For Higher Housing Costs (Note 2) 10,000

Total Employment Income At New Location $75,000

Note 1 Under ITA 6(20), one-half of any housing loss reimbursement in excess of $15,000
must be included in income. As the total reimbursement was $75,000 ($625,000 - $550,000),
the inclusion would be $30,000 [(1/2)($75,000 - $15,000)].

Note 2 Any amounts paid to compensate an employee for higher housing costs must be
included in income in full.

As the deductible costs are less than the income at the new location, they are fully deductible in
Michelle’s 2018 tax return. There would be no carry forward of moving costs.

Part B - Costs Paid By Montreal Office

If the $60,000 had been paid prior to December out of funds provided from the Montreal office, it would
not be considered “earned at the new work location”. Under this scenario, only $15,000 in moving costs
would have been deductible in 2018, with the remaining $36,051 ($51,051 - $15,000) carried forward to
subsequent years.

588 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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TIF Solution Nine - 8

Income At New Location
As both the general moving allowance and the compensation for the housing loss were paid for by the
Ottawa office, these would likely be considered income at the new location. Given this view,
Lawrence’s employment income at the new location can be calculated as follows:

General Moving Allowance $18,000

Compensation For Loss On Halifax Residence (Note 1) 7,500

Salary At New Location (1 Month At $8,000) 8,000

Total Employment Income At New Location $33,500

Note 1 Under ITA 6(20), one-half of any housing loss reimbursement in excess of $15,000
must be included in income. As the total reimbursement was $30,000, the inclusion would be
$7,500 [(1/2)($30,000 - $15,000)].

Deductible Expenses
Deductible moving expenses can be calculated as follows:

Real Estate Commission - Halifax Home $21,000

Legal Fees - Halifax Home 800

Other Halifax Home Costs (Not Deductible) Nil

Car Moving Costs 1,100

Moving Company Costs ($3,500 + $1,200) 4,700

Costs Of Lodging (Note 2):

House Hunting Trip (4 Nights At $200) 800

In Ottawa (11 Nights At $160) 1,760

Food - Maximum (15 Days At $51 Flat Rate) 765

Costs Of Airfare On Move To Ottawa 600

Moving Expense Deductions Available $31,525

Note 2 As soon as the lease is signed (assuming that the person doesn’t back out before the
lease actually begins) the premises is a new residence. Costs of food and lodging at or near the
old or new residence are limited to a maximum period of 15 days.

589 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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Lawrence has a total of 23 eligible days, 4 days after he signs a lease at $200 per day and 19
days at $160 per day prior to the delivery of his furnishings. Since the daily costs are higher
during the house hunting trip, he claims them in order to maximize his moving expense
deduction. Lawrence can claim the lodging costs of $800 [(4)($200)] for the 4 days after the
lease is signed. The costs for the remaining 11 days total $1,760 [(11)($160)].

Actual Deduction
As the deductible costs are less than the income at the new location, they are fully deductible in
Lawrence’s 2018 tax return. There would be no carry forward of moving costs.

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TIF Solution Nine - 9

Andrea Brock
Generally, the spouse with the lower income must claim the deduction for child care expenses.
However, under certain circumstances, for example if this spouse is a full time student, the spouse with
the higher income can claim the deduction for the period the spouse is a student. Under this provision,
Andrea can claim the least of the following:

Case A Case B

Actual Payments [($350)(50)] $17,500 $17,500

2/3 Of Earned Income [(2/3)($109,100)]* $72,733 $72,733

Annual Expense Limit:

Case A ($5,000 + $8,000) $13,000

Case B ($5,000 + $8,000 + $11,000) $24,000

Periodic Expense Limit:

Case A [($125 + $200)(7)] $ 2,275

Case B [($125 + $200 + $275)(7)] $ 4,200

*Andrea’s Earned Income would be calculated as follows:

Gross Salary (No RPP Deduction) $ 92,300

Tax Preparation Fees 12,700

Stock Option Benefit 4,100

Earned Income $109,100

In Case A, the least of these figures is $2,275, the Periodic Expense Limit.
In Case B, the least of the figures is $4,200, also the Periodic Expense Limit.

Andrew Brock
The calculations for Andrew are as follows:

Case A Case B

591 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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Actual Payments [($350)(50)] $17,500 $17,500

2/3 Of Earned Income [(2/3)($24,000)]* $16,000 $16,000

Annual Expense Limit:

Case A ($5,000 + $8,000) $13,000

Case B ($5,000 + $8,000 + $11,000) $24,000

* The net business income, not gross revenues is used to calculate earned income.

The least of the figures in Case A is $13,000, the annual expense limit. Deducting from this the amount
claimed by Andrea leaves a deduction for Andrew of $10,725 ($13,000 - $2,275).
In Case B, the least of the figures is $16,000. Deducting from this the amount claimed by Andrea leaves
a deduction for Andrew of $11,800 ($16,000 - $4,200).
As Andrea is the higher income spouse, the number of weeks she is unable to care for the children has
no effect on the child care expense calculations.

No Carry Forward
In both Cases, the total deductible child care costs is less than the actual amount paid. Any amounts
paid in the year that are not deductible are lost and cannot be carried forward.

592 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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TIF Solution Nine - 10

Mrs. Holmes
Generally, the spouse with the lower income must claim the deduction for child care expenses.
However, under certain circumstances, for example if this spouse is a full time student, the spouse with
the higher income can claim the deduction for the period the spouse is a student. Under this provision,
Mrs. Holmes can claim the least of the following:

Case A Case B

Actual Payments [($300)(50)] $15,000 $15,000

2/3 Of Earned Income* [(2/3)($81,000)] $54,000 $54,000

Annual Expense Limit:

Case A [(2)($8,000)] $16,000

Case B [(2)($8,000) + (1)($5,000)] $21,000

Periodic Expense Limit:

Case A [(2)($200)(6 weeks)] $ 2,400

Case B {[(2)($200)(6 weeks)] + [(1)($125)(6 weeks)]} $ 3,150

*The employment income figure used for this purpose is gross and not net employment
income.

In Case A, the least of these figures is $2,400, the Periodic Expense Limit.
In Case B, the least of the figures is $3,150, also the Periodic Expense Limit.

Mr. Holmes
The calculations for Mr. Holmes are as follows:

Case A Case B

Actual Payments $15,000 $15,000

2/3 Of Earned Income [(2/3)($18,000)] $12,000 $12,000

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Annual Expense Limit:

Case A [(2)($8,000)] $16,000

Case B [(2)($8,000) + (1)($5,000)] $21,000

The lowest figure in both cases is $12,000, two-thirds of Mr. Holmes’ earned income. Mr. Holmes’
deduction is reduced by the amount claimed by Mrs. Holmes.
Given this, Mr. Holmes’ deduction is:

 $9,600 ($12,000 - $2,400) in Case A, and

 $8,850 ($12,000 - $3,150) in Case B.

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TIF Solution Nine - 11

Tax Payable - No Pension Income Splitting

Laura Laura’s federal Tax Payable would be calculated as follows:

Tax Before Credits [(15%)($10,500)] $1,575

Basic Personal Credit [(15%)($11,809) ( 1,771)

Age - Transferred To Alex Nil

Pension - No Qualifying Income Nil

Federal Tax Payable - Laura Nil

Alex Alex’s federal Tax Payable would be calculated as follows:

Tax On First $46,605 $ 6,991

Tax On Next $25,395 ($72,000 - $46,605) At 20.5% 5,206

Total Before Credits $12,197

Credits:

Basic Personal ($11,809)

Spousal ($11,809 - $10,500) ( 1,309)

Age [$7,333 - (15%)($72,000 - $36,976)] ( 2,079)

Transfer Of Age From Laura ( 7,333)

Pension ( 2,000)

Total ($24,530)

Rate 15% ( 3,680)

Federal Tax Payable $ 8,517

OAS Clawback N/A

Federal Tax Payable - Alex $ 8,517

As Alex’s Net Income For Tax Purposes is less than the OAS clawback threshold of $75,910, no
clawback is required

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Tax Payable - With Pension Income Splitting

Revised Taxable Incomes Neither OAS payments nor CPP receipts are eligible for reallocation under
the pension income splitting provisions. Given this, only Alex’s $52,000 in RPP receipts can be split
between the spouses.
With this $26,000 [(1/2)($52,000)] reallocation, Alex’s Net Income For Tax Purposes and Taxable
Income will be $46,000 ($72,000 - $26,000).
The corresponding figure for Laura will be $36,500 ($10,500 + $26,000).

Laura With pension income splitting, Laura’s federal Tax Payable would be calculated as follows:

596 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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Tax Before Credits [(15%)($36,500)] $5,475

Credits:

Basic Personal ($11,809)

Age [$7,333 - (15%)($36,500- $36,976) ( 7,333)

Pension ( 2,000)

Total ($21,142)

Rate 15% ( 3,171)

Federal Tax Payable $2,304

OAS Clawback N/A

Federal Tax Payable - Laura $2,304

Alex With pension income splitting, Alex’s federal Tax Payable would be calculated as follows:

Tax On $46,000 $6,900

Total Before Credits $6,900

Credits:

Basic Personal ($11,809)

Spousal ($11,809 - $36,500) Nil

Age [$7,333 - (15%)($46,000 - $36,976) ( 5,979)

Pension ( 2,000)

Total ($19,788)

Rate 15% ( 2,968)

Federal Tax Payable $3,932

OAS Clawback N/A

Federal Tax Payable - Alex $3,932

Comparison
The results, with and without pension income splitting can be compared as follows:

Federal Tax Payable - No Pension Income Splitting $8,517

Federal Tax Payable - With Pension Income Splitting

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($2,304 + $3,932) ( 6,236)

Savings Resulting From Pension Income Splitting $2,281

Factors Creating The Tax Payable Difference

 Tax savings as the amount of Alex’s income that is taxed at 20.5 percent, rather than 15 percent is
greatly decreased.

 Tax savings from an increase in the value of Alex’s age credit that is considerably larger than the
decrease in Laura’s age credit.

 Tax savings since Laura can now deduct a pension income credit.

 Increased combined Tax Payable to a modest degree from the elimination of the small spousal
credit.

Note that it might be possible to request that Alex’s CPP benefits be split, especially as they have been
married many years. The portion paid separately to Laura would be taxed in her hands. This would be
unlike pension income splitting which is implemented entirely in the tax returns and does not involve
any actual payments being split.
Since a small portion of Alex’s income is being taxed at 20.5 percent, splitting his CPP benefit could
result in no income being taxed at 20.5 percent if maximum pension income splitting is used.

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TIF Solution Nine - 12

Part A - Net And Taxable Income

Bennett’s Income Alternative 1 Alternative 2

Pension Receipt $120,000 $120,000

Pension Income To Belinda N/A ( 60,000)

OAS N/A 7,000

Net Income Before OAS Clawback $120,000 $ 67,000

OAS Clawback (Notes 1 and 2) N/A N/A

Net And Taxable Income $120,000 $ 67,000

Belinda’s Income Alternative 1 Alternative 2

OAS $ 7,000 $ 7,000

Eligible Dividends Received 39,000 39,000

Gross Up [(38%)($39,000)] 14,820 14,820

Pension Income From Bennett N/A 60,000

Net Income Before OAS Clawback $60,820 $120,820

OAS Clawback (Note 3) Nil ( 6,737)

Net And Taxable Income $60,820 $114,083

Note 1 As Bennett did not apply for OAS in Alternative 1, there can be no clawback.
Belinda’s income is below the OAS clawback threshold of $75,910.

Note 2 In Alternative 2, Bennett’s Net Income is less than the clawback income threshold of
$75,910 so there is no clawback.

Note 3 With pension income splitting, the OAS clawback for Belinda would be the lesser of
$7,000 and $6,737 [(15%)($120,820 - $75,910)].

Part B - Alternative 1
Without pension income splitting, Bennett’s Amount Owing would be calculated as follows:
599 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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Tax On First $93,208 $16,544

Tax On Next $26,792 ($120,000 - $93,208) At 26% 6,966

Total Before Credits $23,510

Credits:

Basic Personal ($11,809)

Age [$7,333 - (15%)($120,000 - $36,976) Nil

Pension ( 2,000)

Total ($13,809)

Rate 15% ( 2,071)

Federal Tax Payable $21,439

OAS Clawback N/A

Total Amount Owing - Bennett $21,439

600 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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Without pension income splitting, Belinda’s Amount Owing would be calculated as follows:

Tax On First $46,605 $6,991

Tax On Next $14,215 ($60,820 - $46,605 At 20.5% 2,914

Total Before Credits $9,905

Credits:

Basic Personal ($11,809)

Age [$7,333 - (15%)($60,820 - $36,976) ( 3,756)

Total ($15,565)

Rate 15% ( 2,335)

Dividend Tax Credit [(6/11)($14,820)] ( 8,084)

Total Amount Owing - No Clawback - Belinda Nil

Part B - Alternative 2
With pension income splitting and the OAS payments, Bennett’s Amount Owing would be calculated as
follows:

Tax On First $46,605 $ 6,991

Tax On Next $20,395 ($67,000 - $46,605) At 20.5% 4,181

Tax Before Credits $11,172

Credits:

Basic Personal ($11,809)

Age [$7,333 - (15%)($67,000 - $36,976)] ( 2,829)

Pension ( 2,000)

Total ($16,638)

Rate 15% ( 2,496)

Total Amount Owing - No Clawback - Bennett $ 8,676

With pension income splitting, Belinda’s Amount Owing would be calculated as follows:
601 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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Tax On First $93,208 $16,544

Tax On Next $20,875 ($114,083 - $93,208) At 26% 5,428

Tax Before Credits $21,972

Credits:

Basic Personal ($11,809)

Age [$7,333 - (15%)($114,083 - $36,976)] Nil

Pension ( 2,000)

Total ($13,809)

Rate 15% ( 2,071)

Dividend Tax Credit [(6/11)($14,820)] ( 8,084)

Federal Tax Payable $11,817

OAS Clawback 6,737

Total Amount Owing - Belinda $18,554

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Part B - Comparison Of After Tax Income

This amount would be calculated as follows:

Amount Owing - Alternative 1 $21,439

Amount Owing - Alternative 2 ($8,676 + $18,554)($27,230)

OAS Benefits Received - Alternative 2 7,000 ( 20,230)

Cash Advantage (Disadvantage) - Alternative 2 $ 1,209

This problem illustrates the complexity associated with pension income splitting. By splitting the
$120,000 in pension income on an equal basis, Belinda became the higher income spouse by a
significant amount. As a result, Bennett had no OAS clawback, but Belinda had all of her OAS clawed
back.
Although there is a cash advantage to Alternative 2, the result would be improved if pension income
splitting was limited to an amount that would give Bennett a Net Income of the OAS clawback income
threshold as that would reduce Belinda’s OAS clawback without clawing back his OAS.
However, that may not be the best solution. Finding the optimum solution is not an intuitive process,
especially if there are other factors such as medical costs, and would require the proper use of tax
software.

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TIF Solution Nine - 13

Part A - Net Income For Tax Purposes
The minimum Net Income For Tax Purposes that can be reported by Ms. Watts is calculated as follows:

Wages From Cold Lake Employment $9,600

Moving Costs To Cold Lake (Note 1) ( 685) 8,915

Scholarship Received $4,000

Exempt Portion Of Scholarship (100%) ( 4,000) Nil

Child Care Costs (Note 2) ( 1,500)

Employment Income In Calgary $600

Moving Costs To Calgary (Note 1) ( 600) Nil

Eligible Dividends Received 3,500

Gross Up Of Dividends [(38%)($3,500)] 1,330

Child Support Received (Note 3) Nil

Inheritance (Not Taxable) Nil

TFSA Contributions (Note 4) Nil

TFSA Withdrawal (Note 4) Nil

RESP Contributions (Note 5) Nil

Net Income For Tax Purposes $12,245

Note 1 The cost of the move to Cold Lake is deductible against the income that was earned
there as it is more than 40 km from Calgary. The moving costs related to the move back to
Calgary can be deducted to the extent of her employment income at that location. The
remaining $226 ($826 - $600) can be carried forward to apply against any eligible income that
is earned in Calgary during 2019.

Note 2 As she is the lower income spouse, Ms. Watts will deduct the child care payments. The
deduction is the least of the following amounts:

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 The amount paid = $1,500 [(12)($125)].

 The annual child care expense amount = $10,000 [(2)($5,000)].

 Two-thirds of Earned Income = $6,800 [(2/3)($9,600 + $600)].

Note 3 Child support payments are not deductible to the payor and are not taxed in the hands
of the recipient.

Note 4 TFSA contributions and withdrawals have no tax consequences. There is also no
income attribution as a result of the TFSA contribution by Ms. Watts’ husband.

Note 5 Contributions to RESPs are not deductible.

Part B - Registered Education Savings Plan

While contributions to RESPs are not deductible, earnings within the plan accumulate on a tax free
basis. Further, when the earnings are withdrawn, they are likely to be taxed in the hands of the plan
beneficiaries. As they will be full or part time students at this time, they will either be in a low tax
bracket or, in many cases, have income that is below the basic personal tax credit. This arrangement can
involve a considerable savings in taxes.
In addition, for contributions of up to $2,500 per year, the federal government will make additional
contributions under the Canada Education Savings Grants (CESG) program. These contributions will
add a minimum of $500 to the first $2,500 of annual contributions. Note, however, that given her
husband’s level of income, the family will not be eligible for the Canada Learning Bonds program.

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Given the potential tax savings, as well as the federal government contributions under the CESG
program, Ms. Watts and her husband should consider contributing at least $2,500 per year to each of the
children’s RESPs.
Since her children have not had RESPs before, they have CESG contribution room carried forward. Ms.
Watts should determine the contribution schedule required to maximize the CESGs for both children so
that she can plan to take advantage of the CESG contribution room if there are sufficient funds available.

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TIF Solution Nine - 14

Part A - Case 1 - Sale To Arm’s Length Party
The result for Martin would be as follows:

Proceeds Of Disposition $500,000

Adjusted Cost Base ( 360,000)

Capital Gain $140,000

Inclusion Rate 1/2

Taxable Capital Gain $ 70,000

With respect to the subsequent sale by the arm’s length purchaser, the results for that individual would
be as follows:

Proceeds Of Disposition $500,000

Adjusted Cost Base ( 500,000)

Capital Gain Nil

Part A - Case 2 - Sale To Sister

The result for Martin would be as follows:

Deemed Proceeds Of Disposition - ITA 69(1)(b) $500,000

Adjusted Cost Base ( 360,000)

Capital Gain $140,000

Inclusion Rate 1/2

Taxable Capital Gain $ 70,000

With respect to the subsequent sale by Martin’s sister, the results for her would be as follows:

Proceeds Of Disposition (Actual) $500,000

Adjusted Cost Base ( 360,000)

Capital Gain $140,000

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Inclusion Rate 1/2

Taxable Capital Gain $ 70,000

Note that in this case the $140,000 capital gain is subject to double taxation.

Part A - Case 3 - Gift To Son

The result for Martin would be as follows:

Deemed Proceeds Of Disposition - ITA 69(1)(b) $500,000

Adjusted Cost Base ( 360,000)

Capital Gain $140,000

Inclusion Rate 1/2

Taxable Capital Gain $ 70,000

With respect to the subsequent sale by Martin’s son, the results for him would be as follows:

Proceeds Of Disposition $500,000

Adjusted Cost Base (Actual) ( 500,000)

Capital Gain Nil

The fact that his son is younger than 18 years of age does not affect the results.

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Part A - Case 4 - Sale To Mother

The result for Martin would be as follows:

Proceeds Of Disposition (Actual) $600,000

Adjusted Cost Base ( 360,000)

Capital Gain $240,000

Inclusion Rate 1/2

Taxable Capital Gain $120,000

With respect to the subsequent sale by Martin’s mother, the results for her would be as follows:

Proceeds Of Disposition (Actual) $500,000

Adjusted Cost Base - ITA 69(1)(a) ( 500,000)

Capital Gain Nil

Despite the fact that Martin had to record the actual proceeds of $600,000, his mother’s adjusted cost
base will be the fair market value of $500,000. This means that she did not have a $100,000 capital loss
to economically offset (for the family unit) the effect of his capital gain.

Part B
In Case 2, the sale was for $360,000, less than the $500,000 fair market value of the asset. Martin might
agree to do this in an attempt to transfer the $140,000 gain to his sister. This could be motivated by the
fact that she is in a lower tax bracket. It could also reflect the fact that she has unused capital losses that
she would like to be able to use.
In Case 4, the sale was for $600,000, more than the $500,000 fair market value of the asset. The
motivation here could be that his mother has capital gains that she would like to offset with a capital loss
resulting from her re-selling the asset for $500,000 and/or Martin has unused capital losses greater than
$140,000 that he would like to be able to use.

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 TIF Solution One - 4

TIF Solution Nine - 15

Case One - FMV Transferor’s Capital Cost
The results of the disposition for John can be calculated as follows:

UCC Balance $69,000

Lesser Of:

Proceeds Of Disposition = $165,000

Capital Cost = $97,000 ( 97,000)

Negative Ending UCC Balance = Recapture Of CCA ($28,000)

Proceeds Of Disposition $165,000

Capital Cost ( 97,000)

Capital Gain $ 68,000

Inclusion Rate 1/2

Taxable Capital Gain $ 34,000

John’s Net Income For Tax Purposes will increase by $62,000 ($28,000 + $34,000).
For his son, his capital cost for capital gains purposes will be the transfer price of $165,000. However,
because the fair market value of the asset exceeded its original capital cost, ITA 13(7)(e) will limit the
value used for CCA and recapture calculations to the following amount:

[$97,000 + (1/2)($165,000 - $97,000)] = $131,000

Case Two - FMV Transferor’s Capital Cost

The results of this disposition for John can be calculated as follows:

UCC Balance $189,000

Lesser Of:

Proceeds Of Disposition = $210,000

Capital Cost = $286,000 ( 210,000)

Negative Ending UCC Balance = Recapture Of CCA ($ 21,000)

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John’s Net Income For Tax Purposes will increase by $21,000.

In this case, where the fair market value of the asset is less than its capital cost, ITA 13(7)(e) deems the
transferee’s capital cost of the transferred asset to be equal to the transferor’s capital cost, an amount of
$286,000. This capital cost will be used for purposes of determining any capital gain and/or recapture
on a future disposition.
The $76,000 ($286,000 - $210,000) difference between this value and the transfer price will be
considered deemed CCA. The resulting UCC balance of $210,000 will be used by John’s daughter for
calculating future CCA.
Since John was taxed on the $21,000 difference between his UCC of $189,000 and the fair market value
of $210,000 as recapture, it makes economic sense that his daughter’s UCC balance should be $210,000.

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TIF Solution Nine - 16

Note To Instructor Part B of this problem requires knowledge of ITA 13(21.1) as there is a
capital gain on the land and a terminal loss on the building. This provision is covered in detail
in Chapter 8.

Case A(1)
Assuming that the transfer was to Margarette’s spouse, the land would have been transferred at its cost
and the building would have been transferred at its UCC. As a consequence, there would have been no
tax effects to be included in Margarette’s final return.
For CCA purposes, the building would have been transferred at Margarette’s UCC of $363,000. Given
this, maximum CCA would be $14,520 [(4%)($363,000)] for 2018 leaving a UCC of $348,480. Since
the acquisition of the building is a non-arm’s length transaction, it was used and continues to be used to
produce income and was owned for more than one year by Margarette, the half year rule does not apply
to Gianni.
Note, however, that after the transfer, Gianni would have retained the building’s old capital cost of
$473,000. Using this figure for the building, the tax effects that would occur at the time of the 2019 sale
of the property would be as follows:

Land Building

Proceeds Of Disposition $160,000 $525,000

Adjusted Cost Base/Capital Cost ( 150,000) ( 473,000)

Capital Gain $ 10,000 $ 52,000

Inclusion Rate 1/2 1/2

Taxable Capital Gain $ 5,000 $ 26,000

UCC $348,480

Deduct Disposition - Lesser Of:

 Capital Cost = $473,000

 Proceeds Of Disposition = $525,000 ( 473,000)

Negative Closing UCC Balance = Recaptured CCA ($124,520)

A total of $155,520 ($5,000 + $26,000 + $124,520) would be added to the 2019 Net Income For Tax
Purposes of Gianni. With the death of Margarette, there can be no income or capital gains attributed to
her from Gianni.

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Case A(2)
As the transfer was to her daughter, Ciara, the deemed proceeds will be recorded at fair market value for
the land and building. Based on this, the following calculations show the tax effects that will be
included in Margarette’s final return:

Land Building

Deemed Proceeds $175,000 $571,000

Adjusted Cost Base/Capital Cost ( 150,000) ( 473,000)

Capital Gain $ 25,000 $ 98,000

Inclusion Rate 1/2 1/2

Taxable Capital Gain $ 12,500 $ 49,000

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UCC $363,000

Deduct Disposition - Lesser Of:

 Capital Cost = $473,000

 Deemed Proceeds = $571,000 ( 473,000)

Negative Closing UCC Balance = Recaptured CCA ($110,000)

A total of $171,500 ($12,500 + $49,000 + $110,000) would be added to Margarette’s 2018 Net Income
For Tax Purposes.
With respect to Ciara’s tax records, the land will have a tax cost of $175,000 and the building will be a
Class 1 asset with a tax cost equal to Margarette’s deemed proceeds of $571,000.
Maximum 2018 CCA is $22,840 [($571,000)(4%)], leaving a UCC of $548,160 ($571,000 - $22,840).
Since the acquisition of the building is a non-arm’s length transaction, it was used and continues to be
used to produce income and was owned for more than one year by Margarette, the half year rule does
not apply to Ciara. In addition, ITA 13(7)(e), which requires the calculation of a limited UCC balance,
is not applicable to transfers at death.
Since there cannot be a capital loss on depreciable property and the building is the only asset in the
class, the 2019 tax effects associated with the sale of the building would be calculated as follows:

Land Building

Proceeds Of Disposition $160,000 $525,000

Adjusted Cost Base ( 175,000)

Capital Cost Limited To Proceeds ( 525,000)

Capital Gain (Loss) ($ 15,000) Nil

Inclusion Rate 1/2 N/A

Allowable Capital Loss ($ 7,500) Nil

UCC $548,160

Deduct Disposition - Lesser Of:

 Capital Cost = $571,000

 Proceeds Of Disposition= $525,000 ( 525,000)

Positive Closing UCC Balance = Terminal Loss $ 23,160

A total of $30,660 ($23,160 + $7,500) would be deducted from the 2019 Net Income For Tax Purposes
of Ciara as the problem indicates that she has sufficient income and taxable capital gains.

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Comparison Case A(1) And A(2)

The overall tax consequences in the two cases are as shown in the following table:

Case A(1) Case A(2) Case A(2)

Gianni Margarette Ciara

2018 Nil $171,500 Nil

2018 - CCA Taken ($ 14,520) ($22,840)

2019 155,520 ( 30,660)

Net Income For Tax Purposes (Loss) $141,000 $171,500 ($53,500)

There is a difference in the Case A(1) and Case A(2) results of $23,000 [$141,000 - ($171,500 -
$53,500)]. This reflects the fact that, in Case A(2), a portion of the amount that was taxed as a capital
gain (50 percent) in Margarette’s final return was deducted by Ciara as CCA and a terminal loss (100
percent).

This can be shown in the following calculation:

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Actual Sale Price Of Building For Ciara $525,000

Fair Market Value (Deemed Proceeds) At Death ( 571,000)

Amount Deducted By Ciara As CCA And Terminal Loss*($ 46,000)

Portion Taxed As Capital Gain In Final Return [(1/2)($46,000)] 23,000

Difference ($ 23,000)

*$23,160 + $22,840 = $46,000

Part B
If the proceeds of the sale of the property by Ciara were allocated $300,000 to the land and $385,000 to
the building, the tax effects associated with the sale of the building would be initially calculated as
follows:

Land Building

Proceeds Of Disposition $300,000 $385,000

Adjusted Cost Base ( 175,000)

Capital Cost Limited To Proceeds ( 385,000)

Capital Gain $125,000 Nil

Inclusion Rate 1/2 1/2

Taxable Capital Gain $ 62,500 Nil

UCC $548,160

Deduct Disposition - Lesser Of:

 Capital Cost = $571,000

 Proceeds Of Disposition= $385,000 ( 385,000)

Positive Closing UCC Balance = Terminal Loss $163,160

Since there is a capital gain on the land and a terminal loss on the building, ITA 13(21.1)(a) requires the
deemed proceeds of disposition for the building to be determined as follows:

The Lesser Of:

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The FMV of the land and building $685,000

Reduced By The Lesser Of:

 The ACB of the land = $175,000

 The FMV of the land = $300,000 ( 175,000) $510,000

The Greater Of:

 The FMV of the building = $385,000

 The Lesser Of:

The cost of the building = $571,000

The UCC of the building = $548,160 $548,160

The proceeds that would be allocated to the building would be $510,000, leaving $175,000 ($685,000 -
$510,000) to be allocated to the land. The net result is that the terminal loss would be reduced by
$125,000 (the amount of the potential capital gain) to $38,160 ($510,000 - $548,160) and the capital
gain would be nil ($175,000 - $175,000).

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TIF Solution Nine - 17

Case A
Whenever a taxpayer dies, there is a deemed disposition of all of his property. If the transfer is to a
spouse, the disposition is deemed to have taken place at the adjusted cost base of capital property other
than depreciable property, and at the UCC of depreciable property. This would mean that there would
be no immediate tax consequences associated with Mr. Cheever’s death in this Case, since all of the
property is transferred to his spouse. Note, however, that on a subsequent disposition by Mr. Cheever’s
spouse, her tax base would be the same as Mr. Cheever’s. Although fair market value elections are
available, the problem states that none were made.

Case B
This Case is more complex and would follow the general rules applicable to transfers made at death to
anyone other than a spouse. Such transfers, unless they involve farm property, will be deemed to have
taken place at fair market value.

Farm Land In the case of farm land that is being used by the taxpayer or a member of his family, ITA
70(9.01) permits a tax free transfer of such property to a child. The deemed proceeds would be Mr.
Cheever’s adjusted cost base, resulting in no tax consequences for his estate. As you would expect, the
adjusted cost base to Mr. Cheever’s daughter, Mary, would be the same $525,000 that was deemed to be
the proceeds of the disposition on Mr. Cheever’s death.

Rental Property In the case of the rental property, the tax consequences to Mr. Cheever’s estate would
be as follows:

Land Building

Deemed Proceeds $100,000 $870,000

Adjusted Cost Base/Capital Cost ( 100,000) ( 450,000)

Capital Gain Nil $420,000

Inclusion Rate N/A 1/2

Taxable Capital Gain Nil $210,000

UCC $270,000

Deduct Disposition - Lesser Of:

 Capital Cost ($550,000 - $100,000) = $450,000

 Deemed Proceeds ($970,000 - $100,000) = $870,000 ( 450,000)

Negative Closing UCC Balance = Recaptured CCA ($180,000)

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Shares In the case of the Brazeway Dynamics shares and the shares of Cheever Inc., the deemed
proceeds would be the fair market value and the tax consequences to Mr. Cheever’s estate would be as
follows:

Brazeway Dynamics Cheever Inc.

Deemed Proceeds $425,000 $227,000

Adjusted Cost Base/Capital Cost ( 275,000) ( 155,000)

Capital Gain $150,000 $ 72,000

Inclusion Rate 1/2 1/2

Taxable Capital Gain $ 75,000 $ 36,000

This gives a total increase in Net Income For Tax Purposes for Mr. Cheever of $501,000 ($210,000 +
$180,000 + $75,000 + $36,000).

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Case C
With respect to the departure from Canada, ITA 128.1(4)(b) indicates that when a taxpayer ceases to be
a resident of Canada, he is deemed to have disposed of all property except real property, property of a
business carried on in Canada by an individual, and excluded personal property [a variety of items
specified in ITA 128.1(9)]. As the farm land and the rental property are real property, there would be no
deemed disposition of these assets.
There would, however, be a deemed disposition of both the Brazeway Dynamics shares and the Cheever
Inc. shares. The results would be as follows:

Brazeway Dynamics Cheever Inc.

Deemed Proceeds $425,000 $227,000

Adjusted Cost Base ( 275,000) ( 155,000)

Capital Gain $150,000 $ 72,000

Inclusion Rate 1/2 1/2

Taxable Capital Gain $ 75,000 $ 36,000

This gives a total increase in Net Income For Tax Purposes of $111,000 ($75,000 + $36,000).

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TIF Solution Nine - 18

Part A
In the absence of an election by James not to have ITA 73(1) apply, the disposition will be deemed to
have taken place at his tax values. These would be the $52,000 adjusted cost base of the land and the
$97,000 UCC for the building. Note, however, the transferee would retain the original capital cost of
$170,000. Given this information, the transfer would not result in any tax effects for either James
Hadley or Gwyneth Rowe.
As James did not elect out of ITA 73(1), the net rental loss for 2018 of $7,400 would be attributed to
him.
When the property is sold on January 1, 2019, the income from the sale of the property would also be
attributed to James. The relevant amount would be as follows:

Land Building

Proceeds Of Disposition $102,000 $244,000

Adjusted Cost Base ( 52,000) ( 170,000)

Capital Gain $ 50,000 $ 74,000

Inclusion Rate 1/2 1/2

Taxable Capital Gain $ 25,000 $ 37,000

Capital Cost $170,000

UCC ( 97,000)

Recapture Of CCA $ 73,000

This would result in an increase in James Hadley’s 2019 Net Income For Tax Purposes of $135,000
($25,000 + 37,000 + $73,000).
There would be no effect on Gwyneth’s Net Income For Tax Purposes in either year.

Part B
The preceding result would be changed if Gwyneth agrees to purchase the property at its fair market
value. Provided James elects out of ITA 73(1), there will be no income attribution. Under this
approach, the transfer would result in the following amounts of income for James.

Land Building

Deemed Proceeds Of Disposition $102,000 $214,000

Adjusted Cost Base ( 52,000) ( 170,000)

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Capital Gain $ 50,000 $ 44,000

Inclusion Rate 1/2 1/2

Taxable Capital Gain $ 25,000 $ 22,000

Capital Cost $170,000

UCC ( 97,000)

Recapture Of CCA $ 73,000

This would result in an increase in James Hadley’s 2018 Net Income For Tax Purposes of $120,000
($25,000 + $22,000 + $73,000).

In the absence of income attribution, all of the net rental loss will be included in Gwyneth’s 2018 Net
Income For Tax Purposes. In addition, the income resulting from the January 1, 2019 sale of the
property would be included in her income. The relevant amounts would be as follows:

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Land Building

Proceeds Of Disposition $102,000 $244,000

Adjusted Cost Base ( 102,000) ( 214,000)

Capital Gain Nil $ 30,000

Inclusion Rate N/A 1/2

Taxable Capital Gain Nil $ 15,000

You might wish to note that, while the allocation of the income differs in Part A and Part B, the total
amount of income is the same. This is shown in the following tables:

Part A

James For 2018

Net Rental Loss ($ 7,400)

James For 2019

Taxable Capital Gains ($25,000 + $37,000) 62,000

Recapture 73,000

Total (No Income For Gwyneth) $127,600

Part B

James For 2018

Taxable Capital Gains ($25,000 + $22,000) $47,000

Recapture 73,000

Gwyneth For 2018

Net Rental Loss ( 7,400)

Gwyneth For 2019

Taxable Capital Gain 15,000

Total $127,600

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624 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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TIF Solution Nine - 19

Tiffani
At Transfer
As Tiffani did not elect out of the ITA 73(1) spousal rollover, no income will result from the transfer to
her spouse Hugh. However, there is no rollover for the transfer of public company shares to a related
minor. This means there will be a taxable capital gain on the transfer of 14,000 shares to her son as
follows:

Deemed Proceeds Of Disposition [($11)(14,000)] $154,000

Adjusted Cost Base [($10)(14,000)] ( 140,000)

Capital Gain $ 14,000

Inclusion Rate 1/2

Taxable Capital Gain $ 7,000

Dividends
As all of the shares were given to a spouse and a related minor, 100 percent of the dividends would be
attributed back to Tiffani. Her increase in Net Income For Tax Purposes due to the dividends would be
$14,490 [(21,000)(138%)($0.50)].

Sale Of Shares
As there is no attribution of capital gains when shares are transferred to a related minor, the sale of
shares by Tiffani’s son would have no effect on her 2018 Net Income For Tax Purposes. However, the
gain on the sale of shares by her spouse would be attributed back to Tiffani. The amount is calculated as
follows:

Proceeds Of Disposition [($13)(7,000)] $91,000

Adjusted Cost Base [($10)(7,000)] ( 70,000)

Capital Gain $21,000

Inclusion Rate 1/2

Taxable Capital Gain $10,500

Hugh
None of these transactions would have any effect on Hugh’s 2018 Income For Tax Purposes.

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Mark
When Mark sells his shares, he will have a taxable capital gain calculated as follows:

Proceeds Of Disposition [($13)(14,000)] $182,000

Adjusted Cost Base [($11)(14,000)] ( 154,000)

Capital Gain $ 28,000

Inclusion Rate 1/2

Taxable Capital Gain $ 14,000

If Tiffani Dies
Since Tiffani dies after the dividends are paid, but before Hugh sells his shares, the dividends will still
be attributed back to Tiffani, but the taxable capital gain on the sale of Hugh’s shares of $10,500 will be
taxed in Hugh’s hands.
The taxable capital gain on the sale of Mark’s shares is already being taxed in Mark’s hands, so there
would be no change in tax effects for Mark if Tiffani were to die.

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TIF Solution Nine - 20

Alonso
At Transfer
As Alonso did not elect out of the ITA 73(1) spousal rollover, no income will result from the transfer to
his spouse Alice. However, there is no rollover for the transfer of public company shares to a related
minor. This means there will be a taxable capital gain on the transfer of 10,000 shares to his son as
follows:

Deemed Proceeds Of Disposition [($17.00)(10,000)] $170,000

Adjusted Cost Base [($12.50)(10,000)] ( 125,000)

Capital Gain $ 45,000

Inclusion Rate 1/2

Taxable Capital Gain $ 22,500

Dividends
As all of the shares were given to a spouse and a related minor, 100 percent of the dividends would be
attributed back to Alonso. His increase in Net Income For Tax Purposes due to the dividends would be
$16,560 [(15,000)(138%)($0.80)].

Sale Of Shares
As there is no attribution of capital gains when shares are transferred to a related minor, the sale of
shares by Alonso’s son would have no effect on Alonso’s 2018 Net Income For Tax Purposes.
However, the gain on the sale of shares by his spouse would be attributed back to Alonso. The amount
is calculated as follows:

Proceeds Of Disposition [($16.00)(5,000)] $80,000

Adjusted Cost Base [($12.50)(5,000)] ( 62,500)

Capital Gain $17,500

Inclusion Rate 1/2

Taxable Capital Gain $8,750

Alice
None of these transactions would have any effect on Alice’s 2018 Income For Tax Purposes.

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Alonso Jr.
When Alonso Jr. sells his Lisgar Inc. shares, he will have an allowable capital loss calculated as follows:

Proceeds Of Disposition [($16.00)(10,000)] $160,000

Adjusted Cost Base [($17.00)(10,000)] ( 170,000)

Capital Loss ($ 10,000)

Inclusion Rate 1/2

Allowable Capital Loss ($ 5,000)

This loss can only be deducted in 2018 to the extent that Alonso Jr. has taxable capital gains during
2018. As a result, the sale will not affect Net Income For Tax Purposes unless he has taxable capital
gains.

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TIF Solution Nine - 21

Employment Income
Ms. Jansan’s Net employment income would be calculated as follows:

Base Salary $ 75,000

Bonus (Paid In 2018) 19,500

Standby Charge On Automobile (Note 1) 1,845

Operating Costs (Note 2) ( 5,103)

RPP Contributions ( 3,400)

Provincial Health Care Premium [(12)($44)] 528

Life Insurance Premiums (Note 3) Nil

Housing Compensation (Note 4) 15,000

Housing Loan Benefit [(2%)($200,000)(9/12)] 3,000

Moving Allowance (Note 5) 10,000

Net Employment Income $116,370

Note 1 The reduced standby charge would be calculated as follows:

[(2/3)(12)($560)(11/12)][8,240 ÷ 18,337] = $1,845

Note 2 As Ms. Jansan pays her own operating costs, she can deduct the portion that relates to
employment use. This amount would be $5,103 [($6,300)(35,120 ÷ 43,360)].

Note 3 An employee’s payments for life insurance are not deductible. While this is not the
case here, if the employer had made a contribution for Peta’s life insurance, the payment would
be considered a taxable benefit.

Note 4 As Ms. Jansan is being relocated, the loss on her Edmonton home is an ITA 6(22)
eligible housing loss. Under ITA 6(20), only one-half of amounts in excess of $15,000 of such
compensation have to be included in income. As the compensation here was only $7,200
($257,800 - $265,000), none of this amount is included in income. However, there is no
similar provision which allows tax free treatment of amounts paid for high costs in the new
location. As a consequence, the full $15,000 of the compensation for higher house costs in
Calgary would have to be included in income.

Note 5 As the moving allowance is general in nature, it will have to be included in income.
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Property Income
Ms. Jansan’s only property income would be the dividends on the Dutch Foods Ltd. shares.

Dividends Received [(1,260)($0.30)] $378

Gross Up [($378)(38%)] 144

Taxable Dividends $522

Taxable Capital Gain

Ms. Jansan’s only capital gain would be on the sale of the Dutch Foods Ltd. shares. It would be
calculated as follows:

Proceeds Of Disposition [(900)($6.10)] $5,490

Adjusted Cost Base (Note 6) ( 4,878)

Capital Gain $ 612

Inclusion Rate 1/2

Taxable Capital Gain $ 306

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Note 6 The average per share cost of the Dutch Foods shares is $5.42 {[(360)($5.00) + (500)
($5.25) + (400)($6.00)] ÷ 1,260}. This gives an adjusted cost base for the shares sold of $4,878
[(900)($5.42)].

Other Income And Deductions

Mr. Jansan’s other income and other deductions would be calculated as follows:

Spousal Support (Note 7) $ 4,000

Annuity Income (Note 8) 1,408

Moving Expenses (Note 9) ( 12,750)

Child Care Costs (Note 10) ( 12,500)

Total Other Income And Deductions ($19,842)

Note 7 When incomplete support payments are made, the payments that are made are first
allocated to child support. Given this, Ms. Jansan’s income inclusion will be $4,000 [$40,000 -
(12)($3,000)].

Note 8 The net inclusion of annuity income would be calculated as follows:

Payment - ITA 56(1)(d) $5,000

Return Of Capital - ITA 60(a)

[($5,000)($28,733 ÷ $40,000)] ( 3,592)

Net Income Inclusion $1,408

Note 9 The deductible amount of moving expenses would be calculated as follows:

Calgary Lodging [(12)($325) + (3)($200)] $ 4,500

Calgary Food [(15)($51)(4)] 3,060

Moving And Storing Household Effects 3,640

Legal Costs Of Selling Old Home 950

Legal Costs Of New Home 600

Total Deductible Amount $12,750

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The cost of visiting Calgary to find a new home was reimbursed and is not a taxable benefit.
With respect to the costs of staying in a hotel in Calgary, ITA 62(3)(c) allows only 15 days of
such costs as a deduction and the cost of the remaining 4 days is not deductible. Moving costs
are maximized if Ms. Jansan deducts 12 nights at the higher rate. You should note that if the
employer had paid directly for the costs of these 4 days, it would not have created a taxable
benefit. Unfortunately, they chose to pay a general allowance, all of which has to be included
in Ms. Jansan’s income.

Note 10 The child care costs would be $12,300, the least of the following three amounts:

 Actual Costs And Deductible Camp Costs $12,500

 Annual Limit ($8,000 + $5,000) $13,000

 Income Limit $83,249

Actual costs are limited to $200 per week for Lotte and $125 per week for Bram during the
four week period the children are at camp. When combined with the other costs, the total is as
follows:

Edmonton - 11 Weeks At $200 Per Week $ 2,200

Calgary - 36 Weeks At $250 Per Week 9,000

Camp - 4 Weeks At $325 ($200 + $125) Per Week 1,300

Total $12,500

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The income limit is based on gross employment income, without consideration of the car
operating costs deduction or RPP contributions. This figure is $83,249 [(2/3)($116,370 +
$5,103 + $3,400)].

Net Income For Tax Purposes And Taxable Income

Ms. Jansan’s Net Income For Tax Purposes would be calculated as follows:

Net Employment Income $116,370

Property Income 522

Taxable Capital Gain 306

Other Income And Other Deductions ( 19,842)

Net Income For Tax Purposes And Taxable Income $ 97,356

Note that the contributions to the TFSAs do not enter into the calculation of Net Income For
Tax Purposes. Such contributions are not deductible.

Tax Payable
The required calculations here are as follows:

Tax On First $93,208 $16,544

Tax On Next $4,148 ($97,356 - $93,208) At 26 Percent 1,078

Tax Before Credits $17,622

Tax Credits:

Basic Personal ($11,809)

Eligible Dependant (Either Child) ( 11,809)

Canada Caregiver

(Grandfather Is Not Infirm) Nil

EI ( 858)

CPP ( 2,594)

Canada Employment ( 1,195)

Medical Expenses (Note 11) ( 12,234)

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Total Credit Base ($40,499)

Rate 15% ( 6,075)

Dividend Tax Credit [(6/11)($144)] ( 79)

Federal Tax Payable $17,622

Note 11 The medical expenses eligible for the credit are as follows:

Medical Expenses Of Ms. Jansan And Her Children

($465 + $493 + $245) $ 1,203

Lesser Of:

 [(3%)($97,356)] = $2,921

 2018 Threshold Amount = $2,302 ( 2,302)

Balance Before Dependants 18 And Over Nil

Grandfather’s Medical Expenses $12,473

Reduced By The Lesser Of:

 $2,302

 [(3%)($7,950)] = $239 ( 239) 12,234

Total Medical Expense Claim $12,234

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Chapter Ten Test Item File Solutions

TIF Solution Ten - 1

1. The major advantages can be described as follows:

 Eligible contributions are fully deductible and provide an immediate reduction in Tax Payable.

 While the contributions are invested in the plan, earnings on the investments accumulate on a
tax free basis. (This would not provide any advantage with respect to contributions made to a
defined benefit RPP.)

 When the funds are withdrawn from the plan, the individual may be in a lower tax bracket than
he was in when he made the contributions. When this is the case, there is tax avoidance in that
the taxes saved on the deduction are greater than the taxes paid on the withdrawal.

 The payments from an RPP or RRSP may be eligible for both the pension income tax credit
and for pension income splitting.

 An additional advantage for RRSPs only is that funds can be temporarily withdrawn on a tax
free basis using the home buyers plan or the lifelong learning plan.

2. With respect to the first statement, making contributions to an RRSP results in deferral as the
contributions are deductible when made, but will only be taxed when withdrawn. As the
withdrawal will usually be in a later taxation year, the payment of taxes is deferred from the year of
contribution to the year of withdrawal.

In some cases, an individual may be subject to the same tax rate in the year of withdrawal as was
applicable in the year of contribution. However, if the tax rate is lower, either because of the
individual’s income level or because applicable rates have changed, the amount of tax on
withdrawal will be less than the amount saved at the time of contribution. This results in actual tax
avoidance.

3. The reason tax advisors make these recommendations is to extend the period of tax free
compounding. A payment made on January 1 will benefit from a full extra year of tax free
compounding, as compared to a payment made on December 31 of that year.

4. In defined benefit plans, the plan sponsor undertakes to provide a specified benefit, usually
expressed as a percentage of earnings, for each year of qualifying service. In promising this benefit,

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the employer has effectively agreed to make whatever amount of contributions is required to
provide these benefits.

In contrast, in a money purchase plan, the employer agrees to make specified contributions for each
plan participant. In this case, the employer has no responsibility beyond making the required
contributions. The benefit that will be received by the employee will be based on the amounts of
funds that are accumulated in the plan.

5. Such a contribution would not be a good idea. ITA 40(2)(g)(iv) does not allow the recognition of a
loss when an individual transfers assets into an RRSP. This means the loss would never be
available to the individual. If the individual is short of cash, the better alternative would be to sell
the shares and use the proceeds to make the RRSP contribution. Using this approach, the loss
would be available to apply against any capital gains that may accrue to the individual.

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6. The income earned by equity securities consists of dividends and capital gains, both of which
receive tax treatment that, when earned outside an RRSP, is more favourable than that given to
interest on debt securities. Specifically, only one-half of capital gains are subject to tax while, in
the case of both eligible and non-eligible dividends, the gross up and tax credit procedure serves to
significantly reduce the rate applicable to this type of income. In contrast, when accumulated
dividends or capital gains are removed from an RRSP, the amounts are taxable at full personal rates,
thereby eliminating any tax advantages associated with capital gains or dividends. For this reason,
it makes sense to keep equity holdings outside of an RRSP and to allocate interest bearing debt
securities to the RRSP.

7. The RRSP Deduction Limit, as the name implies, is a limit on the amount of contributions that can
be deducted in a particular year. However, a limited amount of non-deductible contributions, that
are in excess of the RRSP Deduction Limit, can be made without attracting a penalty. Further,
contributions made in earlier years that were not deducted in those years, or contributions made in
the first 60 days of the following year, can be deducted under the RRSP Deduction Limit for the
current year.

8. The components of Earned Income for purposes of determining the RRSP Deduction Limit are as
follows:

 Employment income computed without the deduction of RPP contributions.

 Royalties, provided the taxpayer is the author, inventor, or composer.

 Taxable (deductible) support payments.

 Supplementary unemployment benefits.

 Business income (loss).

 Income (loss) earned as an active partner.

 Net rental income (loss).

 CPP disability benefits.

9. In simplified terms, benefits earned in defined benefit plans are converted to a contribution-like
number by multiplying the benefits earned by an individual by the number 9. The use of this
approach does not take into consideration the fact that it would take a much larger contribution to
provide $1 of benefits to a 64 year old individual who will retire in one year, than it would to
provide $1 of benefits to a 20 year old individual who will not receive the benefit for 45 years. This
would suggest that the approach used is systematically unfair to younger taxpayers.

10. The situations that are described in the text are as follows:

 A new RPP is implemented by an employer and benefits are extended retroactively for years of
service prior to the plan initiation.

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 The benefit formula is changed, increasing the percentage that is applied to pensionable
earnings to determine benefits earned. Again, a PSPA is created only if the increased benefits
are extended retroactively to years of service prior to the plan amendment.

 An individual, either voluntarily or because of terms contained in the plan, works for a number
of years without being a member of the plan. On joining the plan, the employee is credited for
years of service prior to entry into the plan.

11. Pension adjustment reversals arise when an individual earns non-vested benefits for which PAs
have been issued. If the non-vested benefits are lost, most commonly through leaving the service of
the employer granting the benefits, the employer must report a pension adjustment reversal to add
the previously deducted PAs back to the individual’s RRSP deduction room.

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12. With respect to contributions, amounts contributed to an RRSP are deductible, while similar
contributions to a TFSA cannot be deducted. With respect to earnings on assets held within the
plan, both types of plans feature tax free accumulation of these earnings.

However, withdrawals are treated differently by the two types of plans. In general, amounts
withdrawn from an RRSP are subject to tax at full individual rates. No consideration is given to the
type of income that formed the basis for the withdrawals. In contrast, withdrawals from a TFSA are
not subject to tax.

A further difference between the two types of plans is that, in general, amounts withdrawn from an
RRSP cannot be returned. This means that withdrawals represent a permanent reduction in an
individual’s RRSP deduction room. In contrast, amounts withdrawn from a TFSA can be returned
to the plan in the following year. Such returned amounts serve to restore the contribution room that
was removed by earlier withdrawals.

13. There are several points to be made here:

 Contributions that are more than $2,000 greater than the individual’s unused deduction room
should not be made as they attract a penalty of 1 percent per month.

 Non-deductible contributions of $2,000 or less have the advantage of having the earnings
resulting from their investment accumulate on a tax free basis.

 The basic point for your friend, however, is that while he cannot deduct contributions in excess
of his unused deduction room at the time the contributions are made, he can deduct them in any
future period when deduction room becomes available. As a consequence, his basic point is
only valid if the excess contributions are never deducted.

14. The disadvantages can be described as follows:

 Such withdrawals can subject a large amount of income to the highest marginal tax rates.

 Such withdrawals are not eligible for the pension income tax credit.

 Such withdrawals are not eligible for pension income splitting.

While it probably would not be considered a disadvantage, we would note that there is withholding
on withdrawals, starting at a rate of 10 percent on the first $5,001 and increasing to 30 percent on
amounts in excess of $15,000.

15. When an individual reaches age 71, his RRSP must be collapsed. The basic alternatives for
withdrawing the funds in the plan, along with the related tax consequences, are as follows:

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 The total amount of assets in the plan can simply be withdrawn. This alternative will result in
the fair market value of all of the assets being included in the individual’s income in the year of
withdrawal.

 The assets in the plan can be converted to cash and the proceeds used to purchase an annuity.
There will be no immediate consequences associated with the purchase of the annuity.
However, the subsequent payments will be included in full in the taxpayer’s income as they
are received.

 The assets in the RRSP can be transferred to a RRIF. There are no tax consequences associated
with this rollover. However, the taxpayer will have to make a minimum withdrawal from the
RRIF in each subsequent year. The full amount of each withdrawal will be taxed in the year
that it is received.

These are not mutually exclusive choices. They can be used in combinations (e.g., one-half the
funds to a RRIF, with the remaining one-half being used to purchase an annuity).

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16. Contributions to a spousal plan are desirable when the individual’s spouse or common-law partner
is currently in a lower tax bracket and is expected to remain in a lower bracket. There are two
advantages to making such contributions:

 Income splitting. When the contributions are withdrawn they will be taxed at the spouse or
common-law partner’s lower tax rate.

 In situations where the spouse or common-law partner has no other source of pension income,
withdrawals from the spousal plan could be eligible for the pension income tax credit.

Note that although these results could also be achieved through the use of the provisions which
allow for the splitting of qualified pension income, a spousal RRSP provides the couple with more
flexibility in planning retirement income.

17. If an individual has made any contribution to an RRSP that has his spouse or common-law partner
as the registrant, it is a spousal RRSP. With respect to such plans, if a contribution is made, either
in the year of a withdrawal or in either of the two preceding calendar years, that withdrawal must be
included in the contributor’s income to the extent of the spousal contributions made in the year of
the withdrawal or in either of the two preceding calendar years.

18. The basic factors to consider would be as follows:

 Whether the required funds could be acquired through a conventional mortgage.

 What rate would be paid on conventional mortgage financing.

 What rate is being earned on the investments in the plan.

 The fact that the earnings lost while the funds are out of the plan can never be put back in the
plan, resulting in a permanent loss of tax assisted savings.

19. The basic factors to consider would be as follows:

 Alternative sources of financing.

 The financing rate on alternative sources of financing.

 The rates of return on assets that are in the RRSP.

 The fact that the earnings lost while the funds are out of the plan can never be put back in the
plan, resulting in a permanent loss of tax assisted savings.

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20. The general rule here is that the fair market value of the assets in the unmatured plan will be
included as income in the decedent’s final tax return. However, there are two exceptions to this
general rule:

 If the beneficiary of the RRSP is the decedent’s spouse, there is a rollover provision that allows
the transfer of the balances in the plan to a spouse or common-law partner without tax
consequences. In effect, the spouse becomes the new registrant of the plan and there are no tax
consequences for the decedent.

 If the beneficiary of the RRSP is a financially dependent child or grandchild, the assets will be
taxed as income to that dependent. In addition, if the child or grandchild has a physical or
mental infirmity, the dependant can avoid current taxation by transferring the assets to an
RRSP, RRIF, RDSP, or using them to purchase an annuity.

21. There are two classes of potential members. One class would be employees of an employer that
offers participation in a PRPP. The second class of members would include employees of an
employer that does not offer a PRPP, as well as self-employed individuals.

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22. The basic differences are as follows:

 RRIFs are only funded through a transfer from an RRSP or another RRIF. In contrast, the
individual can make deductible contributions or transfer funds from another retirement savings
plan (RRSP, RPP, DPSP) in order to get funds into an RRSP.

 There is no requirement to make minimum annual withdrawals from an RRSP. In contrast, an

individual must make a minimum withdrawal each year from a RRIF.

 An individual can have a RRIF after the age of 71. They cannot have an RRSP after that age.

 RRIFs are not eligible for withdrawals under either the home buyers plan or the lifelong
learning plan.

23. DPSPs provide tax deferral in that employer contributions to these plans do not create a taxable
benefit until they are withdrawn from the plan. There is further deferral in the fact that amounts
earned on the DPSP investments accumulate tax free, with these amounts also not being taxed until
they are withdrawn from the plan. In contrast, employer contributions to a PSP are treated as
taxable benefits to the employees who receive them. In addition, amounts earned on the PSP’s
assets are taxed in the hands of the employees as they are earned. While there may be human
resource or motivational reasons for using PSPs, the use of these plans does not provide any tax
advantages to employees.

24. An employer’s contributions to a retirement compensation arrangement (RCA) are fully deductible
in computing Taxable Income. However, all contributions are subject to a Part XI.3 refundable tax
at a rate of 50 percent. In addition, all of the earnings on the assets that are in the plan are subject
to this same 50 percent tax. The Part XI.3 taxes that the employer pays are refunded at a 50 percent
rate when payments are made to the beneficiaries of the plan. The recipients will be subject to
income tax at relevant rates when the benefits are paid.

25. As defined in ITA 248(1), a salary deferral arrangement is a plan or arrangement, whether funded or
not, under which any person has a right to receive an amount in a year subsequent to the year in
which it was earned. The definition also requires that one of the main purposes of the arrangement
is defer Tax Payable. The definition goes on to exclude such items as RPPs, sabbatical
arrangements, and bonuses that are paid within three calendar years.

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TIF Solution Ten - 2

1. True. In general, deferral is available as individuals can deduct contributions when they are made,
are not taxed on amounts earned within the plan, and only pay taxes when amounts are withdrawn
from the plan. Avoidance may also be available if the individual is in a lower tax bracket when
taxable withdrawals are made than he was when the deductible contributions were made.

2. True. A pension plan that provides for a pension equal to 3 percent of an employee’s average
annual salary for each year of service is a defined benefit plan.

3. True. All of these items are components of Earned Income for RRSP purposes.

4. False. Only those undeductible contributions in excess of $2,000 are subject to the penalty.

5. True. Once a spouse or common-law partner has made a contribution, the plan is permanently
designated a spousal RRSP.

6. True. The amounts must be repaid over 15 years, beginning in the second calendar year after
withdrawal.

7. False. While the tax free withdrawal is conditional on being enrolled in a qualified educational
program at a designated educational institution, there is no requirement that the funds be used for
any particular purpose.

8. False. The employees’ contributions have no effect on the deductibility of the employer’s
contributions. A maximum of $25,000 is deductible.

9. False. Contributions to DPSPs are not considered to be taxable benefits to employees.

10. False. The tax free transfer is limited to $2,000 per year of service with the employer prior to 1996,
plus an additional $1,500 for each year of service prior to 1989 for which the employer’s
contributions to an RPP or a DPSP had not become vested at the time the retiring allowance is
granted.

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TIF Solution Ten - 3

Defined Benefit Vs. Defined Contribution
1. D. Past Service Pension Adjustments can only arise when the plan is a defined benefit
plan.

2. B. The employer promises each employee a retirement benefit that is based on a

contractually specified formula.

3. D. The employee’s pension benefit is not affected by rates of return on the pension plan
assets.

RRSPs
4. C. If an individual has terminated his RRSP because he has turned 71, he can no longer
make RRSP contributions, even if he has Earned Income. Such an individual can continue
making contributions to a spousal RRSP.

5. C. Direct investments in rental properties.

6. B. $580 [(18%)($40,000 - $16,000 + $7,000) - ($2,000 + $3,000)]

7. D. $2,580 [(18%)($40,000 - $16,000 + $7,000) - $3,000].

8. B. $5,580 [(18%)($40,000 - $16,000 + $7,000)].

9. A. $3,580 [(18%)($40,000 - $16,000 + $7,000) - $2,000].

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10. D. $12,360.

Unused RRSP Deduction Room carried forward from 2017:

Lesser Of:

 ($26,010 - $6,000) = $20,010*

 [(18%)($50,000) - $6,000] = $3,000 $ 3,000

Plus 2018 RRSP deduction room

Lesser Of:

 2018 RRSP Dollar Limit = $26,230

 [(18%)($52,000)] = $9,360 9,360

RRSP Deduction Limit $12,360

* Previous year’s RRSP dollar limit is not needed as $3,000 is obviously the lesser number.

11. A. Resource royalties, CPP retirement benefits and scholarships do not form part of the
Earned Income calculation for RRSP purposes.

12. D. Contributions made during the current year can be deducted in any subsequent year.

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13. D. Mrs. Wu’s 2018 taxable income increased by $600 and Mr. Wu’s increased by $1,000.

14. A. She will receive cash of $8,000 and her 2018 taxable income will increase by $10,000.
$10,000 less 20% withholding tax = $8,000.

15. D. His taxable income will be increased by $2,000.

16. B. $43,000

Home Buyers’ Plan

17. C. Repayments in excess of an annual requirement will reduce future annual
requirements. While the applicable fraction will not change, the balance to which the fraction
will apply will be reduced.

18. A. All amounts withdrawn must be repaid within 10 years of the year of withdrawal.

19. C. $1,600.00 ($24,000 – 1,000 pmt – 600 included in 2018 taxable income) = $22,400 x
1/14 = $1,600

20. B. An increase of $300. (min. repayment of $1,000 – 700)

Lifelong Learning Plan

21. B. An individual can only participate in this program once during his life. There is no
limit on the number of times, as long as all previous withdrawals have been repaid.

22. C. Minimum repayments must be made over a period of ten years.

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23. D. March 1, 2020. Since 2019 is the fifth year after the first withdrawal, she has 60 days
after the year end to make the repayment.

RPPs
24. B. Employee contributions provide the contributor with credit against tax payable.

25. A. Eileen can deduct her contribution from her Net Income For Tax Purposes and her
employer’s contribution is not considered a taxable benefit.

26. A. Contributions can be made only by employers.

RRIFs
27. A. Withdrawals from a RIFF are not eligible for pension income splitting.

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28. C. Earnings accumulate within the RRIF on a tax free basis.

29. A. $12,400 ($62,000 x 20%)

Deferred Profit Sharing Plans

30. B. Contributions to DPSPs are limited to one-half the money purchase limit for the year.

Profit Sharing Plans

31. D. Withdrawals from the plan are received tax free by employee.

32. B. Income earned within the plan is accumulated on a tax-free basis.

Transfers Between Plans

33. A. He wants to split his RRIF withdrawal with his wife.

34. C. Profit Sharing Plan to Deferred Profit Sharing Plan.

35. D. the individual reaches age 71

Retirement Compensation Arrangements

36. B. Contributions to RCAs are subject to a 50 percent, non-refundable tax.

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Retiring Allowances
37. C. The amount of the retiring allowance which Mr. Smith can transfer to his RRSP in the
year he retires is $59,500 [(20)($2,000) + (13)($1,500)]. This is $2,000 per year prior to 1996,
plus $1,500 per year prior to 1989 during which no employer contributions vested to a pension
plan.

Pension Tax Credit

38. B. a lump sum withdrawal from a RRIF

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TIF Solution Ten - 4

Exam Exercise Solution Ten - 1 (Dividends Earned In An RRSP)
Alternative 1 - As the $50,000 is from an inheritance, this Exam Exercise differs from the example in
the text and from the Exercise that is included in the text. In those examples, the available funds
involved pre-tax income, resulting in a need to pay taxes on the funds prior to making an investment
outside of an RRSP. In this example, no payment of taxes is required prior to investment and the full
$50,000 can be used to acquire preferred shares. Given this, the results are as follows:

Dividends Received [(5.5%)($50,000)(5)] $13,750

Taxes [(26%)($13,750)] ( 3,575)

After Tax Income $10,175

Principal Amount 50,000

Available Funds For Home Purchase $60,175

Alternative 2 - Again, because we are dealing with a tax-free inheritance, rather than pre-tax income,
the calculations for this alternative are different. Specifically, we have to take into consideration the
$21,500 [([(43%)($50,000)], tax savings that will be created by the RRSP deduction. Assuming that he
invests these savings outside the RRSP in the preferred shares, he would have the following amount
available for his home purchase after 5 years:

Dividends Received [(5.5%)($21,500)(5)] $ 5,913

Taxes [(26%)(5,913)] ( 1,537)

After Tax Income $ 4,376

Principal Amount 21,500

Available Funds For Home Purchase $25,876

The additional amount of funds after withdrawing the total amount of funds that have accumulated in the
RRSP and paying taxes on this amount would be calculated as follows:

Dividends Received In The RRSP [(5.5%)($50,000)(5)] $13,750

Contribution Withdrawn 50,000

Total Withdrawal $63,750

Taxes [(43%)($63,750)] ( 27,413)

Available Funds For Home Purchase $36,337

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When this $36,337 amount is combined with the $25,876 from the non-RRSP investment, the total is
$62,213. This is $2,038 better than the $60,175 that was available when the $50,000 was invested
outside the RRSP.

Exam Exercise Solution Ten - 2 (Earned Income)

His Earned Income for RRSP purposes will be $61,550 ($78,300 + $2,400 - $6,750 - $12,400).

Exam Exercise Solution Ten - 3 (Earned Income)

Her Earned Income for RRSP purposes will be $67,700 ($56,200 + $1,800 - $2,300 + $12,000).

Exam Exercise Solution Ten - 4 (Pension Adjustments)

The Pension Adjustment will be $6,900 ($2,600 + $1,700 + $2,600).

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Exam Exercise Solution Ten - 5 (Pension Adjustments)

The Pension Adjustment will be $6,250 ($2,500 + $1,250 + $2,500).

Exam Exercise Solution Ten - 6 (Unused RRSP Deduction Room)

The required calculation would be as follows:

Unused Deduction Room - End Of 2017 $5,100

Lesser Of:

 2018 RRSP Dollar Limit = $26,230

 18% Of 2017 Earned Income Of $43,500 = $7,830 7,830

Less 2018 Deduction ( 5,200)

Unused RRSP Deduction Room - End Of 2018 $7,730

Mrs. Lair has undeducted contributions of $1,800 ($7,000 - $5,200) that can be carried forward and
deducted in any subsequent year as there is already sufficient RRSP deduction room.

Exam Exercise Solution Ten - 7 (Unused RRSP Deduction Room)

The required calculation would be as follows:

Unused Deduction Room - End Of 2017 $6,500

Lesser Of:

 2018 RRSP Dollar Limit = $26,230

 18% Of 2017 Earned Income Of $96,000 = $17,280 17,280

Less 2018 Deduction ( 8,500)

Unused RRSP Deduction Room - End Of 2018 $15,280

Mr. Flack has undeducted contributions of $500 ($9,000 - $8,500) that can be carried forward and
deducted in any subsequent year as there is already sufficient RRSP deduction room.

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Exam Exercise Solution Ten - 8 (Maximum RRSP Deduction)

The required calculations would be as follows:

Net Employment Income $80,200

RPP Contributions 3,000

Net Rental Income 5,720

Spousal Support Deducted ( 15,000)

2017 Earned Income $73,920

Unused Deduction Room - End Of 2017 $11,120

Lesser Of:

 2018 RRSP Dollar Limit = $26,230

 18% Of 2017 Earned Income Of $73,920 = $13,306 13,306

Less 2017 PA ( 6,000)

2018 RRSP Deduction Limit $18,426

RRSP Deduction Is Lesser Of:

 RRSP Deduction Limit = $18,426

 Available Contributions = $19,275 ($6,275 + $13,000) ( 18,426)

Unused RRSP Deduction Room - End Of 2018 Nil

Mrs. White has undeducted contributions of $849 ($19,275 - $18,426) that can be carried forward and
deducted in a subsequent year in which there is sufficient RRSP deduction room.

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Exam Exercise Solution Ten - 9 (Maximum RRSP Deduction)

The required calculations would be as follows:

Net Employment Income $45,000

RPP Contributions 1,800

Spousal Support Received 18,000

Business Loss ( 3,500)

2017 Earned Income $61,300

Unused Deduction Room - End Of 2017 $ 4,800

Lesser Of:

 2018 RRSP Dollar Limit = $26,230

 18% Of 2017 Earned Income Of $61,300 = $11,034 11,034

Less 2017 PA ( 3,600)

2018 RRSP Deduction Limit $12,234

RRSP Deduction Is Lesser Of:

 RRSP Deduction Limit = $12,234

 Available Contributions = $13,200 ($3,800 + $9,400) ( 12,234)

Unused RRSP Deduction Room - End Of 2018 Nil

Ms. Blue has undeducted contributions of $966 ($13,200 - $12,234) that can be carried forward and
deducted in a subsequent year in which there is sufficient RRSP deduction room.

Exam Exercise Solution Ten - 10 (Excess RRSP Contributions)

The required calculations are as follows:

2017 Contribution $13,500

2017 Addition To Deduction Room [(18%)($75,000)] ( 13,500)

Excess Contribution Nil

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2018 Contribution $16,000

$2,000 Cushion ( 2,000)

2018 Addition To Deduction Room [(18%)($75,000)] ( 13,500)

Excess Contribution Subject To Penalty $ 500

As the $16,000 contribution was made on May 1, 2018, there will be a 2018 penalty of $40 [(1%)($500)
(8)]. The fact that there is no RRSP deduction is not relevant to the penalty.

Exam Exercise Solution Ten - 11 (Excess RRSP Contributions)

The required calculations are as follows:

2017 Contribution $18,900

2017 Addition To Deduction Room [(18%)($105,000)]( 18,900)

Excess Contributions Nil

2018 Contribution $22,000

$2,000 Cushion ( 2,000)

2018 Addition To Deduction Room [(18%)($105,000)]( 18,900)

Excess Contribution Subject To Penalty $ 1,100

As the $22,000 contribution was made on April 1, 2018, there will be a 2018 penalty of $99 [(1%)
($1,100)(9)]. The fact that there is no RRSP deduction is not relevant to the penalty.

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Exam Exercise Solution Ten - 12 (Spousal RRSP Withdrawal)

The wife’s plan is a spousal plan as contributions to the plan have been made by Mr. Peters. Given this,
when the 2018 withdrawal is made, any contributions made by Mr. Peters in 2018, or the two preceding
years are attributed to him. This means that $3,500 ($1,500 + $2,000) of the 2018 withdrawal will be
attributed to him. The remaining $800 ($4,300 - $3,500) will be taxed in the hands of his wife.

Exam Exercise Solution Ten - 13 (Spousal RRSP Withdrawal)

The wife’s plan is a spousal plan as contributions to the plan have been made by Mr. Bryant. Given this,
when the 2018 withdrawal is made, any contributions made by Mr. Bryant in 2018, or the two preceding
years are attributed to him. This means that $10,000 ($4,500 + $5,500) of the 2018 withdrawal will be
attributed to him. The remaining $1,000 ($11,000 - $10,000) will be taxed in the hands of his wife.

Exam Exercise Solution Ten - 14 (Home Buyers’ Plan)

Mr. Debon’s minimum payment for 2017 would be $433 [(1/15)($15,000 - $8,500)]. Note that the
voluntary payment that was made during 2016 did not reduce the fraction of the remaining balance that
must be repaid in 2017. If he does not make this payment, the amount will be added to his 2017 Net
Income For Tax Purposes and subtracted from his HBP balance. Without regard to whether or not he
makes this $433 payment, his minimum payment for 2018 would again be $433 [(1/14)($15,000 -
$8,500 - $433)].

Exam Exercise Solution Ten - 15 (Home Buyers’ Plan)

Mr. Borshiov’s minimum payment for 2017 would be $933 [(1/15)($21,000 - $7,000)]. Note that the
voluntary payment made in 2016 did not reduce the fraction of the remaining balance that must be
repaid in 2017. If no payment is made in 2017, the $933 will be added to his Net Income For Tax
Purposes and subtracted from his HBP balance. Whether or not he makes the 2017 payment, the
minimum payment for 2018 would again be $933 [(1/14)($21,000 - $7,000 - $933)].

Exam Exercise Solution Ten - 16 (Lifelong Learning Plan)

As the withdrawals are within the annual limit of $10,000 and the overall limit of $20,000, there will be
no tax consequences associated with the withdrawals from Mr. Forsyth’s RRSP.
The repayment period will begin in 2018, as this is the fifth year (the maximum delay) of his
participation in the Lifelong Learning Plan. It did not begin earlier because he was enrolled in a
qualifying education program in the years 2013 through 2017.
There are no tax consequences in 2018, as his designated repayment of $2,900 exceeds the required
amount of $2,000 ($20,000 ÷ 10).
The required repayment for 2019 is $1,900 [($20,000 - $2,900) ÷ 9]. The shortfall in his payment of
$400 ($1,900 - $1,500) will be included in his income for 2019. This illustrates the fact that excess
payments in some years cannot be applied against shortfalls in subsequent years.
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Exam Exercise Solution Ten - 17 (Lifelong Learning Plan)

As the withdrawals are within the annual limit of $10,000 and the overall limit of $20,000, there will be
no tax consequences associated with the $18,000 [(3)($6,000)] of withdrawals from Mr. Botterill’s
RRSP.
The required repayment period begins in 2018, the fifth year of his participation in the Lifelong
Learning Plan. This is the maximum delay for repayment.
There are no tax consequences in 2018 as Mr. Botterill’s designated payment of $2,200 exceeds the
required minimum of $1,800 ($18,000 ÷ 10).
The required payment in 2019 is $1,756 [($18,000 - $2,200) ÷ 9]. The shortfall of $556 ($1,756 -
$1,200) will be included in his 2019 Net Income For Tax Purposes.

Exam Exercise Solution Ten - 18 (Minimum RRIF Withdrawal)

There is no required withdrawal from the RRIF in 2018, as this is the year that it is established. For
2019, the minimum withdrawal is $61,364 [$1,350,000 ÷ (90 - 68)].

Exam Exercise Solution Ten - 19 (Minimum RRIF Withdrawal)

In the year a RRIF is established, there is no minimum withdrawal. This means that there is no required
minimum withdrawal for 2018. For 2019, the minimum would be $130,000 [$2,600,000 ÷ (90 - 70)].

Exam Exercise Solution Ten - 20 (Retiring Allowance)

If Mrs. Barth has worked for 35 years as of 2018, she must have started in 1984. Given this, she can
rollover a total of $31,500 [($2,000)(12 Years Before 1996) + ($1,500)(5 Years Before 1989)]. The
remaining $53,500 ($85,000 - $31,500) will be subject to tax in 2018.

Exam Exercise Solution Ten - 21 (Retiring Allowance)

If Ms. Jones has worked for 37 years as of 2018, she must have started in 1982. Given this, she can
rollover a total of $38,500 [($2,000)(14 Years Before 1996) + ($1,500)(7 Years Before 1989)]. The
remaining $23,500 ($62,000 - $38,500) will be subject to tax in 2018.

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TIF Solution Ten - 5A

The correct definitions for each of the listed key terms are as follows:

A. 10

B. 9

C. 7

D. 8

E. 5

F. 3

G. 1

H. 4

The two unused definitions are as follows:

Registered Pension Plan = 2

Registered Retirement Savings Plan = 6

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TIF Solution Ten - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.
The correct definitions for each of the listed key terms listed below.

A. 13

B. 12 (not 3)

C. 9 (not 10)

D. 11 (not 14)

E. 6

F. 4 (not 7)

G. 1

H. 5

The two unused definitions are as follows:

Registered Pension Plan = 2

Registered Retirement Savings Plan = 8

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TIF Solution Ten - 6

Case 1
The required 2018 PA would be calculated as follows:

Employer’s Contribution To DPSP $2,500

Employer’s Contribution To RPP 1,000

Fredia’s Contribution To RPP 1,000

PA $4,500

Case 2
The required 2018 PA would be calculated as follows:

[(1.25%)(9)($71,000)] = $7,988

Note that the contributions made during 2018 have no influence on the PA for a defined benefit RPP.

Case 3
The required PSPA would be calculated as follows:

2016 Amount [(1.1%)(9)($38,000)] $3,762

2017 Amount [(1.1%)(9)($42,000)] 4,158

2018 PSPA $7,920

In addition to the PSPA calculated above, there would be a 2018 PA of $5,049 [(1.1%)(9)($51,000)].

Case 4
The required PAR would be calculated as follows:

2016 PA $ 5,200

2017 PA 5,400

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2018 PAR $10,600

Case 5
The required PSPA would be calculated as follows:

2016 Amount [(1.5% - 1.3%)(9)($58,000)] $1,044

2017 Amount [(1.5% - 1.3%)(9)($62,000)] 1,116

2018 PSPA $2,160

There would also be a 2018 PA. However, this cannot be calculated as the problem does not provide the
2018 pensionable earnings.

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TIF Solution Ten - 7

Part A - Maximum RRSP Deduction
Deeta’s maximum 2018 RRSP deduction would be calculated as follows:

Unused Deduction Room - January 1, 2017 $35,000

2017 Addition Nil

2018 Addition (Based On 2017 Earned Income Of Nil) Nil

Maximum 2018 RRSP Deduction $35,000

Part B - Excess RRSP Contributions

At the beginning of 2017, Deeta’s undeducted contributions of $37,000 are equal to her $35,000 unused
deduction room, plus the permitted $2,000 cushion. As she withdraws $25,000 and made no further
contributions during 2017, there are no excess contributions during the 2017 taxation year.
The excess contributions for 2018 would be calculated as follows:

Undeducted Contributions

January 1, 2018 ($37,000 - $25,000) $12,000

Additional Contribution On May 2, 2018 40,000

Total Undeducted Contributions $52,000

Unused Deduction Room ( 35,000)

Permitted Cushion ( 2,000)

Excess Contributions Subject To Penalty $15,000

Penalty Rate 1%

Monthly Penalty $ 150

Months (May To December) 8

Total Penalty For 2018 $ 1,200

Part C - Advice On Tax Planning

As the preceding calculation demonstrates, Deeta’s excess contributions are attracting a significant
penalty, based on a monthly charge of 1 percent of the excess amount.
As her earned income for 2018 will be $61,000, the addition to her 2019 deduction room will be
$10,980. As her December 31, 2018 excess contributions are $15,000, she will need to withdraw $4,020
($15,000 - $10,980) in order to avoid having an additional penalty in 2019. If the excess contributions
are withdrawn from the RRSP prior to the end of the year following the year in which an assessment is
received for the year in which the contribution is made, an offsetting deduction is available. If,
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however, any excess is not withdrawn within this specified time frame, it will be included in income and
taxed on withdrawal, even though it was never deducted from income. Deeta should withdraw the
$4,020 immediately to stop the assessment of the penalty.
Since she has never had a TFSA, she should open one. The withdrawn funds should be contributed to
her TFSA, along with any other excess funds up to her TFSA contribution room. For 2018, the
maximum total contributions are $57,500 and, while TFSA contributions are not deductible, earnings
accumulate on a tax free basis. In addition, withdrawals can be made without tax consequences.
Whether Deeta should withdraw the $2,000 cushion as well depends on future expectations. As there is
no time limit on using contributions that are in the plan, it would make sense to simply leave the $2,000
in place, provided that she expects to have earned income in some future year.
In the future, she should ensure that she continues to contribute to her RRSP and TFSA, but should limit
the amounts to the maximum permitted contribution.

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TIF Solution Ten - 8

Part A
Ms. Wheeler’s net employment income for 2017 would be $20,800, her gross salary of $22,000, reduced
by her RPP contributions of $1,200.

Part B
The annual addition for 2018 would be the lesser of $26,230 and 18 percent of Earned Income for 2017.
The latter amount would be calculated as follows:

Net Employment Income (Part A) $20,800

Add Back RPP Contributions 1,200

Spousal Support Received [(6)($1,200)] 7,200

Net Business Loss ( 2,500)

Earned Income $26,700

Percent 18%

Annual Addition (Less than $26,230) $ 4,806

Ms. Wheeler’s maximum deductible RRSP contribution would be calculated as follows:

Opening Unused Deduction Room Nil

Annual Addition $ 4,806

Less 2017 PA ($1,200 + $1,200) ( 2,400)

Maximum Deductible RRSP Contribution $ 2,406

Part C
As Ms. Wheeler has made no contributions prior to 2018, she has no undeducted contributions. In
addition, she has interest income and dividends that are subject to current Tax Payable. Given this, as
well as the fact that her lump-sum payment of $80,000 and $50,000 inheritance leaves her with cash in
excess of her needs, she should contribute the maximum deductible amount of $2,406 for 2018.
While she could deduct the $2,406 in 2018, it would be advantageous to defer this deduction until 2019
when she expects to be in a higher tax bracket. At the federal level, the tax savings will be $626 [(26%)
($2,406)] in 2019, as compared to $361 [(15%)($2,406)] in 2018.

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Given her available funds, Ms. Wheeler should be advised to consider contributing the maximum
allowable amount to a Tax Free Savings Account, as well as over contributing up to $2,000 to her
RRSP. Although she would not be able to deduct these contributions, they would enjoy the benefit of
having any income earned while in the plan compounded on a tax free basis. An over contribution to
her RRSP would be deductible in a future year with sufficient RRSP deduction room.
All of these contributions should be made as soon as possible in order to maximize the tax free earnings
that will accrue inside of her RRSP and/or TFSA.

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TIF Solution Ten - 9

Part A
Donald’s maximum 2018 RRSP deduction will include the lesser of $26,230 and 18 percent of his 2017
Earned Income. This latter figure is calculated as follows:

Gross Salary $40,000

Commissions 20,000

Employment Expenses ( 3,000)

Taxable Benefit On Loan 2,750

Net Rental Loss ( 2,500)

Spousal Support Received 2,400

Spousal Support Paid ( 3,500)

Royalties (Note) Nil

Earned Income $56,150

Percent 18%

Annual Addition (Less Than $26,230) $10,107

Note Royalties received due to someone else’s work are not part of Earned Income for RRSP
purposes.

Donald’s maximum 2018 RRSP deduction is calculated as follows:

Opening Unused RRSP Deduction Room $25,000

Annual Addition 10,107

2017 Pension Adjustment [(2)($1,400)] ( 2,800)

RRSP Deduction Limit For 2018 $32,307

The Pension Adjustment is equal to the sum of the employee and employer contributions to his money
purchase RPP.

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Part B
Since Donald wants to contribute the maximum allowable to his RRSP, the appropriate advice would be
to contribute enough to make the maximum 2018 deduction, plus the allowed overcontribution of
$2,000. This amount would be calculated as follows:

RRSP Deduction Limit For 2018 $32,307

Allowable Excess Amount 2,000

Non-Penalty Contribution Limit $34,307

Undeducted Contributions From Previous Years ( 7,500)

Maximum Contribution For 2018 $26,807

Given his available funds, Donald should be advised to also consider contributing the maximum
allowable amount to a Tax Free Savings Account.

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TIF Solution Ten - 10

Registered Pension Plan
His 2018 RPP contribution of $2,800 will be deductible in 2018.

Registered Retirement Savings Plan

Mr. Plate’s maximum RRSP deduction would be calculated as follows:

Opening Unused Deduction Room Nil

Annual Addition - Lesser Of:

 2018 RRSP Deduction Limit = $26,230

 [(18%)($52,000)] = $9,360 $9,360

2017 Pension Adjustment ($2,500 + $2,500) ( 5,000)

2018 RRSP Deduction Limit $4,360

If he deducts the $4,360 limit for the year, he will have an unused contribution of $640 ($5,000 -
$4,360) that can be carried forward for deduction in subsequent years.

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TIF Solution Ten - 11

The annual addition for 2018 would be the lesser of $26,230 and 18 percent of Earned Income for 2017.
The latter amount would be calculated as follows:

Salary $86,200

Taxable Benefits 5,600

RPP Contributions (Note 1) Nil

Union Dues ( 450)

Net Employment Income (RRSP Figure) $91,350

Business Loss ( 4,500)

Rental Income 6,700

Common-Law Partner Support Paid ( 12,000)

Eligible Dividends (Note 2) Nil

Interest (Note 2) Nil

2017 Earned Income $81,550

Rate 18%

Annual Addition (Less Than $26,230) $14,679

Note 1 While Ms. Storm’s RPP contribution would be deducted in determining Net Income
For Tax Purposes, it is not deducted in calculating employment income for RRSP Earned
Income purposes.

Note 2 Neither the eligible dividends nor the interest are part of RRSP Earned Income.

Ms. Storm’s maximum deductible RRSP contribution would be calculated as follows:

Opening Unused RRSP Deduction Room $17,000

Annual Addition 14,679

2017 Pension Adjustment [(2)($2,500)] ( 5,000)

RRSP Deduction Limit For 2018 $26,679

Undeducted Contributions From Prior Years ( 8,000)

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Maximum Deductible Contribution For 2018 $18,679

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TIF Solution Ten - 12

Part A
Mr. Detwiller’s Net Income For Tax Purposes would be calculated as follows:

Income Under ITA 3(a):

Net Employment Income $56,000

Eligible Dividends 7,800

Gross Up [(38%)($7,800)] 2,964 $66,764

Income Under ITA 3(b):

Taxable Capital Gains $ 5,400

Allowable Capital Losses ( 8,200) Nil

Balance From ITA 3(a) And (b) $66,764

Subdivision e Deductions ( 2,500)

Balance From ITA 3(c) $64,264

Deductions Under ITA 3(d):

Net Rental Loss ( 9,000)

Net Income For Tax Purposes $55,264

Mr. Detwiller’s Net Income For Tax Purposes is $55,264 and he has a net capital loss carry over of
$2,800 ($5,400 - $8,200).

Part B - Case 1
Mr. Detwiller’s 2017 Earned Income would be calculated as follows:

Net Employment Income $56,000

Add Back RPP Contributions 1,500

Net Rental Loss ( 9,000)

Earned Income $48,500

Given this, his maximum 2018 contribution would be calculated as follows:

Unused Deduction Room - End Of 2017 $10,000

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Annual Addition - Lesser Of:

 2018 RRSP Dollar Limit = $26,230

 18% of 2017 Earned Income Of $48,500 = $8,730 8,730

Less 2017 PA ($1,500 + $3,000 + $1,000) ( 5,500)

2018 RRSP Deduction Limit $13,230

Allowable Excess Amount 2,000

Non-Penalty Contribution Limit $15,230

Undeducted Contributions From Previous Years ( 4,500)

Maximum RRSP Contribution $10,730

If Mr. Detwiller contributes this amount of $10,730, his deduction will be equal to $13,230 and he will
carry forward RRSP contributions of $2,000 ($4,500 + $10,730 - $13,230).

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Part B - Case 2

Mr. Detwiller’s 2017 Earned Income would be calculated as follows:

Net Employment Income $56,000

Net Rental Loss ( 9,000)

Earned Income $47,000

Given this, his maximum 2018 contribution would be calculated as follows:

Unused Deduction Room - End Of 2017 $10,000

Annual Addition - Lesser Of:

 2018 RRSP Dollar Limit = $26,230

 18% of 2017 Earned Income Of $47,000 = $8,460 8,460

Less 2017 PA ( 4,500)

2018 RRSP Deduction Limit $13,960

Allowable Excess Amount 2,000

Non-Penalty Contribution Limit $15,960

Undeducted Contributions From Previous Years ( 4,500)

Maximum RRSP Contribution $11,460

If Mr. Detwiller contributes this amount of $11,460, his deduction will be equal to $13,960 and he will
carry forward RRSP contributions of $2,000 ($4,500 + $11,460 - $13,960).

Part B - Case 3

Mr. Detwiller’s 2017 Earned Income would be calculated as follows:

Net Employment Income $ 56,000

Net Rental Loss ( 9,000)

Business Income 220,000

Earned Income $267,000

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Given this, his maximum 2018 contribution would be calculated as follows:

Unused Deduction Room - End of 2017 $10,000

Annual Addition - Lesser Of:

 2018 RRSP Dollar Limit = $26,230

 18% of 2017 Earned Income Of $267,000 = $48,060 26,230

Less 2017 PA Nil

2018 RRSP Deduction Limit $36,230

Allowable Excess Amount 2,000

Non-Penalty Contribution Limit $38,230

Undeducted Contributions From Previous Years ( 4,500)

Maximum RRSP Contribution $33,730

If Mr. Detwiller contributes this amount of $33,730, his deduction will be equal to $36,230 and he will
carry forward RRSP contributions of $2,000 ($4,500 + $33,730 - $36,230).

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TIF Solution Ten - 13

Part A
Minimum Net Income For Tax Purposes would be calculated as follows:

Business Income

Accounting Net Income $156,470

Additions:

Accounting Amortization 23,400

Recapture (Note 1) 14,151

Meals And Entertainment (Note 2) 4,280

Deductions:

Maximum CCA (Given) ( 31,460)

Accounting Gain On Asset Sale ($26,500 - $15,900)( 10,600)

Net Business Income (For Tax Purposes) $156,241

Property Income

Interest 875

Eligible Dividends 4,620

Gross Up On Eligible Dividends [(38%)($4,620)] 1,756

Royalties 8,600

Taxable Capital Gains

Taxable Capital Gain - Personal Assets [(1/2)($32,180)] 16,090

Allowable Capital Loss - Sale Of Shares [(1/2)($7,250)] ( 3,625)

Spousal Support Paid ( 12,000)

2018 Net Income Before RRSP Deduction $172,557

Note 1 Recapture of CCA would be calculated as follows:

UCC - January 1, 2018 $12,349

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Reduced By The Lesser Of:

Capital Cost = $31,000

Proceeds Of Disposition = $26,500 ( 26,500)

Negative Ending UCC Balance = Recapture Of CCA ($14,151)

Note 2 As only one-half of the $8,560 in business meals and entertainment that were deducted
in determining accounting Net Income can be deducted for tax purposes, $4,280 [(1/2)($8,560)]
must be added back to accounting Net Income to arrive at Net Business Income.

Part B
Given that we are asked to assume the Stefanie’s 2017 Earned Income is equal to her 2018 Earned
Income, we will need to calculate the 2018 figure. The calculations are as follows:

Net Business Income $156,241

Royalties (Taxpayer Was Author) 8,600

Spousal Support Paid ( 12,000)

Earned Income For RRSP Purposes $152,841

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Using this information, the maximum RRSP deduction for 2018 would be calculated as follows:

Unused Deduction Room - January 1, 2018 $ 7,300

Lesser Of:

2018 RRSP Limit = $26,230

[(18%)($152,841)] = $27,511 26,230

PA N/A

Maximum RRSP Deduction For 2018 $33,530

The required amount of additional contributions would be calculated as follows:

Maximum 2018 Deduction $33,530

Undeducted Contributions at January 1 ( 3,200)

Required Additional Contributions $30,330

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TIF Solution Ten - 14

Retiring Allowance Rollover
If Mr. White accepts his employer’s offer of cash, he has two alternative courses of action. First, he can
do nothing, in which case the full $68,000 will be an addition to his Net Income For Tax Purposes for
the current year. His second alternative will be to transfer some part of the payment to a Registered
Retirement Savings Plan (RRSP) on a tax free basis. While he will still have to include the full $68,000
in his income, he will be eligible for a deduction equal to a specified amount of such transfers.
The rules prior to 1989 permit tax free transfers of up to $2,000 per year of service with the employer
who is making the payments, plus an additional $1,500 per year of service for each year during which
the employer was not making vested contributions to either a Registered Pension Plan or a Deferred
Profit Sharing Plan. For 1989 through 1995, the amount of this transfer is limited to $2,000 per year of
post-1988 service. For service after 1995, the transfer is no longer available.
In 2018, Mr. White’s limit would be $31,500 [(12 years)($2,000) + (5 years)($1,500)]. The excess of
$36,500 ($68,000 - $31,500) will be taxed in the year in which it is received.

Alternatives Available
As to the appropriate course of action, it depends on Mr. White’s circumstances. If he anticipates
finding another job within a short period of time and has no immediate need for the additional cash, the
tax free transfer to an RRSP is probably the most appropriate course of action. He could use the excess
retiring allowance to make his maximum regular RRSP contribution.
Although he could make a non-deductible RRSP contribution of up to $2,000 without being assessed
any penalty, there are other alternative savings plans available to him. If he has available funds, he
should consider contributions to an RESP for the triplets and TFSAs for himself and his wife.
On the other hand, if he wishes to take some time off, or is uncertain as to his future job prospects, he
may wish to retain all of the cash on a personal basis. Note, however, if the offer is accepted late in the
year after Mr. White has received most of his annual income, the retention of the additional $68,000
would likely push Mr. White into the highest tax bracket. This could be avoided by putting the
maximum of $31,500 into an RRSP, with funds withdrawn as needed in the following year.
Another possibility is that Mr. White is at or near retirement age. If this is the case, he will probably
wish to transfer the maximum of $31,500 to an RRSP in order to gain flexibility in terms of when the
income will be taxed during his retirement years.
If the funds are subsequently transferred to a RRIF or withdrawn from the RRSP in the form of an
annuity, the payments will be eligible for the pension income tax credit after Mr. White reaches age 65.
The RRIF and annuity payments will also be eligible for the pension income splitting provisions (see
Chapter 9).
As a final note, if Mr. White chooses to make a tax free transfer to an RRSP, the transaction does not
change his RRSP Deduction Limit for the year. That is, the maximum deductible RRSP contribution for
2018 will be the same, whether or not he transfers part of the retiring allowance into his plan.

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TIF Solution Ten - 15

Part A - RRSP Contribution
In order to determine his maximum RRSP deduction for 2018, we need to calculate Mr. Arnold’s Earned
Income for 2017. The calculation is as follows:

Net Employment Income $93,000

Registered Pension Plan Contributions (Add Back) 4,000

Net Rental Loss ( 7,000)

Net Business Income 9,000

2017 Earned Income $99,000

His maximum deductible RRSP contribution for 2018 is calculated as follows:

Unused Deduction Room - End Of 2017 $ 6,200

Annual Addition - Lesser Of:

 2018 RRSP Dollar Limit = $26,230

 18% Of 2017 Earned Income Of $99,000 = $17,820 17,820

Less 2017 PA ( 8,000)

Maximum Deductible RRSP Contribution $16,020

Part B
Net Employment Income
Mr. Arnold’s net employment income for the year would be calculated as follows:

Gross Salary $103,000

Additions:

Commission Income 26,140

Taxable Car Benefit (Note One) 3,503

Disability Benefit (Note Two) 6,150

Hotel Allowance (Note Three) Nil

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Gift Certificate (Note Four) 750

Award (Note Four) 300

Deductions:

Registered Pension Plan Contributions ( 4,200)

Union Dues ( 260)

Employment Expenses (Note Five) ( 6,570)

Net Employment Income $128,813

Note One The taxable benefit on the car would be calculated as follows:

Standby Charge [(2%)($38,000)(10)(6,000  16,670)]$2,735

Operating Cost Benefit - Lesser Of:

 [(6,000)($0.26)] = $1,560

 [(1/2)($2,735)] = $1,368 1,368

Total Benefit Before Payments For Personal Use $4,103

Payments For Personal Use Of The Car ( 600)

Taxable Benefit $3,503

As Mr. Arnold’s employment related driving is more than 50 percent of the total, he is eligible
for the reduced standby charge calculation. This also means that he is eligible to use the
alternative operating cost benefit calculation based on one-half the standby charge and this
approach produces the lower operating cost benefit.

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Note Two As Mr. Arnold’s employer contributes to the disability plan, the $10,950 benefit
must be included in income. However, the amount can be reduced by the $4,800 [($1,200)(4
Years)] contributions that he made in 2015 through 2018. This leaves a net inclusion of $6,150
($10,950 - $4,800).

Note Three As the $4,800 hotel allowance appears to be reasonable, it will not be included in
Mr. Arnold’s income. As it is not included in his income, he cannot deduct the actual costs of
$5,100.

Note Four The department store gift certificate would be viewed as a near cash award and
would not be eligible for the $500 annual gift exemption. Performance awards must always be
included in income.

Note Five As Mr. Arnold has commission income, he can deduct a pro rata share of insurance
and property taxes in addition to a pro rata share of utilities and maintenance. However, as an
employee, he cannot deduct the mortgage interest or CCA. Also deductible because of Mr.
Arnold’s commission income is 50 percent of the client meals and entertainment. This
provides total deductible expenses as follows:

Utilities And Maintenance $ 5,000

Insurance 4,500

Property Taxes 7,600

Total Home Costs $17,100

Workspace Share 20%

Deductible Home Workspace Costs $ 3,420

Business Meals And Entertainment [(50%)($6,300)] 3,150

Total Employment Expenses Deduction $ 6,570

As this total is less than Mr. Arnold’s commission income, he does not need to consider any
alternative calculation of deductible expenses.

Net Income For Tax Purposes And Taxable Income

As Mr. Arnold has no deductions applicable to the determination of Taxable Income, his Taxable
Income is equal to his Net Income For Tax Purposes. Mr. Arnold’s Net Income For Tax Purposes and
Taxable Income would be calculated as follows:

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Employment Income (See Preceding Calculations) $128,813

Taxable Capital Gains (Given) 4,500

Net Rental Loss (Given) ( 6,000)

Net Business Income (Given) 8,600

RRSP Deduction (Part A) ( 16,020)

Net Income For Tax Purposes And Taxable Income $119,893

Tax Payable
The required calculations here are as follows:

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 TIF Solution One - 5A

Tax On First $93,208 $16,544

Tax On Next $26,685 ($119,893 - $93,208) At 26 Percent 6,938

Tax Before Credits $23,482

Tax Credits:

Basic Personal Amount ($11,809)

Spousal ($11,809 - $8,500) ( 3,309)

Employment Insurance ( 858)

Canada Pension Plan ( 2,594)

Canada Employment ( 1,195)

Medical Expenses (Note Three) ( 11,448)

Total Credit Base ($31,213)

Rate 15% ( 4,682)

Charitable Donations (Note Four)

[(15%)($200) + (29%)($1,200 + $2,400 - $200)] ( 1,016)

Federal Tax Payable $17,784

Note Three The base for Mr. Arnold’s medical expense credit would be calculated as follows:

Allen $ 3,650

Brenda 2,600

Sarah 1,300

Derek 6,200

Total $13,750

Lesser Of:

 [(3%)($119,893)] = $3,597

 2018 Threshold Amount = $2,302 ( 2,302)

Tax Credit Base $11,448

Note Four As none of his income is taxed at 33 percent, this rate will not be applicable to the
calculation of the charitable donations tax credit.

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686 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions
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TIF Solution Ten - 16

Part A - Cynthia’s Net And Taxable Income
Cynthia’s Employment Income
Cynthia’s net employment income would be calculated as follows:

Salary $62,000

Additions:

Travel Allowances (Note 1)

Hotels And Food Nil

Use Of Personal Automobile 5,200

Deductions:

Hotels And Food (Note 1) Nil

Automobile Costs (Note 2) ( 6,969)

RPP Contributions ( 2,500)

Net Employment Income $57,731

Note 1 Given her actual costs, the allowance for hotels and food seems reasonable. This
means it does not have to be included in income. However, this will prevent Cynthia from
deducting her actual costs which total to more than the allowance. With respect to the
allowance for personal use of her automobile, it is not based on kilometers driven and this
means it cannot be considered “reasonable”. It must be included in income.

Note 2 Her deductible automobile costs would be calculated as follows:

Operating Costs $3,465

CCA On Class 10.1 [(1/2)(30%)($30,000)]* 4,500

Total Automobile Costs $7,965

Personal Usage [($7,965)(4,500  36,000)] ( 996)

Total Deductible Costs $6,969

*The luxury car rules for Class 10.1 limit the capital cost of the car to $30,000.

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Cynthia’s Net And Taxable Income

As Cynthia has no Taxable Income deductions, her Taxable Income is equal to her Net Income For Tax
Purposes. Cynthia’s Net Income For Tax Purposes and Taxable Income would be calculated as follows:

Net Employment Income $57,731

RRSP Withdrawal ($7,000, Less $5,000 Attributed

To Aldo) (Note 3) 2,000

RRSP Deduction (Note 4) ( 7,000)

Gift From Brother (Not Taxable) Nil

Net Income For Tax Purposes And Taxable Income $52,731

Note 3 As Aldo’s contribution to Cynthia’s plan occurred in one of the two years prior to her
withdrawal of $7,000, the $5,000 amount of his contribution will be included in his Net Income
For Tax Purposes. The fact that he deducted the contribution in 2015 does not affect the
required attribution.

Note 4 Cynthia’s maximum RRSP deduction for 2018 is calculated as follows:

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Unused Deduction Room At January 1 $7,000

Addition - Lesser Of:

 2018 RRSP Dollar Limit = $26,230

 18% Of $51,000 Earned Income For 2017 = $9,180 9,180

2017 Pension Adjustment ( 4,800)

2018 Past Service Pension Adjustment (Note 5) ( 2,993)

Available Deduction Room $8,387

Maximum Deduction (Limited To Contribution) ( 7,000)

Unused Deduction Room - December 31, 2018 $1,387

Note 5 In the 3 years prior to 2018 that Cynthia was a member of her employer’s RPP, her
pensionable earnings totaled $133,000 ($40,000 + $45,000 + $48,000). Given this, the Past
Service Pension Adjustment resulting from the increased benefit formula would be calculated
as follows:

[(1.75% - 1.5%)(9)($133,000)] = $2,993

Part B - Aldo’s Net And Taxable Income

Aldo’s Business Income
Aldo’s minimum net business income for the year ending December 31, 2018 can be calculated as
follows:

Aldo Broome

Statement Of Business Income

For Year Ending December 31, 2018

Services Delivered In 2018 $345,000

January 1, 2018 Unbilled Receivables

[(100%)($71,000)] 71,000

December 31, 2018 Unbilled Receivables ($82,000)

Less Realized [(20%)($82,000)] (Note 6) 16,400 ( 65,600)

Total Revenue $350,400

Vehicle Operating Costs [($4,800)(29,000 ÷ 32,000)] $ 4,350

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Building Operating Costs 24,300

Payments To Staff 42,000

Miscellaneous Office Costs 17,500

Business Meals [(50%)($15,300)] 7,650

CCA (Note 7) 56,513

Total Expenses $152,313

Net Business Income $198,087

Note 6 As Aldo is a professional accountant, he has been eligible to use the billed basis of
income recognition. As noted in the text, this provision is being phased out over 5 years,
beginning in 2018 for businesses that use the calendar year for tax purposes. This means that,
while he must add back 100 percent of the opening unbilled receivables, he can only deduct
$65,600, 80 percent of the $82,000 year end balance.

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Note 7 The total CCA deductible would be as follows:

Class 1 (Calculation Follows) $25,901

Class 8 (Calculation Follows) 24,157

Class 50 (Calculation Follows) 330

Class 12 (Calculation Follows) 1,022

Class 10.1 (Calculation Follows) 4,078

Class 14.1 (Calculation Follows) 1,025

Total CCA $56,513

Class 1 As the building is used 100 percent for non-residential purposes, it is eligible for the
enhanced rate of 6 percent. The maximum CCA would be:

Class 1 [($431,676)(6%)] $25,901

Class 8 The required calculations are as follows:

Opening Balance $ 34,284

Additions $204,000

Disposal - Lesser Of:

 Proceeds = $31,000

 Cost = $93,000 ( 31,000) 173,000

One-Half Net Additions [(1/2)($173,000)] ( 86,500)

CCA Base $120,784

Rate 20%

Class 8 CCA $ 24,157

Class 50 The CCA on the new computer would be calculated as follows:

Class 50 [(1/2)(55%)($1,200)] $330

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Class 12 The CCA on the applications software would be calculated as follows:

Class 12 [(1/2)(100%)($2,044)] $1,022

Class 10.1 As the car cost more than $30,000, it must be put into a separate Class 10.1. The
addition is limited to $30,000. The deductible CCA is reduced by the personal usage of the car
and would be calculated as follows:

Maximum Class 10.1 CCA [(1/2)(30%)($30,000)] $4,500

Personal Usage [(3,000/32,000)($4,500)] ( 422)

Deductible Class 10.1 CCA $4,078

Class 14.1 The CCA on the client list would be calculated as follows:

Class 14.1 [(1/2)(5%)($41,000)] $1,025

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Aldo’s Income From Investments

Aldo’s income from investment would be calculated as follows:

Taxable Capital Gains [(1/2)($22,960)] $11,480

Eligible Dividends 8,500

Gross Up On Eligible Dividends [(38%)($8,500)] 3,230

Interest Income 5,500

Total Income From Investments $28,710

Aldo’s Net And Taxable Income

As Aldo has no Taxable Income deductions, his Taxable Income is equal to his Net Income For Tax
Purposes. Aldo’s Net Income For Tax Purposes and Taxable Income would be calculated as follows:

Net Business Income $198,087

Income From Investments 28,710

Spousal RRSP Attribution (Note 3) 5,000

Home Buyers’ Plan Inclusion (Note 8) 1,000

RRSP Deduction (Note 9) ( 33,140)

Deductible CPP Contributions [(1/2)($5,188)] (Note 10) ( 2,594)

Net Income For Tax Purposes And Taxable Income $197,063

Note 8 Aldo’s 2015 Home Buyers’ Plan withdrawal was $25,000. While no repayment was
required until 2017, he made a voluntary repayment of $10,000 in 2016, reducing the
outstanding balance to $15,000. Based on this, he should have made a repayment in 2017 of
$1,000 ($15,000  15).

As he didn’t make a payment, this $1,000 was added to his 2017 Net Income For Tax Purposes
and deducted from the required Home Buyers’ Plan balance. The required payment for 2018
would also be $1,000 [($15,000 - $1,000)  14]. As he again failed to make the payment, it
will be added to his 2018 Net Income For Tax Purposes.

Note 9 Aldo’s maximum RRSP deduction for 2018 would be calculated as follows:

Unused Deduction Room At January 1 $11,000

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Addition - Lesser Of:

2018 RRSP Dollar Limit = $26,230

18% Of $123,000 Earned Income For 2017 = $22,140 22,140

Deduction Room At December 31 $33,140

Aldo has available contributions of $35,000 ($13,000 + $22,000). Given this he can deduct the
full $33,140 of available room. This means that there will be no unused deduction room at the
end of the year. However, there will be $1,860 ($35,000 - $33,140) of undeducted
contributions at that time.

Note 10 Given his business income, Aldo must pay the maximum CPP contributions for self
employed contractors. Since CPP contributions are deducted under ITA 60(e) of subdivision e,
they will not affect the calculation of business income, which, in turn, means that they will not
affect earned income for RRSP purposes.

Part C - Cynthia’s Federal Tax Payable

Cynthia’s federal Tax Payable will be calculated as follows:

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Tax On First $46,605 $6,991

Tax On Next $6,126 ($52,731 - $46,605) At 20.5 Percent1,256

Tax Before Credits $8,247

Tax Credits:

Basic Personal Amount ($11,809)

EI Premiums ( 858)

CPP Contributions ( 2,594)

Canada Employment ( 1,195)

Medical Expenses - (Note 11) ( 1,843)

Total Credit Base ($18,299)

Rate 15% ( 2,745)

Cynthia’s Federal Tax Payable $5,502

Note 11 Cynthia claims the medical expenses as she will have a higher medical expense credit
base since her income is lower than Aldo’s and 3 percent of her Net Income is less than the
income threshold. Although Aldo paid the expenses, as stated in Chapter 4:

“Both ITA 118.2 and Income Tax Folio S1-F1-C1, clearly state that medical expenses can only
be deducted by the individual who paid for them. However, in the T1 Guide, this rule is
contradicted for couples. According to this Guide, either spouse can claim the medical expense
credit, without regard to who actually paid for the expenses.”

The $4,300 cost of hair replacement and the $950 paid for teeth whitening would be considered
cosmetic and cannot be included in the base for the medical expense tax credit. Given this, the
base for the medical expense tax credit would be calculated as follows:

Eligible Expenses ($8,675 - $4,300 - $950) $3,425

Reduced By The Lesser Of:

[(3%)($52,731)] = $1,582

2018 Threshold Amount = $2,302 ( 1,582)

Base For Medical Expenses Credit $1,843

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Part D - Aldo’s Federal Tax Payable

Aldo’s Federal Tax Payable will be calculated as follows:

Tax On First $144,489 $29,877

Tax On Next $52,574 ($197,063 - $144,489) At 29 Percent 15,246

Tax Before Credits $45,123

Credits:

Basic Personal Amount ($11,809)

Spousal (Income Too High) Nil

Volunteer Search And Rescue ( 3,000)

CPP (Maximum) ( 2,594)

Medical Expenses - Claimed By Cynthia Nil

Credit Base For Personal Credits ($17,403)

Rate 15% ( 2,610)

Dividend Tax Credit [(6/11)(38%)($8,500)] ( 1,762)

Aldo’s Federal Tax Payable $40,751

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Canadian Tax Principles 2018 / 2019

Test Items Solutions – Chapters 11 to 21

Test Items Solutions Table of Contents – Chapters 11 to 21

The .PDF version of the Test Items Solutions is available 1at the Instructor’s Resource Centre on the
online catalogue listing for this book, at

catalogue.pearsoned.ca

The table of contents is hyperlinked to the beginning of each Solution. To go to a Solution, hold down
the Control key and click on the solution listing. Control + Home will bring you back to this table of
contents from anywhere in the document.

Chapter Eleven Test Item File Solutions................5

TIF Solution Eleven - 1...........................................................5

TIF Solution Eleven - 2.........................................................10

TIF Solution Eleven - 3.........................................................11

TIF Solution Eleven - 4.........................................................14

TIF Solution Eleven - 5A.......................................................26

TIF Solution Eleven - 5B.......................................................27

TIF Solution Eleven - 6.........................................................28

TIF Solution Eleven - 7.........................................................31

TIF Solution Eleven - 8.........................................................32

TIF Solution Eleven - 9.........................................................34

TIF Solution Eleven - 10.......................................................35

TIF Solution Eleven - 11.......................................................37

TIF Solution Eleven - 12.......................................................39

TIF Solution Eleven - 13.......................................................40

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Chapter Twelve Test Item File Solutions..............49

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Chapter Thirteen Test Item File Solutions............91

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Chapter Fourteen Test Item File Solutions.........130

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Chapter Fifteen Test Item File Solutions............164

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TIF Solution Fifteen - 3.......................................................170

TIF Solution Fifteen - 4.......................................................173

TIF Solution Fifteen - 5A.....................................................185

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Chapter Sixteen Test Item File Solutions...........206

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TIF Solution Sixteen - 6......................................................225

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Chapter Seventeen Test Item File Solutions......251

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Chapter Eighteen Test Item File Solutions.........288

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Chapter Nineteen Test Item File Solutions.........321

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Chapter Twenty Test Item File Solutions............348

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Chapter Twenty-One Test Item File Solutions. . .369

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Chapter Eleven Test Item File Solutions

TIF Solution Eleven - 1

1. Such lump-sum payments often reflect compensation for services rendered over several years. The
fact that it is received in a single year can result in significant portions of it being taxed at rates
higher than would have been applicable had it been received over the several years during which it
was earned. The deduction of such amounts provides the basis for an alternative Tax Payable
calculation which attempts to adjust the amount paid to the amount that would have been paid if the
amount had been received over several years. The objective of such provisions is fairness or equity.

2. The carry forward periods for the various types of losses identified in the Income Tax Act and
covered in the text up to Chapter 11 are as follows:

 Non-Capital Losses and Farm Losses: 20 years.

 Net Capital Loss: Unlimited.

 Listed Personal Property Losses: 7 years.

 Allowable Business Investment Losses: 10 years, then converted to net capital loss with
unlimited carry forward.

Covered in Chapter 18 are limited partnership losses. They have no carry back and an unlimited
carry forward, but only against the partnership income to which they relate.

3. There are two reasons for having to track each type of loss carry forward separately. First, different
types of losses have different carry forward periods (e.g., 20 years for farm losses vs. unlimited for
capital losses). Second, some types of losses can only be applied against the equivalent type of
income (e.g., capital losses can only be carried over and applied against capital gains).

4. This recommendation reflects the fact that most tax credits are non-refundable and cannot be carried
over to past or future years. This means that, unless a taxpayer has Taxable Income and Tax
Payable, the value of these credits is simply lost. This, in effect, is what would happen if various
types of loss carry overs were used to reduce Taxable Income to Nil.

5. Losses on listed personal property can be deducted during the current year, but only against gains
on listed personal property. If the loss cannot be used during the current year, it can be carried back
three years or forward seven years. However, in the carry back or carry forward years, it can only
be deducted to the extent of capital gains on listed personal property during those years.

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6. There is no clear cut answer to this question. Net capital losses have an unlimited life but can only
be carried over to the extent of net taxable capital gains in the carry over year. This would suggest
that, if net taxable capital gains are present in the current year, the use of net capital losses should
receive priority. This would be particularly true if additional net taxable capital gains are not
expected in future years. In contrast, non-capital losses can be deducted against any type of income.
However, the downside here is that their carry forward period is limited to 20 years. While no firm
conclusion is available, in most cases the lengthy carry forward period for non-capital losses, would
suggest using net capital losses first. However, this tentative conclusion would be altered if the
taxpayer commonly has net taxable capital gains.

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7. The difference between the two loss carry forwards is that the non-capital loss balance is time
limited and will expire at the end of 20 years. In contrast, the net capital loss will never expire but
can only be applied against taxable capital gains. If Mr. Broley is concerned about having sufficient
income to use the non-capital balance in the time remaining until it expires, he should deduct that
balance. Alternatively, if he feels that he is likely to have sufficient income in that period, but that
he is unlikely to have further capital gains, he should deduct the net capital loss. There is no clear
answer to this question as it involves estimates about the future.

8. ITA 111(2) contains a special provision with respect to both net capital losses from years prior to
death and to net capital losses arising in the year of death. Essentially, this provision allows these
accumulated losses to be applied against any type of income in the year of death, or the immediately
preceding year, as long as the lifetime capital gains deduction has not been claimed. A further
difference is that, in the case of carry overs, the deduction in the year of death is applied using the
capital gains inclusion rate (1/2, 2/3, or 3/4) that prevailed in the year the loss was realized, rather
than at the rate that applies in the year of deduction.

9. An Allowable Business Investment Loss (ABIL) is the deductible portion of a capital loss resulting
from the disposition of shares or debt of a small business corporation. The special provisions
associated with this type of loss are:

 It can be deducted against any type of income in the year in which it occurs.

 It can be carried back and applied against any type of income in the preceding 3 taxation
years.

 If it cannot be used during the current or 3 preceding years, it becomes part of the non-
capital loss carry forward balance and can be deducted against any type of income in the
10 subsequent years.

 If it is not used in the subsequent 10 years, it becomes part of the net capital loss balance
and can be carried forward indefinitely, subject to the constraint that during these
additional years, it can only be deducted against taxable capital gains.

 It is disallowed as an ABIL (i.e., it becomes a regular allowable capital loss), to the extent
that the taxpayer has used the ITA 110.6 lifetime capital gains deduction.

 The realization of an ABIL reduces the annual gains limit that is used to determine the
maximum deduction under ITA 110.6.

10. A small business corporation is defined in ITA 248(1) as a Canadian controlled private corporation
(CCPC) of which “all or substantially all”, of the fair market value of its assets are used in an active
business carried on “primarily” in Canada. In tax work, the term “substantially all” generally means
90 percent or more, while “primarily” is generally interpreted to mean more than 50 percent.

11. The three categories, along with the treatment of their losses, are as follows:

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Hobby Farmer This is an individual who runs a farming operation on a part time basis as a
hobby or as a way of enhancing his lifestyle. The operation has no reasonable expectation of a
profit and its losses cannot be deducted against any other source of income.

Part Time Farmer This is an individual for whom farming is subordinate to some other
source of income. However, if there is a reasonable expectation of a profit, the farmer is
allowed to deduct a portion of his farm losses. In each year, the portion of the farm loss that
can be deducted against any source of income is limited to the first $2,500, plus one-half of the
next $30,000, to a maximum amount of $17,500. Losses in excess of this deductible amount
are referred to as restricted farm losses and, when they are carried over to earlier or later years,
they can only be deducted to the extent of farm income in that year.

Full Time Farmer This is an individual for whom farming is his principal source of income
and activity. For this category of farmer, farm losses are fully deductible against any other
source of income.

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12. In order to be a qualified small business corporation for the purposes of the lifetime capital gains
deduction, the corporation must be a “small business corporation” at the time of the disposition of
the shares. This means that substantially all (90 percent or more) of the fair market value of its
assets must be used to produce active business income, primarily (more than 50 percent) in Canada.
If the small business corporation test is met, two other conditions must be met for the enterprise to
be a “qualified” small business. These are as follows:

 the shares must not be owned by anyone other than the taxpayer or a related person for at least
24 months preceding the disposition; and

 throughout this 24 month period, more than 50 percent of the fair market value of the
corporation’s assets must be used in an active business carried on primarily in Canada.

13. In these circumstances, the annual gains limit is equal to the taxable capital gain on the qualified
farm property, less:

 Allowable capital losses realized during the current year.

 Net capital loss carry overs from previous deducted in the current year.

 Allowable Business Investment Losses realized during the current year.

14. Most subdivision e deductions such as child care expenses cannot be carried forward to other
taxation years. This means that, if they are not deducted during the current taxation year, they are
lost forever. In contrast, business and property losses can be both carried back to previous taxation
years and forward to subsequent taxation years. In contrast to subdivision e deductions, business
and property losses are not lost if they are not deducted during the current taxation year. This
means that, in situations where there is not sufficient income to deduct all available amounts, it will
generally be desirable to deduct any subdivision e deductions first. This prevents a permanent loss
of these deductions.

15. Non-capital losses would include current year employment losses, most business losses, property
losses, and allowable business investment losses. The definition excludes farm losses (a type of
business loss) and current year capital losses, but does include net capital losses carried over from
other years and deducted in the current year.

16. The TOSI may be applicable when a Specified Individual receives income from a related business.
In general, a business is related when a person related to a Specified Individual is connected to the
business. This latter individual is referred to as a Source Individual. This connection occurs when
the Source Individual:

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 carries on the business as a proprietorship, or

 owns shares in a private corporation that is carrying on the business.

Note that such income is only subject to the TOSI if it is not one of the Excluded Items.

Where the business is a partnership, the Source Individual must have a direct or indirect interest in
the partnership. If the business is carried on by a corporation, the business will be a related business
if the Source Individual owns shares that represent 10 percent or more of the fair market value of all
of the corporation’s issued shares. As was the case with the definition of a Specified Individual, the
definition of a Source Individual requires the individual to be a Canadian resident.

17. The two items that are specifically mentioned in the text are employment income and compound
income resulting from the re-investment of split income amounts. Other items (e.g., dividends from
publicly traded shares), could also be mentioned if they do not fall within the definition of split
income.

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18. Amounts received from an Excluded Business are not considered to be Split Income and are not
subject to the TOSI. An Excluded Business is one in which the taxpayer is actively engaged on a
regular, continuous, and substantial basis. This active engagement must be in the current taxation
year or in at least 5 prior taxation years. Note, however, the years do not have to be current or
consecutive. That is, any 5 years of active engagement will satisfy this condition.

19. For shares to be classified as Excluded Shares, the taxpayer must be aged 25 or older and must own,
in terms of both fair market value and voting rights, at least 10 percent of the outstanding shares of
the corporation. In addition, the corporation must meet the following conditions:

 It must not be a professional corporation.

 Less than 90 percent of its income in the previous year was from the provision of services.

 Less than 10 percent of its income in the previous year was from a related business.

20. For taxpayers age 25 or older, the measurement of a Reasonable Return requires consideration of
labour contributions, capital contributions, as well as the assumption of business risk. For
individuals between the age of 18 and 24, the reasonableness test is more restrictive. It does not
take into consideration either active engagement in the business or business related risk assumed. It
is based solely on capital contributions to the business.

21. Dividends can be transferred from a spouse or common-law partner if they serve to create or
increase the taxpayer’s spousal tax credit.

22. As presented in the text, the descriptions are as follows:

1. Total Charitable Gifts is defined to include all eligible amounts donated by an individual to a
registered charity, a registered Canadian amateur athletic association, a Canadian municipality,
the United Nations or an agency thereof, a university outside of Canada which normally enrolls
Canadian students, and a charitable organization outside of Canada to which Her Majesty in
right of Canada has made a gift in the year or in the immediately preceding year.

2. Total Crown Gifts is defined as the aggregate of eligible amounts donated to Her Majesty in
right of Canada or a province.

3. Total Cultural Gifts is defined as the aggregate of all eligible gifts of objects that the
Canadian Cultural Property Export Review Board has determined meet the criteria of the
Cultural Property And Import Act.

4. Total Ecological Gifts is defined as all eligible gifts of land certified by the Minister of the
Environment to be ecologically sensitive land, the conservation and protection of which is
important to the preservation of Canada’s environmental heritage. The beneficiary of the gift

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must be a Canadian municipality or a registered charity, the primary purpose of which is the
conservation and protection of Canada’s environmental heritage.

23. Donations in excess of $200 provide the donor with a federal tax credit equal to either 29 percent or
33 percent of the amount of the donation (the rate depends on the Taxable Income of the taxpayer).
If the donation involves a non-depreciable asset, electing the higher fair market value will result in
a capital gain, only one-half of which will be taxed. This means that the effective tax rate for a
taxpayer in the highest tax bracket on the excess amount elected is only 16.5 percent [(1/2)(33%)].
This assures the taxpayer that the value of the federal credit resulting from the extra amount elected
will usually be double the increase in federal tax on the resulting capital gain.

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24. When there is a disposition of publicly traded shares that have been acquired through stock options,
the difference between the fair market value at the time the shares were exercised and the option
price at which they were acquired is treated as employment income, not as a capital gain. While the
general rule under ITA 38(a.1) deems capital gains on such donations to be nil, a special rule is
required to exempt the employment income which may arise on such dispositions. The solution
takes the form of an additional deduction under ITA 110(1)(d.01).

25. Both credits are based on the lesser of the amount withheld and an amount determined by the
following formula:

[Foreign Non-Business Income ÷ Adjusted Division B Income][Tax Otherwise Payable]

The differences are as follows:

 For individuals, the figure used for the amount withheld for the non-business foreign credit is
limited to 15 percent of the foreign non-business income. Any amount of withholding in
excess of 15 percent becomes a deduction in the determination of Net Income For Tax
Purposes. There is no such limit on the actual amount for the foreign business income credit.

 When the amount withheld on foreign business income exceeds the amount that can be
deducted, the excess can be carried back 3 years and forward 10 years to apply against tax
payable in those years. If the amount of foreign non-business taxes withheld exceeds the
amount that can be deducted, the taxpayer can deduct such amounts in the determination of Net
Income For Tax Purposes.

 The foreign business income credit is further limited by the amount of tax otherwise payable,
reduced by any foreign non-business tax credit taken in the year. In effect, the credit is the
least of the actual amount withheld, the amount determined by the formula, and tax otherwise
payable reduced by any foreign non-business tax credit.

26. The tax policy issue is the fact that some individuals, through the use of tax privileges (e.g., lifetime
capital gains deduction, the non-taxable component of capital gains, or employee stock option
deductions) can wind up paying little or no tax, despite having a very large income. The alternative
minimum tax deals with this by requiring an alternative calculation of income in which these tax
privileges are added back. After the deduction of a basic $40,000 exemption, the minimum tax rate
is applied to the balance. If the result is a Tax Payable figure that is larger than that resulting from
the regular calculation, this amount must be paid. Any excess of alternative minimum tax over
regular Tax Payable can be carried forward for up to seven years to be applied against any future
excess of regular Tax Payable over the alternative minimum tax.

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TIF Solution Eleven - 2

1. False.

There are other deductions that can create a difference between Net Income For Tax Purposes
and Taxable Income.

2. False.

It can be carried back 3 years and forward 20 years.

3. False.

The Allowable Business Investment Loss is $10,000 [(1/2)($20,000)].

4. False.

Its net allowable capital loss for the year is $5,500 [(1/2)($11,000)].

5. True.

Net capital losses can only be carried forward or back to be deducted against net taxable capital
gains.

6. i. False.

In the current year, she can deduct a maximum of

$10,250 [$2,500 + (1/2)($18,000 - $2,500)] of the farm loss against other income.

ii. False.

Any loss that is not deductible in the current year can be carried forward for a maximum of
20 years.

iii. True.

A restricted farm loss can only be used to the extent of farm income in the carry over
period.

7. True.

The $424,126 deduction can be used against gains arising on the disposition.

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8. True.

There are no Excluded Amounts in this type of situation.

9. False.

For the shares to be Excluded Shares, the Specified Individual must be 25 years of age or older.

10. True.

ITA 82(3) only allows such transfers when the spousal credit is either created or increased for
the taxpayer.

11. True. Any gain would be deemed to be nil.

12. False.

The limit also includes 25 percent of any capital gains resulting from the donation and 25
percent of any recapture that results from the donation.

13. True.

For individuals, the foreign tax credit deductible from federal Tax Payable cannot exceed 15
percent of the foreign investment income. In this case it is $1,500. The remaining $500
would be deductible under ITA 20(11).

14. False.

Regardless of their income level, individuals will only pay alternative minimum tax if they
have some amount of what the legislation refers to as preference items (e.g., losses on tax
shelters).

15. True.

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TIF Solution Eleven - 3

Taxable Income
1. D. A credit for a charitable donation.

2. A. A non-capital loss carried forward from a previous year.

3. C. i and iv.

Lump Sum Payments

4. D. Mr. Chechetto can use a special relief mechanism in the Income Tax Act which will
have the effect of spreading the lump-sum payment over the 8 taxation years affected.

Treatment Of Losses
5. C. Net capital loss carry overs cannot be deducted in years in which Net Income For Tax
Purposes is nil, even if there are taxable capital gains in that year.

6. C. If a gain occurs, one-half of this amount can be offset by allowable capital losses on
any disposition of capital property.

7. A. Nil.

8. D. Such balances can be carried forward for 20 years.

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9. B. $3,800. [$15,000 - $18,000 + ($1,200 - $2,000)]

10. D. Business losses.

11. D. It is never advisable to use a loss carry over to reduce taxable income to nil in the
carry over year.

12. A. Listed personal property losses.

13. B. $28,000. [$25,000 + (1/2)($8,000) +(1/2)($6,000) - (1/2)($8,000) (LPP loss carry

forward can only be used against LPP gains in calculation of Net Income For Tax Purposes )]

14. C. $91,250. [$90,000 + $5,000 – carry forward of $3,750). Deducted $6,250 [$2,500 +
(1/2)($10,000 - $2,500). This leave a carry forward of $3,750 ($10,000 - $6,250)

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Allowable Business Investment Losses

15. D. $48,000

Loss On Disposition $30,000

Disallowed By Use Of ITA 110.6 ( 20,000)

Business Investment Loss $10,000

Inclusion Rate 1/2

Allowable Business Investment Loss $5,000

Employment Income $50,000

Taxable Capital Gain [(1/2)($26,000)] $13,000

Disallowed Loss [(1/2)($20,000)] ( 10,000) 3,000

Allowable Business Investment Loss ( 5,000)

Net And Taxable Income $48,000

16. D. If they are not used during the current year, they are added to the non-capital loss
balance.

17. B. If not used during the current year, an Allowable Business Investment Loss can only
be applied against taxable capital gains in a carry forward or carry back period.

Lifetime Capital Gains Deduction

18. C. For 2018, the maximum deduction for qualified small business corporations is
different than the maximum deduction for qualified farm corporations.

19. B. An individual sells 15 percent of the shares of a CCPC that uses 95 percent of its
assets in the operation of an active business.

20

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D. The deduction is available on any disposition of shares or debt of a qualified small business
corporation.

21. C. The shares must not have been owned by a related individual in the past 24 months.

22. D. Northern residents deduction.

23. C. Within a particular type of loss, the oldest losses must be utilized first.

Tax On Split Income

24. B. $4,077 [(33%)(116%)($15,300) – (8/11)(16%)($15,300)]

25. D. $3,198 [(33%)(116%)($12,000) – (8/11)(16%)($12,000)]

26. B. The federal tax is applied at a 33 percent rate to all of the income of a specified
individual.

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27. C. Specified Individuals under the age of 18 can never claim that income received is from
an Excluded Business.

28. A. Employment income earned by a specified individual from a private corporation.

Tax Credits Revisited

29. A A decrease of $1,090.

Increase In Tax Payable [(20.5%)(138%)($9,000)] $2,546

Increase In Spousal Tax Credit [(15%)($11,809)] ( 1,771)

Dividend Tax Credit [(38%)(6/11)($9,000)] ( 1,865)

Increase (Decrease) In Tax Payable ($1,090)

30. C. The basis for a charitable donations tax credit for the current year can never exceed 75
percent on the individual’s Net Income For Tax Purposes.

31. B. $2,731

The credit would be the lesser of $4,500 [($30,000)(15%)] and an amount determined by the following
formula:

[$30,000 ÷ ($102,000 - $10,000)][$8,376] = $2,731

32. B. If Mr. Mantz is in the 15 percent federal tax bracket.

33. C. $139,500 [(75%)($147,500) + (25%)(1/2)($300,000 - $225,000) + (25%)($225,000 -

$147,000)]

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34. A. A donation to a charitable organization outside of Canada to which the taxpayer’s

province of residence has also made a donation.

35. A. Business income only.

36. C. Foreign interest income.

37. B. The Foreign Non-Business Income Tax Credit is limited to 15% of the foreign non-
business income.

38. C. Business income from a contract with a foreign entity

39. B. Dividend tax credits.

40. A. Stock options not yet exercised.

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TIF Solution Eleven - 4

Exam Exercise Solution Eleven - 1 (Listed Personal Property Losses)
Ms. Michaels will have a listed personal property loss carry forward from 2017 of $12,000 [(1/2)
($78,000 - $102,000)]. This can be applied against the 2018 taxable capital gain on listed personal
property of $2,950 [(1/2)($7,000 - $1,100)]. Based on this, her Net and Taxable Income would be
calculated as follows:

Income Under ITA 3(a) $69,000

Income Under ITA 3(b) ($2,950 - $2,950) Nil

Net Income For Tax Purposes And Taxable Income $69,000

In this case, there is a listed personal property loss carry forward of $9,050 ($12,000 - $2,950)
that can only be applied against taxable capital gains on listed personal property.

If the sale had been of shares, Ms. Michaels would have had a regular net capital loss carry forward of
$12,000 from 2017. Her Net and Taxable Income would be calculated as follows:

Income Under ITA 3(a) $69,000

Income Under ITA 3(b) 2,950

Net Income For Tax Purposes $71,950

Loss Carry Forward (Limited To Taxable Capital Gains) ( 2,950)

Taxable Income $69,000

In this case, the net capital loss carry forward of $9,050 can be applied against any taxable capital gains.
While the Taxable Income figure is not changed, Net Income For Tax Purposes is different.

Exam Exercise Solution Eleven - 2 (Listed Personal Property Losses)

At the beginning of 2018, Mr. Legal will have a carry forward of a listed personal property loss in the
amount of $15,000 [(1/2)($150,000 - $120,000)]. For the year 2018, he will have a taxable capital gain
of $26,500 [(1/2)($125,000 - $72,000)]. As the listed personal property loss carry forward cannot be
deducted against this type of gain, Mr. Legal’s Net Income For Tax Purposes and his Taxable Income
will be $26,500. This will leave the $15,000 listed personal property loss carry forward balance
unchanged.
If the 2017 loss had been on publicly traded securities, it would have been a regular capital loss and
could be applied as follows:

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2018 Net Income For Tax Purposes $26,500

Loss Carry Forward (Less Than Taxable Capital Gain) ( 15,000)

Taxable Income $11,500

There would be no remaining capital loss carry forward.

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Exam Exercise Solution Eleven - 3 (Loss Carry Overs)

The original 2017 result is as follows:

Business Income $19,000

Taxable Capital Gain 3,000

Net Income For Tax Purposes $22,000

Deductions Nil

Taxable Income $22,000

His 2018 Net Income For Tax Purposes and Taxable Income would be nil.
After the maximum carry backs from 2018, the amended 2017 results would be as follows:

Business Income $19,000

Taxable Capital Gain 3,000

Net Income For Tax Purposes $22,000

Net Capital Loss Carry Back

(Limited To Taxable Capital Gain) ( 3,000)

Non-Capital Loss Carry Back

(Reduces Taxable Income To Nil) ( 19,000)

Amended Taxable Income Nil

At the end of 2018, the remaining loss carry forwards would be as follows:

 Net Capital Loss Carry Forward = [(1/2)($9,800 - $3,200) - $3,000] = $300

 Non-Capital Loss Carry Forward = ($56,000 - $19,000) = $37,000

Exam Exercise Solution Eleven - 4 (Loss Carry Overs)

The original 2017 result is as follows:

Business Income $28,000

Taxable Capital Gain 6,500

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Net Income For Tax Purposes $34,500

Deductions Nil

Taxable Income $34,500

Her 2018 Net Income For Tax Purposes and Taxable Income would be nil.
After maximum carry backs from 2018, the results would be as follows:

Business Income $28,000

Taxable Capital Gain 6,500

Net Income For Tax Purposes $34,500

Net Capital Loss Carry Back

(Limited To Taxable Capital Gain) ( 6,500)

Non-Capital Loss Carry Back

(Reduces Taxable Income To Nil) ( 28,000)

Amended Taxable Income Nil

At the end of 2018, the remaining loss carry forwards would be as follows:

 Net Capital Loss Carry Forward = ($10,800 - $6,500) = $4,300

 Non-Capital Loss Carry Forward = ($85,000 - $28,000) = $57,000

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Exam Exercise Solution Eleven - 5 (Loss Carry Overs)

For 2017, Ms. Claus had Net Income For Tax Purposes and Taxable Income of $45,000. At the end of
this year, she had a net capital loss carry forward of $5,250.
For 2018, she has a net taxable capital gain of $3,150 [(1/2)($12,600 - $6,300)], providing for a carry
forward from 2017 of this amount as part of the non-capital loss balance. Based on this course of action,
the 2018 non-capital loss would be calculated as follows:

Amount E ($83,000 + $3,150) $86,150

Income Under ITA 3(c) ( 3,150)

Non-Capital Loss $83,000

Of this amount, $45,000 can be carried back to 2017, resulting in an amended return for that year as
follows:

Net Income for Tax Purposes $45,000

Non-Capital Loss Carry Back ( 45,000)

Amended Taxable Income Nil

At the end of 2018, the following loss carry forwards remain:

 Net Capital Loss Carry Forward = ($5,250 - $3,150) = $2,100

 Non-Capital Loss Carry Forward = ($83,000 - $45,000) = $38,000

Exam Exercise Solution Eleven - 6 (Loss Carry Overs)

For 2017, Dora had Net Income For Tax Purposes and Taxable Income of $95,000. At the end of this
year, she had a net capital loss carry forward of $9,250.
For 2018, she has a net taxable capital gain of $7,200, providing for a carry forward from 2017 of this
amount as part of the non-capital loss balance. Based on this course of action, the 2018 non-capital loss
would be calculated as follows:

Amount E ($123,000 + $7,200) $130,200

Income Under ITA 3(c) ( 7,200)

Non-Capital Loss $123,000

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Of this amount, $95,000 can be carried back to 2017, resulting in an amended return for that year as
follows:

Net Income for Tax Purposes $95,000

Non-Capital Loss Carry Back ( 95,000)

Amended Taxable Income Nil

At the end of 2018, the following loss carry forwards remain:

 Net Capital Loss Carry Forward = ($9,250 - $7,200) = $2,050

 Non-Capital Loss Carry Forward = ($123,000 - $95,000) = $28,000

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Exam Exercise Solution Eleven - 7 (Net Capital Losses At Death)

The net amount that would be included in Ms. Forester’s income as a result of these items would be
calculated as follows:

Employment Income $47,000

Taxable Capital Gain 15,500

Net Capital Loss Applied Against Current

Taxable Capital Gain [(1/2)($31,000)] ( 15,500)

Net Capital Loss Applied Against Other

Income [(1/2)($43,600 - $31,000)] ( 6,300)

Net Inclusion $40,700

As it is Ms. Forester’s year of death, the net capital loss can be deducted against any type of income.

Exam Exercise Solution Eleven - 8 (Net Capital Losses At Death)

The net amount that would be included in Barton’s final tax return as a result of these items would be
calculated as follows:

Employment Income $61,000

Taxable Capital Gain [(1/2)($32,000)] 16,000

Net Capital Loss Applied Against Current

Taxable Capital Gain [(1/2)($32,000)] ( 16,000)

Net Capital Loss Applied Against Other

Income [(1/2)($54,000 - $32,000)] ( 11,000)

Net Inclusion $50,000

As it is Barton’s year of death, the net capital loss can be deducted against any type of income.

Exam Exercise Solution Eleven - 9 (ABILs)

The Allowable Business Investment Loss for the year would be calculated as follows:

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Actual Loss On Disposition $47,000

Disallowed By Lifetime Capital Gains Deduction Use ( 30,000)

Business Investment Loss $17,000

Inclusion Rate 1/2

Allowable Business Investment Loss $ 8,500

All of the $8,500 can be deducted against Mrs. Brown’s employment income. With respect to the
disallowed $30,000, it becomes an ordinary capital loss, of which $21,000 can be deducted against the
current year’s capital gains on the publicly traded securities. This leaves a net capital loss carry over of
$4,500 [(1/2)($30,000 - $21,000)].

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Exam Exercise Solution Eleven - 10 (ABILs)

The Allowable Business Investment Loss for the year would be calculated as follows:

Actual Loss On Disposition $38,000

Disallowed By Lifetime Capital Gains Deduction Use ( 8,000)

Business Investment Loss $30,000

Inclusion Rate 1/2

Allowable Business Investment Loss $15,000

The $15,000 can be deducted against Jasmine’s employment income. With respect to the disallowed
portion of the loss, it becomes a regular capital loss, of which $5,000 can be deducted against the current
year capital gain. This will leave a net capital loss carry over of $1,500 [(1/2)($8,000 - $5,000)].

Exam Exercise Solution Eleven - 11 (Farm Losses)

It appears that Bob’s farming activities are a subordinate source of income. Given this, the deduction of
the 2017 loss would be limited to $13,250 [$2,500 + (1/2)($24,000 - $2,500)]. The remaining $10,750
($24,000 - $13,250) is a restricted farm loss carry forward.
Bob’s 2018 Net Income For Tax Purposes and Taxable Income would be as follows:

Employment Income $105,000

Farm Income 6,000

Net Income For Tax Purposes $111,000

Farm Loss (Limited To Farm Income) ( 6,000)

Taxable Income $105,000

This leaves a restricted farm loss carry forward to future years of $4,750 ($10,750 - $6,000).

Exam Exercise Solution Eleven - 12 (Lifetime Capital Gains Deduction)

Ms. Close’s maximum lifetime capital gains deduction is the least of the following three items:

Available Deduction Her remaining deduction would be $388,126 [$424,126 - (1/2)($18,000

+ $54,000)].

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Annual Gains Limit In the absence of capital gains on non-qualified property in any of the
years under consideration, the simplified version of this calculation can be used. The annual
gains limit for 2018 would be as follows:

Qualified Taxable Capital Gain [(1/2)($748,000)] $374,000

Net Capital Loss Deducted ( 30,000)

Annual Gains Limit $344,000

Cumulative Gains Limit This amount would be calculated as follows:

Sum Of Annual Gains Limits ($9,000 + $27,000 + $344,000) $380,000

Previous Years’ Capital Gains Deduction ($9,000 + $27,000) ( 36,000)

CNIL ( 23,000)

Cumulative Gains Limit $321,000

The least of these three amounts is $321,000, the Cumulative Gains Limit.

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Exam Exercise Solution Eleven - 13 (Ordering Of Losses)

Joanne’s Net Income For Tax Purposes would be calculated as follows:

Income Under ITA 3(a):

Employment Income $61,000

Business Income 14,200

Farming Income 2,950 $78,150

Income Under ITA 3(b):

Taxable Capital Gains 10,500

Net Income For Tax Purposes $88,650

Joanne’s Taxable Income is as follows:

Net Income For Tax Purposes $88,650

Loss Carry Forwards:

Restricted Farm Losses (Limited to farming income) ( 2,950)

Net Capital Losses (Limited to taxable capital gains) ( 10,500)

Non-Capital Losses (All) ( 41,000)

Taxable Income $34,200

Loss Carry Forwards

 Restricted farm loss carry forward ($7,200 - $2,950) $ 4,250

 Net capital loss carry forward ($25,000 - $10,500) 14,500

 Non-capital loss carry forward Nil

Exam Exercise Solution Eleven - 14 (Ordering Of Losses)

Cindy’s Net Income For Tax Purposes would be calculated as follows:

Income Under ITA 3(a):

Business Income $74,000

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 TIF Solution Eleven - 1

Farming Income 2,500 $76,500

Income Under ITA 3(b):

Taxable Capital Gains 21,000

Net Income For Tax Purposes $97,500

Cindy’s Taxable Income is as follows:

Net Income For Tax Purposes $97,500

Loss Carry Forwards:

Restricted Farm Losses (Limited to farming income) ( 2,500)

Net Capital Losses (Limited to taxable capital gains) ( 21,000)

Non-Capital Losses (All) ( 25,000)

Taxable Income $49,000

Loss Carry Forwards

 Restricted farm loss carry forward ($4,000 - $2,500) $ 1,500

 Net capital loss carry forward ($32,000 - $21,000) 11,000

 Non-capital loss carry forward Nil

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Exam Exercise Solution Eleven - 15 (Tax On Split Income)

Harriet’s regular Tax Payable would be calculated as follows:

Taxable Non-Eligible Dividends [(116%)($13,000)] $15,080

Modeling Income 13,100

Deduction For Split Income - Non-Eligible Dividends ( 15,080)

Net Income For Tax Purposes = Taxable Income $13,100

Rate 15%

Tax Payable Before Credit $ 1,965

Basic Personal Credit [(15%)($11,809)] ( 1,771)

Regular Tax Payable $ 194

Her tax on split income would be calculated as follows:

Split Income - Taxable Non-Eligible Dividends $15,080

Rate 33%

Tax Payable Before Dividend Tax Credit $ 4,976

Dividend Tax Credit [(8/11)(16%)($13,000)] ( 1,513)

Tax Payable On Split Income $ 3,463

Harriet’s total tax payable would be $3,657 ($194 + $3,463).

Exam Exercise Solution Eleven - 16 (Transfer Of Dividends To A Spouse)

In the absence of the transfer, Mrs. Senton would have no spousal tax credit. In contrast, with the
transfer, she would be eligible for the full $1,771 [(15%)($11,809)]. Given this, the analysis of her
position at the federal level would be as follows:

Additional Tax On Dividends [($12,420)(33%)] $4,099

Spousal Tax Credit ( 1,771)

Dividend Tax Credit [(6/11)(38%)($9,000)] ( 1,865)

Tax Increase (Decrease) $ 463

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As there is an increase in federal Tax Payable, the election would not be beneficial.

Exam Exercise Solution Eleven - 17 (Donation Of Non-Depreciable Property)

Net Income For Tax Purposes Ms. Wave’s gift will result in a taxable capital gain of $55,250 [(1/2)
($132,500 - $22,000)]. Her Net Income For Tax Purposes equals $67,750 ($12,500 + $55,250).

Maximum Credit Note that, because Ms. Wave’s Taxable Income is less than $205,842, the 33 percent
tax rate is not relevant in calculating the charitable donations tax credit. The maximum base for the
charitable donations tax credit is calculated as follows:

75% Of Net Income For Tax Purposes [(75%)($67,750)] $50,813

25% Of Taxable Capital Gain [(25%)($55,250)] 13,813

Charitable Donations Credit Base Limit $64,626

This base results in a potential credit of $18,714 [(15%)($200) + (29%)($64,626 - $200)].

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 TIF Solution Eleven - 1

Credit To Reduce Tax Payable To Nil The credit claim that will reduce Tax Payable to nil is
calculated as follows:

Tax On First $46,605 $ 6,991

Tax On Next $21,145 ($67,750 - $46,605) At 20.5% 4,335

Tax Payable Before Credits $11,326

Basic Personal Credit ( 1,771)

Federal Tax Payable Before Donations Credit $ 9,555

In order to determine the donation that will produce a charitable donations credit of $9,555, the
following equation must be solved:

$9,555 = [(15%)($200) + (29%)(X - $200)]

Solving this equation results in a value for X of $33,045. Using this amount of her credit base will result
in the required $9,555 [(15%)($200) + (29%)($33,045 - $200)], thereby eliminating her federal Tax
Payable.

Carry Forward This will leave a carry forward of $99,455 ($132,500 - $33,045).

Exam Exercise Solution Eleven - 18 (Donation Of Non-Depreciable Property)

Net Income For Tax Purposes Lara’s gift will result in a taxable capital gain of $33,000 [(1/2)
($84,000 - $18,000)]. Given this, her 2018 Net Income For Tax Purposes equals $56,000 ($23,000 +
$33,000).

Maximum Credit Note that, because Lara’s Taxable Income is less than $205,842, the 33 percent tax
rate is not relevant in calculating the charitable donations tax credit. The maximum base for the
charitable donations tax credit is calculated as follows:

75% Of Net Income For Tax Purposes [(75%)($56,000)] $42,000

25% Of Taxable Capital Gain [(25%)($33,000)] 8,250

Charitable Donations Credit Base Limit $50,250

This base results in a potential credit of $14,545 [(15%)($200) + (29%)($50,250 - $200)].

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 TIF Solution Eleven - 1

Credit To Reduce Tax Payable To Nil The credit claim that will reduce Tax Payable to nil is
calculated as follows:

Tax On First $46,605 $6,991

Tax On Next $9,395 ($56,000 - $46,605) At 20.5% 1,926

Tax Payable Before Credits $8,917

Basic Personal Credit ( 1,771)

Federal Tax Payable Before Donations Credit $7,146

In order to determine the donation that will produce a charitable donations credit of $7,146, the
following equation must be solved:

$7,146 = [(15%)($200) + (29%)(X - $200)]

Solving this equation gives a value for X of $24,738. The use of $24,738 of her donation will produce a
credit of $7,146 [(15%)($200) + (29%)($24,738 - $200)], an amount sufficient to eliminate her federal
Tax Payable.

Carry Forward This will leave a carry forward of $59,262 ($84,000 - $24,738).

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 TIF Solution Eleven - 1

Exam Exercise Solution Eleven - 19 (Donation Of Depreciable Property)

Net Income For Tax Purposes Mr. Deveau’s Net Income For Tax Purposes can be calculated as
follows:

Net Rental Income $ 8,300

Taxable Capital Gain - Land [(1/2)($86,000 - $34,000) 26,000

Taxable Capital Gain - Building

[(1/2)($260,000 - $138,000)] 61,000

Recapture ($138,000 - $43,000) 95,000

Net Income For Tax Purposes $190,300

Maximum Credit Note that, because Mr. Deveau’s Taxable Income is less than $205,842, the 33
percent tax rate is not relevant in calculating the charitable donations tax credit. The maximum base for
the charitable donations tax credit is calculated as follows:

75% Of Net Income For Tax Purposes [(75%)($190,300)]$142,725

25% Of Taxable Capital Gain [(25%)($26,000 + $61,000)] 21,750

25% Of Recapture [(25%)($95,000)] 23,750

Charitable Donations Credit Base Limit $188,225

This base results in a maximum charitable donations tax credit of $54,557 [(15%)($200) + (29%)
($188,225 - $200)].

Credit To Reduce Tax Payable To Nil The credit claim that will reduce Tax Payable to nil is
calculated as follows:

Tax On First $144,489 $29,877

Tax On Next $45,811 ($190,300 - $144,489) At 29% 13,285

Tax Payable Before Credits $43,162

Basic Personal Credit ( 1,771)

Federal Tax Payable Before Donations Credit $41,391

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 TIF Solution Eleven - 1

In order to determine the donation that will produce a charitable donations credit of $41,391, the
following equation must be solved:

$41,391 = [(15%)($200) + (29%)(X - $200)]

Solving this equation gives a value for X of $142,824. The use of $142,824 of his donation will produce
a credit of $41,391 [(15%)($200) + (29%)($142,824 - $200)], an amount sufficient to eliminate his
federal Tax Payable.

Carry Forward This will leave a carry forward of $203,176 ($346,000 - $142,824).

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 TIF Solution Eleven - 1

Exam Exercise Solution Eleven - 20 (Donation Of Depreciable Property)

Net Income For Tax Purposes Victor’s Net Income For Tax Purposes can be calculated as follows:

Net Rental Income $16,000

Taxable Capital Gain - Land Nil

Taxable Capital Gain - Building

[(1/2)($346,000 - $176,000)] 85,000

Recapture ($176,000 - $110,000) 66,000

Net Income For Tax Purposes $167,000

Maximum Credit Note that, because Victor’s Taxable Income is less than $202,800, the 33 percent tax
rate is not relevant in calculating the charitable donations tax credit. The maximum base for the
charitable donations tax credit is calculated as follows:

75% Of Net Income For Tax Purposes [(75%)($167,000)] $125,250

25% Of Taxable Capital Gain [(25%)($85,000)] 21,250

25% Of Recapture [(25%)($66,000)] 16,500

Charitable Donations Credit Base Limit $163,000

This base results in a maximum charitable donations tax credit of $47,242 [(15%)($200) + (29%)
($163,000 - $200)].

Credit To Reduce Tax Payable To Nil The credit claim that will reduce Tax Payable to nil is
calculated as follows:

Tax On First $144,489 $29,877

Tax On Next $22,511 ($167,000 - $144,489) At 29% 6,528

Tax Payable Before Credits $36,405

Basic Personal Credit ( 1,771)

Federal Tax Payable Before Donations Credit $34,634

In order to determine the donation that will produce a charitable donations credit of $34,634, the
following equation must be solved:

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 TIF Solution Eleven - 1

$34,634 = [(15%)($200) + (29%)(X - $200)]

Solving this equation for X gives a value of $119,524. The use of $119,524 of his donation will
produce a credit of $34,634 [(15%)($200) + (29%)($119,524 - $200)], an amount sufficient to eliminate
his Tax Payable.

Carry Forward This will leave a carry forward of $276,476 ($396,000 - $119,524).

Exam Exercise Solution Eleven - 21 (Foreign Tax Credit)

Mr. Fung’s Adjusted Division B Income would be calculated as follows:

Net Income For Tax Purposes $56,500

Net Capital Loss Deducted ( 3,200)

Adjusted Division B Income $53,300

Non-Capital Loss Carry Forward ( 5,000)

Taxable Income $48,300

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 TIF Solution Eleven - 1

His Tax Otherwise Payable would be calculated as follows:

Tax On First $46,605 $6,991

Tax On Next $1,695 ($48,300 - $46,605) At 20.5% 347

Tax Before Credit $7,338

Basic Personal Credit ( 1,771)

Tax Otherwise Payable $5,567

Mr. Fung’s credit for foreign tax paid would be the lesser of the foreign tax withheld of $507 [(13%)
($3,900)] and an amount determined by the following formula:

[(Foreign Non-Business Income ÷ Adjusted Division B Income)(Tax Otherwise Payable)]

= [($3,900 ÷ $53,300)($5,567)] = $407

As the amount determined by the formula would be the lesser of the two figures, his foreign tax credit
would be $407.

Exam Exercise Solution Eleven - 22 (Foreign Tax Credit)

The total withholding is equal to $900 [(20%)($4,500)] However, because he is an individual, Andy’s
credit is limited to 15 percent of the non-business income or $675 [(15%)($4,500)]. The remaining $225
($900 - $675) is available for deduction under ITA 20(11). Given this, Andy’s Net Income For Tax
Purposes and Taxable Income are calculated as follows:

Net Foreign Non-Business Income ($4,500 - $225) $ 4,275

Taxable Capital Gain 38,000

Net Income For Tax Purposes $42,275

Net Capital Loss Carry Forward ( 26,000)

Taxable Income = Adjusted Division B Income $16,275

His adjusted Division B Income is $16,275, the same amount as his Taxable Income.
His Tax Otherwise Payable would be calculated as follows:

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 TIF Solution Eleven - 1

Tax Before Credit [(15%)($16,275)] $2,441

Basic Personal Credit ( 1,771)

Tax Otherwise Payable $ 670

His credit against Tax Payable for foreign tax withheld would be the lesser of $675 [(15%)($4,500)] and
an amount determined by the following formula:

[(Foreign Non-Business Income ÷ Adjusted Division B Income)(Tax Otherwise Payable)]

= [($4,500 ÷ $16,275)($670)] = $185

As the amount determined by the formula would be the lesser of the two figures, his foreign tax credit
would be $185. This would result in a final figure for Tax Payable of $485 ($670 - $185).

Exam Exercise Solution Eleven - 23 (Alternative Minimum Tax)

Mr. Leigh’s regular Tax Payable would be calculated as follows:

$24,288 At 15 Percent $3,643

Basic Personal Credit ( 1,771)

Dividend Tax Credit [(6/11)(38%)($17,600)] ( 3,648)

Federal Tax Payable - Regular Nil

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 TIF Solution Eleven - 1

His Adjusted Taxable Income for minimum tax purposes would be calculated as follows:

Regular Taxable Income $24,288

30 Percent Of Capital Gains [(30%)(2)($120,000)] 72,000

Dividend Gross Up [(38%)($17,600)] ( 6,688)

Adjusted Taxable Income $89,600

The calculation of the alternative minimum tax would be as follows:

Adjusted Taxable Income $89,600

Basic Exemption ( 40,000)

Amount Subject To Tax $49,600

Rate 15%

Minimum Tax Before Credit $ 7,440

Basic Personal Credit ( 1,771)

Alternative Minimum Tax Payable $ 5,669

As the alternative minimum tax payable is higher than the regular tax payable, the alternative amount
would have to be paid. The $5,669 excess over regular Tax Payable can be carried forward to be
applied against any excess of regular tax payable over minimum tax payable in the next seven years.

Exam Exercise Solution Eleven - 24 (Alternative Minimum Tax)

Shelly’s regular Tax Payable would be calculated as follows:

$31,740 At 15 Percent $4,761

Basic Personal Credit ( 1,771)

Dividend Tax Credit [(6/11)(38%)($23,000)] ( 4,767)

Federal Tax Payable - Regular Nil

Her Adjusted Taxable Income for minimum tax purposes would be calculated as follows:

Regular Taxable Income $31,740

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30 Percent Of Capital Gains [(30%)(2)($200,000)] 120,000

Dividend Gross Up [(38%)($23,000)] ( 8,740)

Adjusted Taxable Income $143,000

The calculation of the alternative minimum tax would be as follows:

Adjusted Taxable Income $143,000

Basic Exemption ( 40,000)

Amount Subject To Tax $103,000

Rate 15%

Minimum Tax Before Credit $ 15,450

Basic Personal Credit ( 1,771)

Alternative Minimum Tax Payable $ 13,679

As the alternative minimum tax payable is higher than the regular tax payable, the alternative amount
would have to be paid. The $13,679 excess over regular Tax Payable can be carried forward to be
applied against any excess of regular tax payable over minimum tax payable in the next seven years.

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TIF Solution Eleven - 5A

The correct definitions for each of the listed key terms are as follows:

A. 5

B. 2

C. 7

D. 8

E. 10

F. 1

G. 9

H. 6

The two unused definitions are as follows:

Cumulative Gains Limit = 4

Non-Capital Loss = 3

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TIF Solution Eleven - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.
The correct definitions for each of the listed key terms listed below.

A. 7

B. 3 (not 14)

C. 10

D. 11 (not 1)

E. 13

F. 2

G. 12 (not 9)

H. 8 (not 5)

The two unused definitions are as follows:

Cumulative Gains Limit = 6

Non-Capital Loss = 4

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TIF Solution Eleven - 6

2015 Analysis
The required information can be calculated as follows:

ITA 3(a)

Business Income $19,800

Taxable Dividends [(138%)($1,870)] 2,581 $22,381

ITA 3(b)

Taxable Capital Gains [(1/2)($1,320)] $ 660

Allowable Capital Losses [(1/2)($4,620)] ( 2,310) Nil

ITA 3(c) $22,381

ITA 3(d)

Farm Loss (See Note) ( 6,750)

Net Income For Tax Purposes And Taxable Income $15,631

Note Dale’s farm losses are restricted as follows:

Total Farm Loss $11,000

Deductible Amount:

First $2,500 ($2,500)

One-Half Of $8,500 ($11,000 - $2,500) ( 4,250) ( 6,750)

Restricted Farm Loss Carry Forward $ 4,250

As noted in the problem, none of the losses can be carried back before 2015. This would leave the
following carry forward balances at the end of 2015:

 Restricted Farm Loss Carry Forward $4,250

 Net Capital Loss Carry Forward ($2,310 - $660) $1,650

2016 Analysis
The required information can be calculated as follows:

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ITA 3(a)

Farm Income $ 2,200

Taxable Dividends [(138%)($2,351)] 3,244 $ 5,444

ITA 3(b)

Taxable Capital Gains [(1/2)($2,200)] $ 1,100

Allowable Capital Losses Nil 1,100

ITA 3(c) $ 6,544

ITA 3(d)

Business Loss ( 15,400)

Net Income For Tax Purposes Nil

2015 Net Capital Loss Carry Forward ($ 1,100)

Taxable Income (Loss) Nil

Since there are taxable capital gains this year, and the problem states that Dale would like to deduct the
maximum amount of his net capital loss carry forwards, the net capital loss carry forward of $1,100 is
added to the balance of the non-capital loss.
The non-capital loss carry over is calculated as follows:

Business Loss $15,400

2015 Net Capital Loss Deducted 1,100

ITA 3(c) Income ( 6,544)

Non-Capital Loss Carry Over For 2016 $ 9,956

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 TIF Solution Eleven - 1

The entire non-capital loss carry over could be carried back to 2015, but since Dale requires $15,400 in
Taxable Income to fully utilize his tax credits, the maximum carry back to 2015 is $231, calculated as
follows:

2015 Taxable Income (As Reported) $15,631

Non-Capital Loss Carry Back From 2016 ( 231)

2015 Amended Taxable Income (Minimum) $15,400

This carry back leaves Dale with his required $15,400 in Taxable Income. There would be the
following carry forward balances at the end of 2016:

 Restricted Farm Loss Carry Forward (Unchanged) $4,250

 Net Capital Loss Carry Forward ($1,650 - $1,100)] $ 550

 Non-Capital Loss Carry Forward ($9,956 - $231) $9,725

2017 Analysis
The required information can be calculated as follows:

ITA 3(a)

Business Income $33,000

Farm Income 3,465

Taxable Dividends [(138%)($3,160)] 4,361 $40,826

ITA 3(b)

Taxable Capital Gains [(1/2)($4,400)] $2,200

Allowable Capital Losses Nil 2,200

Net Income For Tax Purposes $43,026

Restricted Farm Loss Carry Forward (Equal To Farm Income) ( 3,465)

Net Capital Loss Carry Forward (Less Than $2,200) ( 550)

Non-Capital Loss Carry Forward (All) ( 9,725)

Taxable Income $29,286

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 TIF Solution Eleven - 1

There would be the following carry forward balance at the end of 2017:

 Restricted Farm Loss Carry Forward ($4,250 - $3,465) $ 785

2018 Analysis
The required information can be calculated as follows:

ITA 3(a)

Taxable Dividends [(138%)($5,140)] $ 7,093

ITA 3(b)

Taxable Capital Gains [(1/2)($4,950)] $ 2,475

Allowable Capital Losses [(1/2)($15,950)] ( 7,975) Nil

ITA 3(c) $ 7,093

ITA 3(d)

Business Loss ($20,900)

Farm Loss ( 2,200) ( 23,100)

Net Income For Tax Purposes And Taxable Income Nil

The available non-capital loss can be calculated as follows:

Business Loss $20,900

Farm Loss (Unrestricted) 2,200 $23,100

ITA 3(c) Income ( 7,093)

Non-Capital Loss Carry Over For 2018 $16,007

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Although technically, the farm loss is accounted for separately from the non-capital loss, since the farm
loss is less than $2,500 it is treated as an unrestricted farm loss and can be applied against all types of
income. ITA 31 states that any loss allowed under that provision is considered an unrestricted loss from
a farming business for the year for the purposes of calculating the non-capital loss carryover. As a
result, the preceding loss carry over of $16,007 is available for carry back to 2017 to be applied against
any type of income.
With respect to the net capital loss of $5,500 ($7,975 - $2,475), there are $1,650 ($2,200 - $550) in
taxable capital gains left in 2017 as the basis for a carry back. This means that $1,650 of the 2018 net
capital loss can be carried back, leaving $3,850 ($5,500 - $1,650) to be carried forward as a net capital
loss balance.
If both the $16,007 non-capital loss and the $1,650 net capital loss were carried back to 2017, the result
would be a Taxable Income of $11,629 ($29,286 - $16,007 - $1,650), less than the $15,400 that is
required to fully utilize Dale’s available tax credits. As the net capital loss can only be deducted to the
extent of taxable capital gains, it would be advisable to claim the full amount of this loss carry back.
Based on this view, the non-capital loss deduction will be limited to $12,236 ($29,286 - $15,400 -
$1,650), an amount that will provide for full use of Dale’s 2017 tax credits:

2017 Taxable Income (As Reported) $29,286

Non-Capital Loss Carry Back From 2018 ( 12,236)

Net Capital Loss Carry Back From 2018 ( 1,650)

2017 Amended Taxable Income $15,400

These carry backs leave Dale with his required $15,400 in 2017 Taxable Income. There would be the
following carry forward balances at the end of 2018:

 Restricted Farm Loss Carry Forward (Unchanged) $ 785

 Net Capital Loss Carry Forward ($5,500 - $1,650)] $3,850

 Non-Capital Loss Carry Forward (Nil + $16,007 - $12,236) $3,771

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TIF Solution Eleven - 7

The calculation of Mr. Atkins’ Taxable Income for 2017 would be as follows:

Net Rental Income $36,870

Interest Income 5,250

Net Income For Tax Purposes And Taxable Income $42,120

In 2018, there is a loss of $210,000 ($275,000 - $65,000) on the common shares. As these were shares
in a Canadian controlled private company that used all of its assets to produce active business income,
this would be a business investment loss (BIL).
The allowable portion (ABIL) would be $105,000 [(1/2)($210,000)]. In contrast to other types of capital
losses, ABILs can be deducted against any source of income.
Based on this analysis, Mr. Atkins’ Taxable Income for 2018 would be calculated as follows:

Net Rental Income $41,200

Interest Income 5,650 $46,850

Allowable Business Investment Loss ( 105,000)

Net Income For Tax Purposes And Taxable Income Nil

As the ABIL was recognized in 2018, it must first be used to reduce that year’s income to nil. Note that,
because of this rule, Mr. Atkins cannot deduct a smaller amount in order to have sufficient income to
absorb his basic personal tax credit. This will use up $46,850 of the $105,000 total and leave a balance
of $58,150 to be carried over to other years.
In carrying this amount back to 2017, the optimum solution would leave $11,635 of Taxable Income so
that Mr. Atkins can take advantage of his basic personal tax credit. Note that the calculation of the
optimum carry back uses the basic personal amount of the carry back year, not the current year.
This means that Larry will need a loss carry back deduction of $30,485 ($42,120 - $11,635) in 2017.
This deduction will leave a Taxable Income of $11,635. As planned, the taxes on this amount will be
eliminated by Larry’s basic personal credit.
A carry back of $30,485 in 2017 leaves a carry forward balance of $27,665 ($58,150 - $30,485) to be
used in future years.
For the next 10 years, the undeducted Allowable Business Investment Loss will be treated as a non-
capital loss carry forward that can be deducted against other sources of income. If it has not been
utilized within the 10 years, it then becomes a net capital loss carry forward, deductible for an unlimited
number of future periods, but only against net taxable capital gains.

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58 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions

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TIF Solution Eleven - 8

To the extent that there has been use of the lifetime capital gains deduction in previous years, business
investment losses (BILs) are disallowed. When they are disallowed, they become ordinary capital losses
that must be deducted against the current year’s taxable capital gains. Given this, the non-disallowed
portion of the BIL would be calculated as follows:

2018 BIL Realized ($345,000 - $78,000) $267,000

BIL Disallowed By Previous Use Of ITA 110.6 ($29,500 + $49,000) ( 78,500)

Remaining Business Investment Loss $188,500

Inclusion Rate 1/2

Allowable Business Investment Loss $ 94,250

Doug’s Net Income For Tax Purposes would be calculated as follows:

Net Employment Income $142,000

Allowable Business Investment Loss ( 94,250)

Net Taxable Capital Gains:

Taxable Capital Gain

[(1/2)($480,000 - $187,000 - $4,000)] $144,500

Allowable Capital Loss (Disallowed ABIL)

[(1/2)($78,500)] ( 39,250) 105,250

Net Income For Tax Purposes $153,000

Doug’s Taxable Income under the two different assumptions would be calculated as follows:

Part A Part B

Net Income For Tax Purposes $153,000 $153,000

Net Capital Loss Carry Forward Deducted ( 3,400) Nil

Lifetime Capital Gains Deduction (Note) ( 5,300) ( 8,700)

Taxable Income $144,300 $144,300

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Note As the only capital gains during 2018 are on qualified property, the simplified formula
for the annual gains limit can be used. Given this, the lifetime capital gains deduction is the
cumulative gains limit for both Part A and B as it is the least of the following:

Part A Part B

Amount Available [(1/2)($848,252*)] $424,126 $424,126

Amount Used [(1/2)($29,500 + $49,000)] ( 39,250) ( 39,250)

Amount Available $384,876 $384,876

*This is the 2018 limit for gains on dispositions of shares of a qualified small business
corporation. For gains on qualified farm or fishing property, the 2018 limit would be
$1,000,000.

Part A Part B

Taxable Capital Gain On Qualified Property $144,500 $144,500

ABIL Realized ( 94,250) ( 94,250)

Allowable Capital Loss Deducted (Disallowed ABIL) ( 39,250) ( 39,250)

Net Capital Loss Carry Forward Deducted ( 3,400) Nil

Annual Gains Limit $ 7,600 $ 11,000

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Part A Part B

Sum Of Annual Gains Limits

($14,750 + $24,500 + $7,600) $46,850

($14,750 + $24,500 + $11,000) $50,250

Amounts Deducted In Previous Years

($14,750 + $24,500) ( 39,250) ( 39,250)

CNIL (Given) ( 2,300) ( 2,300)

Cumulative Gains Limit $ 5,300 $ 8,700

In Part B, Doug will still have his $3,400 net capital loss carry forward, but will have used $3,400 more
of his lifetime capital gains deduction. His Taxable Income in both cases is the same.

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TIF Solution Eleven - 9

Case A
As Jane is actively engaged in the business on a regular, continuous, and substantial basis, the
corporation is an Excluded Business. Given this, Jane’s dividends will not be classified as Split Income.
As Jill has never been actively involved in Jahil, it is not an Excluded Business from her point of view.
However, Jill owns more than 10 percent of the number of voting rights and market value of the Jahil
shares. In addition, Jahil is not a professional corporation, less than 90 percent of its business involves
performing services, and substantially all of its income is not derived from a related business. Given
this, Jill’s shares would be Excluded Shares and the dividends she received would not be classified as
Split Income.

Case B
While Gary is no longer actively involved with Justor’s business in 2018, he was actively engaged in a
continuous and substantial manner for more than five years (2010 through 2017). Given this, Justor
would be an Excluded Business from his perspective and the dividends that he received in 2018 would
not be classified as Split Income.
While this is not required in dealing with the case, you should note that Gary’s shares, because they are
non-voting would not be classified as Excluded Shares.

Case C
The dividends received by Tom originated from property that was transferred to him pursuant to a
marriage separation agreement. Given this they would be an Excluded Amount and would not be
classified as Split Income.
While this is not required in dealing with the case, you should note that Tom’s shares, because they are
non-voting would not be classified as Excluded Shares.

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TIF Solution Eleven - 10

Part A - Taxable Income
Mr. and Mrs. Hanson’s Taxable Income would be calculated as follows:

Mr. Hanson Mrs. Hanson

Old Age Security Benefits $ 7,000 $ 7,000

RRIF Income 50,000 Nil

Registered Pension Plan Receipts 25,380 1,680

Dividends Received 800 180

Gross Up On Dividends (38 Percent) 304 68

Interest On Government Bonds 500 4,359

Net Taxable Capital Gain Nil Nil

Net Income Before Clawback $83,984 $13,287

Social Benefits Repayment (See Note) ( 1,211) Nil

Net Income For Tax Purposes And Taxable Income$82,773 $13,287

Note Mrs. Hanson would not have to repay any of her OAS benefits as her Net Income is well
below the threshold income of $75,910. Mr. Hanson’s social benefits repayment would be the
lesser of:

 $7,000, and

 [(15%)($83,984 - $75,910)] = $1,211.

Part A - Tax Credits

Mr. Hanson cannot take the spousal credit because Mrs. Hanson’s Net Income is more than the $11,809
base for this credit. Mrs. Hanson cannot transfer her dividends under ITA 82(3) as the transfer would
leave her with Net Income of $13,039 ($13,287 - $180 - $68). This would still be more than the $11,809
base for the spousal credit and, as a consequence, no spousal tax credit would be created. Given these
considerations, the amount that can be transferred from Mrs. Hanson to Mr. Hanson is calculated as
follows:

Age $7,333

Pension (On RPP Only) 1,680

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Less Excess Of Taxable Income Over

Basic Personal Amount ($13,287 - $11,809) ( 1,478)

Credit Base Transferred To Spouse $7,535

Mr. Hanson’s maximum tax credits would be as follows:

Basic Personal Amount $ 11,809

Age $7,333 - [(15%)($82,773 - $36,976)] 463

Pension 2,000

Transfers From Mrs. Hanson (See Preceding) 7,535

Total Base $21,807

Rate 15%

Total $ 3,271

Dividend Tax Credit [(6/11)($304)] 166

Charitable Donations

[(15%)($200) + (29%)($600 + $200 - $200)] 204

Total Credits $ 3,641

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Charitable donations can be claimed by either spouse, as long as the total donations are less than 75
percent of the claiming spouse’s Net Income For Tax Purposes. As Mrs. Hanson has no Tax Payable,
Mr. Hanson will claim her charitable donations. It is usually advantageous for one spouse to claim all
the charitable donations if they total more than $200, as the low rate of credit is only applied once. Note
that as none of Mr. Hanson’s Taxable Income is taxed at the 33 percent federal tax rate, that rate is not
relevant to the calculation of his charitable donations tax credit.

Part A - Loss Carry Overs

Mrs. Hanson’s net capital loss of $175 [(1/2)($725 - $375)] can be carried back 3 years and forward
indefinitely to be claimed against taxable capital gains.

Part B - Pension Income Splitting

The optimum use of pension income splitting would accomplish the following objectives:

 it would permit Mrs. Hanson to claim her dividend tax credit,

 it would permit Mrs. Hanson to fully utilize her pension income tax credit,

 it would eliminate Mr. Hanson’s OAS clawback, and

 it would enable both Mr. and Mrs. Hanson to be in the same 20.5 percent tax bracket.

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TIF Solution Eleven - 11

Case One
The regular Tax Payable calculation for Serge Lawson would be as follows:

Net Rental Income $73,100

Eligible Dividends Received 14,000

Gross Up [(38%)($14,000)] 5,320

RRSP Deduction ( 22,000)

Net And Taxable Income $70,420

Tax On First $46,605 $ 6,991

Tax On $23,815 ($70,420 - $46,605) At 20.5 Percent 4,882

Tax Before Credits $11,873

Basic Personal Credit ( 1,771)

Dividend Tax Credit [(6/11)($5,320)] ( 2,902)

Regular Federal Tax Payable $ 7,200

The alternative minimum tax calculations are as follows:

Regular Taxable Income $70,420

Dividend Gross Up ( 5,320)

Adjusted Taxable Income $65,100

AMT Exemption ( 40,000)

AMT Base $25,100

Rate 15%

Federal AMT Before Credit $ 3,765

Basic Personal Credit ( 1,771)

Federal AMT $ 1,994

Since the regular federal Tax Payable is greater than the federal AMT, there is no liability for AMT and
no related carry forward.

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Case Two
The regular Tax Payable calculation for Sarah Bonito would be as follows:

Eligible Dividends $ 26,000

Gross Up [(38%)($26,000)] 9,880

Net Taxable Capital Gains 263,000

Net Income For Tax Purposes $298,880

Lifetime Capital Gains Deduction ( 260,000)

Taxable Income $ 38,880

Federal Tax Before Credit [(15%)($38,880)] $ 5,832

Basic Personal Credit ( 1,771)

Dividend Tax Credit [(6/11)($9,880)] ( 5,389)

Regular Federal Tax Payable Nil

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The alternative minimum tax calculations are as follows:

Regular Taxable Income $ 38,880

30 Percent Of Capital Gains [(30%)(2)($263,000)] 157,800

Dividend Gross Up ( 9,880)

Adjusted Taxable Income $ 186,800

AMT Exemptions ( 40,000)

AMT Base $146,800

Rate 15%

Federal AMT Before Credit $ 22,020

Basic Personal Credit ( 1,771)

Federal AMT $ 20,249

Since the regular federal Tax Payable is nil, the AMT is larger and must be paid. The excess AMT over
regular tax payable for Sarah of $20,249 can be carried forward for 7 years and applied against any
future excess of regular Tax Payable over the alternative minimum tax.

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TIF Solution Eleven - 12

The regular Tax Payable calculations would be as follows:

Walter Wendel Winston

Employment And Business Income $ 52,100 $42,300 $ 41,300

Eligible Dividends Received 82,300 Nil 12,300

Dividend Gross Up (38 Percent) 31,274 Nil 4,674

RRSP Deduction Nil ( 27,000) Nil

Taxable Capital Gains 36,400 Nil 226,550

Net Income For Tax Purposes $202,074 $15,300 $284,824

Lifetime Capital Gains Deduction ( 36,400) Nil ( 221,500)

Taxable Income $165,674 $15,300 $ 63,324

Federal Tax (Note 1) $ 36,021 $ 2,295 $ 10,418

Basic Personal Credit ( 1,771) ( 1,771) ( 1,771)

Dividend Tax Credit (6/11 of Gross Up) ( 17,059) Nil ( 2,549)

Regular Federal Tax Payable $ 17,191 $ 524 $ 6,098

Note 1 The federal tax payable, before the dividend tax credit, is as follows:

Taxable Federal Tax Federal

Income Calculations Tax

Walter $165,674 $29,877 + (29%)($21,185) $36,021

Wendel $ 15,300 (15%)($15,300) $ 2,295

Winston $ 63,324 $6,991 + (20.5%)($16,719) $10,418

The alternative minimum tax (AMT) calculations would be as follows:

Walter Wendel Winston

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Regular Taxable Income $165,674 $15,300 $ 63,324

30% Of Capital Gains (Note 2) 21,840 Nil 135,930

Dividend Gross Up ( 31,274) Nil ( 4,674)

Adjusted Taxable Income $156,240 $15,300 $194,580

AMT Exemption ( 40,000) ( 40,000) ( 40,000)

AMT Base $116,240 $ Nil $154,580

Rate 15% 15% 15%

Federal AMT Before Credit $ 17,436 $ Nil $ 23,187

Basic Personal Credit ( 1,771) ( 1,771) ( 1,771)

Federal AMT $ 15,665 Nil $ 21,416

Regular Federal Tax Payable ( 17,191) ( 6,098)

Additional Tax Required (Note 3) Nil Nil $ 15,318

Note 2 The 30 percent capital gain inclusion can be calculated by taking 30 percent of double
the taxable capital gain.

Note 3 The excess AMT over regular tax payable for Winston can be carried forward for 7
years and applied against any future excess of regular Tax Payable over the alternative
minimum tax.

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TIF Solution Eleven - 13

The various components of Mr. Bronson’s Net Income For Tax Purposes would be calculated as
follows:

Pension Income

RPP Receipts $83,000

Canada Pension Plan Receipts 10,680

Pension Income $93,680

Land Sales (Note 1)

Capital Gain On Plot A ($150,000 - $125,000) $ 25,000

Capital Gain On Plot B ($250,000 - $175,000) 75,000

Total Capital Gain $100,000

Inclusion Rate 1/2

Taxable Capital Gain $ 50,000

Note 1 As these are non-arm’s length sales, ITA 69 is applicable. Plot A was sold below fair
market value and, because of this, the proceeds would be deemed to be the fair market value of
$150,000. Note that Phil’s adjusted cost base would be limited to the $50,000 that was paid.
Since the note was paid during 2018, there is no capital gains reserve available. Plot B was
sold at a value in excess of fair market value and, in this case, ITA 69 indicates that the sale
price will be the proceeds of disposition. Note that Gary’s adjusted cost base would be the
$210,000 fair market value.

YP Real Estate Income Trust Units (Note 2)

Income Distribution [(1)($800) + (11)($800)] $ 9,600

Capital Gain ($310,000 - $300,000) $10,000

Inclusion Rate 1/2

Taxable Capital Gain $ 5,000

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Note 2 As Brenda is under 18 years of age, all of the income on the trust units that is paid to
her ($8,800) would be attributed back to Mr. Bronson. The income attribution will stop when
Mr. Bronson dies. As there is no rollover provision with respect to transfers to a minor, Mr.
Bronson must transfer the units at fair market value and will have to pay taxes on the taxable
capital gain resulting from the gift to Brenda. If Brenda had sold the units while he was alive,
there would have been no attribution of capital gains.

Gift Of Baron Inc. Shares

Proceeds Of Disposition (Note 3) $294,000

Adjusted Cost Base [(4,500)($60)] ( 270,000)

Capital Gain $ 24,000

Inclusion Rate 1/2

Taxable Capital Gain $ 12,000

Note 3 The adjusted cost base of the Baron Inc. shares would be their average cost, determined
as follows:

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1st Purchase (4,000 Shares @ $50) $200,000

2nd Purchase (8,000 Shares @ $65) 520,000

Total Cost $720,000

Based on this cost, the average cost of the shares is $60 ($720,000 ÷ 12,000) per share.

Since the problem requires the minimum Net Income For Tax Purposes, Mr. Bronson will not
elect out of the ITA 73(1) rollover. As a result, the 1,500 shares given to his spouse will be
transferred at their adjusted cost base. In contrast, the proceeds of disposition for the shares
gifted to his children would be their fair market value of $68 per share. Given this, the
proceeds of disposition would be calculated as follows:

1,500 Shares @ $60 $ 90,000

3,000 Shares @ $68 204,000

Total Proceeds Of Disposition $294,000

Dividends On Baron Inc. Shares

Dividends Received And Attributed Back (Note 4) $13,500

Gross Up Of 38 Percent 5,130

Taxable Dividends $18,630

Note 4 The dividends on the 1,500 shares gifted to Melissa would be attributed back to Mr.
Bronson. The dividends on the shares gifted to his (adult) children will be taxed in their hands.
Since he is holding 7,500 shares on July 1, the dividends he will be taxed on for the year total
$13,500 [(1,500 + 7,500)($1.50)].

Condominium Units Immediately before the time of Mr. Bronson’s death, there is a deemed
disposition of all of his capital property. If the beneficiary is a spouse, the deemed proceeds of
disposition are equal to the tax cost of the property (UCC in this case). This means that the unit
transferred to Melissa will be transferred at its tax cost of $205,000. She will, however, retain
the original capital cost of $300,000, with the difference being deemed CCA.

For the transfers to the children, the transfer will be deemed to take place at the $420,000 fair
market value figure. That will result in following tax consequences for Mr. Bronson:

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Proceeds Of Disposition [(2)($420,000)] $840,000

Capital Cost [(2)($300,000)] 600,000

Capital Gain $240,000

Inclusion Rate 1/2

Taxable Capital Gain $120,000

Capital Cost [(2)($300,000)] $600,000

UCC [(2)($205,000)] ( 410,000)

Recapture $190,000

In addition to the taxable capital gain and recapture, the properties earned $93,750 of net rental
income prior to Mr. Bronson’s death.

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Other Properties At Death

Baron Inc. Shares At the time of his death, Mr. Baron owns the 7,500 remaining shares of
Baron Inc. As these are transferred to his spouse, the deemed proceeds will be equal to the tax
cost of the shares and there will be no 2018 tax consequences.

Principal Residence As with the Baron Inc. shares, the property can be transferred to Melissa
at its tax value. Alternatively, the executor could elect to transfer it at fair market value and use
the principal residence gain reduction formula to eliminate the $417,000 capital gain. In either
case, there are no tax consequences for Mr. Bronson.

Part A - Net Income For Tax Purposes And Taxable Income

Mr. Bronson’s minimum Net Income For Tax Purposes and Taxable Income would be calculated as
follows:

Pension Income $ 93,680

Income Trust Distribution 9,600

Taxable Dividends 18,630

Net Rental Income 93,750

Recapture 190,000

Taxable Capital Gains:

On Land $ 50,000

On Trust Units 5,000

On Gift Of Baron Inc. Shares 12,000

On Condominium Units 120,000 187,000

Net Income For Tax Purposes $592,660

Net Capital Loss Carry Forward ( 30,000)

Taxable Income $562,660

Part A - Tax Payable

Mr. Bronson’s minimum federal Tax Payable would be calculated as follows:

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Tax On First $205,842 $ 47,670

Tax On Next $356,818 ($562,660 - $205,842) At 33 Percent 117,750

Tax Before Credits $165,420

Tax Credits:

Basic Personal ($11,809)

Spousal Including Infirm Amount

($11,809 + $2,182) ( 13,991)

Age (Income Too High) Nil

Pension Income ( 2,000)

Spouse’s Disability ( 8,235)

Medical Expenses (Note 5) ( 54,698)

Total Credit Base ($90,733)

Rate 15% ( 13,610)

Dividend Tax Credit [(6/11)($5,130)] ( 2,798)

Federal Tax Payable $149,012

Note 5 The base for the medical expenses tax credit would be the total medical costs of
$57,000 ($45,000 + $12,000), reduced by the lesser of $17,780 [(3%)($592,660)] and $2,302.

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Part B - Pension Splitting Tax Savings

If the pension splitting of Mr. Bronson’s RPP payments is for $41,500, it will increase Melissa’s income
by $41,500 and decrease Wally’s by the same amount. Melissa’s federal Tax Payable and Wally’s net
tax savings will be as follows:

Tax Before Credits [(15%)($41,500)] $6,225

Basic Personal ($11,809)

Disability ( 8,235)

Pension (Not Previously Available) ( 2,000)

Total Credit Base ($22,044)

Rate 15% ( 3,307)

Melissa’s Federal Tax Payable $2,918

Wally’s Tax Saving [(33%)($41,500)] $13,695

Spousal Credit Including $2,182 ($13,991)

Disability Credit Taken By Melissa ( 8,235)

Total Credits Lost ($22,226)

Rate 15% ( 3,334)

Wally’s Net Tax Savings $10,361

With pension income splitting, the total federal tax savings amount to $7,443 ($10,361 - $2,918).
Further savings would be available at the provincial level.
Note that the total medical expenses are much greater than Melissa’s income. As a result, although
Melissa could claim a larger medical expense credit given her lower Net Income, she could not fully
utilize that credit, so it remains on Wally’s return.

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TIF Solution Eleven - 14

Part A
Mr. Leonard’s net employment income would be calculated as follows:

Salary $58,000

Housing Benefit (12 Months At $3,000) 36,000

Less: Rents Paid ( 12,000)

Award 2,100

Director’s Fees 1,300

Stock Option Benefits [(100)($16 - $7)] 900

Net Employment Income $86,300

Part B
Since Mr. Leonard’s son is over 17 years of age, the interest on the bonds is not attributed to Mr.
Leonard. Mr. Leonard’s income from property would be calculated as follows:

Royalties On Patent $24,070

Interest On Bonds 430

Income From Property $24,500

Part C
Mr. Leonard’s net taxable capital gains would be calculated as follows:

Listed Personal Property:

Proceeds From Ring $1,200

Deemed Cost ( 1,000) $ 200

Proceeds From Painting $1,100

Cost ( 1,800) ( 700) Nil

Personal Use Property:

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Proceeds From Pistols $2,000

Cost ( 1,400)

Capital Gain $ 600

Inclusion Rate 1/2 $300

Net Taxable Capital Gains $300

The preceding calculations indicate that Mr. Leonard would be left with a listed personal property loss
of $250 [(1/2)($200 - $700)]. This unused loss can be carried back three years and forward for seven
years, but it can only be deducted against taxable capital gains on listed personal property.

Part D
Mr. Leonard’s Net Income For Tax Purposes would be calculated as follows:

Employment Income $ 86,300

Income From Property 24,500

Taxable Capital Gain 300

RRSP Contribution (See Note) ( 15,534)

Net Income For Tax Purposes $95,566

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Note Mr. Leonard’s RRSP Deduction Limit for 2018 is the lesser of $26,230 and 18 percent of his
2017 Earned Income. His Earned Income for 2017 is assumed to be equal to his 2018 Earned
Income. The only item in his 2018 Earned Income is his Net Employment Income of $86,300.
Eighteen percent of this amount is $15,534, less than the $26,230 RRSP deduction limit for the
year.

As there is no PA to take into consideration and he has contributed $16,000, his maximum
deduction will be $15,534.

Part E
Mr. Leonard’s Taxable Income would be calculated as follows:

Net Income For Tax Purposes $95,566

Stock Option Deduction [(1/2)($900)] ( 450)

Taxable Income $95,116

Part F
Mr. Leonard’s federal Tax Payable would be calculated as follows:

Federal Tax On First $93,208 $16,544

Federal Tax On Next $1,908 ($95,116 - $93,208) At 26 Percent 496

Gross Federal Tax $17,040

Tax Credits:

Basic Personal Amount ($11,809)

Spousal ($11,809 - $2,990) ( 8,819)

CPP ( 2,594)

EI ( 858)

Canada Employment ( 1,195)

Transfer Of Son’s Tuition Credit - Lesser Of (See Note)

The Absolute Limit of $5,000

The Actual Tuition Of $4,860 ( 4,860)

Credit Base ($30,135)

Rate 15% ( 4,520)

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Federal Tax Payable $12,520

Note As his son’s income is $3,700 [(12)$250) + $700], he will have no Tax Payable and Mr.
Leonard will be able to take the full credit. There is no credit for his aunt because she is not a
resident of Canada.

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TIF Solution Eleven - 15

Part A - Taxable Income

Daniel Tong’s employment income would be calculated as follows:

Inclusions:

Salary $78,000

2017 Bonus (Cash Basis) 6,000

Home Office Allowance 2,400

Standby Charge - No Reduction [($5,200)(2/3)] 3,467

Automobile Operating Benefit [(14,000 km)($0.26)] 3,640

Group Term Life Insurance Premium 650

Dental Insurance Nil

Stock Option Benefit [(2,500)($15 - $12)] 7,500 $101,657

Deductions:

Company Pension Contributions ($ 3,900)

Home Office [(30/300)($2,100 + $750)] ( 285)

Office Supplies ( 230) ( 4,415)

Net Employment Income $ 97,242

Notes

 In general, the only home office costs that can be deducted are utilities and maintenance.
In the case of employees with commission income, a pro rata share of insurance and
property taxes would also be deductible. However, it does not appear that Mr. Tong has
any commission income.

 As the only capital costs that are deductible by an employee are those related to an
automobile, aircraft, or musical instrument, the cost of the computer and peripherals are
not deductible.

 The use of employment related frequent flyer points is not considered a taxable benefit by
the CRA.

Mr. Tong’s Net Income For Tax Purposes and Taxable Income would be calculated as follows:
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Net Employment Income (See Preceding) $ 97,242

Business Income - Sale Of Automobile

[$14,500 - ($2,500 + $8,100)] 3,900

Property Income:

Portus Dividends Received $4,500

Gross Up [(38%)($4,500)] 1,710

Less Interest Expense ( 1,200) 5,010

Spousal RRSP Withdrawal (Attributed To Mr. Tong) 1,000

Net Taxable Capital Gain:

Taxable Capital Gain On Portus Shares (Note 1)$3,581

Allowable Capital Loss On Global Shares (Note 2) Nil 3,581

RRSP Contribution (Note 3) ( 10,200)

Net Income For Tax Purposes $100,533

Stock Option Benefit [(1/2)($7,500)] ( 3,750)

Net Capital Loss Carry Forward (Note 4) ( 3,581)

Taxable Income $ 93,202

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Note 1 For shares acquired through the exercise of stock options, the adjusted cost base is the fair
market value of the shares at the time of exercise. Based on this, the average cost of his Portus Ltd.
shares is calculated as follows:

2,500 Shares At $15 $37,500

250 Shares At $18 4,500

Total Adjusted Cost Base $42,000

Based on this total, the average cost per share is $15.27 ($42,000  2,750). Using this figure,
the taxable capital gain would be calculated as follows:

Proceeds [(1,250)($21)] $26,250

Adjusted Cost Base [(1,250)($15.27)] ( 19,088)

Capital Gain $ 7,162

Inclusion Rate 1/2

Taxable Capital Gain $ 3,581

Note 2 The $2,400 loss ($8,600 - $11,000) is deemed to be superficial, as Mr. Tong repurchased
more than 800 Global shares within 30 days of the original disposition. This means that the loss
will be disallowed. However, it will be added to the adjusted cost base of the replacement shares,
giving a total adjusted cost base of $8,200 ($5,800 + $2,400).

Note 3 Mr. Tong’s 2018 RRSP deduction room would be calculated as follows:

Lesser Of:

2018 RRSP Limit = $26,230

18% Of $61,500 = $11,070 $11,070

2017 Pension Adjustment Nil

Total 2018 Deduction Room $11,070

While he has $11,070 in deduction room, his actual deduction is limited to $10,200, his $2,200
in undeducted contributions from the beginning of the year, plus his $8,000 contribution to his
wife’s RRSP.

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Note 4 Mr. Tong has a net capital loss balance of $11,500 ($2,500 + $6,000 + $3,000). However,
the amount that can be deducted is limited to the 2018 taxable capital gain, or $3,581. This will
leave a net capital loss balance of $7,919 ($11,500 - $3,581).

Part B - Tax Payable

Mr. Tong’s minimum federal Tax Payable is calculated as follows:

Tax On First $46,605 $6,991

Tax On Next $46,597 ($93,202 - $46,605) At 20.5 Percent 9552

Gross Federal Tax $16,543

Basic Personal Amount ($11,809)

Spousal ( 11,809)

CPP ( 2,594)

EI ( 858)

Canada Employment ( 1,195)

Transfer Of Tuition (Note 5) ( 5,000)

Credit Base ($33,265)

Rate 15% ( 4,990)

Dividend Tax Credit [(6/11)(38%)($4,500)] ( 933)

Federal Tax Payable $10,620

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Note 5 Marion’s federal Tax Payable is nil as the scholarship is not taxable income.

Interest Income $ 3,000

Scholarship ($10,000 - $10,000) Nil

Taxable Income $ 3,000

Basic Personal Amount ( 11,809)

Federal Tax Payable Nil

As Marion is unable to use any of her tuition credit, the transfer is the lesser of:

The absolute limit of $5,000

The actual tuition cost of $7,150

Given this, the maximum transfer is $5,000. However, the $2,150 ($7,150 - $5,000) excess can be
carried forward indefinitely to be used against Marion’s future Tax Payable.

Part B - Carry Forwards

 From Note 4, there is a net capital loss of $7,919 available for carry forward to subsequent years.

 From Note 5, Marion has a $2,150 tuition amount available for carry forward to subsequent years.

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Chapter Twelve Test Item File Solutions

TIF Solution Twelve - 1

1. The required three items can be selected from the list presented in Figure 12-1 of the text. These
items are:

 Income tax expense

 Amortization, depreciation, and depletion of tangible and intangible assets (accounting

amounts)

 Recapture of CCA

 Tax reserves deducted in the prior year

 Losses on the disposition of capital assets (accounting amounts)

 Pension expense (accounting amounts)

 Scientific research expenditures (Accounting amounts)

 Warranty expense (accounting amounts)

 Amortization of discount on long-term debt issued (see discussion in Chapter 7)

 Foreign tax paid (accounting amounts)

 Excess of taxable capital gains over allowable capital losses

 Interest and penalties on income tax assessments

 Non-deductible automobile costs

 50 percent of business meals and entertainment expenses

 Club dues and cost of recreational facilities

 Non-deductible reserves (accounting amounts)

 Charitable donations

 Asset write-downs including impairment losses on intangibles

 Fines, penalties, and illegal payments

2. The required items can be selected from the following list:

 employee stock option deduction

 deduction for payments (social assistance and workers’ compensation benefits)

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 lump-sum payments

 lifetime capital gains deduction

 northern residents deductions

3. A corporation does not get a tax deduction for dividends paid. As a consequence, dividends are
paid out of the corporation’s after tax income. When such dividends are received by an individual,
they are subject to taxation (the gross up and tax credit procedures result in dividends being taxed at
favourable rates).

However, if a corporation had to pay taxes on dividends received out of the after tax income of
another corporation, it would involve double taxation of the same income stream. In fact, if the
income passed through more than one corporation, the result could be triple or even higher
multiples of taxation. This would clearly not be an equitable situation and, as a consequence, a
corporation is generally not required to pay taxes on dividends received from another taxable
Canadian corporation.

4. The stop loss rules reflect the fact that the value of shares usually falls when dividends are paid.
Further, the payment of such dividends is, in general, fairly predictable. Given this, a corporation
could acquire shares in anticipation of receiving a dividend payment. As dividend payments to
corporations are, in general, not subject to tax, this dividend payment could be received tax free.
Provided the value of the shares falls after the dividend payment, the corporation could then sell the
shares at a loss. The net result would be the receipt of tax free income, combined with a deductible
loss for a similar amount.

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As this is not an appropriate result, the stop loss rules will disallow the loss if:

 the shares are held for less than one year; or

 if the corporation holding the shares, along with other non-arm’s length persons, owns
more than 5 percent of the class of shares on which the dividend was received.

5. For corporations, charitable donations are a deduction in the calculation of Taxable Income. In
contrast, charitable donations made by an individual form the basis for a credit against Tax Payable.
Note, however, that the other rules associated with contributions are the same for corporations and
individuals (e.g., they can only be used to the extent of 75 percent of Net Income For Tax Purposes
and unused amounts can be carried forward for 5 years).

6. For corporations, dividends received are included in Net Income For Tax Purposes, but deducted in
the determination of Taxable Income. If business or property losses are sufficient to reduce the
amount of income recorded in ITA 3(a) and 3(b) to less than the amount of dividends included in
Net Income For Tax Purposes, the result could be all or part of such dividends being subject to tax.
This is avoided by defining Non-Capital Loss in a manner that includes any dividends received that
cannot be deducted during the current year.

7. ITA 111(3) requires that losses within any single category must be deducted in chronological order.
That is, if a corporation chooses to deduct a portion of its non-capital loss balance during the
current year, the oldest losses of this type must be deducted first. However, there are no rules with
respect to the order in which the individual types of loss carry forwards must be deducted.

In deciding which loss should be deducted first, management must evaluate which type of loss is
more likely to be lost or can be used more quickly. Non-capital loss carry forwards have
restrictions on the time for which they are available. If there are losses that are nearing the end of
their carry forward period and there is uncertainty of whether there will be sufficient income in that
period to be able to use the losses, these losses should be deducted first.

While there is no restriction on the period of availability for net capital loss carry forwards, these
amounts can only be used to the extent that there are net taxable capital gains during the period. For
a corporation that experiences only limited or unpredictable capital gains, these restrictions may be
a more important consideration than the period of time during which the loss will be available as the
carry forward period for non-capital losses is 20 years.

A decision will have to be made on the basis of considerations such as these.

8. Provincial taxes are paid in provinces where the corporation has permanent establishments. The
amount allocated to each province is based on the simple average of two percentages — the
percentage of sales in the province and the percentage of wages and salaries paid in the province.

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9. The 10 percent federal tax abatement is only fully available on income that is allocated to a
Canadian province. If, for example, only 80 percent of Taxable Income was allocated to a Canadian
province, the 10 percent abatement would only apply to 80 percent of Taxable Income.

10. The required two goals and related examples can be selected from the ones in the text. These are as
follows:

 Incentives For Small Business While there are several features of the tax system directed
at encouraging small businesses, the major tax incentive for these organizations is the
small business deduction.

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 Incentives For Certain Business Activities The Canadian tax system encourages
scientific research through a generous system of tax credits and a liberal policy towards
deductible amounts. Tax credits are available to encourage business activities such as the
employment of apprentices and the creation of child care spaces. Support is also provided
to the natural resource industries through a variety of programs.

 Incentives For Certain Regions Certain regions of Canada are given assistance through
investment tax credits and other programs.

 Integration One of the goals of the Canadian tax system is to keep the level of taxes paid
on a given stream of income the same, regardless of whether or not a corporation is placed
between the original source of the income and the ultimate recipient. The dividend gross
up and tax credit procedures are in place to improve integration.

11. The general conditions are as follows:

 The corporation must be a Canadian controlled private corporation.

 The income must be active business income.

 The deduction is only available on the first $500,000 of active business income.

 The $500,000 limit must be shared by associated corporations.

12. A specified investment business is a business carried on by a corporation, the principal purpose of
which is to earn property income, but does not include a corporation that employs more than five
full time employees in the business throughout the year.

The problem that was resolved by this definition was that, while the government did not want to
make the small business deduction available to individuals attempting to simply shelter income
earned by their investments, it did recognize that it was possible to have a business that was
“actively” engaged in earning property income. The specified investment business definition
provided a clear, though somewhat arbitrary, criteria for identifying such businesses.

13. Interest income will be considered to be active business income in the following circumstances:

 The income is earned by a CCPC with more than 5 full time employees and its principal
business is producing property income.

 The interest results from the investment of temporary cash balances associated with
fluctuations in producing active business income.

 The interest received has been deducted by another CCPC in its determination of active
business income.

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14. This limitation is included in order to ensure that these deductions are not given on amounts of
income that have not been taxed. Amounts of active business income and/or M&P profits that have
been included in Net Income For Tax Purposes may be eliminated by either charitable donations or
non-capital loss carry forwards, resulting in their not being included in Taxable Income and not
being subject to tax.

15. This reduction is made in order to eliminate the amount of foreign business income on which the
foreign tax credit has eliminated all of the Canadian taxation. The 4 times figure is based on the
assumption that the corporation’s tax rate is 25 percent (1 ÷ 4) on this type of income.

16. The policy goal of the small business deduction is to assist small businesses. Unfortunately,
because the basic provisions of this legislation are based on the type of corporation and the type of
income, the deduction could be available to many large corporations. To deal with this, ITA
125(5.1) requires the annual business limit to be reduced based on Taxable Capital Employed In
Canada. Because this is a measure of the corporation or the associated group of companies’ size, it
effectively prevents very large corporations from benefitting from the small business deduction.

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17. The formal definition of a personal services business is as follows:

... a business of providing services where

(a)

an individual who performs services on behalf of the corporation (referred to as an

incorporated employee), or

(b)

any person related to the incorporated employee

is a specified shareholder of the corporation and the incorporated employee would reasonably
be regarded as an officer or employee of the person or partnership to whom or to which the
services were provided but for the existence of the corporation, unless

(c)

the corporation employs in the business throughout the year more than five full time
employees, or

(d)

the amount paid or payable to the corporation in the year for the services is received or
receivable by it from a corporation with which it was associated in the year.

With respect to special tax features, personal services businesses are not eligible for the small
business deduction. In addition, no deduction is permitted to the corporation for any expenses other
than:

 salaries, wages, other remuneration, and benefits paid in the year to the individual who
performed the services on behalf of the corporation; and

 other expenses that would normally be deductible against employment income, for
example, travel expenses incurred to earn employment income.

18. The M&P deduction is no longer important in the determination of federal Tax Payable as the rate
for this deduction is identical to that used in the general rate reduction. While income that is
eligible for the M&P deduction can be used for the general rate reduction, the taxpayer cannot use
both. As the rate is the same for each of these tax preferences, there is little point in bothering to
determine M&P profits at the federal level.

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However, the legislation has not been eliminated because some provinces still provide special
treatment for M&P profits. More specifically, Ontario and Saskatchewan have reduced rates for
this type of income.

19. The calculation of the general rate reduction would begin by determining the CCPC’s Taxable
Income and deducting from that:

 income eligible for the small business deduction; and

 income eligible for the M&P deduction.

The resulting full rate taxable income would be multiplied by 13 percent to calculate the general
rate reduction.

20. The “tax otherwise payable” calculation is to ensure that any foreign tax credit does not exceed a
proportionate share of Canadian taxes paid on the foreign income. Foreign business income is not
earned in a province and, as a consequence, there will be no applicable provincial taxes. As the ITA
124(1) abatement was put in place to leave room for provincial taxes, it would not be appropriate to
deduct this amount in determining “tax otherwise payable”, which serves as a limiting factor for the
foreign business income tax credit.

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TIF Solution Twelve - 2

1. False.

Corporations deduct their charitable donations in the determination of Taxable Income.

2. True.

The carry forward rules are the same for corporations and individuals.

3. True.

Only individuals and trusts use the dividend gross up and tax credit procedures.

4. True.

Such dividends are included in the E component of the non-capital loss calculations.

5. False.

The fact that net capital losses can only be applied against taxable capital gains may make it
more appropriate to deduct these losses first.

6. True.

While there is no requirement that non-capital losses be deducted prior to other types of losses,
ITA 111(3) requires that a given type be deducted in the order in which the losses were
incurred.

7. False.

Full Rate Taxable Income does not include income that is eligible for the manufacturing and
processing deduction.

8. True.

If a corporation’s ownership of rental units was so extensive as to constitute a business (e.g., a

hotel chain with 10,000 rooms), the rental income would be considered active business
income.

9. False.

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If a business earning property income employs more than 5 full time individuals, it is not a
Specified Investment Business.

10. True.

Not only does the corporation lose access to the small business deduction, the deductions for
the corporation are limited to salaries, wages, and other expenses that would normally be
deductible against employment income.

11. False.

CCPCs may have income that it not eligible for the small business deduction (e.g., active
business income in excess of $500,000). Active business income that is not eligible for the
small business deduction would be considered Full Rate Taxable Income and would be
eligible for the General Rate Reduction provision.

12. False.

The base used for calculating the M&P deduction is reduced by the amount that is eligible for
the small business deduction, not by the amount of the small business deduction.

13. True.

Taxes paid on foreign source business income not used during the current year can be carried
back to the 3 preceding taxation years and forward to the 10 subsequent taxation years.

14. False. This rule applies to individuals but not to corporations.

15. True.

A corporation’s Net Income For Tax Purposes includes the full amount of any foreign non-
business income, without regard to the amount of taxes withheld in the foreign venue.

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TIF Solution Twelve - 3

Computation Of Net And Taxable Income
1. A. A deduction of $28,000 [removes accounting gain of $28,000 ($130,000 - $112,000)],
an addition of $5,000 [adds taxable capital gain of $5,000 (1/2)($140,000 - $130,000)], and an
addition of $34,000 [adds recapture of $34,000 ($130,000 - $96,000)].

2. D. The correct amount is calculated as follows:

Amount E

Business Loss $375,000

Allowable Business Investment Loss 23,000

Dividends Received 53,000 $451,000

Amount F

Net Taxable Capital Gains ( $67,000)

Dividends Received ( 53,000) ( 120,000)

Non-Capital Loss For The Year $331,000

3. D. Included in Net Income For Tax Purposes, but not in Taxable Income.

4. C. They are a deduction in the determination of corporate Taxable Income but not in the
determination of corporate Net Income.

5. C. The lifetime capital gains deduction.

6. A. Net Income for Tax Purposes - $105,500; Taxable Income - $51,000.

Net Income for Tax Purposes = $76,000 + (1/2)($38,000) + $69,000 + $2,500 – $61,000 = $105,500;

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Taxable Income = $105,500 - $2,500 - $52,000 = $51,000.

7. B. $3,750 [(20%)(15,000)($29 - $32.50) - (20%)(15,000)($2.25)]. The stop loss rules

apply as Victoria owns over 5% of the shares of Vancouver, and also because the shares were
held for less than one year.

8. B. Net Income For Tax Purposes = $91,000 + $10,000 - $84,000 = $17,000

$17,000 × 75% = $12,750

Geographical Allocation Of Income

9. B. Gross revenue and salaries and wages paid by the establishment.

10. D. 71.57% (100% - 28.43%)

Foreign percentage = {[1/2][($4,500,000/$13,500,000) + ($2,000,000/$8,500,000)]} = 28.43%

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Federal Tax Payable

11. B. The federal tax abatement is always equal to 10 percent of corporate Tax Payable.

12. D. Full rate taxable income includes any income that is not eligible for the small business
deduction.

13. A. Public and private corporations are eligible for the general rate reduction.

Provincial Tax Payable

14. C. The provincial systems use a rate structure similar to the federal system for
corporations and, except for Alberta and Quebec, the calculation of taxable income is the same
as that used federally.

Small Business Deduction

15. C. $231,000 ($223,000 + $8,000)

16. B. A Specified Investment Company is a Canadian controlled private corporation whose

primary purpose is earning property income and it has less than 5 full-time employees.

17. E. None of the above.

18. E. Both A and C.

19. B. The small business deduction is calculated as the least of three figures:

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Net Income For Tax Purposes $185,000

Taxable Capital Gain ( 2,000)

Village’s Active Business Income $ 183,000

Net Income For Tax Purposes $185,000

Charitable Donations ( 2,500)

Village’s Taxable Income $182,500

Annual Business Limit $500,000

Allocation To Bob’s ( 116,500)

Business Limit $383,500

Therefore, the small business deduction is $32,850 [($182,500)(18%)].

20. A. A business which principally derives its income from rental property and has less than
5 full-time employees.

21. B. A branch of Moose Jaw Corporation invests surplus cash for 2-3 months every year
earning interest income which is less than 1% of corporate income.

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22. D. $400,000 [($500,000)(0.225%)($14,000,000-$10,000,000) ÷ $11,250]

23. C. $18,000.

{18%} {$500,000 - [($500,000)(0.225%)($14,000,000-$10,000,000) ÷ $11,250]}

24. C. The company would be able to deduct the salary paid to Ammar, any benefits paid on
his behalf, and any other expenses that would be normally be deductible against employment
income. (This is a personal services corporation, and these are the only expenses it will be
permitted to deduct.)

25. B. [(18%)($145,500)] = $26,190

26. A. Donald Dorsey is not a Canadian resident throughout the year.

27. C. Personal services business income

Manufacturing And Processing Deduction

28. C. $15,210

The base for the small business deduction is limited to the annual business limit of $500,000. Given
this, the M&P deduction would be equal to 13 percent of the lesser of:

M&P Profits $617,000

Amount Eligible For the Small Business Deduction ( 500,000)

$117,000

Taxable Income $788,000

Amount Eligible For The Small Business Deduction ( 500,000)

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Aggregate Investment Income ( 65,000)

$223,000

The deduction would be $15,210 [(13%)($117,000)].

29. A. The manufacturing and processing deduction is available to any corporation that has
manufacturing and processing profits. M&P has to be 10 percent or more of Canadian active
business income.

General Rate Reduction

30. B. $18,330 (13%)($396,000 - ($36,900 ÷ 18%) - ($6,500 ÷ 13%)]

31. C. The general rate reduction is not available to Canadian Controlled Private
Corporations (CCPCs).

32. C. $29,000 [(38%)($250,000) – (10%)(87%)($250,000) – (18%)($235,000) – (13%)

($250,000 - $235,000)]

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Foreign Tax Credits For Corporations

33. B. Any amount of a corporation’s foreign non-business tax credit in excess of 15 percent
of foreign non-business income must be deducted in determining Net Income For Tax
Purposes.

34. B. In the formula that limits this credit, the Tax Otherwise Payable is reduced by the
federal tax abatement.

35. D. $ 211,000 [$246,000 - $5,000 - $30,000]

36. C. $ 46,500 [$48,000 - $1,500]

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TIF Solution Twelve - 4

Exam Exercise Solution Twelve - 1 (Schedule 1 Reconciliation)

Item 1

You would deduct the accounting gain of $66,600 ($93,000 - $26,400). You would also add
the taxable capital gain of $1,850 [(1/2)($93,000 - $89,300)], for a net deduction of
$64,750.

Item 2

You would add the estimated warranty costs of $22,000.

Item 3

The $68,000 cost of the goodwill would be added to Class 14.1. As this Class is subject to the
half-year rule and specifies maximum amortization at a rate of 5 percent, the resulting
CCA of $1,700 [(5%)(1/2)($68,000)] would be deducted from accounting Net Income.

Item 4

You would add the discount amortization of $2,300.

Exam Exercise Solution Twelve - 2 (Schedule 1 Reconciliation)

Item 1

You would deduct the premium amortization of $5,600.

Item 2

You would add the accounting amortization of $1,600, and deduct the full cost of $16,000 for
tax purposes.

Item 3

You would deduct the accounting gain of $60,000 ($145,000 - $85,000), add the taxable capital
gain of $12,500 [(1/2)($145,000 - $120,000)], and add the recapture of CCA of $15,000
($105,000 - $120,000).

Item 4

You would add the $4,500 of interest charged on late tax instalments.

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Exam Exercise Solution Twelve - 3 (Corporate Taxable Income)

Net Income For Tax Purposes $275,000

Dividends Received ( 15,600)

Charitable Donations ( 9,100)

Non-Capital Loss Carry Forward (All) ( 74,000)

Net Capital Loss Carry Forward* ( 13,720)

Taxable Income $162,580

*While there is a $20,000 net capital loss available, the actual deduction is limited to the
current year’s taxable capital gains of $13,720. The remaining net capital loss carry forward is
$6,280 ($20,000 - $13,720).

Exam Exercise Solution Twelve - 4 (Corporate Taxable Income)

Net Income For Tax Purposes $472,000

Dividends Received ( 22,000)

Charitable Donations ( 14,500)

Non-Capital Loss Carry Forward (All) ( 102,000)

Net Capital Loss Carry Forward* ( 12,400)

Taxable Income $321,100

*While there is a $56,000 net capital loss available, the actual deduction is limited to the
current year’s net taxable capital gains of $12,400. The remaining net capital loss carry
forward is $43,600 ($56,000 - $12,400).

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Exam Exercise Solution Twelve - 5 (Stop Loss Rules)

As Markham has not held the shares for 365 days, this transaction would be subject to the stop loss
rules. The deductible loss would be calculated as follows:

Proceeds Of Disposition [($22.11)(1,000)] $22,110

Adjusted Cost Base [($27.60)(1,000)] ( 27,600)

Total Loss ($ 5,490)

Disallowed Portion [($1.97)(1,000)] 1,970

Capital Loss ($ 3,520)

Inclusion Rate 1/2

Allowable Capital Loss ($ 1,760)

Exam Exercise Solution Twelve - 6 (Stop Loss Rules)

As Invest has not held the Glee shares for 365 days, this transaction would be subject to the stop loss
rules. Given this, the deductible loss would be calculated as follows:

Proceeds Of Disposition [(5,000)($16.75)] $83,750

Adjusted Cost Base [(5,000)($18.95)] ( 94,750)

Total Loss ($11,000)

Disallowed Portion [(5,000)($1.50)] 7,500

Capital Loss ($ 3,500)

Inclusion Rate 1/2

Allowable Capital Loss ($ 1,750)

Exam Exercise Solution Twelve - 7 (Non-Capital Loss Carry Forward)

The non-capital loss balance at the end of the year would be calculated as follows:

Amount E

Net Business Loss $427,500

ABIL 10,450

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Dividends Received And Deducted 87,000

Net Capital Loss Carry Forward Deducted* 16,500

Total For Amount E $541,450

Amount F - ITA 3(c) Income

Dividends ($87,000)

Interest ( 53,100)

Net Taxable Capital Gains

[(1/2)($204,000 - $171,000)] ( 16,500) ( 156,600)

Non-Capital Loss At End Of Year $384,850

*While there is a net capital loss carry forward of $37,400 available, the deduction is limited to
the net taxable capital gains of $16,500 [($204,000 - $171,000)(1/2)]. This leaves a net capital
loss carry forward of $20,900 ($37,400 - $16,500).

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Exam Exercise Solution Twelve - 8 (Non-Capital Loss Carry Forward)

The non-capital loss balance at the end of the year would be calculated as follows:

Amount E

Net Business Loss $286,000

ABIL 23,000

Dividends Received And Deducted 34,000

Net Capital Loss Carry Forward Deducted* 18,000

Total For Amount E $361,000

Amount F - ITA 3(c) Income:

Dividends ($34,000)

Interest ( 42,000)

Net Taxable Capital Gains ( 18,000) ( 94,000)

Non-Capital Loss At End Of Year $267,000

*While there is a net capital loss of $24,000 available, the deduction is limited to the net
taxable capital gains of $18,000. This leaves a net capital loss carry forward of $6,000
($24,000 - $18,000).

Exam Exercise Solution Twelve - 9

(Net Capital And Non-Capital Loss Carry Forwards)
The required calculations for 2017 would be as follows:

Accounting Net Income $225,000

Adjustments:

Donations 7,100

Accounting Gain On Sale Of Shares ( 33,000)

Taxable Capital Gain [(1/2)($33,000)] 16,500

Net Income For Tax Purposes $215,600

Donations ( 7,100)

Dividends Received ( 23,000)

Non-Capital Loss Carry Forward (All) ( 12,000)

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Net Capital Loss Carry Forward (All) ( 10,000)

2017 Taxable Income $163,500

There are no carry forwards of any type at the end of 2017.

The net business loss for 2018 would be calculated as follows:

Accounting Net Loss ($372,000)

Charitable Donations 9,600

Accounting Loss On Sale Of Shares 17,000

Dividends Included In Accounting Income ( 37,000)

Net Business Loss ($382,400)

The 2018 Net Income For Tax Purposes and Taxable Income would be nil, calculated as follows:

Net Business Loss ($382,400)

Dividends Received 37,000

2018 Net Income For Tax Purposes And Taxable IncomeNil

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The non-capital loss for the year is calculated as follows:

Amount E

Net Business Loss $382,400

Dividends Deducted 37,000 $419,400

Amount F (Income Under ITA 3(c) - Dividends) ( 37,000)

2018 Non-Capital Loss $382,400

Of the $382,400 loss, $163,500 can be carried back to 2017, leaving a non-capital loss carry forward of
$218,900 ($382,400 - $163,500).
As the policy of the Company is to minimize non-capital losses, none of the 2018 capital loss can be
carried back. This will leave a net capital loss carry forward of $8,500 [(1/2)($17,000)].
There is also a carry forward of charitable donations of $9,600.

Exam Exercise Solution Twelve - 10

(Net Capital And Non-Capital Carry Forwards)
The 2017 Net Income For Tax Purposes and Taxable Income would be calculated as follows:

Accounting Income $427,000

Adjustments:

Donations 12,100

Accounting Gains ( 65,000)

Taxable Capital Gains [(1/2)($65,000)] 32,500

Net Income For Tax Purposes $406,600

Donations ( 12,100)

Dividends Received ( 41,000)

Non-Capital Loss Carry Forward (All) ( 26,000)

Net Capital Loss Carry Forward (All) ( 19,000)

2017 Taxable Income $308,500

There are no loss carry forwards at the end of 2017.

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The 2018 net business loss would be calculated as follows:

Accounting Loss ($625,000)

Donations 17,600

Accounting Loss On Sale Of Shares 31,000

Dividends Included In Accounting Income ( 58,000)

Net Business Loss ($634,400)

The 2018 Net Income For Tax Purposes and Taxable Income would be nil, calculated as follows:

Net Business Loss ($634,400)

Dividends Received 58,000

2018 Net Income For Tax Purposes And Taxable IncomeNil

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The 2018 non-capital loss can be calculated as follows:

Amount E

Net Business Loss $634,400

Dividends Deducted 58,000 $692,400

Amount F - (Income Under ITA 3(c) - Dividends) ( 58,000)

Non-Capital Loss For 2018 $634,400

The $634,400 non-capital loss can be carried back to 2017 to the extent of that year’s Taxable Income of
$308,500. This will leave a non-capital loss carry forward of $325,900 ($634,400 - $308,500).
As the Company’s policy is to minimize non-capital loss carry overs, none of the share loss can be
deducted. This leaves a net capital loss carry over of $15,500 [(1/2)($31,000)]. There is also a $17,600
carry forward of charitable donations.

Exam Exercise Solution Twelve - 11 (Geographical Allocation)

The percentage of Taxable Income earned in each province would be calculated as follows:

Gross Revenues Wages And Salaries

Amount Percent Amount Percent

Saskatchewan $1,520,000 50.4% $ 63,000 32.8%

Alberta 912,000 30.3% 85,000 44.3%

Not Related To A Province 581,000 19.3% 44,000 22.9%

Total $3,013,000 100.0% $192,000 100.0%

The average of the two percentages applicable for income not related to a province is 21.1%, leaving an
average for income related to a province of 78.9%. Given this, federal Tax Payable can be calculated as
follows:

Base Amount Of Part I Tax [(38%)($242,000)] $91,960

Federal Tax Abatement [(10%)(78.9%)($242,000)] ( 19,094)

General Rate Reduction [(13%)($242,000)] ( 31,460)

Federal Tax Payable $41,406

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Exam Exercise Solution Twelve - 12 (Geographical Allocation)

The percentage of Taxable Income earned in each province would be calculated as follows:

Gross Revenues Wages And Salaries

Amount Percent Amount Percent

Ontario $ 840,000 35% $ 300,000 25%

Manitoba 1,080,000 45% 540,000 45%

U.S.480,000 20% 360,000 30%

Total $2,400,000 100.0% $1,200,000100.0%

The average of the two percentages applicable to the U.S. is 25%, leaving an average for income related
to a province of 75%. Given this, federal Tax Payable can be calculated as follows:

Base Amount Of Part I Tax [(38%)($362,000)] $137,560

Federal Tax Abatement [(10%)(75%)($362,000)] ( 27,150)

General Rate Reduction [(13%)($362,000)] ( 47,060)

Federal Tax Payable $ 63,350

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Exam Exercise Solution Twelve - 13 (Small Business Deduction)

As a CCPC throughout the year and with no associated companies, Meridian is eligible for the full
amount of the $500,000 annual business limit. The amount eligible for the small business deduction is
the least of:

Active Business Income $400,000

Adjusted Taxable Income (See following calculation) $281,786

Annual Business Limit $500,000

Net Income For Tax Purposes $522,000

Dividends Received ( 72,000)

Non-Capital Loss Carry Forward ( 145,000)

Taxable Income $305,000

100/28 Times Foreign Non-Business Tax Credit

[(100/28)(13%)($50,000)] ( 23,214)

Adjusted Taxable Income $281,786

The small business deduction is equal to $50,721 [(18%)($281,786)].

Exam Exercise Solution Twelve - 14 (Small Business Deduction)

As a CCPC throughout the year and with no associated companies, Sardo is eligible for the full amount
of the $500,000 annual business limit. The amount eligible for the small business deduction is the least
of:

Active Business Income $375,000

Adjusted Taxable Income (See following calculation) $299,571

Annual Business Limit $500,000

Net Income For Tax Purposes $472,000

Dividends Received ( 65,000)

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Non-Capital Loss Carry Forward ( 96,000)

Taxable Income $311,000

100/28 Times Foreign Non-Business Tax Credit

[(100/28)($3,200)] ( 11,429)

Adjusted Taxable Income $299,571

The small business deduction is equal to $53,923 [(18%)($299,571)].

Exam Exercise Solution Twelve - 15 (Small Business Deduction Reduction)

The B component of the ITA 125(5.1) reduction formula is $6,638 [(.00225)($12,950,000 -
$10,000,000)]. Given this, the required reduction would be calculated as follows:

[($500,000)($6,638 ÷ $11,250)] = $295,022 Reduction

This reduction leaves the annual business limit at $204,978 ($500,000 - $295,022).
The small business deduction for Teeny Ltd. is equal to 18 percent of the least of:

Active Business Income ($652,000 - $21,000) $631,000

Taxable Income ($652,000 - $415,000) $237,000

[(100/28)(10%)($21,000)] ( 7,500) $229,500

Reduced Annual Business Limit $204,978

The small business deduction is equal to $36,896 [(18%)($204,978)].

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Exam Exercise Solution Twelve - 16 (M&P And SBD)

The small business deduction for Bartlett Operations Inc. would be equal to 18 percent of the least of:

Canadian Active Business Income $424,000

Taxable Income ($476,000 - $201,000) $275,000

Less 4 Times Business Income FTC Of $3,700 ( 14,800) $260,200

Annual Business Limit $500,000

Based on this, the small business deduction would be $46,836 [(18%)($260,200)].

The M&P deduction would be equal to 13 percent of the lesser of:

M&P Profits $424,000

Less Amount Eligible For Small Business Deduction ( 260,200) $163,800

Taxable Income $275,000

Less:

Amount Eligible For Small Business Deduction ( 260,200)

4 Times Business Income FTC Of $3,700 ( 14,800)

Aggregate Investment Income (Taxable Capital Gain) ( 27,000) Nil

The M&P profits deduction would be equal to nil.

It would have been possible to increase the amount eligible for the small business deduction to the
$424,000 of active business income by increasing Taxable Income to $438,800 ($424,000 + $14,800).
This could be accomplished by deducting only $37,200 ($476,000 - $438,800) of the charitable
donations. The remaining unclaimed donations of $163,800 ($201,000 - $37,200) could be carried
forward for up to five years.
Although this increases Taxable Income and the total Tax Payable for the year, there could still be an
ultimate tax savings with this approach, as the small business deduction cannot be carried forward, while
charitable donations can be. As the Exercise states that Bartlett expects large increases in income in the
future, this approach would be advantageous if Bartlett’s expectations turn out to be correct.

Exam Exercise Solution Twelve - 17 (M&P And SBD)

The small business deduction for Lardon Inc. would be equal to 18 percent of the least of:

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Canadian Active Business Income $553,000

Taxable Income ($652,000 - $187,000) $465,000

Less 4 Times Business Income FTC Of $6,000 ( 24,000) $441,000

Annual Business Limit $500,000

Based on this, the small business deduction would be $79,380 [(18%)($441,000)].

The M&P deduction would be equal to 13 percent of the lesser of:

M&P Profits $553,000

Less Amount Eligible For Small Business Deduction ( 441,000) $112,000

Taxable Income ($652,000 - $187,000) $465,000

Less:

Amount Eligible For Small Business Deduction ( 441,000)

4 Times Business Income FTC Of $6,000 ( 24,000)

Aggregate Investment Income (Taxable Capital Gain) ( 59,000) Nil

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The M&P profits deduction would be equal to nil.

It would have been possible to increase the amount eligible for the small business deduction to the
$500,000 annual business limit by increasing Taxable Income to $524,000 ($500,000 + $24,000). This
could be accomplished by deducting only $128,000 ($652,000 - $524,000) of the charitable donations.
The remaining unclaimed donations of $59,000 ($187,000 - $128,000) could be carried forward for up
to five years.
Although this increases Taxable Income and the total Tax Payable for the year, there could still be an
ultimate tax savings with this approach, as the small business deduction cannot be carried forward, while
charitable donations can be. On the other hand, Lardon’s loss of customers and staff may result in
substantially lower income in the future. If all income in the foreseeable future will benefit from the
small business deduction, it would be advantageous to minimize Taxable Income by deducting all of the
charitable donations in the current year.

Exam Exercise Solution Twelve - 18

(Simple Federal Tax Payable - Public Company)
The federal Tax Payable for Tuleta Ltd. would be calculated as follows:

Base Amount Of Part I Tax [(38%)($296,000)] $112,480

Federal Tax Abatement [(10%)($296,000)] ( 29,600)

M&P Deduction [(13%)($165,000)] ( 21,450)

General Rate Reduction [(13%)($296,000 - $165,000)] ( 17,030)

Federal Tax Payable $ 44,400

Exam Exercise Solution Twelve - 19

(Simple Federal Tax Payable - Public Company)
The federal Tax Payable for Odaon Ltd. would be calculated as follows:

Base Amount Of Part I Tax [(38%)($625,000)] $237,500

Federal Tax Abatement [(10%)($625,000)] ( 62,500)

M&P Deduction [(13%)($362,000)] ( 47,060)

General Rate Reduction [(13%)($625,000 - $362,000)] ( 34,190)

Federal Tax Payable $ 93,750

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Exam Exercise Solution Twelve - 20 (Simple Federal Tax Payable - CCPC)

The federal Tax Payable for Danforth Inc. would be calculated as follows:

Base Amount Of Part I Tax [(38%)($262,000)] $99,560

Federal Tax Abatement [(10%)($262,000)] ( 26,200)

Small Business Deduction (Note One) ( 21,060)

M&P Deduction (Note Two) ( 10,920)

General Rate Reduction (Note Three) ( 7,930)

Federal Tax Payable $33,450

Note One The small business deduction would be equal to 18 percent of the least of active
business income ($262,000), Taxable Income ($262,000), and the Company’s business limit
($117,000). The deduction is $21,060 [(18%)($117,000)].

Note Two The M&P deduction would be equal to 13 percent of the lesser of $84,000 (M&P
profits of $201,000, reduced by the $117,000 that is eligible for the small business deduction),
and $145,000 (Taxable Income, reduced by the $117,000 that is eligible for the small business
deduction). The M&P deduction would be $10,920 [(13%)($84,000)].

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Note Three The general rate reduction would be calculated as follows:

Taxable Income $262,000

Amount Eligible For The SBD ( 117,000)

Amount Eligible For The M&P Deduction ( 84,000)

Full Rate Taxable Income $ 61,000

Rate 13%

General Rate Reduction $ 7,930

Exam Exercise Solution Twelve - 21 (Simple Federal Tax Payable - CCPC)

The federal Tax Payable for Brokton Inc. would be calculated as follows:

Base Amount Of Part I Tax [(38%)($472,000)] $179,360

Federal Tax Abatement [(10%)($472,000)] ( 47,200)

Small Business Deduction (Note 1) ( 25,200)

M&P Deduction (Note 2) ( 21,450)

General Rate Reduction (Note 3) ( 21,710)

Federal Tax Payable $ 63,800

Note 1 The small business deduction would be equal to 18 percent of the least of:

 Active Business Income $472,000

 Taxable Income $472,000

 Company’s Business Limit $140,000

The amount would be $25,200 [(18%)($140,000)].

Note 2 The M&P deduction would be 13% of the lesser of:

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 $165,000 - M&P profits, less the amount eligible for the small business deduction
($305,000 - $140,000).

 $332,000 - Taxable income, less the amount eligible for the small business deduction
($472,000 - $140,000).

The amount would be $21,450 [(13%)($165,000)].

Note 3 The general rate reduction would be calculated as follows:

Taxable Income $472,000

Amount Eligible For The SBD ( 140,000)

Amount Eligible For The M&P Deduction ( 165,000)

Full Rate Taxable Income $167,000

Rate 13%

General Rate Reduction $ 21,710

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Exam Exercise Solution Twelve - 22 (Foreign Tax Credits)

The Taxable Income figure would be $42,000 ($135,000 - $23,000 - $51,000 - $19,000). Based on this
figure, the required calculation of Part I Tax Payable would be as follows:

Base Amount Of Part I Tax [(38%)($42,000)] $15,960

Federal Tax Abatement [(91%)(10%)($42,000)] ( 3,822)

General Rate Reduction [(13%)($42,000)] ( 5,460)

Foreign Business Income Tax Credit (See Note) ( 3,048)

Part I Tax Payable $ 3,630

Note The foreign business income tax credit would be the least of:

The amount withheld $ 4,050

[$27,000 ÷ ($135,000 - $23,000 - $19,000)][$15,960 - $5,460] $ 3,048

$15,960 - $5,460 $10,500

The unused foreign business tax amount of $1,002 ($4,050 - $3,048) can be carried back 3 years and
forward for 10 years. In calculating the allowable tax credit for such carry overs, these unused amounts
will be added to the foreign tax paid factor in the calculation of the foreign business income tax credit.

Exam Exercise Solution Twelve - 23 (Foreign Tax Credits)

Sundal’s Part I Tax Payable is calculated as follows:

Base Amount Of Part I Tax [(38%)($83,000)] $31,540

Federal Tax Abatement [(89%)(10%)($83,000)] ( 7,387)

General Rate Reduction [(13%)($83,000)] ( 10,790)

Foreign Business Income Tax Credit (See Note) ( 5,298)

Part I Tax Payable $ 8,065

Note The foreign business income tax credit would be the least of:

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The amount withheld $ 7,200

[$48,000 ÷ ($265,000 - $41,000 - $36,000)][$31,540 - $10,790] $ 5,298

$31,540 - $10,790 $20,750

The unused foreign business tax amount of $1,902 ($7,200 - $5,298) can be carried back 3 years and
forward for 10 years. In calculating the allowable tax credit for such carry overs, these unused amounts
will be added to the foreign tax paid factor in the calculation of the foreign business income tax credit.

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TIF Solution Twelve - 5A

The correct definitions for each of the listed key terms are as follows:

A. 8

B. 1

C. 5

D. 11

E. 6

F. 9

G. 4

H. 7

The three unused definitions are as follows:

Associated Corporations = 10

Personal Services Business = 2

Specified Investment Business = 3

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TIF Solution Twelve - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.

The correct definitions for each of the listed key terms are as follows:

A. 10 (not 3)

B. 1 (not 8)

C. 6

D. 15

E. 7 (not 14)

F. 12

G. 5

H. 9

The three unused definitions are as follows:

Associated Corporations = 13

Personal Services Business = 2

Specified Investment Business = 4

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Specified Investment Business (close answer) = 11

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TIF Solution Twelve - 6

1. The adjustments here would be as follows:

 Add the donation of $45,000.

 Deduct the accounting gain of $7,000 ($45,000 - $38,000).

 Add the taxable capital gain of $1,500 [(1/2)($45,000 - $42,000)].

 Add the recapture of $5,500 ($42,000 - $36,500).

2. The adjustments here would be as follows:

 Add the amortization expense of $32,450.

 Deduct the CCA of $27,650.

3. The adjustment here would be as follows:

 Add the increase in the warranty liability of $2,010 ($10,470 - $8,460).

4. Since item 1 created a taxable capital gain of $1,500, the adjustments here would be as follows:

 Add the accounting loss of $550 ($12,870 - $12,320).

 Deduct the allowable capital loss of $275 [(1/2)($12,870 - $12,320)].

5. The adjustment here would be as follows:

 Add the $2,600 in bond discount amortization.

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6. The adjustments here would be as follows:

 Add the accounting loss of $14,810 ($107,000 - $92,190).

 Deduct the terminal loss of $9,580 ($92,190 - $101,770).

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TIF Solution Twelve - 7

The Taxable Income of Dunway Ltd. would be calculated as follows:

Operating Income ($725,000 - $533,000) $192,000

Dividends Received ($37,500 + $15,000) 52,500

Taxable Capital Gain [(1/2)($222,000)] 111,000

Net Income For Tax Purposes $355,500

Deductions:

Dividends Received ($ 52,500)

Donation To Government (Note 1) ( 26,000)

Donations To Registered Charities (Note 1) ( 141,000)

Net Capital Loss Carry Forward (Note 2) ( 111,000) ( 330,500)

Taxable Income Before Non-Capital Loss Carry Forward $ 25,000

Non-Capital Loss Carry Forward (Note 3) ( 25,000)

Taxable Income Nil

Note 1 There is no addition to Net Income For Tax Purposes with respect to the donations as this
calculation does not start with accounting Net Income. The donations to registered Canadian
charities total less than 75 percent of Net Income For Tax Purposes and are therefore fully
deductible in the calculation of Taxable Income.

Note 2 The net capital loss carry forward can only be deducted to the extent of the $111,000
taxable capital gain.

Note 3 The non-capital loss carry forward has only been deducted to the extent of the amount
required to reduce Taxable Income to nil. It would have been possible to carry forward the
donations instead, but the non-capital loss carry forward period is greater than the five year
donation carry forward.

Loss Carry Forwards

At the end of the current year, Dunway will have:

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 a net capital loss balance of $69,000 ($180,000 - $111,000). Since the problem states that no
future capital gains are anticipated, the maximum amount of the net capital loss carry forward was
claimed first.

 a non-capital loss carry forward of $112,000 ($137,000 - $25,000).

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TIF Solution Twelve - 8

The Net Income For Tax Purposes and Taxable Income of Sweat Ltd. for the 8 month period ending
August 31, 2018 is as follows:

Accounting Income Before Taxes $ 87,400

Add:

Reserve For Inventory Obsolescence

(Included In Cost Of Sales) $17,800

Bonus (Note 1) 35,000

Amortization 49,300

Non-Deductible Meals And Entertainment

[(1/2)($15,200)] 7,600

Golf Club Memberships 7,700

Increase In Warranty Reserve ($6,200 - $5,400) 800

Charitable Donations 3,100

Taxable Capital Gain On Investments [(1/2)($3,900)] 1,950 123,250

Deduct:

Accounting Gain On Sale Of Investments ($ 3,900)

CCA (Note 2) ( 32,010) ( 35,910)

Net Income For Tax Purposes $174,740

Deduct:

Charitable Donations ($ 3,100)

Net Capital Loss Carry Forward (Note 3) ( 1,950)

Non-Capital Loss Carry Forward (All) ( 18,700) ( 23,750)

Taxable Income $ 150,990

Note 1 As the bonus is not paid until more than 180 days, but less than 3 years after the
Company’s fiscal year end, it cannot be deducted until it is paid.

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Note 2 The CCA for the 8 month period ending August 31 , 2018 (243 days), can be calculated as
follows:

Class 8 Opening UCC $79,800

Additions $20,500

Disposals - Lesser Of:

 Capital Cost = $14,200

 Proceeds Of Disposition = $9,500 ( 9,500) 11,000

One-Half Net Additions [(1/2)($11,000)] ( 5,500)

CCA Base $85,300

Rate (Class 8) 20%

Full Year Amount $17,060

Proration For Short Fiscal Year 243/365

Class 8 CCA $11,358

The total CCA for the 8 month period ending August 31, 2018 would be as follows:

Class 8 CCA (Preceding Calculation) $11,358

Class 10 CCA [(30%)($103,400)(243/365)] 20,652

Total CCA $32,010

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Note 3 The net capital loss carry forward deducted is limited to the taxable capital gain of $1,950.
This deduction will leave a net capital loss balance of $4,300 ($6,250 - $1,950).

The following additional points are relevant to the solution:

 Dividends declared are not deducted in the calculation of either accounting Net Income or
Taxable Income.

 The interest expense is fully deductible.

 Where a foreign exchange loss arises in the normal course of business operations, it is fully
deductible.

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TIF Solution Twelve - 9

Part A
The required calculation of Net Income For Tax Purposes and Taxable Income is as follows:

ITA 3(a) Dividends $ 30,400

ITA 3(b) Taxable Capital Gains $21,400

Allowable Capital Losses ( 6,500) 14,900

ITA 3(c) $ 45,300

ITA 3(d) Business Loss ( 142,000)

Net Income For Tax Purposes Nil

Dividends Received ($ 30,400)

Net Capital Loss Carry Forward

(Limited To Net Taxable Capital Gains) ( 14,900)

Charitable Donations Nil

Taxable Income Nil

The carry forward balances available at the end of the year are as follows:

Net Capital Loss Carry Forward

Beginning Balance $75,600

Used During Year ( 14,900)

Net Capital Loss Carry Forward $60,700

Charitable Donations Carry Forward

Beginning Balance $4,600

Added During Year 3,200

Used During Year Nil

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Unused Charitable Donations $7,800

2018 Non-Capital Loss

Balance Under E

Net Business Loss $142,000

Dividends 30,400

Net Capital Loss Carry Forward Deducted 14,900

Subtotal $187,300

Balance Under F - Income Under ITA 3(c) ( 45,300)

2018 Non-Capital Loss $142,000

Non-Capital Loss Carry Forward

Balance From Previous Years $ 51,400

Added During Year 142,000

Used During Year Nil

Non-Capital Loss Carry Forward $193,400

As per the policy stated in Part A, this solution minimizes the net capital loss carry forward. In the
absence of this policy, an alternative solution could minimize the non-capital loss balance as is found in
Part B.

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Part B
The required calculation of Net Income For Tax Purposes and Taxable Income is as follows:

ITA 3(a) Dividends $ 30,400

ITA 3(b) Taxable Capital Gains $21,400

Allowable Capital Losses ( 6,500) 14,900

ITA 3(c) $ 45,300

ITA 3(d) Business Loss ( 142,000)

Net Income For Tax Purposes Nil

Dividends Received ($ 30,400)

Net Capital Loss Carry Forward Nil

Charitable Donations Nil

Taxable Income Nil

The carry forward balances available at the end of the year are as follows:

Net Capital Loss Carry Forward

Beginning Balance $75,600

Used During Year Nil

Net Capital Loss Carry Forward $75,600

Charitable Donations Carry Forward

Beginning Balance $4,600

Added During Year 3,200

Used During Year Nil

Unused Charitable Donations $7,800

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2018 Non-Capital Loss

Balance Under E

Business Loss $142,000

Dividends 30,400

Net Capital Loss Carry Forward Deducted Nil

Subtotal $172,400

Balance Under F - Income Under ITA 3(c) ( 45,300)

2018 Non-Capital Loss $127,100

Non-Capital Loss Carry Forward

Balance From Previous Years $ 51,400

Added During Year 127,100

Used During Year Nil

Non-Capital Loss Carry Forward $ 178,500

Note that, in contrast to Part A, the non-capital loss carryforward is $14,900 lower ($193,400 -
$178,500), reflecting the fact that in this Part we were asked to minimize the non-capital loss balance,
as opposed to the net capital loss balance. As you would expect, the net capital loss balance is $14,900
higher ($75,600 - $60,700).

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Comparison (Not Required)

A comparison of the carry forward amounts under the two Parts is as follows:

Part A Part B

Net Capital Loss Carry Forward $ 60,700 $ 75,600

Non-Capital Loss Carry Forward 193,400 178,500

Charitable Donations Carry Forward 7,800 7,800

Total Of The Carry Forwards $261,900 $261,900

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TIF Solution Twelve - 10

The required calculation of Net Income For Tax Purposes and Taxable Income is as follows:

ITA 3(a) Dividends $ 51,500

ITA 3(b)

Taxable Capital Gains [(1/2)($41,500)] $20,750

Allowable Capital Losses [(1/2)($7,300)] ( 3,650) 17,100

ITA 3(c) $ 68,600

ITA 3(d) Business Loss ( 225,000)

Net Income For Tax Purposes Nil

Dividends Received ($ 51,500)

Net Capital Loss Carry Forward

(Limited To Net Taxable Capital Gains) ( 17,100)

Charitable Donations Nil

Taxable Income Nil

The carry forward balances available at the end of the year are as follows:

Net Capital Loss Carry Forward

Beginning Balance $78,250

Used During Year ( 17,100)

Net Capital Loss Carry Forward $61,150

Charitable Donations Carry Forward

Beginning Balance $ 6,400

Added During Year 6,300

Used During Year Nil

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Unused Charitable Donations $12,700

2018 Non-Capital Loss

Balance Under E

Dividends Received And Deducted $ 51,500

Business Loss 225,000

Net Capital Loss Carry Forward Deducted 17,100

Subtotal $293,600

Balance Under F - Income Under ITA 3(c) ( 68,600)

2018 Non-Capital Loss $225,000

Non-Capital Loss Carry Forward

Balance From Previous Years $ 61,400

Added During Year 225,000

Used During Year Nil

Non-Capital Loss Carry Forward $286,400

As per the policy of the Company, this solution minimizes the net capital loss carry forward. In the
absence of this policy, an alternative solution could minimize the non-capital loss balance.

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TIF Solution Twelve - 11

2015 Analysis
Net And Taxable Income
The required calculations for Net Income For Tax Purposes and Taxable Income are as follows:

Net Business Income $123,000

Dividends 6,000

Net Income For Tax Purposes $129,000

Dividends ( 6,000)

Charitable Donations ( 1,500)

Taxable Income $121,500

There is an allowable capital loss of $6,000 [(1/2)($12,000)] that can only be deducted against taxable
capital gains.

2015 Carry Forwards

The following carry forward amount is available at the end of 2015:

 Net Capital Loss $6,000

2016 Analysis
Net And Taxable Income
The required calculations for Net Income For Tax Purposes and Taxable Income are as follows:

Net Business Income $18,000

Taxable Capital Gain [(1/2)($32,000)] 16,000

Dividends 7,000

Net Income For Tax Purposes $41,000

Dividends ( 7,000)

Charitable Donations ( 8,500)

Net Capital Loss Carry Forward (All) ( 6,000)

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Taxable Income $19,500

2016 Carry Forwards

As the Company was able to deduct all of the net capital loss from 2015, no carry forward amounts
remain.

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2017 Analysis
Net And Taxable Income
The required calculations for Net Income For Tax Purposes and Taxable Income are as follows:

Dividends = Income Under ITA 3(c) $ 6,000

Business Loss [ITA 3(d)] ( 85,000)

Net Income For Tax Purposes And Taxable Income Nil

Net Capital Loss Carry Back And Amended 2016 Return

In 2017, there is a net capital loss of $12,500 [(1/2)($25,000)]. While there was a $16,000 taxable
capital gain in 2016, $6,000 of this amount was used by the net capital loss carry forward from 2015.
This means that only $10,000 of the $12,500 can be carried back to 2016. Given this, the 2016
amended return would be as follows:

Taxable Income As Reported $19,500

Net Capital Loss Carry Back From 2017 ( 10,000)

Amended 2016 Taxable Income $ 9,500

Non-Capital Loss Carry Back And Amended 2015 Return

The 2017 non-capital loss would be calculated as follows:

Business Loss $85,000

Dividends Received And Deducted 6,000

Amount E $91,000

Income Under ITA 3(c) ( 6,000)

2017 Non-Capital Loss $85,000

As the 2015 Taxable Income was $121,500, all of this loss can be carried back to that year. Given this,
the amended return for 2015 would be as follows:

Taxable Income As Reported In 2015 $121,500

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Non-Capital Loss Carry Back from 2017 ( 85,000)

Amended 2015 Taxable Income $ 36,500

2017 Carry Forwards

The following carry forward amounts are available at the end of 2017:

 Net Capital Loss ($12,500 - $10,000) $2,500

 Charitable Donations 4,200

 Non-Capital Loss Nil

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2018 Analysis
Net And Taxable Income
The required calculations for Net Income For Tax Purposes and Taxable Income are as follows:

Net Business Income $32,000

Taxable Capital Gains 8,000

Dividends 9,000

Net Income For Tax Purposes $49,000

Dividends ( 9,000)

Current Charitable Donations ( 1,800)

Charitable Donations Carry Forward ( 4,200)

Net Capital Loss Carry Forward (All) ( 2,500)

Taxable Income $31,500

2018 Carry Forwards

At the end of 2018, there are no carry forward balances.

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TIF Solution Twelve - 12

The allocation to each of these provinces and the United States would be based on the following
calculations:

Salaries And Wages Gross Revenues

Province Amount Percent Amount Percent

Manitoba $ 369,750 15% $1,252,000 20%

Ontario 616,250 25% 1,565,000 25%

Quebec 986,000 40% 2,191,000 35%

United States 493,000 20% 1,252,000 20%

Total $2,465,000 100% $6,260,000 100%

The province by province average of the two percentages, calculated above, would be used to allocate
the total Taxable Income of $1,467,000 as follows:

Taxable

Province Wages Revenues Average Income

Manitoba 15% 20% 17.5% $ 256,725

Ontario 25% 25% 25.0% 366,750

Quebec 40% 35% 37.5% 550,125

United States 20% 20% 20.0% 293,400

Total 100% 100% 100.0% $1,467,000

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TIF Solution Twelve - 13

Wankana’s Part I tax payable for the year would be calculated as follows:

Base Amount Of Part I Tax [(38%)($1,235,000)] $469,300

Federal Tax Abatement [(10%)(85%)($1,235,000)] (Note One) ( 104,975)

Foreign Business Tax Credit

(Assumed To Be Equal To Taxes Withheld) ( 12,600)

Small Business Deduction (Note Two) ( 9,299)

General Rate Reduction (Note Three) ( 153,834)

Part I Tax Payable $188,592

Note One The federal tax abatement must be reduced because of the foreign business income. The
percentage would be calculated as follows:

Canadian Gross Revenues As A Percentage Of Total

[($3,450,000 - $621,000)  $3,450,000] 82%

Canadian Wages And Salaries As Percentage Of Total

[($561,000 - $67,320)  $561,000] 88%

Using these figures, the average percent would be 85 percent [(82% + 88%) ÷ 2].

Note Two Since Wankana’s Taxable Capital Employed In Canada for the previous taxation year
was greater than $10 million, its small business deduction is reduced. The B component of the ITA
125(5.1) reduction formula is $5,438 [(.00225)($12,417,000 - $10,000,000)]. In addition, because
of Wankana’s association with other companies, the A component of the formula would be reduced
to $100,000 [($500,000)(20%)]. Given these considerations, the reduction would be calculated as
follows:

[($100,000)($5,438 ÷ $11,250)] = $48,338 Reduction

Using this information, Wankana’s small business deduction is equal to 18.0 percent of the least of:

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Canadian Active Business Income (Given) $1,172,000

Taxable Income $1,235,000

Less: Foreign Business Tax Credit

Adjustment [(4)($12,600)] ( 50,400) $1,184,600

Reduced Annual Business Limit ($100,000 - $48,338) $51,662

The small business deduction would be $9,299 [(18.0%)($51,662)].

Note Three The general rate reduction would be calculated as follows:

Taxable Income $1,235,000

Amount Eligible For Small Business Deduction ( 51,662)

Full Rate Taxable Income $1,183,338

Rate 13%

General Rate Reduction $ 153,834

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TIF Solution Twelve - 14

Part A
The minimum Taxable Income for Devza Ltd. would be calculated as follows:

Net Income For Tax Purposes $1,092,400

Deductions:

Dividends ($346,100)

Charitable Donations ( 102,600)

Non-Capital Loss Carry Forward ( 123,450) ( 572,150)

Taxable Income $ 520,250

Based on this, the Company’s Tax Payable would be calculated as follows:

Base Amount Of Part I Tax [(38%)($520,250)] $197,695

Federal Tax Abatement [(10%)($520,250)] ( 52,025)

Small Business Deduction (Note 1) ( 36,000)

M&P Deduction (Note 2) ( 41,633)

General Rate Reduction (Note 3) Nil

Part I Federal Tax Payable $ 68,037

Note 1 The small business deduction is based on the least of the following:

Canadian Active Business Income $746,300

Taxable Income (no foreign tax credit adjustment needed)520,250

Annual Business Limit 200,000

The small business deduction is equal to $36,000 [(18.0%)($200,000)].

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Note 2 The base for the Manufacturing And Processing deduction would be the lesser of:

M&P Profits (Given) $584,600

Amount Eligible For The SBD ( 200,000) $384,600

Taxable Income $520,250

Amount Eligible For The SBD ( 200,000)

Aggregate Investment Income Nil $320,250

Based on these figures, the deduction would be equal to $41,633 [(13%)($320,250)].

Note 3 The General Rate Reduction would be calculated as follows:

Taxable Income $520,250

Amount Eligible For The SBD ( 200,000)

Amount Eligible For The M&P Deduction ( 320,250)

Base Nil

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Part B
While the M&P deduction would be eliminated, the general rate reduction would be calculated as
follows:

Taxable Income $520,250

Amount Eligible For The SBD ( 200,000)

Base $320,250

Rate 13%

General Rate Reduction $ 41,633

Using these change figures, the final Tax Payable would be unchanged from Part A. This is shown in
the following table:

Base Amount Of Part I Tax [(38%)($520,250)] $197,695

Federal Tax Abatement [(10%)($520,250)] ( 52,025)

Small Business Deduction (Note 1) ( 36,000)

M&P Deduction Nil

General Rate Reduction ( 41,633)

Part I Federal Tax Payable $ 68,037

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TIF Solution Twelve - 15

Part A - Tax Payable
The calculation of federal Part I Tax Payable would be as follows:

Canadian Active Business Income $187,000

Foreign Income (U.S. Branches) 32,000

Net Income For Tax Purposes And Taxable Income $219,000

Base Amount of Part I Tax [(38%)($219,000)] $ 83,220

Federal Tax Abatement [(10%)(90%)($219,000)]

- Note One ( 19,710)

Small Business Deduction - Note Two ( 32,508)

General Rate Reduction - Note Three ( 4,992)

Foreign Business Income Tax Credit - Given ( 9,600)

Part I Tax Payable $ 16,410

Note One Since only 90 percent of the Company’s Taxable Income is allocated to Canadian provinces,
the abatement must be multiplied by 90 percent.

Note Two The small business deduction would be equal to 18.0 percent of the least of:

1. Canadian Active Business Income $187,000

2. Taxable Income $219,000

Less [(4)($9,600)] ( 38,400) $180,600

3. Annual Business Limit $500,000

The least of the three figures is $180,600, and 18.0 percent of this amount is $32,508.

Note Three The general rate reduction would be calculated as follows:

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Taxable Income $219,000

Amount Eligible For Small Business Deduction ( 180,600)

Full Rate Taxable Income $ 38,400

Rate 13%

General Rate Reduction $ 4,992

Part B - Foreign Tax Credit

The foreign business income tax credit is $9,600, the least of the following three amounts:

1. Actual Foreign Taxes Withheld ($6,200 + $3,400) $9,600

2. An amount calculated as follows:

[Foreign Business Income ÷ Adjusted Net Income][Tax Otherwise Payable]

= [($32,000 ÷ $219,000)($83,220 - $4,992)] $11,431

3. Tax Otherwise Payable, Less Non-Business Foreign Tax Credit Deducted

[($83,220 - $4,992) - Nil] $78,228

Note that the tests of the foreign tax credit amounts include the effect of the general rate reduction.

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TIF Solution Twelve - 16

The minimum Taxable Income for Zenox Ltd. would be calculated as follows:

Net Income For Tax Purposes $625,000

Deductions:

Dividends ($102,000)

Charitable Donations ( 46,000)

Non-Capital Loss Carry Forward ( 54,000) ( 202,000)

Taxable Income $423,000

Based on this, the Company’s Tax Payable would be calculated as follows:

Base Amount Of Part I Tax [(38%)($423,000)] $160,740

Federal Tax Abatement [(10%)($423,000)] ( 42,300)

Small Business Deduction (Note 1) ( 45,000)

M&P Deduction (Note 2) ( 21,580)

General Rate Reduction (Note 3) ( 910)

Part I Federal Tax Payable $ 50,950

Note 1 The small business deduction is based on the least of the following:

Active Business Income $523,000

Taxable Income (no foreign tax credit adjustment needed) 423,000

Annual Business Limit [(1/2)($500,000)] 250,000

The small business deduction is equal to $45,000 [(18%)($250,000)].

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Note 2 The base for the Manufacturing And Processing Deduction would be the lesser of:

M&P Profits (Given) $416,000

Amount Eligible For The SBD ( 250,000) $166,000

Taxable Income $423,000

Amount Eligible For The SBD ( 250,000) $173,000

Based on these figures, the deduction would be equal to $21,580 [(13%)($166,000)].

Note 3 The General Rate Reduction would be calculated as follows:

Taxable Income $423,000

Amount Eligible For The SBD ( 250,000)

Amount Eligible For The M&P Deduction ( 166,000)

Full Rate Taxable Income $ 7,000

Rate 13%

General Rate Reduction $ 910

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TIF Solution Twelve - 17

Note to Instructor As the ART is not covered until Chapter 13, this problem does not require
the calculation of the ART which would be nil due to the capital loss carry forward applied.

Part A - Net Income For Tax Purposes

The calculation of MIL’s Net Income For Tax Purposes would be as follows:

Accounting Net Income Before Taxes $ 609,400

Additions:

Amortization Expense (Income Statement) $285,000

Taxable Capital Gain On Building (Note 1) 7,500

Taxable Capital Gain On Land (Note 1) 12,500

Taxable Capital Gain On Vacant Land (Note 2)5,100

Recapture On Building (Note 3) 125,646

Accounting Loss On Vehicles (Income Statement) 40,000

Non-Deductible Meals And Entertainment

(50% of $32,000) 16,000

Golf Club Membership Fees 14,600

Bond Discount Amortization 3,500

Donations To Registered Charities 16,900

Interest On Late Income Tax Instalments 900

Foreign Tax Withheld 2,400 530,046

$1,139,446

Deductions:

Accounting Gain On Building (Income Statement) ($ 75,000)

Accounting Gain On Vacant Land

(Income Statement) ( 51,000)

Landscaping ( 15,000)

Capital Cost Allowance (Note 3) ( 287,102)

Terminal Loss (Note 3) ( 19,417) ( 447,519)

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Net Income For Tax Purposes $ 691,927

Note 1 While the accounting gain on the building is calculated on the combined value of the land
and building, separate tax figures are required for each asset. The taxable capital gain on the
building is calculated as follows:

Proceeds Of Disposition ($1,185,000 - $225,000) $960,000

Capital Cost ($1,145,000 - $200,000) ( 945,000)

Capital Gain $15,000

Inclusion Rate 1/2

Taxable Capital Gain $ 7,500

In addition to the taxable capital gain on the building, there will be a taxable capital gain on the land
of $12,500 [(1/2)($225,000 - $200,000)]

Note 2 There is a capital gain on the vacant land of $51,000 ($623,000 - $572,000). However, as
not all of the proceeds of disposition were received in 2018, a reserve can be deducted. The reserve
will be the lesser of the following two amounts:

 [($51,000)($573,000  $623,000)] = $46,907

 [($51,000)(20%)(4 - 0] = $40,800

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Deducting the lesser amount leaves a capital gain of $10,200 ($51,000 - $40,800), and a taxable
capital gain of $5,100 [(1/2)($10,200)].

Note 3 Maximum CCA and other related inclusions and deductions are found in the tables
which follow. Note that the new building was added to a separate Class in order to qualify for
the enhanced CCA rate of 10 percent. This resulted in recapture on the old building that was
disposed of.

Class 1 - Old Building

January 1, 2018 Class 1 Balance $819,354

Disposition - Lesser Of:

 Proceeds = $960,000 ($1,185,000 - $225,000)

 Capital Cost = $945,000 ($1,145,000 - $200,000)( 945,000)

Negative Ending UCC Balance ($125,646)

Recapture 125,646

January 1, 2019 UCC Balance Nil

Class 1 - New Building

New Class 1 Addition ($1,425,000 - $260,000) $1,165,000

One-Half Net Additions ( 582,500)

Balance $ 582,500

CCA [(10%)($582,500)] ( 58,250)

One-Half Net Additions 582,500

January 1, 2019 UCC Balance $1,106,750

Class 8

January 1, 2018 Class 8 Balance $ 985,261

Additions 98,000

One-Half Net Additions ( 49,000)

CCA Base $1,034,261

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CCA [(20%)($1,034,261)] ( 206,852)

One-Half Net Additions 49,000

January 1, 2019 UCC Balance $ 876,409

Class 10

January 1, 2018 Class 10 Balance $96,417

Disposition - Lesser Of:

 Proceeds = $77,000

 Capital Cost = $193,000 ( 77,000)

Positive Ending Balance With No Assets Left In Class $ 19,417

Terminal Loss ( 19,417)

January 1, 2019 UCC Balance Nil

Class 13

January 1, 2018 Class 13 Balance $187,000

2018 CCA:

2016 Expenditures ($180,000  10 Years) ( 18,000)

2017 Expenditures ($36,000  9 Years) ( 4,000)

January 1, 2019 UCC Balance $165,000

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Summary Of CCA And UCC Results

Class Maximum CCA UCC

Class 1 - Old (Recapture = $125,646) Nil Nil

Class 1 - New $ 58,250 $1,106,750

Class 8 206,852 876,409

Class 10 (Terminal Loss = $19,417) Nil Nil

Class 13 ($18,000 + $4,000) 22,000 165,000

Total $287,102

Part B - Taxable Income

MIL’s Taxable Income would be calculated as follows:

Net Income For Tax Purposes $691,927

Dividends From Taxable Canadian Corporations ( 37,000)

Contributions To Registered Charities ( 16,900)

Net Capital Loss Carry Over (Note 4) ( 25,100)

Non-Capital Loss Carry Over (All) ( 46,800)

Taxable Income $566,127

Note 4 MIL’s Net Income For Tax Purposes contained net taxable capital gains calculated as
follows:

Taxable Capital Gain On Building $ 7,500

Taxable Capital Gain On Building Land 12,500

Taxable Capital Gain On Vacant Land 5,100

Total Taxable Capital Gains $25,100

While there is a net capital loss of $128,000, the amount to be used is limited to the $25,100 in net
taxable capital gains for the year.

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Part B - Loss Carry Forwards

At the end of 2018, there would be a net capital loss carry forward of $102,900 ($128,000 - $25,100).
There is no remaining non-capital loss carry forward.

Part C - Tax Payable

MIL’s Tax Payable would be calculated as follows:

Base Amount Of Part I Tax [(38%)($566,127)] $215,128

Federal Tax Abatement [(10%)(93%)($566,127)] ( 52,650)

Small Business Deduction (Note 5) ( 27,000)

General Rate Reduction (Note 6) ( 54,097)

Foreign Business Tax Credit (Given) ( 2,400)

Part I Tax Payable $ 78,981

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Note 5 The amount eligible for the small business deduction would be the least of the following
amounts:

Canadian Source Active Business Income (Given) $613,168

Taxable Income $566,127

Less: 4 Times The Foreign Business Tax Credit [(4)($2,400)] ( 9,600)

Adjusted Taxable Income $556,527

Annual Business Limit (Given) $150,000

The least of these figures is $150,000, resulting in a small business deduction of $27,000 [(18.0%)
($150,000)].

Note 6 The general rate reduction would be calculated as follows:

Taxable Income $566,127

Amount Eligible For The Small Business Deduction ( 150,000)

Full Rate Taxable Income $416,127

Rate 13%

General Rate Reduction $ 54,097

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Chapter Thirteen Test Item File Solutions

TIF Solution Thirteen - 1

1. As presented in the text, the two views can be described as follows:

Entity View The entity view holds that corporations have a perpetual life of their own, that
they are independent of their shareholders, and that they are legal entities. As such, they should
pay tax separately on their earnings.

Integration View Under the integration approach to the taxation of business income,
corporations are viewed as simply the legal form through which one or more individuals
(shareholders) carry on business. Therefore, business income that flows through a corporation
to an individual should not be taxed differently, in total, from business income earned directly
by that individual as a proprietor or partner.

2. The basic objective of integration is to neutralize the effect of incorporating a source of income.
That is, integration procedures attempt to ensure that, for a given income source, the after tax
amount that will be received by an individual will be the same, whether the income is received
directly or, alternatively, flowed through a corporation. This would mean that the individual taxes
paid on income received directly would be equal to the combined corporate and individual taxes
paid on income flowed through a corporation.

In a somewhat broader sense, full integration would imply that the timing of the tax payments
would be the same under the two alternatives. That is, integration should serve to prevent a
corporation from being used to defer payment of part of the total tax obligation.

3. The 16 percent gross up of dividends received is based on the assumption of a notional 13.79
percent tax rate being applicable at the corporate level. When this rate is applicable, the 16 percent
gross up restores the Taxable Income to the same amount that was initially earned at the corporate
level.

After the shareholder’s taxes are calculated, a dividend tax credit is deducted. At the federal level,
this credit equals 8/11 of the gross up. In those cases where the provincial tax credit is equal to 3/11
of the gross up, the result is a combined credit that is equal to the gross up. As the 16 percent gross
up reflects corporate taxes paid at a 13.79 percent rate, this combined credit will eliminate the effect
of corporate taxation, thereby achieving the basic goal of integration, assuring that the same amount
of taxes will be paid whether the income is received directly or channeled through a corporation.

4. As defined in ITA 129(4), aggregate investment income is made up of:

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 Net taxable capital gains for the year, reduced by any net capital loss carry overs deducted
during the year.

 Property income other than dividends that are deductible in determining the corporation’s
Taxable Income.

5. Aggregate investment income includes taxable gains, reduced by any net capital losses deducted
during the year. Property income does not include taxable capital gains. These items are covered in
subdivision c of the Income Tax Act.

Property income includes dividends from Canadian corporations. Aggregate investment income
does not include dividends that are deductible in determining the corporation’s Taxable Income.

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6. When a corporation’s income is distributed to its shareholders, the Part I refund lowers the effective
corporate tax rate to about 20 percent. However, until the income is distributed, the rate is between
50-1/6 and 54-2/3 percent, depending on what province the corporation’s income is taxed in. As
this rate is similar to that which is applicable on the direct receipt of investment income, it makes no
economic sense to place investments in a corporation unless there is an intent to distribute most of
the resulting income to shareholders. If, alternatively, the corporate tax rate had been lowered to 20
percent, the corporation could be used to defer a portion of the taxes on investment income. While
the total tax on the flow through of income to the individual would be at the appropriate rate, the
portion that is to be paid by the individual shareholder would be deferred until dividends were paid.
It would appear that the policy goal of using a refundable tax, as opposed to a lower corporate tax
rate, is to prevent this deferral.

7. The objective is to discourage the use of a corporation to shelter income from property. This
additional tax is assessed on the aggregate investment income of a Canadian controlled private
corporation in order to raise the combined federal/provincial tax rate on the investment income of
such companies to a level that is as high or higher than the combined federal/provincial rate that
would be paid by an individual in the highest tax bracket on direct receipt of the income. When this
is accomplished, the individual has no tax incentive to channel this type of income into a CCPC. In
the absence of this tax, the corporate tax rate could be lower than the individual tax rate, resulting in
a deferral of tax until such time as the income is distributed as dividends.

8. The problem here is that a corporation will receive dividends on a tax free basis. If these are
portfolio dividends or dividends on which the payor corporation has received a dividend refund, the
result will be a significant amount of deferral, relative to direct receipt of such dividends, through
the use of a corporation. Imposing a Part IV refundable tax on portfolio dividends and dividends
received from a connected corporation, on which the payor received a refund (dividends paid by a
private corporation or a subject corporation out of investment income) corrects this imperfection in
the integration system. By making the tax refundable, the goal of having the total corporate and
personal taxes approximate the taxes that would be imposed on an individual receiving the income
directly is still achieved.

9. A subject corporation is defined in ITA 186(3) as follows:

Subject Corporation means a corporation (other than a private corporation) resident in

Canada and controlled, whether because of a beneficial interest in one or more trusts or
otherwise, by or for the benefit of an individual (other than a trust) or a related group of
individuals (other than trusts).

For purposes of Part IV tax, subject corporations are treated as private corporations, despite the
fact that some of their shares are publicly traded.

10. A connected corporation is either:

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 a controlled corporation, where control represents ownership of more than 50 percent of

the voting shares by any combination of the other corporation and persons with whom it
does not deal at arm’s length, or

 a corporation in which the other corporation owns more than 10 percent of the voting
shares, and more than 10 percent of the fair market value of all of the issued shares of the
corporation.

Dividends from such corporations are subject to Part IV tax to the extent they are the basis for a
dividend refund received by the paying corporation.

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11. As described in your text, the circumstances are as follows:

 A dividend is received from an unconnected company that is deductible in the calculation of the
recipient’s Taxable Income. While the Income Tax Act refers to such dividends as “assessable
dividends”, it is a common practice to refer to such dividends as “portfolio dividends”.

 The dividend is received from a connected company, and the company paying the dividend
received a refund as a consequence of making the dividend payment.

12. In general, this procedure would not be advantageous. The reason being that, if this option is
chosen, the corporation has effectively used a possible permanent reduction in future taxes to
acquire a reduction of Tax Payable that could otherwise ultimately be refunded. This would only
make sense in situations where the non-capital loss carry forward was about to expire, or where the
company did not expect to have Taxable Income in the carry forward period. With the non-capital
loss carry forward period set at 20 years, this is unlikely to be a very useful strategy.

13. The RDTOH balance is made up of:

 the refundable portion of Part I tax for the year; plus

 the Part IV taxes paid for the year; plus

 the corporation’s RDTOH balance at the end of the preceding year; less

 the corporation’s dividend refund for the preceding year.

14. The 30-2/3 percent rate that is applied to aggregate investment income is based on the notional
assumption that such income is taxed at a combined federal/provincial rate of 50-2/3 percent.
Providing a 30-2/3 percent refund reduces the effective rate on this income to 20 percent. Note that
this was not changed to reflect the fact that the rate that is inherent in the gross up and tax credit
procedures for non-eligible dividends has been reduced from 20 percent to 13.79 percent.

The subtraction is based on the notional assumption that foreign non-business income is only taxed
in Canada at a combined federal/provincial rate of 38-2/3 percent. If the foreign tax credit is less
than or equal to 8 percent, the result will reduce the rate on such income to 30-2/3 percent, the rate
applicable to the refund. In these circumstances, no deduction is required.

However, if the foreign tax credit exceeds 8 percent, the rate of Canadian tax paid on foreign non-
business income falls below the refund rate of 30-2/3 percent. Given this, the formula requires that
the excess of the foreign non-business tax credit over 8 percent of the foreign investment income be
deducted. If this were not the case, the refund could exceed the amount of Canadian taxes paid.

15. The amount of the refund is the lesser of:

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 the balance in the RDTOH account at the end of the year; and

 38-1/3 percent of taxable dividends paid during the year.

16. The two most common additions to the GRIP balance of a CCPC would be:

 72 percent of the excess of taxable income over the sum of the amount of income that is
eligible for the small business deduction plus the amount of aggregate investment income.

 The full amount of eligible dividends received from other corporations.

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17. The most common addition would probably be non-eligible dividends received from a CCPC. The
other possibility would be income retained by a CCPC before it became a public company.

18. For a CCPC, the EEDD (Part III.1) tax is equal to 20 percent of the excess of the eligible dividends
designated during the year, over the end-of-year balance in the CCPC’s GRIP account. If the CRA
concludes that the EEDD was a deliberate attempt to manipulate the CCPC’s GRIP account, the rate
goes to 30 percent.

19. For a public company, the EEDD (Part III.1) tax is equal to 20 percent of the lesser of the amount of
the eligible dividends designated and the balance in the company’s LRIP account at the point in
time that the eligible dividend was paid. If the CRA concludes that the EEDD was a deliberate
attempt to manipulate the company’s LRIP account, the rate goes to 30 percent.

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TIF Solution Thirteen - 2

1. True.

After tax rates of return are higher for eligible dividends.

2. False.

If public company has an LRIP balance, any dividend declared will be a non-eligible dividend.

3. True.

Aggregate investment income is reduced by any net capital losses that are deducted during the
year.

4. True.

The objective of the Additional Refundable Tax On Investment Income is to discourage the use
of a Canadian controlled private corporation to defer taxes on investment income.

5. False.

It is only assessed when the connected company has received a dividend refund as a result of
paying the dividend.

6. True.

The definition of a connected company includes a corporation in which the other corporation
owns more than 10 percent of the voting shares, and more than 10 percent of the fair
market value of all of the issued shares of the corporation.

7. False.

It is reduced by the dividend refund in the preceding year.

8. True.

The dividend refund for the current year cannot exceed the balance in the RDTOH account at
the end of the year.

9. False.

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Even if the CCPC has a GRIP balance, the designation of a dividend as eligible is discretionary.
There is no required designation.

10. True.

A Canadian controlled private corporation’s GRIP balance is reduced by dividends that were
designated as eligible in the preceding taxation year.

11. True.

12. False.

The combined federal/provincial dividend tax credit must be equal to 100 percent of the gross
up.

13. False. It is the RDTOH balance at the end of the year that is relevant.

14. False.

GRIP is increased by 100 percent of eligible dividends received during the year.

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TIF Solution Thirteen - 3

Integration
1. C. The combined federal/provincial dividend tax credit will always be equal to the gross
up.

2. C. They can only be designated as eligible dividends by public companies.

3. B. A capital dividend.

4. D. For integration to be effective in situations where non-eligible dividends are paid, the
combined federal/provincial tax rate on corporations must be equal to 13.79 percent.

5. C. The combined corporate federal and provincial tax rates must equal 13.79% for non-
eligible dividends and 27.54% for eligible dividends, and the combined federal and provincial
dividend tax credits must equal the gross up.

6. A. Some CCPCs have some portion of their income taxed at full rates while some non-
CCPCs have some portion of their income taxed at lower rates.

7. B. If the combined corporate tax rate is equal to the benchmark rate, then the use of a
corporation will result in the same amount of taxation.

8. A. If the combined dividend tax credit rate is less than 100 percent of the gross up, then
the use of a corporation will result in additional taxation.

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Refundable Taxes On Investment Income

9. D. Dividends from taxable Canadian companies.

10. A. $6,000 [$45,000 - $42,000 + $3,000]

11. B. Lower rates would provide a significant deferral of taxes on investment income.

12. D. Dividends from taxable Canadian corporations.

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Refundable Part I Tax On Investment Income

13. A. It is always equal to 30-2/3 percent of aggregate investment income.

14. C. $7,040 [(10-2/3%)($45,000 + $21,000)]

15. A. $640 [(10-2/3%)($45,000 - $42,000 + $3,000)]

16. B. [($250,000 - $200,000)(30-2/3%)] = $15,333. The addition is limited by Taxable

Income, less the amount eligible for the small business deduction [ITA 129(3)(a)(ii)].

17. D. It is designed to prevent the deferral of taxes on investment income that is retained by
a CCPC.

18. A. Prevent tax deferral in situations where there are multiple levels of corporations in a
corporate group.

19. B. A resident public corporation that is controlled largely for the benefit of an individual
or a related group of individuals.

Refundable Part IV Tax On Dividends Received

20. D. Part IV tax is assessed at a rate of 30-2/3 percent.

21. C. The correct answer is as follows:

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Dividends Received $20,000

Part IV Tax Rate 38-1/3% $7,667

Less: Non-Capital Losses Applied:

Non-Capital Losses ($ 3,000)

Farm Losses ( 7,000)

Subtotal ($10,000)

Rate 38-1/3% ( 3,833)

Minimum Part IV Tax $3,834

In general, reducing Part IV tax by applying non-capital losses would only be advantageous if
the losses were about to expire.

22. B. $ 32,417 [(38-1/3%)($35,000) + [(1005)($15,000)] + (40%)($10,000)]

23. B. The dividend will be subject to a tax of 38-1/3 percent.

24. D. The holding company will receive dividends from the operating company tax free.

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Refundable Dividend Tax On Hand

25. A. The balance is reduced by 38-1/3 percent of any dividends paid during the year.

26. B. $18,400 [($60,000)(30-2/3%)]

27. A. The dividend refund allows corporations with a balance in their RDTOH account to
reduce their tax payable by paying dividends.

28. C. [$70,000 - (38-1/3%)($120,000) + $42,000] = $66,000

Designation Of Eligible Dividends

29. D. A CCPC’s GRIP account is increased by 72 percent of the company’s Taxable
Income.

30. A. The required amount would be calculated as follows:

Balance At End Of 2017 $53,400

Taxable Income $143,000

Income Eligible For SBD

($15,300 ÷ 18.0%) ( 85,000)

Aggregate Investment Income ( 19,000)

Adjusted Taxable Income $ 39,000

Rate 72% 28,080

Eligible Dividends Received 12,300

Eligible Dividends Designated in 2017 ( 13,700)

GRIP At End Of 2018 $80,080

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31. A. The GRIP account is used to track balances that can be used by a CCPC as the basis
for designating eligible dividends.

32. C. $163,000 [$78,000 + $85,000]

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TIF Solution Thirteen - 4

Exam Exercise Solution Thirteen - 1 (Integration - Non-Eligible Dividends)
If he incorporates, the corporation will pay taxes of $18,200 [(14%)($130,000)], leaving $111,800 to be
distributed as dividends. His individual Tax Payable on these dividends would be calculated as follows:

Dividends Received $111,800

Gross Up [(16%)($111,800)] 17,888

Grossed Up Dividends $129,688

Tax Rate 42%

Tax Before Credit $ 54,469

Dividend Tax Credit [(8/11 + 20%)($17,888)] ( 16,587)

Tax Payable On Dividends $ 37,882

The net after tax retention would be $73,918 ($111,800 - $37,882). This compares to $75,400
[($130,000)(1 - .42)] retained if a corporation is not used which is $1,482 higher. The use of a
corporation is not desirable in terms of after tax returns, especially if the costs associated with
maintaining a corporate entity are considered.

Exam Exercise Solution Thirteen - 2 (Integration - Non-Eligible Dividends)

If Nashwa incorporates, the corporation will pay taxes of $15,000 [(15%)($100,000)], leaving $85,000
available for paying dividends. Individual taxes on these dividends would be calculated as follows:

Dividends Received $85,000

Gross Up [(16%)($85,000)] 13,600

Taxable Dividends $98,600

Rate 43%

Tax Before Credit $42,398

Dividend Tax Credit [(8/11 + 29%)($13,600)] ( 13,835)

Tax Payable On Dividends $28,563

Dividends Received $85,000

Tax Payable ( 28,563)

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After Tax Retention $56,437

Retention After Direct Receipt [($100,000)(1 - 43%)] ( 57,000)

Savings (Loss) With Incorporation ($ 563)

The after tax retention with the use of a corporation is $56,437, $563 lower than the retention if the
income was received directly. The use of a corporation is not desirable in terms of after tax returns,
especially if the costs associated with maintaining a corporate entity are considered.

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Exam Exercise Thirteen - 3 Solution (Integration - Eligible Dividends)

If she incorporates, the corporation will pay taxes of $21,000 [(28%)($75,000)], leaving $54,000 to be
distributed as dividends. Her individual Tax Payable on these eligible dividends would be calculated as
follows:

Dividends Received $54,000

Gross Up [(38%)($54,000)] 20,520

Grossed Up Dividends $74,520

Personal Tax Rate 46%

Tax Before Credit $34,279

Dividend Tax Credit [(6/11 + 32%)($20,520)] ( 17,759)

Tax Payable On Dividends $16,520

The net after tax retention would be $37,480 ($54,000 - $16,520). This compares to $40,500 [($75,000)
(1 - .46)] retained if a corporation is not used. Clearly the use of a corporation is not desirable in this
situation.

Exam Exercise Solution Thirteen - 4 (Integration - Eligible Dividends)

With incorporation, corporate taxes would be $29,000 [(29%)($100,000)], leaving $71,000 available to
pay dividends. Individual taxes on this would be calculated as follows:

Dividends Received $71,000

Gross Up [(38%)($71,000)] 26,980

Grossed Up Dividends $97,980

Personal Tax Rate 43%

Tax Before Credit $42,131

Dividend Tax Credit [(6/11 + 29%)($26,980)] ( 22,541)

Tax Payable On Dividends $19,590

Dividends Received $71,000

Tax Payable ( 19,590)

After Tax Retention $51,410

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Retention After Direct Receipt [($100,000)(1 - 43%)] ( 57,000)

Savings (Loss) With Incorporation ($ 5,590)

Exam Exercise Solution Thirteen - 5 Solution

(Additional Refundable Tax On Investment Income)
Axco’s Taxable Income would be calculated as follows:

Net Income For Tax Purposes $342,000

Dividends From Taxable Canadian Corporations ( 31,000)

Net Capital Loss Carry Forward ( 32,000)

Non-Capital Loss Carry Forward ( 29,000)

Taxable Income $250,000

Axco’s amount eligible for the small business deduction of $226,000 is the least of active business
income of $226,000, Taxable Income of $250,000, and the annual business limit of $500,000.

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Given these calculations, Axco’s additional refundable tax on investment income would be calculated
using the lesser of:

Aggregate Investment Income

Taxable Capital Gains $51,000

Net Capital Loss Deducted ( 32,000)

Interest Income 34,000 $53,000

Taxable Income $250,000

Amount Eligible For SBD ( 226,000) $24,000

The additional refundable tax on investment income would be $2,560 [(10-2/3%)($24,000)]. Note that
the Taxable Income limit is $29,000 ($53,000 - $24,000) less than the Aggregate Investment Income.
This difference is the result of the deduction of the $29,000 non-capital loss carry forward.

Exam Exercise Solution Thirteen - 6 Solution

(Additional Refundable Tax On Investment Income)
Barnum’s Taxable Income would be calculated as follows:

Net Income For Tax Purposes $436,000

Dividends From Taxable Canadian Corporations ( 61,000)

Net Capital Loss Carry Forward ( 47,000)

Non-Capital Loss Carry Forward ( 163,000)

Taxable Income $165,000

Barnum’s amount eligible for the small business deduction of $165,000 is the least of active business
income of $256,000, Taxable Income of $165,000, and the annual business limit of $250,000 [(1/2)
($500,000)].
Given these calculations, Barnum’s additional refundable tax on investment income would be 10-2/3
percent of the lesser of:

Aggregate Investment Income

Taxable Capital Gains $85,000

Net Capital Loss Deducted ( 47,000)

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Interest Income 34,000 $72,000

Taxable Income $165,000

Amount Eligible For SBD ( 165,000) Nil

Based on these calculations, the additional refundable tax on investment income would be nil.

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Exam Exercise Solution Thirteen - 7 (Flow Through Of Investment Income)

If Mr. Fisher receives the income directly, he will retain $45,120 [($94,000)(1 - .52)]. Alternatively, if
the investments are transferred to a corporation, the results would be as follows:

Corporate Investment Income $94,000

Corporate Tax At 51 Percent ( 47,940)

Income Before Dividends $46,060

Dividend Refund [($46,060 ÷ .61667) - $46,060] 28,632

Dividends Paid To Mr. Fisher $74,692

Non-Eligible Dividends Received $74,692

Gross Up Of 16 Percent 11,951

Personal Taxable Income $86,643

Personal Tax Rate 52%

Tax Payable Before Dividend Tax Credit $45,054

Dividend Tax Credit [(8/11 + 30%)($11,951)] ( 12,277)

Personal Tax Payable With Corporation $32,777

Non-Eligible Dividends Received $74,692

Personal Tax Payable ( 32,777)

After Tax Cash Retained With Corporation $41,915

The increase in the RDTOH of $28,827 [(30-2/3%)($94,000)] would permit the payment of a dividend
refund of $28,632.
With the corporate tax rate at 51 percent, only 1 percent below the personal rate of 52 percent, there
would only be limited deferral on income left in the corporation.
There would be $3,205 ($45,120 - $41,915) less retained income with the use of a corporation.

Exam Exercise Solution Thirteen - 8 (Flow Through Of Investment Income)

If the income is received directly by Ms. Fox, the after tax retention would be as follows:

Interest Received $172,000

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Personal Taxes [(53%)($172,000)] ( 91,160)

After Tax Cash Retained Without Corporation $ 80,840

The alternative results if the income is flowed through a corporation would be as follows:

Corporate Investment Income $172,000

Corporate Tax At 50 Percent ( 86,000)

After Tax Income $ 86,000

Dividend Refund (Note) 52,747

Dividend To Ms. Fox $138,747

Note Based on the amount of after tax income available, the maximum possible dividend
would be $53,459 [($86,000 ÷ .61667) - $86,000]. However, the refund is limited by the
balance in the RDTOH account. As this is a new corporation, there would be no opening
balance in this account and the addition would be $52,747 [(30-2/3%)($172,000)]. Given this,
the refund would be limited to $52,747.

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Non-Eligible Dividends Received $138,747

Gross Up Of 16 Percent 22,200

Taxable Dividends $160,947

Personal Tax Rate 53%

Tax Payable Before Dividend Tax Credit $ 85,302

Dividend Tax Credit [(8/11 + 35%)($22,200)] ( 23,915)

Personal Tax Payable With Corporation $ 61,387

Non-Eligible Dividends Received $138,747

Personal Tax Payable ( 61,387)

After Tax Cash Retained With Corporation $ 77,360

With the high personal tax rate in this example, the use of the corporation would result in some deferral:

Taxes If Income Received Directly $91,160

Taxes If Income Retained In Corporation ( 86,000)

Deferral $ 5,160

Overall, the use of a corporation would reduce after tax funds as follows:

After Tax Retention - Direct Receipt $80,840

After Tax Retention - Corporate Flow Through ( 77,360)

Reduction In After Tax Retention $ 3,480

Exam Exercise Solution Thirteen - 9 (Part IV Tax)

The amount of Part IV Tax Payable would be calculated as follows:

Tax On Portfolio Investments [(38-1/3%)($21,300)] $ 8,165

Tax On Saston Inc. Dividends Nil

Tax On Raston Inc. Dividends [(40%)($25,000)] 10,000

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Part IV Tax Payable $18,165

Exam Exercise Solution Thirteen - 10 (Part IV Tax)

The amount of Part IV Tax Payable would be calculated as follows:

Tax On Whitewood Ltd. Dividends [(65%)($20,000)] $13,000

Tax On Redwood Inc. Dividends Nil

Tax On Portfolio Investments [(38-1/3%)($35,000)] 13,417

Part IV Tax Payable $26,417

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Exam Exercise Solution Thirteen - 11 (Refundable Part I Tax)

The refundable amount of Starfare Ltd.’s Part I tax would be the least of the following three figures:

Net Rental Income $17,600

Taxable Capital Gains [(1/2)($91,500)] 45,750

Interest Income 17,450

Foreign Non-Business Income (100 Percent) 20,000

Net Capital Losses Deducted ( 24,000)

Aggregate Investment Income Under ITA 129(4) $76,800

Rate 30-2/3%

Amount Before Foreign Income Adjustment $23,552

Less The Excess Of:

Foreign Non-Business Tax Credit ($1,600)

Over 8 Percent Of $20,000 1,600 Nil

ITA 129(3)(a)(i) Amount $23,552

Taxable Income ($232,350 - $41,300 - $24,000) $167,050

Less:

Amount Eligible For The Small Business

Deduction ($13,500 ÷ 18%) ( 75,000)

[(100 ÷ 38-2/3)($1,600)] Foreign Non-Business Tax Credit ( 4,138)

Adjusted Taxable Income $ 87,912

Rate 30-2/3%

ITA 129(3)(a)(ii) Amount $ 26,960

ITA 129(3)(a)(iii) Amount - Part I Tax Payable $37,883

The least of these three amounts is $23,552, and this would be the refundable portion of Part I tax for the
year.

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Exam Exercise Solution Thirteen - 12 (Refundable Part I Tax)

The refundable amount of Elm’s Part I tax would be calculated as follows:

Interest On Long Term Investments $33,000

Taxable Capital Gains 88,000

Net Rental Income 26,000

Foreign Non-Business Income (100 Percent) 40,000

Net Capital Loss Deducted ( 45,000)

Aggregate Investment Income $142,000

Rate 30-2/3%

Amount Before Foreign Income Adjustment $ 43,547

Less The Excess of:

Foreign Non-Business Tax Credit ($4,000)

Over 8 Percent Of $40,000 3,200 ( 800)

ITA 129(3)(a)(i) Amount $ 42,747

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Taxable Income ($458,000 - $83,000 - $45,000) $330,000

Amount Eligible For The SBD ($22,500 ÷ 18%) ( 125,000)

[(100 ÷ 38-2/3)($4,000)] Foreign Non-Business Tax Credit ( 10,345)

Adjusted Taxable Income $194,655

Rate 30-2/3%

ITA 129(3)(a)(ii) Amount $ 59,694

ITA 129(3)(a)(iii) Amount - Part I Tax Payable $ 72,857

The least of these three amounts is $42,747, and this would be the refundable portion of Part I tax for the
year.

Exam Exercise Solution Thirteen - 13 (RDTOH Increase For The Year)

The increase in the RDTOH account would be the least of the following three figures:

Aggregate Investment Income $60,000

Rate 30-2/3%

Amount Before Foreign Income Adjustment $18,400

Less The Excess Of:

Foreign Non-Business Tax Credit ($6,000)

Over 8 Percent Of $60,000 4,800 ( 1,200)

ITA 129(3)(a)(i) Amount $17,200

Taxable Income $200,000

Less:

Amount Eligible For The Small Business Deduction ( 140,000)

[(100 ÷ 38-2/3)($6,000)] Foreign Non-Business Tax Credit ( 15,517)

Adjusted Taxable Income $ 44,483

Rate 30-2/3%

ITA 129(3)(a)(ii) Amount $ 13,641

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ITA 129(3)(a)(iii) Amount - Part I Tax Payable $ 31,200

The least of these three amounts is $13,641, and this would be the increase in the RDTOH for the year.

Exam Exercise Solution Thirteen - 14 (Dividend Refund)

The balance in the RDTOH account of Ho Trading Company would be as follows:

RDTOH, End Of Preceding Year $43,500

Less: Dividend Refund For Preceding Year (Given) ( 6,000)

Opening Balance $37,500

Refundable Part I Tax [(30-2/3%)($43,000)] 13,187

Part IV Tax On Portfolio Dividends [(38-1/3%)($12,350)] 4,734

Closing Balance - RDTOH $55,421

The dividend refund would be $13,417 [(38-1/3%)($35,000)], the lesser of 38-1/3 percent of the
dividends paid and the $55,421 balance in the RDTOH account.

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Exam Exercise Solution Thirteen - 15 (Dividend Refund)

The RDTOH balance at the end of 2018 is calculated as follows:

RDTOH, End Of Preceding Year $15,000

Less: Dividend Refund For Preceding Year (Given) ( 12,000)

Opening Balance $ 3,000

Refundable Part I Tax - Given 2,000

Part IV Tax Payable [(38-1/3%)($18,000)] 6,900

Closing Balance - RDTOH $11,900

The dividend refund is $11,900, the lesser of the $11,900 balance in RDTOH at the end of the year, and
38-1/3 percent of taxable dividends paid or $14,950 [(38-1/3%)($39,000)].

Exam Exercise Solution Thirteen - 16 (GRIP Balance)

Since Taxable Income is greater than Aggregate Investment Income, the 2018 ending balance in GRIP
will be calculated as follows:

GRIP Balance At End Of 2017 $167,000

Taxable Income $476,000

Income Eligible For SBD ($72,000 ÷ 18%) ( 400,000)

Aggregate Investment Income

($14,000 + $7,000 - $14,000) ( 7,000)

Adjusted Taxable Income $ 69,000

Rate 72% 49,680

Eligible Dividends Received 17,000

Eligible Dividends Designated in 2017 ( 153,000)

GRIP At End Of 2018 $ 80,680

The eligible dividends paid during 2018 will be deducted from the GRIP in 2019.

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Exam Exercise Solution Thirteen - 17 (GRIP Balance)

Since Taxable Income is greater than Aggregate Investment Income, the 2018 ending balance in GRIP
will be calculated as follows:

GRIP Balance At End Of 2017 $375,000

Taxable Income $726,000

Income Eligible For SBD ($63,000 ÷ 18%) ( 350,000)

Aggregate Investment Income

($18,000 + $22,000 - $18,000) ( 22,000)

Adjusted Taxable Income $354,000

Rate 72% 254,880

Eligible Dividends Received 36,000

Eligible Dividends Designated in 2017 ( 290,000)

GRIP At End Of 2018 $375,880

The eligible dividends paid during 2018 will be deducted from the GRIP in 2019.

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TIF Solution Thirteen - 5A

The correct definitions for each of the listed key terms are as follows:

A. 10

B. 3

C. 4

D. 8

E. 5

F. 2

G. 7

H. 1

The two unused definitions are as follows:

Low Rate Income Pool = 6

Refundable Part I Tax = 9

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TIF Solution Thirteen - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.

The correct definitions for each of the listed key terms are as follows:

A. 13

B. 4 (not 11)

C. 5

D. 10 (not 3)

E. 6 (not 14)

F. 2 (not 7)

G. 9

H. 1

The two unused definitions are as follows:

Low Rate Income Pool = 8

Refundable Part I Tax = 12

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TIF Solution Thirteen - 6

The required calculations would be as follows:

Corporate Taxes

Income For The Year $80,000

Corporate Taxes (13%) ( 10,400)

Income Available For Dividends $69,600

Personal Taxes On Dividends

Dividend Income $69,600

Gross Up (16%) 11,136

Taxable Dividends $80,736

Tax Payable Before Dividend Tax Credit

[(26% + 8%)($80,736)] $27,450

Dividend Tax Credit [(8/11 + 20%)($11,136)] ( 10,326)

Personal Tax Payable $17,124

Total Taxes On Corporate Flow Through

Corporate Taxes $10,400

Personal Taxes 17,124

Total Taxes $27,524

Total Taxes On Income Earned Directly

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Income For The Year $80,000

Combined Federal/Provincial Tax Rate (26% + 8%) 34%

Personal Tax Payable $27,200

The combined corporate and personal taxes are $324 ($27,524 - $27,200) higher than the taxes that
would be paid on the direct receipt of income. This result reflects a low corporate combined tax rate of
13 percent (perfect integration requires a 13.79 percent corporate tax rate) which encourages the use of a
corporation. Offsetting this is a low provincial dividend tax credit (perfect integration requires a 3/11 or
27.3 percent credit).
While the results are fairly close, integration is not working perfectly.

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TIF Solution Thirteen - 7

Part IV Refundable Tax
The Part IV Tax Payable for Medtech Inc. would be calculated as follows:

Dividend Refund Received By Medcare $20,386

Medtech’s Percentage Of Ownership 42%

Part IV Payable On Delux Inc. Dividends $ 8,562

Part IV Tax On Public Company Dividends

[(38-1/3%)($26,560)] 10,181

Part IV Tax Payable $18,743

Part I Refundable Tax

The refundable portion of the Part I tax would be the least of the following amounts:

Taxable Capital Gain [(1/2)($87,460)] $43,730

Net Rental Income 14,760

Aggregate Investment Income $58,490

Rate 30-2/3%

ITA 129(3)(a)(i) $ 17,937

Taxable Income $456,250

Amount Eligible For Small Business Deduction

(See Note) ( 100,000)

Total $356,250

Rate 30-2/3%

ITA 129(3)(a)(ii) $109,250

ITA 129(3)(a)(iii) Part I Tax Payable - Given $ 82,506

Note The problem states that Medtech’s $100,000 share of the annual business limit is less
than active business income. In addition, it is less than the Company’s Taxable Income. These

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facts establish that the amount eligible for the small business deduction is Medtech’s share of
the annual business limit.

The refundable portion of Part I tax is equal to $17,937, which is the least of the preceding three
amounts.

RDTOH
The end of year balance in the Refundable Dividend Tax On Hand account and refundable Part I tax can
be calculated as follows:

RDTOH Balance - End Of The Preceding Year $26,330

Dividend Refund For The Preceding Year ( 8,885)

Opening Balance $17,445

Part IV Tax Payable 18,743

Refundable Part I Tax 17,937

RDTOH Balance - End Of The Year $54,125

Dividend Refund
The dividend refund will be $25,515 the lesser of:

 $25,515 (38-1/3 percent of the $66,560 in dividends paid); and

 the $54,125 balance in the RDTOH.

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TIF Solution Thirteen - 8

The required calculation of Part I Tax Payable would be as follows:

Taxable Income (Given) $227,000

Base Amount Of Part I Tax [(38%)($227,000)] $86,260

Federal Tax Abatement [(10%)($227,000)] ( 22,700)

Small Business Deduction (Note One) ( 36,000)

Additional Refundable Tax On Investment Income (Note Two) 2,880

Manufacturing And Processing Profits Deduction (Note Three) Nil

General Rate Reduction (Note Four) Nil

Foreign Non-Business Income Tax Credit (Equal To Withholding) ( 4,500)

Part I Tax Payable $

Note One There is a circular calculation involved in the calculation of foreign tax credits, the small
business deduction, and the ART. This adds considerable complexity to the calculation of Tax
Payable and, in most situations, the additional calculations do not influence the outcome (that
would, in fact, be the case in this problem). To avoid these additional calculations, we have stated
that the foreign tax credit is equal to the amount withheld.

Given the preceding assumption with respect to the foreign tax credit, the small business deduction
would be equal to 18.0 percent of the least of:

1. Active Business Income (Given) $237,000

2. Taxable Income $227,000

Deduct:

[(100/28)($4,500)] Foreign

Non-Business Tax Credit ( 16,071) $210,929

3. Allocated Annual Business Limit (Given) $200,000

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The least of the three figures is $200,000, resulting in a small business deduction of $36,000
[(18.0%)($200,000)].

Note Two The aggregate investment income is equal to the gross foreign investment income plus
the taxable capital gain. The ITA 123.3 refundable tax (ART) is 10-2/3 percent of the lesser of:

1. Aggregate Investment Income ($30,000 + $10,000) $40,000

2. Taxable Income $227,000

Deduct: Amount Eligible For The SBD ( 200,000) $27,000

The ITA 123.3 tax on aggregate investment income is $2,880 [(10-2/3%)($27,000)].

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Note Three The manufacturing and processing deduction would be 13 percent of the lesser of:

1. Canadian M & P Profits (Given) $126,000

Deduct: Amount Eligible For SBD ( 200,000) Nil

2. Taxable Income $227,000

Deduct:

Amount Eligible For The SBD ( 200,000)

Aggregate Investment Income (Note Two) ( 40,000) Nil

Given these calculations, the M& P deduction would be nil.

Note Four The general rate reduction is nil, calculated as follows:

Taxable Income $227,000

Amount Eligible For The SBD ( 200,000)

Amount Eligible For The M&P Deduction Nil

Aggregate Investment Income (Note Two) ( 40,000)

Full Rate Taxable Income Nil

Rate 13%

General Rate Reduction Nil

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TIF Solution Thirteen - 9

Part A - Part I Tax Payable
The required calculations to determine Part I federal Tax Payable are as follows:

Net Income For Tax Purposes $1,038,800

Dividends ($297,400 + $89,600) ( 387,000)

Net Capital Loss Carry Forward ( 12,000)

Non-Capital Loss Carry Forward ( 163,400)

Taxable Income $ 476,400

Base Amount Of Part I Tax [(38%)($476,400)] $181,032

Federal Tax Abatement [(10%)($476,400)] ( 47,640)

Small Business Deduction (Note One) ( 18,000)

Additional Refundable Tax On Investment Income (Note Two) 13,376

M&P Deduction (Note Three) ( 29,380)

General Rate Reduction (Note Four) ( 3,250)

Part I Federal Tax Payable $ 96,138

Note One The small business deduction is 18 percent of the least of the following three
amounts:

1. Active Business Income $514,400

2. Taxable Income (no adjustments) $476,400

3. Allocated Annual Business Limit $100,000

The lowest of these figures is the Company’s $100,000 share of the annual business limit. This
gives a small business deduction of $18,000 [(18%)($100,000)].

Note Two The aggregate investment income of $125,400 is calculated as follows:

Taxable Capital Gains $ 93,100

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Net Capital Loss Carry Forward Deducted ( 12,000)

Canadian Source Interest 44,300

Aggregate Investment Income $125,400

The ITA 123.3 refundable tax (ART) is 10-2/3 percent of the lesser of:

1. Aggregate Investment Income $125,400

2. Taxable Income $476,400

Deduct: Amount Eligible For The SBD ( 100,000) $376,400

The ITA 123.3 tax on aggregate investment income is $13,376 [(10-2/3%)($125,400)].

Note Three The manufacturing and processing deduction would be 13 percent of the lesser of:

1. Canadian M & P Profits (Given) $326,000

Deduct: Amount Eligible For SBD ( 100,000) $226,000

2. Taxable Income $476,400

Deduct:

Amount Eligible For The SBD ( 100,000)

Aggregate Investment Income (Note Two) ( 125,400) $251,000

The M&P deduction would be equal to $29,380 [(13%)($226,000)].

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Note Four The general rate reduction would be calculated as follows:

Taxable Income $476,400

Amount Eligible For The Small Business Deduction ( 100,000)

Amount Eligible For The M&P Deduction ( 226,000)

Aggregate Investment Income (Note Two) ( 125,400)

Full Rate Taxable Income $ 25,000

Rate 13%

General Rate Reduction $ 3,250

Part B - Part IV Tax Payable

The required calculation of the Part IV Tax Payable is as follows:

Portfolio Dividends [($89,600)(38-1/3%)] $34,347

Dividend Refund To Wholly Owned Subsidiary 52,800

Total Part IV Tax Payable $87,147

Part C - RDTOH Balance

The calculation of the ending balance in the Refundable Dividend Tax On Hand account is as follows:

RDTOH, End Of The Preceding Year $ 12,000

Dividend Refund For The Preceding Year Nil

Opening Balance $ 12,000

Refundable Portion Of Part I Tax (Note Five) 38,456

Part IV Tax (See Part B) 87,147

RDTOH Balance - December 31, 2018 $137,603

Note Five Using amounts calculated in Part A, the amount of refundable Part I tax is $38,456,
the least of three amounts, calculated as follows:

Amount Under ITA 129(3)(a)(i) [(30-2/3%)($125,400)] $ 38,456

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Amount Under ITA 129(3)(a)(ii) [(30-2/3%)($476,400 - $100,000)] $115,429

Amount Under ITA 129(3)(a)(iii) Part I Tax Payable $ 96,138

Part D - GRIP Balance

Since Taxable Income is greater than Aggregate Investment Income, the December 31, 2018 GRIP
balance would be calculated as follows:

GRIP Balance At End Of 2017 $ 26,700

Taxable Income $476,400

Income Eligible For SBD ( 100,000)

Aggregate Investment Income ( 125,400)

Adjusted Taxable Income $251,000

Rate 72% 180,720

Eligible Dividends Received 89,600

Eligible Dividends Designated in 2017 Nil

GRIP At End Of 2018 $297,020

The designated eligible dividends paid in 2018 will be deducted from the GRIP balance in 2019.

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Part E - Dividend Refund

The dividend refund for the year would be $50,753, the lesser of:

 38-1/3 percent of taxable dividends paid [($132,400)(38-1/3%)] = $50,753

 Ending RDTOH Balance (Part C) = $137,603

Part F - Total Federal Tax Payable

The required calculation to determine federal Tax Payable is as follows:

Part I Tax (See Part A) $ 96,138

Part IV Tax (See Part B) 87,147

Dividend Refund (See Part E) ( 50,753)

Federal Tax Payable $132,532

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TIF Solution Thirteen - 10

Part A - Part IV Refundable Tax
The Part IV Tax Payable for Conrod Holdings Ltd. would be calculated as follows:

Dividend Refund Received By Morsal Inc. $8,050

Conrod’s Percentage Of Ownership 70%

Part IV Payable On Morsal Inc. Dividends $5,635

Part IV Tax On Imperial Oil Dividends [(38-1/3%)($500)] 192

Part IV Tax Payable $5,827

Part B - Part I Refundable Tax

As the interest received appears to be related to temporary balances resulting from the Company’s
normal business activities, it would be viewed as active business income and would not influence the
following calculations.
The refundable portion of the Part I tax would be the least of the following amounts:

Aggregate Investment Income [(1/2)($9,200)] $ 4,600

Rate 30-2/3%

ITA 129(3)(a)(i) $ 1,411

Taxable Income $44,000

Amount Eligible For Small Business Deduction ( 10,000)

Total $34,000

Rate 30-2/3%

ITA 129(3)(a)(ii) $10,427

ITA 129(3)(a)(iii) Part I Tax Payable - Given $ 9,250

The refundable portion of Part I tax is equal to $1,411, which is the least of the preceding three
amounts.

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Part C - RDTOH
The end of year balance in the Refundable Dividend Tax On Hand account can be calculated as follows:

RDTOH Balance - End Of The Preceding Year $ 8,950

Dividend Refund For The Preceding Year ( 4,000)

Opening Balance $ 4,950

Part IV Tax Payable (Part A) 5,827

Refundable Part I Tax (Part B) 1,411

RDTOH Balance - End Of The Year $12,188

Part D - Dividend Refund

The dividend refund is the lesser of:

 $3,833 - 38-1/3 percent of the $10,000 in dividends paid.

 $12,188 - The ending balance in the RDTOH.

The lesser of these two figures is $3,833.

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TIF Solution Thirteen - 11

The required calculation of Part I Tax Payable would be as follows:

Taxable Income (Given) $95,000

Base Amount Of Part I Tax [(38%)($95,000)] $36,100

Federal Tax Abatement [(10%)($95,000)] ( 9,500)

Small Business Deduction (Note One) ( 16,329)

Additional Refundable Tax On Investment Income (Note Two) 457

Foreign Non-Business Income Tax Credit (Equal To Withholding) ( 1,200)

Manufacturing And Processing Profits Deduction (Note Three) Nil

General Rate Reduction (Note Four) Nil

Part I Tax Payable $ 9,528

Note One There is a circular calculation involved in the calculation of foreign tax credits, the small
business deduction, and the ART. This adds considerable complexity to the calculation of Tax
Payable and, in most situations, the additional calculations do not influence the outcome (that
would, in fact, be the case in this problem). To avoid these additional calculations, we have stated
that the foreign tax credit is equal to the amount withheld.

Given the preceding assumption with respect to the foreign tax credit, the small business deduction
would be equal to 18.0 percent of the least of:

1. Active Business Income $133,000

2. Taxable Income $95,000

Deduct:

[(100/28)($1,200)] Foreign Non-Business Tax Credit ( 4,286) $ 90,714

3. Annual Business Limit $500,000

The least of the three figures is $90,714, resulting in a small business deduction of $16,329
[(18.0%)($90,714)].

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Note Two The aggregate investment income is equal to the gross foreign investment income of
$8,000. The ITA 123.3 refundable tax (ART) is 10-2/3 percent of the lesser of:

1. Aggregate Investment Income $8,000

2. Taxable Income $95,000

Deduct: Amount Eligible For The SBD ( 90,714) $4,286

The ITA 123.3 tax on aggregate investment income is $457 [(10-2/3%)($4,286)].

Note Three The manufacturing and processing deduction would be 13 percent of the lesser of:

1. Canadian M & P Profits (Given) $99,000

Deduct: Amount Eligible For SBD ( 90,714) $8,286

2. Taxable Income $95,000

Deduct:

Amount Eligible For The SBD ( 90,714)

Aggregate Investment Income (Note Two) ( 8,000) Nil

Given these calculations, the M& P deduction would be nil.

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Note Four The general rate reduction is nil, calculated as follows:

Taxable Income $95,000

Amount Eligible For The SBD ( 90,714)

Amount Eligible For The M&P Deduction Nil

Aggregate Investment Income (Note Two) ( 8,000)

Full Rate Taxable Income Nil

Rate 13%

General Rate Reduction Nil

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TIF Solution Thirteen - 12

Landor Ltd.’s Taxable Income would be calculated as follows:

Net Income For Tax Purposes $223,500

Net Capital Loss Carry Forward Deducted (All) ( 5,250)

Taxable Income $218,250

Landor Ltd.’s net federal Tax Payable would be calculated as follows:

Base Amount Of Part I Tax [(38%)($218,250)] $82,935

Federal Tax Abatement (Note One) ( 19,643)

Small Business Deduction (Note Two) ( 19,800)

Additional Refundable Tax On Investment Income (Note Three) 640

Manufacturing And Processing Profits Deduction (Note Four) ( 4,771)

General Rate Reduction (Note Five) ( 8,522)

Foreign Tax Credit On Business Income [(10%)($28,800)] ( 2,880)

Part I Tax Payable $27,959

Dividend Refund (Note Six) ( 1,840)

Net Federal Tax Payable $26,119

Note One The abatement is based on 90 percent [(88% + 92%) ÷ 2] of Landor’s income being
taxed in a province. This gives a figure of $19,643 [(90%)(10%)($218,250)].

Note Two The small business deduction is 18 percent of the least of the following three amounts:

1. Canadian Active Business Income (Given) $183,450

2. Taxable Income $218,250

Deduct: [(4)($2,880)] Business FTC ( 11,520) $206,730

3. Allocated Annual Business Limit (Given) $110,000

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The least of these figures is the Company’s $110,000 share of the annual business limit, resulting in
a small business deduction of $19,800 [(18%)($110,000)].

Note Three The aggregate investment income of $6,000 is calculated as follows:

Taxable Capital Gains $11,250

Net Capital Loss Carry Forward Deducted ( 5,250)

Aggregate Investment Income $ 6,000

The ITA 123.3 refundable tax (ART) is 10-2/3 percent of the lesser of:

1. Aggregate Investment Income $ 6,000

2. Taxable Income $218,250

Deduct: Amount Eligible For The SBD ( 110,000) $108,250

The ITA 123.3 tax on aggregate investment income is $640 [(10-2/3%)($6,000)].

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Note Four The manufacturing and processing profits deduction would be 13 percent of the lesser
of:

1. M & P Profits (Given) $146,700

Deduct: Amount Eligible For The SBD ( 110,000) $36,700

2. Taxable Income $218,250

Deduct:

Amount Eligible For The SBD ( 110,000)

[(4)($2,880)] Foreign Business Tax Credit ( 11,520)

Aggregate Investment Income (Note Three) ( 6,000) $90,730

The lesser of these figures is $36,700, resulting in a manufacturing and processing profits deduction
in the amount of $4,771 [(13%)($36,700)].

Note Five The general rate reduction is calculated as follows:

Taxable Income $218,250

Amount Eligible For The SBD ( 110,000)

Amount Eligible For The M&P Deduction ( 36,700)

Aggregate Investment Income (Note Three) ( 6,000)

Full Rate Taxable Income $ 65,550

Rate 13%

General Rate Reduction $ 8,522

Note Six The only addition to the RDTOH account for the year would be the refundable portion of
Part I tax. This amount would be the least of three figures as follows:

Aggregate Investment Income (Note Three) $6,000

Rate 30-2/3%

Amount Under ITA 129(3)(a)(i) $1,840

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Taxable Income $218,250

Deduct:

Amount Eligible For Small Business Deduction ( 110,000)

[(4)($2,880)] Foreign Business Tax Credit ( 11,520)

Balance $ 96,730

Rate 30-2/3%

Amount Under ITA 129(3)(a)(ii) $ 29,664

Amount Under ITA 129(3)(a)(iii) Part I Tax Payable $27,959

The least of these three amounts would be $1,840 and this will be the balance in the RDTOH
account, given that the RDTOH balance at the end of the preceding year was nil.

The dividend refund for the year would be $1,840, the lesser of:

 38-1/3 percent of taxable dividends paid [(38-1/3)($46,000)] = $17,633

 RDTOH balance = $1,840

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TIF Solution Thirteen - 13

Part A - Net And Taxable Income
The Net Income For Tax Purposes and Taxable Income of the Gardner Distributing Company would be
calculated as follows:

Pre-Tax Accounting Income $598,000

Additions:

Amortization Expense $ 47,000

Charitable Donations 15,000

Accounting Loss On Sale Of Truck 19,000

Taxable Capital Gain (Note One) 3,500 84,500

$682,500

Deductions:

Accounting Gain On Investment Sale ($ 7,000)

Capital Cost Allowance (Note Two) ( 138,900)

Terminal Loss (Note Three) ( 12,000) ( 157,900)

Net Income For Tax Purposes $524,600

Charitable Donations ( 15,000)

Eligible Dividends Received ( 27,000)

Taxable Income $482,600

Note One The taxable capital gain on the investment would be calculated as follows:

Proceeds Of Disposition $100,000

Adjusted Cost Base ( 93,000)

Capital Gain $ 7,000

Inclusion Rate 1/2

Taxable Capital Gain $ 3,500

Note Two The CCA can be calculated as follows:

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Class 3 [(5%)($726,000)] $ 36,300

Class 8 {[20%][$472,000 + ($82,000)(1/2)]} 102,600

Total CCA $138,900

Note Three The only remaining asset in Class 10 was sold for $10,000. As this was $12,000
less than the UCC balance ($22,000 - $10,000), this amount becomes a terminal loss for the
year.

Part B - Part I Tax Payable

The Part I federal Tax Payable can be calculated as follows:

Base Amount Of Part I Tax [(38%)($482,600)] $183,388

Federal Tax Abatement [(10%)($482,600)] ( 48,260)

Small Business Deduction (Note Four) ( 86,868)

Additional Refundable Tax On Investment Income (Note Five) Nil

General Rate Reduction (Note Six) Nil

Part I Tax Payable $ 48,260

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Note Four The small business deduction would be equal to 18 percent of the least of:

1. Active Business Income ($524,600 - $3,500 - $27,000) $494,100

2. Taxable Income (no foreign tax credit adjustments) $482,600

3. Annual Business Limit $500,000

The least of the three figures is $482,600 and 18 percent of this amount is $86,868.

Note Five The aggregate investment income is equal to the taxable capital gain of $3,500. The
ITA 123.3 tax on aggregate investment income (ART) is 10-2/3 percent of the lesser of:

1. Aggregate Investment Income (Taxable Capital Gain) $ 3,500

2. Taxable Income $482,600

Deduct: Amount Eligible For The SBD ( 482,600) $ Nil

The lesser of these amounts is Nil and 10-2/3 percent of this amount is Nil.

Note Six The general rate reduction is calculated as follows:

Taxable Income $482,600

Amount Eligible For The SBD ( 482,600)

Aggregate Investment Income (Note Five) ( 3,500)

Full Rate Taxable Income Nil

Rate 13%

General Rate Reduction Nil

Part C - RDTOH Balance

The calculation of the ending balance in the Refundable Dividend Tax On Hand account is as follows:

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RDTOH, End Of The Preceding Year $19,000

Dividend Refund For The Preceding Year ( 5,000) $14,000

Refundable Portion Of Part I Tax (Note Seven) $ Nil

Part IV Tax On Dividends Received [(38-1/3%)($27,000)] 10,350 10,350

RDTOH Balance - Ending Balance $24,350

Note Seven Using amounts calculated in Part B, the amount of refundable Part I tax is Nil,
the least of three amounts, calculated as follows:

Amount Under ITA 129(3)(a)(i) [(30-2/3%)($3,500)] $ 1,073

Amount Under ITA 129(3)(a)(ii) [(30-2/3%)($482,600 - $482,600)] Nil

Amount Under ITA 129(3)(a)(iii) Part I Tax Payable $48,260

Part D - Federal Tax Payable

The minimum federal Tax Payable can be calculated as follows:

Part I Tax (Part B) $48,260

Part IV Tax On Dividends Received [(38-1/3%)($27,000)] 10,350

Dividend Refund (Note Eight) ( 6,517)

Federal Tax Payable $52,093

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Note Eight The dividend refund for the year would be $6,517, the lesser of:

 38-1/3 percent of taxable dividends paid [(38-1/3%)($17,000)] = $6,517

 RDTOH Balance - December 31, 2018 = $24,350

Part E - GRIP Balance

Since Taxable Income is greater than Aggregate Investment Income, the December 31, 2018 GRIP
balance can be calculated as follows:

GRIP Balance At End Of 2017 $ 32,500

Taxable Income $482,600

Income Eligible For SBD ( 482,600)

Aggregate Investment Income ( 3,500)

Adjusted Taxable Income Nil

Rate 72% Nil

Eligible Dividends Received 27,000

Eligible Dividends Designated in 2017 ( 9,600)

GRIP At End Of 2018 $49,900

The eligible dividends paid during 2018 will be deducted from the GRIP in 2019.

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TIF Solution Thirteen - 14

Part A - Minimum Taxable Income
Glandly Inc.’s minimum Taxable Income would be calculated as follows:

Net Income For Tax Purposes (Given) $563,000

Dividends From Taxable Canadian Corporations ($22,670 + $21,600) ( 44,270)

Donations To Registered Charities ( 49,500)

Net Capital Loss Carry Forward (Note One) ( 38,250)

Non-Capital Loss Carry Forward (All) ( 10,200)

Taxable Income $420,780

Note One The deduction of the net capital loss is limited to $38,250, the amount of the
Company’s net taxable capital gains for the current year.

There is a net capital loss carry forward of $6,750 ($45,000 - $38,250).

Part B - Part I Tax Payable

The Part I Tax Payable is calculated as follows:

Base Amount Of Part I Tax [(38%)($420,780)] $159,896

Federal Tax Abatement [(10%)($420,780)(87%)] ( 36,608)

Small Business Deduction (Note Two) ( 21,600)

Additional Refundable Tax On Investment Income (Note Three) 10,256

Manufacturing And Processing Profits Deduction (Note Four) ( 8,350)

General Rate Reduction (Note Five) ( 18,252)

Foreign Non-Business Income Tax Credit (Amount Withheld) ( 4,500)

Foreign Business Income Tax Credit (Amount Withheld) ( 4,150)

Part I Tax Payable $76,692

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Note Two The small business deduction is 18 percent of the least of the following three amounts:

1. Canadian Active Business Income ($184,230 + $117,100) $301,330

2. Taxable Income $420,780

Deduct:

[(100/28)($4,500)] Foreign

Non-Business Tax Credit ( 16,071)

[(4)($4,150)] Foreign Business Tax Credit ( 16,600) $388,109

3. Allocated Annual Business Limit (Given) $120,000

The least of these figures is the Company’s $120,000 share of the annual business limit, resulting in
a small business deduction of $21,600 [(18%)($120,000)].

Note Three The aggregate investment income of $96,150 is calculated as follows:

Taxable Capital Gains $38,250

Net Capital Loss Carry Forward Deducted ( 38,250)

Canadian Interest Income 78,150

Foreign Non-Business Income 18,000

Aggregate Investment Income $96,150

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The ITA 123.3 refundable tax (ART) is 10-2/3 percent of the lesser of:

1. Aggregate Investment Income $ 96,150

2. Taxable Income $420,780

Deduct: Amount Eligible For The SBD ( 120,000) $300,780

The ITA 123.3 tax on aggregate investment income is $10,256 [(10-2/3%)($96,150)].

Note Four The manufacturing and processing profits deduction is 13 percent of the lesser of:

1. M & P Profits As Per ITR 5200 (Given) $184,230

Deduct: Amount Eligible For The SBD ( 120,000) $ 64,230

2. Taxable Income $420,780

Deduct:

Amount Eligible For The SBD ( 120,000)

[(4)($4,150)] Foreign Business Tax Credit ( 16,600)

Aggregate Investment Income (Note Three) ( 96,150) $188,030

The lesser of these figures is $64,230, resulting in a manufacturing and processing profits deduction
in the amount of $8,350 [(13%)($64,230)].

Note Five The general rate reduction is calculated as follows:

Taxable Income $420,780

Amount Eligible For The SBD ( 120,000)

Amount Eligible For The M&P Deduction ( 64,230)

Aggregate Investment Income (Note Three) ( 96,150)

Full Rate Taxable Income $140,400

Rate 13%

General Rate Reduction $ 18,252

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Part C - Part IV Tax Payable

The Part IV tax will be assessed at a rate of 38-1/3 percent on the portfolio dividends. With respect to
the dividends from the connected company, the Part IV tax will be equal to 100 percent of the dividend
refund that was received by the wholly owned subsidiary.
The Part IV Tax Payable would be calculated as follows:

38-1/3 percent Of Portfolio Dividends Received

[(38-1/3%)($22,670)] $ 8,690

Share Of Dividend Refund Included In

Dividends From Subsidiary [(100%)($6,000)] 6,000

Part IV Tax Payable $14,690

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Part D - RDTOH Balance

The refundable portion of the Part I tax would be the least of the following three amounts:

Aggregate Investment Income (Note Three) $96,150

Rate 30-2/3%

$29,486

Deduct Excess Of:

Foreign Non-Business Tax Credit ($4,500)

Over 8% Of Foreign Non-Business Income

[(8%)($18,000)] 1,440 ( 3,060)

Amount Under ITA 129(3)(a)(i) $26,426

Taxable Income $420,780

Deduct:

Amount Eligible For The Small Business Deduction ( 120,000)

[(100 ÷ 38-2/3)($4,500)] Foreign Non-Business Tax Credit ( 11,638)

[(4)($4,150)] Foreign Business Tax Credit ( 16,600)

Total $272,542

Rate 30-2/3%

Amount Under ITA 129(3)(a)(ii) $ 83,580

Amount Under ITA 129(3)(a)(iii) = Part I Tax Payable $76,692

The least of these three figures is $26,426, the amount determined under ITA 129(3)(a)(i).

The balance in the Refundable Dividend Tax On Hand account is calculated as follows:

RDTOH, End Of The Preceding Year $193,500

Dividend Refund For The Preceding Year ( 47,300) $146,200

Refundable Portion Of Part I Tax $ 26,426

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Part IV Tax (Part C) 14,690 41,116

RDTOH Balance - December 31, 2018 $187,316

Part E - Dividend Refund

The dividend refund for the year would be $62,100, the lesser of:

 38-1/3 percent of taxable dividends paid [(38-1/3%)($162,000)] = $62,100

 Ending RDTOH balance (Part D) = $187,316

Part F - GRIP Balance

Since Taxable Income is greater than Aggregate Investment Income, the December 31, 2018 GRIP
balance would be calculated as follows:

GRIP Balance At End Of 2017 $ 32,400

Taxable Income $420,780

Income Eligible For SBD ( 120,000)

Aggregate Investment Income ( 96,150)

Adjusted Taxable Income $204,630

Rate 72% 147,334

Eligible Dividends Received 22,670

Eligible Dividends Designated in 2017 ( 26,800)

GRIP At End Of 2018 $175,604

The eligible dividends paid during 2018 will be deducted from the GRIP in 2019.

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TIF Solution Thirteen - 15

Part A - Part IV Tax Payable

The Part IV Tax Payable on the $17,000 in portfolio dividends received would be $6,517 [($17,000)(38-
1/3%)].

Part B - Part I Tax Payable (FTC = Amount Withheld)

Assuming the foreign business and non-business tax credits are equal to the amounts withheld, the
calculation of Expro’s Part I Tax Payable would be as follows:

Base Amount Of Part I Tax [(38%)($74,000)] $28,120

Federal Tax Abatement [(10%)(90%)($74,000)] ( 6,660)

Small Business Deduction (Note Two) ( 5,469)

Additional Refundable Tax On Investment Income (Note Three) 4,652

Manufacturing And Processing Profits Deduction (Note Four) Nil

General Rate Reduction (Note Five) Nil

Foreign Business Income Credit (Amount Withheld) ( 5,100)

Foreign Non-Business Tax Credit (Amount Withheld) ( 6,500)

Part I Tax Payable $ 9,043

Note Two The small business deduction is 18 percent of the least of the following three amounts:

1. Active Business Income (Given) $273,000

2. Taxable Income $74,000

Deduct:

[(100/28)($6,500)] Foreign Non-Business Tax Credit ( 23,214)

[(4)($5,100)] Foreign Business Tax Credit ( 20,400) $ 30,386

3. Annual Business Limit $500,000

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The lowest of these figures is the adjusted taxable income of $30,386, and this gives a small
business deduction of $5,469 [(18%)($30,386)].

Note Three The aggregate investment income is calculated as follows:

Taxable Capital Gains $14,000

Net Capital Loss Carry Forward Deducted ( 12,000)

Interest On Long-Term Investments 43,000

Foreign Non-Business Income 26,000

Aggregate Investment Income $71,000

The ITA 123.3 refundable tax (ART) is 10-2/3 percent of the lesser of:

1. Aggregate Investment Income $71,000

2. Taxable Income $74,000

Deduct: Amount Eligible For The SBD ( 30,386) $43,614

The ITA 123.3 tax on aggregate investment income is $4,652 [(10-2/3%)($43,614)].

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Note Four The manufacturing and processing profits deduction is nil. It is equal to 13 percent of
the lesser of:

1. Canadian M & P Profits (Given) $126,000

Deduct: Amount Eligible For SBD ( 30,386) $95,164

2. Taxable Income $74,000

Deduct:

Amount Eligible For The SBD ( 30,386)

Aggregate Investment Income (Note Three) ( 71,000) Nil

Given these calculations, the M& P deduction would be nil.

Note Five The general rate reduction would also be nil, as the full rate Taxable Income is nil,
calculated as follows:

Taxable Income $74,000

Amount Eligible For The SBD ( 30,386)

Aggregate Investment Income (Note Two) ( 71,000)

Full Rate Taxable Income Nil

Part C - Dividend Refund

Assuming the foreign business and non-business tax credits are equal to the amounts withheld, the
refundable portion of Part I tax would be the least of the following three amounts:

Aggregate Investment Income (Note Three) $ 71,000

Rate 30-2/3%

$ 21,773

Deduct Excess Of:

Foreign Non-Business Tax Credit ($6,500)

Over 8.0% Of Foreign Non-Business Income

[(8.0%)($26,000)] 2,080 ( 4,420)

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Amount Under ITA 129(3)(a)(i) $ 17,353

Taxable Income $74,000

Deduct:

Amount Eligible For The Small Business Deduction ( 30,386)

[(100 ÷ 38-2/3)($6,500)] Foreign Non-Business Tax Credit ( 16,810)

[(4)($5,100)] Foreign Business Tax Credit ( 20,400)

Total $ 6,404

Rate 30-2/3%

Amount Under ITA 129(3)(a)(ii) $ 1,964

Amount Under ITA 129(3)(a)(iii) = Part I Tax Payable $ 9,043

The refundable amount of Part I tax is $1,964, the amount determined under ITA 129(3)(a)(ii).

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Assuming the foreign business and non-business tax credits are equal to the amounts withheld, the
ending balance in the RDTOH account would be calculated as follows:

RDTOH Balance - End Of The Preceding Year $23,000

Dividend Refund For The Preceding Year ( 11,000) $12,000

Refundable Portion Of Part I Tax $ 1,964

Part IV Tax (Part A) 6,517 8,481

RDTOH Balance - December 31, 2018 $20,481

The dividend refund for the year would be $20,481, the lesser of:

 38-1/3 percent of taxable dividends paid [($186,000)(38-1/3%)] = $71,300

 RDTOH Balance - December 31, 2018 = $20,481

Part D - GRIP Balance

Since Taxable Income is greater than Aggregate Investment Income, the December 31, 2018 GRIP
balance would be determined as follows:

GRIP Balance At End Of 2017 $41,600

Taxable Income $74,000

Income Eligible For SBD ( 30,386)

Aggregate Investment Income ( 71,000)

Adjusted Taxable Income Nil

Rate 72% Nil

Eligible Dividends Received 17,000

Eligible Dividends Designated in 2017 ( 16,000)

GRIP At End Of 2018 $42,600

The eligible dividends paid during 2018 will be deducted from the GRIP in 2019.

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Chapter Fourteen Test Item File Solutions

TIF Solution Fourteen - 1

1. There are many companies that have accumulated loss carry forwards that they have no hope of
realizing. This situation is of concern to the government in that there are billions of dollars of such
benefits available in the economy at any point in time. If access to these benefits was relatively
trouble-free, the cost to the government in lost tax revenues could be enormous. As a consequence,
the government has enacted legislation which significantly restricts the use of loss carry forwards in
situations where there has been an acquisition of control.

2. IT-302R3, which deals with the losses of a corporation, indicates that control requires ownership of
shares that carry with them the ability or right to elect a majority of the board of directors. An
acquisition of control occurs when some event results in a taxpayer (or group) who did not have
control of the corporation acquires sufficient ownership rights so that they have control. A common
event of this type would be a majority shareholder selling all his shares to an arm’s length person.
Other answers are possible.

3. As the use of losses will be restricted after the acquisition of control, this rule prevents losses from
being used prior to the normal end of the taxation year in which the acquisition of control took
place.

4. The basic tax consequences of an acquisition of control are as follows:

 There is a deemed year end at the time the acquisition of control occurs.

 There are special rules requiring the write down of assets to fair market value at the
deemed year end.

 With respect to non-capital losses, they can only be used in years subsequent to the
acquisition of control to offset profits that have occurred from operating in the same or a
similar line of business. There are similar restrictions on the use of pre-acquisition of
control investment tax credits.

 With respect to net capital losses, including allowable business investment losses, they
cannot be carried forward to years subsequent to the acquisition of control. In addition, if
there are capital gains in the three years before the deemed year end, capital losses from
years subsequent to the deemed year end cannot be carried back to those years.

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 Unused charitable deductions cannot be carried forward to years subsequent to the

acquisition of control. In addition, no deduction is available on a gift made subsequent to
the acquisition of control if the gifted property was acquired prior to the acquisition date in
anticipation of the acquisition of control.

5. The ITA 111(4)(e) election is clearly desirable when there are:

 unused charitable donations,

 unused net capital losses from previous years;

 a net allowable capital loss in the current year; or

 unused allowable business investment losses.

If these items are not used in the taxation year created by the deemed year end, they will be lost
forever.

With respect to non-capital losses from previous or current years, the desirability of the election will
depend on whether the company believes they can be used in future years against profits in the same
line of business during the relevant carry forward period.

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6. It is the intent of the government to limit the availability of the small business deduction to an
amount of active business income not exceeding $500,000. In the absence of special rules, the
owner of a corporation with $1,000,000 in active business income could easily split that corporation
into two corporations with $500,000 each in active business income. In the absence of special rules,
this would mean that the taxpayer would get the small business deduction on $1,000,000 in active
business income. The associated company rules prevent this from happening by requiring that these
two companies would have to share a single $500,000 limit.

7. Such shares generally have the following characteristics:

 An absence of voting rights.

 A fixed dividend rate.

 A specified redemption amount.

Such shares are normally referred to as preferred shares.

8. ITA 256(1.2)(a) defines a group as simply two or more persons, each of whom owns shares in the
corporation in question. This would include corporations, individuals, and trusts. There is no
requirement that they be related.

9. For purposes of applying the associated company rules, control is defined as follows:

Control A corporation is deemed to be controlled by another corporation, a person, or a group

of persons, if the corporation, person, or group of persons owns either:

 shares (common and/or preferred) of capital stock with a fair market value of more than 50
percent of all issued and outstanding shares of capital stock; or

 common shares with a fair market value of more than 50 percent of all issued and
outstanding common shares.

10. This deeming provision requires that rights to acquire shares be treated as though they were
exercised for purposes of determining associated companies.

11. Investment tax credits can limit their benefits to very specific types of activity or regions of Canada.
For example, an investment tax credit is available on purchases of qualified property in the Atlantic
provinces. In contrast, general rate reductions are usually available to all taxpayers in all parts of
Canada, without regard to the type of property they acquire or the region of Canada in which it is
acquired. Choosing between these two types of tax benefits would be based on whether the

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government wished to achieve a specific objective (e.g., assistance to business in the Atlantic
provinces) or, alternatively, provide general tax relief to corporations.

12. It is favourable because the deduction that is being given up has a value equal to the amount of the
deduction multiplied by the taxpayer’s tax rate. For example, if a corporation with a tax rate of 25
percent gives up a $1,000 deduction, the cost is only $250 [($1,000)(25%)]. In contrast, the credit
is a direct reduction in Tax Payable. A $1,000 credit would be worth $1,000, regardless of the
corporation’s tax rate.

13. The following types of taxpayers are eligible for refundable investment tax credits:

 an individual;

 a “qualifying corporation”, which is a Canadian controlled private corporation throughout

the year with Taxable Income in the previous year of $500,000 or less before loss carry
backs; or

 a trust where each beneficiary is an individual or a qualifying corporation.

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14. Investment tax credits are deducted from the capital cost of depreciable assets in the year following
receipt. This means that there will no effect on CCA in the year the credit is received. In
subsequent years, the capital cost of the depreciable asset will be reduced by the amount of the
credit, thereby reducing CCA in subsequent years.

15. Per share PUC is based on the total amount of consideration received by the issuing corporation for
the shares, divided by the total number of shares issued and outstanding. It is an average value that,
at a given point in time, is the same for all issued and outstanding shares of a particular class.

Per share ACB, in contrast, is shareholder specific. It is based on the average amount paid by
that investor for the shares he owns. If all of the shares of a corporation are issued to a single
individual at one point in time, the PUC and ACB would be the same for all shares.

While this might be the situation for a private company (e.g., a CCPC issues all of its shares to a
single individual and this individual has retained these shares from the commencement date of the
corporation), it would be very unusual for a large public company. While the PUC for all shares of
a particular class will be the same, each open market purchase will create a new and unique adjusted
cost base for that individual’s shares. It would be very rare for this new adjusted cost base to be
equal to the PUC of the shares acquired.

16. It is the intent of the government to allow certain types of income to be received on a tax free basis
by all taxpayers. While there are other types of income that fall into this category, the most
important example of this type of income is the non-taxable one-half of capital gains. When such
amounts are earned by a private corporation, a special mechanism is required to allow the
corporation to distribute the funds to its shareholders without the amounts losing their tax free
status. The capital dividend account is that mechanism. Eligible income amounts, such as one-half
of capital gains and losses earned by the corporation, are added to or deducted from this account.
To the extent there is a balance in this account, the corporation can elect to distribute such amounts
to shareholders as a tax free capital dividend.

17. A stock dividend is a pro rata distribution of new shares to existing shareholders of a corporation.
For the corporation, this will generally involve an increase in the PUC of the company’s shares to
the extent of the fair market value of the new shares issued. To the extent that the company has
increased the PUC of its shares, such dividends will be treated as taxable dividends to the recipients.
For individuals, stock dividends will be subject to either the eligible or non-eligible dividend gross
up and tax credit procedures. The total adjusted cost base of the new shares will be equal to the
amount of the stock dividend declared.

18. This type of transaction generates an increase in PUC that is larger than the related increase in net
assets. Because PUC represents an amount that can be distributed to shareholders on a tax free
basis, a benefit results from this transaction. This benefit is treated as a deemed dividend under ITA
84(1). As PUC amounts are averaged over all shares, the deemed dividend is allocated to all of the
company’s shareholders, not just those receiving the new shares. Reflecting this taxable benefit, the
adjusted cost base of all of the shares is increased by a corresponding amount.

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19. To the extent of the PUC of the shares, the distribution will be received tax free. However, the
excess of the distribution over the PUC of the shares will be treated as a deemed dividend. This
deemed dividend is further subdivided as follows:

 To the extent that the corporation has a balance in its capital dividend account, part of the
distribution will be considered a separate capital dividend, which will be received on a tax free
basis under ITA 83(2). This treatment will only apply if an appropriate election is made.

 To the extent that the company has a pre-1972 capital surplus on hand account, the balance will
be deemed not to be a dividend.

 Any remaining amount of the deemed dividend will be treated as a taxable dividend under ITA
84(2), subject to either the eligible or non-eligible dividend gross up and tax credit procedures.

20. This is accomplished through the ITA 54 definition of the proceeds of disposition to be used in
determining the capital gain. Under this definition, any amount that has been treated as an ITA
84(3) deemed dividend is removed from the proceeds of disposition for purposes of determining
any capital gain on the transaction.

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TIF Solution Fourteen - 2

Acquisition Of Control
1. True.

2. False.

The corporation is permitted to elect a new year end after an acquisition of control. This could
provide for a full year fiscal period.

3. True.

4. True.

Unused net capital losses cannot be used in periods subsequent to an acquisition of control.

Associated Companies
5. False.

A group is any two or more persons who hold shares in a corporation. They do not have to be
related.

6. True.

Investment Tax Credits

7. False.

Credits related to capital expenditures will be deducted from the related UCC in the following
year.

8. True.

Tax Basis Shareholders’ Equity

9. True.

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Capital Dividend Account

10. False.

The addition would be $25,000 [(1/2)($250,000 - $200,000)].

Distributions Of Corporate Surplus

11. False.

To the extent that there is an increase in PUC as the result of the dividend, there is an increase
in Net Income For Tax Purposes of shareholders.

12. False.

If there is a difference between the tax value and the fair market value of the assets distributed,
there will be tax consequences for the corporation.

13. False. Under ITA 84(3), the difference will be treated as a deemed dividend.

14. True.

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TIF Solution Fourteen - 3

Acquisition Of Control
1. B. Farm losses. While they would not be lost, they could only be applied in future
periods to the extent farm income was present.

2. B. The inability to deduct non-capital losses subsequent to the acquisition of control.

3. C. Subsequent to the deemed year end, non-capital losses can be deducted against any
type of income.

4. A. The corporate tax rate must be prorated for the shortened year.

5. C. The losses cannot be applied in any shortened year ends that occur as a result of the
acquisition of control.

6. A. None. Because the loss was generated from the operations of the catering business,
which did not earn a profit in 2019.

7. C. $2,500,000 [$4 million - $1.5 million]

8. B. Hagrid Inc. will be required to write the land down to its fair market value and
recognize the allowable capital loss of $42,500 at the end of 2018. A deemed disposition of the
depreciable asset should be elected at a value of $185,000, resulting in recapture of $25,000
and a taxable capital gain of $42,500.

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9. C. Non-capital losses arising prior to the change in control may be applied against
income earned by the business that incurred the loss as long as the loss has not expired.

Associated Companies
10. B. Flour and Yeast are associated.

1. C. Hughes and ARC are associated, and Jimbo and ARC are associated.

Hughes and ARC are associated under ITA 256(1)(a). Hughes controls ARC.

Jimbo and ARC - Mr. Hanes is deemed to own 32% [(40%)(80%)] of ARC and his daughter-
in-law is deemed to own 4% [(5%)(80%)] of ARC by the look through rules in ITA 256(1.2)
(d). When added to the 15% that the daughter-in-law owns outright, a related group owns 51%
(32% + 4% + 15%) of ARC. The corporations are associated by ITA 256(1)(d) since Mr.
Hanes controls Jimbo, a related group controls ARC, and Mr. Hanes is deemed to own greater
than 25% of ARC.

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12. C. A Ltd. and B Ltd. are associated under ITA 256(1)(b) as they are controlled by the
same group (Amos and his brother). The fact that they are related is not relevant.

13. C. Wonder and Speedy are associated in that they are both associated with Scarlet. They
would normally share the $500,000 small business deduction limit. However, since they are
associated solely by virtue of their mutual association with the third corporation, the third
corporation can elect not to be associated with them. With this election, the two corporations
are eligible for the full $500,000 small business deduction, for a total of $1,000,000. As a
consequence of making this election, Scarlet is deemed to have an annual business limit of nil.

14. B. Mr. and Mrs. G each own 50% of the shares of W Corp. Their adult children, Girl F
and Boy F, each own 40% of V Corp. Mrs. G owns the remaining 20% of the shares.

Investment Tax Credit

15. A. The total credit would be $239,750 [($685,000)((35%)]. The refundable amount
would be $239,750.

16. A. The company will receive investment tax credits of $206,000. ITC = [10%][(3)
($20,000) + $2,000,000]. CCA will be based on additions to qualified property of $2,000,000.
The ITC will reduce the UCC in the following year.

17. B. $ 2,700,000 [$8 million – (10)($500,000) x (($40 million – ($14 million - $10
million))/$40 million]

Tax Basis Shareholder’s Equity

18. B. $4,665

PUC Per Share = $9.33 {[(10,000)($8) + (10,000)($9) + (10,000)($11)] ÷ 30,000]

Mark’s PUC = $4,665 [(500)($9.33)]

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19. D. If she were to sell the Torin shares for $4,000, she would have a deemed dividend of
$500.

20. B. Dividends received from other taxable Canadian corporations.

21. C. $173,000 [$150,000 + $50,000 - $30,000 + $35,000 - $32,000]

22. D. LRIP

23. D. While the components may be different, retained earnings will have the same value in
both tax based shareholders’ equity and in GAAP based financial statements.

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Stock Dividends
24. C. A dividend will be taxable to the extent that the corporation has increased its PUC in
the process of declaring the dividend.

25. D. All of the above.

Dividends In Kind
26. C. A dividend in kind can result in a capital gain for the declaring corporation.

27. B. Sico has Taxable Income of $8,000 and Mark has Taxable Income of $84,240.

Distributions Of Corporate Surplus

28. D. $28,200 ($23,200 + $5,000)

Proceeds Of Redemption [(10,000)($10.00)] $100,000

PUC [(10,000)($8.00)] ( 80,000)

ITA 84(3) Deemed Dividend $ 20,000

Gross Up [(16%)($20,000)] 3,200

Taxable Dividend $ 23,200

Proceeds Of Disposition[(10,000)($10.00)] $100,000

ITA 84(3) Deemed Dividend ( 20,000)

Adjusted Proceeds Of Disposition $80,000

Adjusted Cost Base [(10,000)($7.00)] ( 70,000)

Capital Gain $ 10,000

Inclusion Rate 1/2

Taxable Capital Gain $ 5,000

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29. B. Redeeming shares for $350,000. The PUC of the shares was $350,000 and the
adjusted cost base was $250,000. There is no deemed dividend as the proceeds are equal to the
PUC.

30. B. $955,000 ($580,000 + $375,000). These amounts would be calculated as follows:

Proceeds Of Redemption $3,500,000

PUC [(10%)($30,000,000)] ( 3,000,000)

ITA 84(3) Deemed Dividend $ 500,000

Gross Up [(16%)($500,000)] 80,000

Taxable Dividend $ 580,000

Proceeds Of Disposition $3,500,000

ITA 84(3) Deemed Dividend ( 500,000)

Adjusted Proceeds Of Disposition $3,000,000

Adjusted Cost Base ( 2,250,000)

Capital Gain $ 750,000

Inclusion Rate 1/2

Taxable Capital Gain $ 375,000

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31. C. A corporation issues shares to a creditor in order to settle debt with a carrying value
less than the PUC of the newly issued shares.

32. B. There will be a deemed dividend which will be allocated to all shareholders including
the new shareholder who acquired shares by giving up debt securities. The adjusted cost base
of the shares will increase by the amount of the deemed dividend.

33. D. $ 340,000. [$350,000 - $10,000]

34. B. $3,400,000. [Deemed dividend = $1,000,000 - $600,000 = $400,000. ACB will be

reduced by $600,000 from $4,000,000 to $3,400,000]

35. A. The shareholders of TTT Ltd. will be deemed to have received a dividend of $10,000.

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TIF Solution Fourteen - 4

Exam Exercise Solution Fourteen - 1 (Acquisition Of Control)
For the year ending December 31, 2017, Net Income For Tax Purposes and Taxable Income would be
nil, without regard to whether there was an acquisition of control. A non-capital loss carry forward of
$79,400 ($104,000 - $24,600) would remain at the end of the year.

No Acquisition Of Control If there was no acquisition of control, the entire $79,400 non-capital loss
carry forward could be deducted. For the year ending December 31, 2018, Taxable Income would be as
follows:

Net Income For Tax Purposes ($133,400 + $21,250) $154,650

Loss Carry Forward From 2017 (All) ( 79,400)

Taxable Income $75,250

Acquisition Of Control There would be a deemed year end on December 31, 2017, the day before the
acquisition of control. However, as this is the usual year end, there would be no tax consequences. In
the year ending December 31, 2018, the loss carry forward could only be used to the extent of the profits
in the engineering services business. Taxable Income would be calculated as follows:

Net Income For Tax Purposes ($133,400 + $21,250) $154,650

Loss Carry Forward From 2017 (Limited To $21,250) ( 21,250)

Taxable Income $133,400

This would leave a non-capital loss carry forward of $58,150 ($79,400 - $21,250).

Exam Exercise Solution Fourteen - 2 (Acquisition Of Control)

For the year ending December 31, 2017, Net Income For Tax Purposes and Taxable Income would be
nil, without regard to whether there was an acquisition of control. A non-capital loss carry forward of
$103,000 ($146,000 - $43,000) would remain at the end of the year.

No Acquisition Of Control If there was no acquisition of control, the entire loss carry forward could
be deducted. For the year ending December 31, 2018, Taxable Income would be as follows:

Net Income For Tax Purposes ($56,000 + $85,000) $141,000

Loss Carry Forward From 2017 (All) ( 103,000)

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Taxable Income $ 38,000

Acquisition Of Control There would be a deemed year end on December 31, 2017, the day before the
acquisition of control. However, as this is the usual year end, there would be no tax consequences. In
the year ending December 31, 2018, the loss carry forward could only be used to the extent of the profits
in the mail order operation. Taxable Income would be calculated as follows:

Net Income For Tax Purposes ($56,000 + $85,000) $141,000

Loss Carry Forward From 2017 - Limited To

Income In The Mail Order Operation ( 56,000)

Taxable Income $ 85,000

This would leave a non-capital loss carry forward of $47,000 ($103,000 - $56,000).

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Exam Exercise Solution Fourteen - 3 (Election On Acquisition Of Control)

It would clearly be desirable to elect to have a deemed disposition of the non-depreciable assets. This
could be achieved by electing to have a deemed disposition of the non-depreciable assets for $740,000.
This would result in a $65,000 taxable capital gain [(1/2)($740,000 - $610,000)] on the deemed
disposition. This will leave $60,000 ($125,000 - $65,000) of the net capital loss carry forward.
This $60,000 could be eliminated by electing to have a deemed disposition of the depreciable property at
an elected value of $495,000. This election would produce the required taxable capital gain of $60,000
[(1/2)($495,000 - $375,000)]
The election would also produce recapture of $95,000 ($375,000 - $280,000). As this is $4,000
($95,000 - $91,000) greater than the operating loss, this would result in Taxable Income and Tax
Payable. However, the ability to use the remaining $60,000 net capital loss carry forward is probably
worth the cost of the Tax Payable on the extra $4,000 of income. In addition, the election would
increase future CCA deductions.

Exam Exercise Solution Fourteen - 4 (Election On Acquisition Of Control)

With a net capital loss balance of $175,000, it would clearly be desirable to elect to have a deemed
disposition of the non-depreciable property at fair market value. This will create a taxable capital gain
of $98,000 [(1/2)($950,000 - $754,000), and leave a net capital loss balance of $77,000 ($175,000 -
$98,000).
If an election at fair market value is also made on the depreciable property, the result will be a taxable
capital gain of $61,000 [(1/2)($612,000 - $490,000)], as well as recapture of $165,000. This would
reduce the net capital loss balance to $16,000 ($77,000 - $61,000), and eliminate the $143,000 operating
loss for the period January 1, 2018 through April 30, 2018. However, it would leave $22,000 ($165,000
- $143,000) in Taxable Income and require the payment of some taxes for this short fiscal period.
It is likely that, in most situations, management would conclude that the benefits of using a large portion
of the net capital loss which will expire, and avoiding a carry forward of the operating loss, would be
worth the cost of the extra taxes that would be paid on $22,000 of operating income. In addition, the
election would increase future CCA deductions.

Exam Exercise Solution Fourteen - 5 (Associated Companies)

Anderson Inc. and BDO Ltd. These Companies are associated under ITA 256(1)(d) as follows:

 John Anderson controls Anderson Inc.

 John Anderson is related to each member of the group that controls BDO Ltd.

 John Anderson owns not less than 25 percent of the shares of BDO Ltd.

Copper Inc. and BDO Ltd. These companies are associated under ITA 256(1)(e) as follows:

 Each corporation is controlled by a related group (Copper Inc. by Mr. and Mrs. Copper, BDO
Ltd. by Mr. and Mrs. Anderson and Mrs. Copper).

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 Each of the members of one of the related groups was related to all of the members of the other
related group.

 One person (Mrs. Copper) who is a member of both related groups owns at least 25 percent of the
shares of each corporation.

They are also associated under ITA 256(1)(b) as both Companies are controlled by the same group (Mr.
and Mrs. Copper).

Anderson Inc. and Copper Inc. Provided they do not elect to not be associated, these Companies are
associated under ITA 256(2) as they are both associated with a third corporation, BDO.

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Exam Exercise Solution Fourteen - 6 (Associated Companies)

With 80 percent ownership, Sarah clearly controls Kern Ltd. In addition, she also controls Lorne Inc. as
per the following calculation:

Direct Interest 5 Percent

Indirect Income Through Control Of Kern Ltd. 30 Percent

Deemed Interest (Daughter’s Shares) 25 Percent

Total Interest 60 Percent

As both Companies are controlled by the same person, Kern Ltd. and Lorne Inc. are associated under
ITA 256(1)(b).

Exam Exercise Solution Fourteen - 7 (Investment Tax Credit Procedures)

With respect to the $460,000 in current expenditures, there will be a $46,000 [(10%)($460,000)] credit
against 2018 Tax Payable. This $46,000 credit will be added to income in 2019.
With respect to the $675,000 in capital expenditures, there will be a 2018 credit against Tax Payable of
$67,500 [(10%)($675,000)].
The $67,500 credit will not influence the calculation of 2018 CCA. This amount will be $101,250
[(30%)(1/2)($675,000)].
In 2019, the $67,500 credit will be deducted from the January 1, 2019 UCC, leaving a balance of
$506,250 ($675,000 - $101,250 - $67,500). Given this, 2019 CCA will be $151,875 [(30%)($506,250)].

Exam Exercise Solution Fourteen - 8 (Investment Tax Credit Procedures)

The $722,000 in current expenditures will generate an investment tax credit of $72,200 [(10%)
($722,000)] to be deducted from the 2018 Tax Payable. The $72,200 credit will be added back to
income in 2019.
The $942,000 in capital expenditures will generate an investment tax credit of $94,200 [(10%)
($942,000)]. This will not be deducted from the capital cost of the acquired assets until 2019. Given
this, 2018 CCA would be $94,200 [(1/2)(20%)($942,000)].
In 2019, the $94,200 credit will be subtracted, leaving a UCC balance of $753,600 ($942,000 - $94,200
- $94,200). Based on this, the 2019 CCA will be $150,720 [(20%)($753,600)].

Exam Exercise Solution Fourteen - 9 (Refundable Investment Tax Credits)

As Future Ventures has Taxable Income of less than $500,000 in the previous year, and its Taxable
Capital Employed in Canada is less than $10 million, the Company’s annual expenditure is not reduced
from the maximum value of $3,000,000.

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Given the $3,000,000 annual expenditure limit for the 35 percent rate, the total amount of investment tax
credits available can be calculated as follows:

Qualified Property [(10%)($132,000)] $ 13,200

SR&ED Current Expenditures [(35%)($1,060,000)] 371,000

Total Available Amount $384,200

The refund available would be as follows:

Qualified Property [(40%)($13,200)] $ 5,280

SR&ED Current Expenditures [(100%)($371,000)] 371,000

Total Refund Available $376,280

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The non-refunded investment tax credit of $7,920 ($384,200 - $376,280) can be carried forward 20
years to be applied against Tax Payable. There was no Tax Payable in the last three years so it cannot be
carried back.
The cost of the qualified property will be reduced in the following year by the refundable investment tax
credit of $5,280. The refundable investment tax credit on current expenditures of $371,000 will be
added to income in the following year.

Exam Exercise Solution Fourteen - 10 (Refundable Investment Tax Credits)

As Forward Ltd. has Taxable Income of less than $500,000 in the previous year, and its Taxable Capital
Employed in Canada is less than $10 million, the Company’s annual expenditure is not reduced from the
maximum value of $3,000,000.

Given the $3,000,000 annual expenditure limit for the 35 percent rate, the total amount of investment tax
credits available can be calculated as follows:

Qualified Property [(10%)($220,000)] $ 22,000

SR&ED Current Expenditures [(35%)($1,450,000)] 507,500

Total Available Amount $529,500

The refund available would be as follows:

Qualified Property [(40%)($22,000)] $ 8,800

SR&ED Current Expenditures [(100%)($507,500)] 507,500

Total Refund Available $516,300

The non-refunded investment tax credit of $13,200 ($529,500 - $516,300) can be carried forward 20
years to be applied against Tax Payable. There was no Tax Payable in the last three years so it cannot be
carried back.
The cost of the qualified property will be reduced in the following year by the refundable investment tax
credit of $8,800. The refundable investment tax credit on current expenditures of $507,500 will be
added to income in the following year.

Exam Exercise Solution Fourteen - 11 (ACB And PUC)

The adjusted cost base of the shares would be determined as follows:

Number of Shares Cost/Share Total Cost

First Purchase 1,350 $ 5.60 $ 7,560

Second Purchase 4,230 $10.15 42,935

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Totals 5,580 $50,495

The adjusted cost base per share would be $9.05 ($50,495 ÷ 5,580).
The PUC for the investor’s shares would be calculated as follows:

Number of Shares PUC/Share Total PUC

First Sale 123,000 $5.60 $ 688,800

Second Sale 32,000 $8.62 275,840

Third Sale 81,000 $10.15 822,150

Total PUC Of Outstanding Shares 236,000 $1,786,790

Number Of Shares (From First Table) 5,580

PUC Per Share [$1,786,790 ÷ 236,000 Shares] $ 7.57

PUC For Investor’s Shares $42,241

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Exam Exercise Solution Fourteen - 12 (ACB And PUC)

The adjusted cost base of the shares would be determined as follows:

Number of Shares Cost/Share Total Cost

First Purchase 10,000 $16.00 $160,000

Second Purchase 5,000 $18.00 90,000

Totals 15,000 $250,000

The adjusted cost base per share would be $16.67 ($250,000 ÷ 15,000).
The PUC for the investor’s shares would be calculated as follows:

Number of Shares PUC/Share Total PUC

2017 Sale 400,000 $16.00 $6,400,000

2018 Sale 160,000 $18.00 2,880,000

Total PUC Of Outstanding Shares 560,000 $9,280,000

Number Of Shares (From First Table) 15,000

PUC Per Share [$9,280,000 ÷ 560,000 Shares] $ 16.57

PUC For Investor’s Shares $248,550

Exam Exercise Solution Fourteen - 13 (Capital Dividend Account)

The balance in the capital dividend account as at December 31, 2018 would be as follows:

2015 Capital Gain [(1/2)($129,000 - $105,000)] $12,000

2016 Capital Loss [(1/2)($83,000 - $91,000)] ( 4,000)

2017 Capital Dividend Received 10,600

2018 Capital Gain [(1/2)($50,000 - Nil)] 25,000

2018 Capital Dividend Paid ( 13,750)

Balance - End Of 2018 $29,850

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Exam Exercise Solution Fourteen - 14 (Capital Dividend Account)

The balance in the capital dividend account as at December 31, 2018 would be as follows:

2015 Capital Dividend Received $ 23,000

2016 Capital Gain [(1/2)($199,000 - $156,000)] 21,500

2017 Capital Loss [(1/2)($102,000 - $120,000)] ( 9,000)

2018 Capital Gain [(1/2)($150,000 - Nil)] 75,000

2018 Capital Dividends Paid ( 10,400)

Balance - End Of 2018 $100,100

Exam Exercise Solution Fourteen - 15 (Stock Dividends)

Jerry will receive 100 new shares [(10%)(1,000)] with a fair market value of $2,700 [(100)($27)]. This
$2,700 non-eligible dividend will be grossed up to a taxable amount of $3,132 [($2,700)(116%)]. As a
result, his Net Income For Tax Purposes will increase by $3,132. The receipt of this dividend will
generate a credit against Jerry’s federal Tax Payable of $314 [(8/11)(16%)($2,700)].
Prior to the stock dividend, the adjusted cost base of Jerry’s shares was $17,000 [(1,000)($17)]. The
$2,700 dividend will be added to this amount, resulting in a new adjusted cost base of $19,700. When
the 100 new shares are added to his total holding, the adjusted cost base per share will be $17.91
($19,700 ÷ 1,100).

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Exam Exercise Solution Fourteen - 16 (Stock Dividends)

Jason will receive 25 [(5%)(500)] new shares with a fair market value of $450 [(25)($18)]. This will be
grossed up to a taxable amount of $522 [(116%)($450)]. This amount will be included in Jason’s Net
Income For Tax Purposes. In addition, he will have a credit against his federal tax payable of $52
[(8/11)(16%)($450)].
Prior to the stock dividend, Jason’s shares had an adjusted cost base of $7,500 [(500)($15)]. The $450
dividend will be added to this amount, resulting in a new adjusted cost base of $7,950. His total number
of shares will be 525 (500 + 25), resulting in a per share adjusted cost base of $15.14 ($7,950 ÷ 525).

Exam Exercise Solution Fourteen - 17 (Dividends In Kind)

For Boucher Inc., the results will be as follows:

Proceeds Of Disposition [(45,000)($42)] $1,890,000

Adjusted Cost Base [(45,000)($33)] ( 1,485,000)

Capital Gain $ 405,000

Inclusion Rate 1/2

Taxable Capital Gain $ 202,500

The results for Martine Cloutier will be as follows:

Dividend Received [(23%)(45,000)($42)] $434,700

Gross Up [(16%)($434,700)] 69,552

Taxable Dividend $504,252

Dividend Tax Credit [(8/11)(16%)($434,700)] $ 50,583

Boucher Inc.’s Net Income For Tax Purposes would be increased by the $202,500 taxable capital gain.
Martine’s Net Income For Tax Purposes would be increased by the taxable dividend of $504,252. Her
federal Tax Payable would be decreased by the dividend tax credit of $50,583.

Exam Exercise Solution Fourteen - 18 (Dividends In Kind)

For Topex Ltd, the results will be as follows:

Proceeds Of Disposition [(62,000)($8.50)] $527,000

Adjusted Cost Base ( 372,000)

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Capital Gain $155,000

Inclusion Rate 1/2

Taxable Capital Gain $ 77,500

The results for the shareholder will be as follows:

Dividend Received [(10%)($527,000)] $52,700

Gross Up [(16%)($52,700)] 8,432

Taxable Dividend $61,132

Dividend Tax Credit [(8/11)(16%)($52,700)] $ 6,132

Topex Ltd.’s Net Income For Tax Purposes would be increased by the $77,500 taxable capital gain. The
shareholder’s Net Income For Tax Purposes would be increased by the taxable dividend of $61,132.
Federal Tax Payable would be decreased by the dividend tax credit of $6,132.

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Exam Exercise Solution Fourteen - 19 (ITA 84(1) Deemed Dividend)

This transaction will result in an ITA 84(1) deemed dividend for all shareholders, calculated as follows:

PUC Of New Shares [(43,000)($12.05)] $518,150

Increase In Net Assets ( 505,000)

ITA 84(1) Deemed Dividend $ 13,150

This would be allocated to all 174,000 (131,000 + 43,000) shares outstanding, on the basis of $0.08 per
share. This would be a taxable dividend, subject to either the eligible or non-eligible dividend gross up
and tax credit procedures. The $0.08 per share dividend would be added to the adjusted cost base of all
174,000 shares.
With the addition of $0.08, the new adjusted cost base of Mr. Scott’s shares would be $11.33 ($11.25 +
$0.08) per share. The taxable capital gain on their disposition would be calculated as follows:

Proceeds Of Disposition [(7,000)($14.36)] $100,520

Adjusted Cost Base [(7,000)($11.33)] ( 79,310)

Capital Gain $ 21,210

Inclusion Rate 1/2

Taxable Capital Gain $ 10,605

Exam Exercise Solution Fourteen - 20 (ITA 84(1) Deemed Dividend)

The transaction will result in an ITA 84(1) deemed dividend as follows:

PUC Of New Shares [($11.25)(10,000)] $112,500

Increase In Net Assets ( 100,000)

ITA 84(1) Deemed Dividend $ 12,500

This will result in a deemed dividend per share of $0.208 ($12,500 ÷ 60,000). On Mr. Kai’s 1,000
shares this will total $208.00.

Exam Exercise Solution Fourteen - 21 (ITA 84(2) Deemed Dividend)

The analysis of the $1,237,000 distribution would be as follows:

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Cash Distributed $1,237,000

PUC Of Shares ( 189,000)

ITA 84(2) Deemed Dividend $1,048,000

ITA 83(2) Capital Dividend ( 146,000)

ITA 88(2)(b) Taxable Dividend $ 902,000

To the extent the company has a balance in its GRIP account, some amount of the $902,000 dividend
could be designated as eligible. Any remainder will be taxed as a non-eligible dividend (Not Required).
The wind-up results in a disposition of the shares. The tax consequences of this disposition are as
follows:

Cash Distributed $1,237,000

ITA 84(2) Deemed Dividend ( 1,048,000)

ITA 54 Proceeds Of Disposition $ 189,000

Adjusted Cost Base ( 189,000)

Capital Gain Nil

As shown by the preceding calculation, there would be no capital gain on the disposition.

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Exam Exercise Solution Fourteen - 22 (ITA 84(2) Deemed Dividend)

The analysis of the $956,000 distribution would be as follows:

Cash Distributed $956,000

PUC Of Shares ( 120,000)

ITA 84(2) Deemed Dividend $836,000

ITA 83(2) Capital Dividend ( 45,000)

ITA 88(2)(b) Taxable Dividend $791,000

To the extent the company has a balance in its GRIP account, some amount of the $791,000 dividend
could be designated as eligible. Any remainder will be taxed as a non-eligible dividend (Not Required).
As the wind-up involves a disposition of shares, the tax consequences of this must also be considered:

Cash Distributed $956,000

ITA 84(2) Deemed Dividend ( 836,000)

ITA 54 Proceeds Of Disposition $120,000

Adjusted Cost Base ( 120,000)

Capital Gain Nil

Exam Exercise Solution Fourteen - 23 (ITA 84(3) Deemed Dividend)

The redemption transaction would have no tax consequences for Mr. Izaak Alleham. For his sister, the
tax consequences would be as follows:

Proceeds Of Redemption [(30,000)($24.35)] $730,500

PUC [(30,000)($22.50)] ( 675,000)

ITA 84(3) Deemed Dividend $ 55,500

Gross Up Of 16 Percent 8,880

Taxable Dividend $ 64,380

Proceeds Of Redemption [(30,000)($24.35)] $730,500

ITA 84(3) Deemed Dividend ( 55,500)

ITA 54 Proceeds of Disposition $675,000

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Adjusted Cost Base [(30,000)($18.75)] ( 562,500)

Capital Gain (PUC - ACB) $112,500

Inclusion Rate 1/2

Taxable Capital Gain $ 56,250

Both the taxable dividend and the taxable capital gain would be included in Mr. Alleham’s sister’s Net
Income For Tax Purposes. The non-eligible dividend qualifies for a federal dividend tax credit of
$6,458 [(8/11)(16%)($55,500)].

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Exam Exercise Solution Fourteen - 24 (ITA 84(3) Deemed Dividend)

The tax consequences to the dissident shareholder would be calculated as follows:

Proceeds Of Redemption [(15,000)($12.50)] $187,500

PUC [(15,000)($12.00)] ( 180,000)

ITA 84(3) Deemed Dividend $ 7,500

Gross Up Of 16 Percent 1,200

Taxable Dividend $ 8,700

Proceeds Of Redemption [(15,000)($12.50)] $187,500

ITA 84(3) Deemed Dividend ( 7,500)

ITA 54 Proceeds of Disposition $180,000

Adjusted Cost Base [(15,000)($10.00)] ( 150,000)

Capital Gain (PUC - ACB) $ 30,000

Inclusion Rate 1/2

Taxable Capital Gain $ 15,000

Both the taxable dividend and the taxable capital gain would be included in the dissident shareholder’s
Net Income For Tax Purposes. The non-eligible dividend would qualify for a federal dividend tax credit
of $873 [(8/11)(16%)($7,500)].

Exam Exercise Solution Fourteen - 25 (ITA 84(4) Deemed Dividend)

To the extent of the $217,000 PUC reduction, the dividend will be treated as a tax free distribution. The
tax consequences will be a reduction in the PUC of these shares to $173,000 ($390,000 - $217,000), as
well as an adjusted cost base reduction to $328,000 ($545,000 - $217,000).
The $82,000 ($299,000 - $217,000) excess of the distribution over the PUC reduction will be an ITA
84(4) deemed dividend, subject to either the eligible or non-eligible dividend gross up and tax credit
procedures. As it will be taxed as a dividend, this part of the distribution will not be subtracted from the
adjusted cost base of the shares.

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Exam Exercise Solution Fourteen - 26 (ITA 84(4) Deemed Dividend)

An amount equal to the PUC reduction of $84,000 will be received as a tax free distribution. In addition
to the PUC reduction for the shares to $141,000 ($225,000 - $84,000), the adjusted cost base for
Martin’s shares will be reduced by the same $84,000 to $226,000 ($310,000 - $84,000).
The remaining $28,000 ($112,000 - $84,000) will be treated as an ITA 84(4) deemed dividend. It will
be subject to either the eligible or non-eligible gross up and tax credit procedures. Given that it will be
taxed as a dividend, there will be no reduction in the adjusted cost base of Martin’s shares for the
$28,000.

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TIF Solution Fourteen - 5A

The correct definitions for each of the listed key terms are as follows:

A. 2

B. 11

C. 6

D. 9

E. 7

F. 1

G. 4

H. 8

The three unused definitions are as follows:

Group of Persons = 10

Deemed Dividends = 3

Shareholders’ Equity = 5

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TIF Solution Fourteen - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.
The correct definitions for each of the listed key terms listed below.

A. 2 (not 13)

B. 15

C. 9

D. 12 (not 6)

E. 10

F. 1 (not 5)

G. 7

H. 11 (not 4)

The three unused definitions are as follows:

Group of Persons = 14

Deemed Dividends = 3

Shareholders’ Equity = 8

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TIF Solution Fourteen - 6

Part A - Non-Capital And Net Capital Losses - All Available Elections

Required Adjustments The following adjustments would be required under the acquisition of control
rules:

Investments In Common Stock As the $28,000 fair market value of the investments is below
their $32,000 cost, they would have to be written down, resulting in an allowable capital loss of
$2,000 [(1/2)($32,000 - $28,000)].

Equipment As the $50,000 fair market value of the Equipment is less than its $60,000 UCC, it
would have to be written down. The result would be deemed CCA of $10,000.

Elections If all available elections were made, the results would be as follows:

Land The Land would be written up to its fair market value of $235,000, resulting in a taxable
capital gain of $75,000 [(1/2)($235,000 - $85,000)].

Building The Building would be written up to its fair market value of $327,000. This would
result in recapture of $42,000 ($327,000 - $285,000).

Net Business Income (Loss) Based on these required and elective adjustments, the net business income
(loss) would be calculated as follows:

Loss As Originally Stated ($79,000)

Deemed CCA On Equipment (Required) ( 10,000)

Recapture On Building (Elected) 42,000

Net Business Loss For Period Ending May 31, 2018 ($47,000)

Net And Taxable Income If all of these elections were made, Nicastro Ltd.’s Net Income For Tax
Purposes and Taxable Income for the period January 1 through May 31, 2018 would be calculated as
follows:

ITA 3(a) - Net Rental Income $ 5,500

ITA 3(b) - Net Taxable Capital Gains:

Taxable Capital Gain On Land Election $75,000

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Allowable Capital Loss On Preferred Shares Sold ( 7,200)

Allowable Capital Loss On Write-Down Of

Common Shares (Required) ( 2,000) 65,800

ITA 3(c) - Total $71,300

ITA 3(d) - Net Business Loss ( 47,000)

Net Income For Tax Purposes $24,300

Net Capital Loss Carry Forward Deducted (100 Percent Of Balance) ( 48,000)

Taxable Income Nil

Loss Carry Forwards As the net capital loss carry forward was less than the net taxable capital gains,
the entire amount can be deducted. None of the balance will be lost as a result of the acquisition of
control.
With respect to the non-capital loss for 2018 and the total carry forward after May 31, 2018, this amount
would be calculated as follows:

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Business Loss For Period Ending May 31, 2018 $47,000

Net Capital Loss Deducted 48,000

Subtotal $95,000

Income Under ITA 3(c) ( 71,300)

Non-Capital Loss For Period Ending May 31, 2018 $23,700

Carry Forward From 2017 ($189,000 - $114,000) 75,000

Non-Capital Loss Carry Forward At May 31, 2018 $98,700

Part B - Non-Capital And Net Capital Losses - Limited Elections

The losses that could not be carried forward at the year end on May 31, 2018 consist of the $48,000 net
capital loss carry forward and the current year total allowable capital loss of $9,200 ($7,200 + $2,000).
To be able to use these losses, a taxable capital gain of $57,200 ($48,000 + $9,200) would have to be
created. This will require a capital gain of $114,400 [(2)($57,200)]. This can be achieved by electing a
disposition value for the land of $199,400 ($85,000 + $114,400).

Net Business Income (Loss) Based on the required adjustment, the net business income (loss) would
be calculated as follows:

Loss As Originally Stated ($79,000)

Deemed CCA On Equipment (Required) ( 10,000)

Net Business Loss For Period Ending May 31, 2018 ($89,000)

Net And Taxable Income Under this alternative as well, none of the capital losses will be lost. Net
Income For Tax Purposes and Taxable Income would be calculated as follows:

ITA 3(a) - Net Rental Income $ 5,500

ITA 3(b) - Net Taxable Capital Gains:

Taxable Capital Gain On Land Election $57,200

Allowable Capital Loss On Preferred Shares Sold ( 7,200)

Allowable Capital Loss On Write-Down Of

Common Shares (Required) ( 2,000) 48,000

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ITA 3(c) - Total $53,500

ITA 3(d) - Net Business Loss ( 89,000)

Net Income For Tax Purposes Nil

Net Capital Loss Carry Forward Deducted (100 Percent Of Balance) ( 48,000)

Taxable Income Nil

Non-Capital Loss Carry Forward With respect to the non-capital loss for 2018 and the total carry
forward after May 31, 2018, this amount would be calculated as follows:

Business Loss For Period Ending May 31, 2018 $ 89,000

Net Capital Loss Deducted 48,000

Subtotal $137,000

Income Under ITA 3(c) ( 53,500)

Non-Capital Loss For Period Ending May 31, 2018 $ 83,500

Carry Forward From 2017 ($189,000 - $114,000) 75,000

Non-Capital Loss Carry Forward At May 31, 2018 $158,500

The difference in the non-capital loss carry forward between Part A and B is equal to $59,800 ($158,500
- $98,700). This is the total of the recapture on the building of $42,000 plus the $17,800 ($75,000 -
$57,200) larger taxable capital gain on the land in Part A.

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Part C - Advice On Course Of Action

If Stella d’Oro either does not intend to continue the same business in which the loss occurred, or does
not expect to have sufficient profits in that business to absorb the non-capital losses within the relevant
carry forward period, Nicastro should make all elections as per Part A.
Alternatively, if Stella d’Oro expects to have sufficient profits in continuing the pasta business to absorb
the losses, Nicastro should use the Part B approach that maximizes the non-capital loss carry forward.
The reason for this is that the tax benefit of the non-capital loss carry forward will be realized as soon as
the appropriate profits are available in the post-acquisition period. Alternatively, the higher asset costs
that result from the Part A elections will only be realized if the assets are sold or, in the case of the
building, as CCA is taken.

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TIF Solution Fourteen - 7

Part A - Non-Capital And Net Capital Losses
Net Business Loss The net business loss for the period to April 30, 2018 would be as follows:

Loss As Per April 30, 2018 Income Statement ($46,000)

Required Accounts Receivable Adjustment ($90,000 - $76,000) ( 14,000)

Building Election - Recaptured CCA ($325,000 - $300,000) 25,000

Equipment - Deemed CCA ($60,000 - $45,000) ( 15,000)

Vehicles Election - Recaptured CCA ($132,000 - $110,000) 22,000

Net Business Loss For Period Ending April 30, 2018 ($28,000)

Net And Taxable Income Net Income For Tax Purposes and Taxable Income for the period ending
April 30, 2018, calculated as per the ITA 3 rules, would be as follows:

ITA 3(a) - Non-Capital Income (Positive Amounts Only) Nil

ITA 3(b) - Net Taxable Capital Gains (Losses):

Elections Under ITA 111(4)(e):

Gain On Land [(1/2)($262,000 - $180,000)] $ 41,000

Gain On Building [(1/2)($380,000 - $325,000)] 27,500

Required Write-Down - ITA 111(4)(c) And (d)

Loss On Temporary Investments

[(1/2)($45,000 - $12,000)] ( 16,500) $ 52,000

ITA 3(c) - Total $ 52,000

ITA 3(d) - Net Business Loss ( 28,000)

Net Income For Tax Purposes $ 24,000

Net Capital Loss Carry Forward

(Limited To Amount Included Under ITA 3(b)) ( 52,000)

Taxable Income Nil

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Lost Net Capital Loss The net capital loss balance that will be lost is calculated as follows:

Carry Forward From 2017 $96,000

Amount Deducted ( 52,000)

Net Capital Loss Lost On Acquisition Of Control $44,000

Non-Capital Loss Carry Forward The non-capital loss carry forward would be calculated as follows:

Business Loss For Period $ 28,000

Net Capital Loss Deducted 52,000

Subtotal $ 80,000

Income Under ITA 3(c) ( 52,000)

Non-Capital Loss For The Period Ending April 30, 2018$ 28,000

Non-Capital Loss Carry Forward From 2016 123,000

Non-Capital Loss Carry Forward From 2017 87,000

Non-Capital Loss Carry Forward At April 30, 2018 $238,000

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Part B - Non-Capital Loss Carry Forward In 2018

The Net Income For Tax Purposes for the period ending December 31, 2018 will be $123,000 ($146,000
- $23,000). As none of this income was from the cleaning services business, none of the non-capital loss
carry forward can be used in this period. This will leave the non-capital loss carry forward balance at
December 31, 2018 unchanged at $238,000.

Part C - Loss Carry Forward In 2019

Net Income For Tax Purposes for 2019 will be $211,000 ($263,000 - $52,000). As all of this income is
from the cleaning services business, this Net Income For Tax Purposes can be completely eliminated by
a non-capital loss carry forward of $211,000, leaving a Taxable Income of nil. This will leave a non-
capital loss carry forward from 2019 of $27,000 ($238,000 - $211,000).

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TIF Solution Fourteen - 8

Case 1
The two Companies are not associated. While Sarah Brandt and Melissa Frank are related, they are not
a group with respect to the two Companies. For association to apply in a case such as this, there would
have to be cross-ownership of at least 25 percent of the shares of one of the two companies. That is,
either Sarah Brandt would have to own 25 percent or more of MF Inc., or Melissa Frank would have to
own 25 percent or more of SB Inc.

Case 2
John Brody controls Heresy Inc., is related to each member of the group (himself and his spouse) that
controls Lason Ltd., and has cross-ownership of Lason Ltd. in excess of 25 percent. This means that
these two Companies are associated under ITA 256(1)(d).
Jessica Brody controls Porter Inc., is related to each member of a group that controls Lason Ltd., and has
the necessary cross-ownership of at least 25 percent of Lason Ltd. shares. This means that these two
Companies are also associated under ITA 256(1)(d).
As they are not controlled by the same individual or group, Heresy Inc. and Porter Inc. are not
associated under ITA 256(1). However, as they are both associated with the same third corporation
(Lason Ltd.), Heresy Inc. and Porter Inc. would be associated under ITA 256(2). Note that ITA 256(2)
allows Heresy Inc. and Porter Inc. to avoid association, provided Lason Ltd. elects not to be associated
with either Company. This will mean, however, that Lason Ltd. will have a business limit for the period
of nil.

Case 3
Surcal Inc. is associated with Basik Inc. under ITA 256(1)(a) as it has control of Basik. Surcal Inc. is
associated with Freon Ltd. under ITA 256(1)(a) as it has indirect control by virtue of its control of Basik.
Basik Inc. and Freon Ltd. are associated under ITA 256(1)(a) in that Basik Inc. has direct control of
Freon Ltd. Basik Inc. and Freon are also associated under ITA 256(1)(b) in that they are both controlled
by the same person (Surcal).

Case 4
For the purposes of determining associated companies, Martin controls Bloc Ltd. which gives him
control over that company’s 25 percent interest in Lorne Inc. In addition, he is deemed to own the 25
percent interest in Lorne Inc. that is held by his minor child [ITA 256(1.3)]. This means his total interest
is as follows:

Direct Interest 20 Percent

Indirect Interest Through Control Of Bloc Ltd. 25 Percent

Son’s Shares 25 Percent

Total Interest 70 Percent

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As this is a controlling interest, Martin has control of both Bloc Ltd. and Lorne Inc. Given this, the two
companies are associated under ITA 256)(1)(b).

Case 5
As a group, Ms. Bright and Ms. Favreau control both Aurora Ltd. and Bock Inc. As a consequence,
these two Companies would be associated under ITA 256(1)(b).

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TIF Solution Fourteen - 9

Part A
Mr. Johnson and Mr. Langley are a group that controls Astro Inc. However, they do not control Borealis
Ltd., as Mr. Kohn (not a member of the group that controls Astro Inc.) owns 50 percent of the shares.
Therefore, Astro Inc. and Borealis Ltd. are not associated.

Part B
While they are not related, Ms. Martineau and Ms. Olson constitute a group [ITA 256(1.2)(a)] with
respect to both Kisler Inc. and Pardo Ltd. As both Kisler Inc. and Pardo Ltd. are controlled by the same
group, the two Companies are associated under ITA 256(1)(b).

Part C
The Lane sisters are clearly related. In addition, under ITA 256(1.5) a person who owns shares in two or
more corporations shall be, as a shareholder of one of the corporations, deemed to be related to himself
as a shareholder of the other corporation(s).
Given this, FL Inc. and Lane Ltd. are associated under ITA 256(1)(d). Fiona Lane controls FL Inc., is a
member of a related group (Fiona and Jennifer Lane) that controls Lane Ltd., and owns more than 25
percent of the shares of Lane Ltd.
In similar fashion, JL Inc. is associated with Lane Ltd. under ITA 256(1)(d). Jennifer Lane controls JL
Inc., is a member of a related group (Fiona and Jennifer Lane) that controls Lane Ltd., and owns more
than 25 percent of the shares of Lane Ltd.
Based on these associations, FL Inc. and JL Inc. are associated under ITA 256(2), as they are both
associated with a third corporation, Lane Ltd.

Part D
For purposes of determining associated companies, Ms. Garland is deemed to own the 10 percent
interest in Newton Ltd. that is held by her minor child [ITA 256(1.3)], as well as the 40 percent interest
for which she holds options [ITA 256(1.4)]. When these interests are combined with her 10 percent
direct interest in Newton Ltd., she would be considered to be in control of Newton Ltd. As she controls
both Garland Inc. and Newton Ltd., these two Companies would be associated under ITA 256(1)(b).

Part E
With his 70 percent interest, Mr. Barnes controls Noble. This, in turn, gives him control over Noble’s
40 percent interest in Borders. When combined with his direct interest of 24 percent, his total interest of
64 percent gives him control over Borders.

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As both companies are controlled by the same person, the two Companies are associated under ITA
256(1)(b).

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TIF Solution Fourteen - 10

Case A
With respect to the $230,000 in apprentice salaries, the investment tax credit is available on an annual
salary maximum of $20,000 per apprentice. As a result, there will be a $20,500 [(7)(10%)($15,000) +
(5)(10%)($20,000 maximum)] credit against 2017 federal Tax Payable. This $20,500 credit will be
added to income in 2018.
With respect to the $1,500,000 in capital expenditures, there will be a 2018 credit against federal Tax
Payable of $150,000 [(10%)($1,500,000)].
The $150,000 credit will not influence the calculation of 2017 CCA. This amount will be $375,000
[(50%)(1/2)($1,500,000)].
In 2018, the $150,000 credit will be deducted from the January 1, 2018 UCC, leaving a balance of
$975,000 ($1,500,000 - $375,000 - $150,000). Given this, 2018 CCA will be $487,500 [(50%)
($975,000)].

Case B
Luxor’s annual expenditure limit would be $1,394,900. This amount is calculated as follows:

[$8 million – (10)($652,000*)][($40 million – $2,300,000) ÷ $40 million]

*Greater of $500,000 and the corporation’s Taxable Income for the preceding year

Case C
Martin’s annual expenditure limit would be $2,917,500, calculated as follows:

[$8 million – (10)($500,000*)][($40 million – $1,100,000) ÷ $40 million]

*Greater of $500,000 and the corporation’s Taxable Income for the preceding year

The amount of SR&ED Expenditure that would be eligible for the 35 percent rate can be calculated as
follows:

Total Current SR&ED Expenditures $3,300,000

Annual Expenditure Limit ( 2,917,500)

Limited To 15 Percent Rate $ 382,500

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The total amount of investment tax credits available can be calculated as follows:

Qualified Property [(10%)($110,000)] $ 11,000

SR&ED Current Expenditures:

At 35 Percent Rate [(35%)($2,917,500)] 1,021,125

At 15 Percent Rate [(15%)($382,500)] 57,375

Total Available Amount $1,089,500

Martin is a qualifying corporation. The refund available would be as follows:

Rate ITC Refund

Qualified Property 40% $ 11,000 $ 4,400

SR&ED Current Expenditures 100% 1,021,125 1,021,125

SR&ED Current Expenditures 40% 57,375 22,950

Total Available $1,089,500 $1,048,475

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The non-refunded investment tax credit of $41,025 ($1,089,500 - $1,048,475) can be carried forward 20
years to be applied against Tax Payable. There was no Tax Payable in the last three years so it cannot be
carried back.
The cost of the qualified property will be reduced in the following year by the refundable investment tax
credit of $4,400. The $1,044,075 ($1,021,125 + $22,950) refundable tax credit on current SR&ED
expenditures will be added to income in the following taxation year.

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TIF Solution Fourteen - 11

The December 31, 2018 balance in the capital dividend account is calculated as follows:

2008 Capital Gain [(1/2)($114,200 - $73,600)] $ 20,300

2011 Capital Dividend Received 42,100

2013 Capital Dividend Paid ( 23,100)

2014 Capital Gain [(1/2)($176,200 - $123,400)] 26,400

2014 Capital Loss [(1/2)($198,600 - $220,400)] ( 10,900)

2015 Life Insurance Proceeds 131,600

2018 Capital Gain [(1/2)($240,000 - $180,000)] 30,000

2018 Capital Dividend Paid ( 45,200)

Balance December 31, 2018 $171,200

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TIF Solution Fourteen - 12

Case One
The debt settlement transaction will result in an ITA 84(1) deemed dividend, calculated as follows:

PUC Of New Shares [(17,000)($22)] $374,000

Increase In Net Assets (Liability Eliminated) ( 350,000)

ITA 84(1) Deemed Dividend $ 24,000

This deemed dividend would be allocated to the 250,000 (233,000 + 17,000) shares that are now
outstanding on the basis of $0.096 ($24,000 ÷ 250,000) per share.
For Jane, this would result in a deemed dividend of $4,474 [($0.096)(46,600)]. For inclusion in Jane’s
Taxable Income, this amount would be grossed up to $5,190 [(116%)($4,474).
When the $0.096 per share deemed dividend is added to the adjusted cost base of Jane’s shares, this
value will be equal to $21.096 per share ($21.00 + $0.096).
The tax consequences of Jane selling her shares would be as follows:

Proceeds Of Disposition [(46,600)($24.00)] $1,118,400

Adjusted Cost Base [(46,600)($21.096)] ( 983,074)

Capital Gain $ 135,326

Inclusion Rate 1/2

Taxable Capital Gain $ 67,663

This will result in a total increase in Taxable Income of $72,853 ($67,663 + $5,190)
Also for Jane, there will be a federal dividend tax credit of $521 [(8/11)(16%)($4,474)].

Case Two
The analysis of the distribution would be as follows:

Cash Distributed $3,850,000

PUC Of Shares ( 106,000)

ITA 84(2) Deemed Dividend $3,744,000

ITA 83(2) Capital Dividend ( 347,000)

ITA 88(2)(b) Wind-Up Dividend $3,397,000

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Cash Distributed $3,850,000

ITA 84(2) Deemed Dividend ( 3,744,000)

ITA 54 Proceeds Of Disposition $ 106,000

Adjusted Cost Base ( 597,000)

Capital Loss ($ 491,000)

Inclusion Rate 1/2

Allowable Capital Loss ($ 245,500)

The capital dividend would be distributed tax free. The $3,397,000 wind-up dividend would be grossed
up to $3,940,520 [(116%)($3,397,000)]. It will also provide for a federal dividend tax credit of
$395,288 [(8/11)(16%)($3,397,000)].
The allowable capital loss can be used in the current year, only to the extent of taxable capital gains
realized in the current year.

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Case Three
The tax consequences to Charlotte Austen resulting from the redemption of her shares would be as
follows:

Proceeds Of Redemption [(75,000)($37)] $2,775,000

PUC [(75,000)($35)] ( 2,625,000)

ITA 84(3) Deemed Dividend $ 150,000

Proceeds Of Redemption $2,775,000

ITA 84(3) Deemed Dividend ( 150,000)

ITA 54 Proceeds Of Disposition $2,625,000

Adjusted Cost Base [($32)(75,000)] ( 2,400,000)

Capital Gain $ 225,000

Inclusion Rate 1/2

Taxable Capital Gain $ 112,500

The deemed dividend will be grossed up to $175,500 [(117%)($150,000)]. This will result in a total
increase in Taxable income of $288,000 ($175,500 + $112,500). The dividend will generate a federal
credit of $18,466 [(21/29)(17%)($150,000)].
With respect to the shares still held by Charlotte Austen, they would have a PUC of $6,125,000 [($35)
(250,000 - 75,000)]. Their adjusted cost base would be $5,600,000 [($32)(250,000 - 75,000)].

Case Four
To the extent of the $63,000 PUC reduction, the liquidating dividend will be treated as a tax free
distribution to Ms. Eliot. However, there will be tax consequences related to this distribution:

 The PUC of Ms. Eliot’s shares will be reduced to $280,000 ($343,000 - $63,000).

 The ACB of Ms. Eliot’s shares will be reduced to $388,000 ($451,000 - $63,000).

The $60,000 ($123,000 - $63,000) excess of the distribution over the PUC reduction will be an ITA
84(4) deemed dividend. For purposes of determining Taxable Income, this amount will be grossed up to
$70,200 [(117%)($60,000)]. It will generate a federal dividend tax credit of $7,386 [(21/29)(17%)
($60,000)]. The deemed dividend part of the distribution will not be subtracted from the adjusted cost
base of the shares.

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TIF Solution Fourteen - 13

Case 1
To the extent of the $162,000 PUC reduction, the liquidating dividend will be treated as a tax free
distribution to Marion. However, there will be tax consequences related to this distribution:

 The PUC of Marion’s shares will be reduced to $521,000 ($683,000 - $162,000).

 The ACB of Marion’s shares will be reduced to $561,000 ($723,000 - $162,000).

The $61,000 ($223,000 - $162,000) excess of the distribution over the PUC reduction will be an ITA
84(4) deemed dividend. The deemed dividend part of the distribution will not be subtracted from the
adjusted cost base of the shares.

Increase In Taxable Income = Grossed Up Dividend [(116%)($61,000)] $70,760

Federal Dividend Tax Credit [(8/11)(16%)($61,000)] $ 7,098

Case 2
This transaction will result in an ITA 84(1) deemed dividend for all shareholders, calculated as follows:

PUC Of New Shares [(30,000)($20)] $600,000

Increase In Net Assets (Liability Eliminated) ( 550,000)

ITA 84(1) Deemed Dividend $ 50,000

This would be allocated to all 255,000 (225,000 + 30,000) shares outstanding, on the basis of $0.196 per
share ($50,000 ÷ 255,000). This amount will also be added to the adjusted cost base of the shares.
Given that Jason acquired his 33,750 [(15%)(225,000)] shares for $15 per share, the tax consequences of
Jason owning and selling his shares would be as follows:

Grossed Up Dividend [(33,750)(116%)($0.196)] $ 7,673

Proceeds Of Disposition [(33,750)($23.00)] $776,250

Adjusted Cost Base [(33,750)($15.00 + $0.196)] ( 512,865)

Capital Gain $263,385

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Inclusion Rate 1/2

Taxable Capital Gain (All Shares Sold) $131,693

Increase In Taxable Income ($7,673 + $131,693) $139,366

Federal Dividend Tax Credit [(33,750)(8/11)(16%)($0.196)] $770

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Case 3
The analysis of the distribution would be as follows:

Cash Distributed $1,875,000

PUC Of Shares ( 125,000)

ITA 84(2) Deemed Dividend $1,750,000

ITA 83(2) Capital Dividend ( 321,000)

ITA 88(2)(b) Wind-Up Dividend $1,429,000

Cash Distributed $1,875,000

ITA 84(2) Deemed Dividend ( 1,750,000)

ITA 54 Proceeds Of Disposition $ 125,000

Adjusted Cost Base ( 364,000)

Capital Loss ($ 239,000)

Inclusion Rate 1/2

Allowable Capital Loss ($ 119,500)

The capital dividend would be distributed tax free.

The allowable capital loss can be used in the current year, only to the extent of taxable capital gains
realized in the current year.

Increase In Taxable Income = Grossed Up Dividend

[(116%)($1,429,000)] $1,657,640

Federal Dividend Tax Credit [(8/11)(16%)($1,429,000)] $166,284

Case 4
The tax consequences to Lawrence Foster resulting from the redemption of his shares would be as
follows:

Proceeds Of Redemption $1,700,000

PUC [(50,000)($32)] ( 1,600,000)

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ITA 84(3) Deemed Dividend $ 100,000

Proceeds Of Redemption $1,700,000

ITA 84(3) Deemed Dividend ( 100,000)

ITA 54 Proceeds Of Disposition $1,600,000

Adjusted Cost Base

[(50,000/300,000)($8,400,000)] ( 1,400,000)

Capital Gain $ 200,000

Inclusion Rate 1/2

Taxable Capital Gain $ 100,000

Increase In Taxable Income [(116%)($100,000) + $100,000] $216,000

Federal Dividend Tax Credit [(8/11)(16%)($100,000)] $11,636

No effect on ACB or PUC of remaining shares.

With respect to the shares still held, they would have a PUC of $8,000,000 [($32)(300,000 - 50,000)].
Their adjusted cost base would be $7,000,000 [($28)(300,000 - 50,000)].

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Chapter Fifteen Test Item File Solutions

TIF Solution Fifteen - 1
1. The use of a corporation only provides significant tax deferral in those cases where income can be
left in the business and not paid out to the shareholders. As Frank requires all of the income of his
business in order to provide for his personal consumption needs, the use of a corporation will not
provide any deferral. However, as he anticipates that the business’s income will exceed his
personal consumption needs in the foreseeable future, there will be deferral on amounts of income
that are left in the corporation in future years.

It appears that Frank’s business would be a CCPC earning active business income. Provided this
income does not exceed the amount eligible for the small business deduction, in most provinces
there will be a tax savings resulting from the use of a corporation. However, this tax savings may
not be large enough to justify the costs of establishing and maintaining a corporation.

2. As described in the text, the two basic types of benefits are as follows:

Tax Reduction In some situations, the total taxes that would be paid at the combined
corporate and personal level will be less when the business is incorporated than would be the
case if the individual had earned the business income directly as an individual proprietor.

Tax Deferral Getting income from its source through a corporation and into the hands of a
shareholder involves two levels of taxation. If the shareholder does not require all available
income for his personal needs, after tax funds can be left in the corporation, resulting in a
postponement of the second level of taxation. If the rate at which the corporation is taxed is
lower than the rate at which the individual would be taxed on the direct receipt of the income,
the use of a corporation provides tax deferral.

3. Because a corporation is a separate legal entity, the shareholders’ liabilities to creditors are limited
to the amount that they have invested. That is, creditors of the corporation can look only to the
assets of the corporation for satisfaction of their claims. However, for owner-managed
corporations, obtaining significant amounts of financing will almost always require the owners to
provide personal guarantees on any loans, making this advantage somewhat illusory for this type of
company. Note, however, limited liability may still be important for a business that is exposed to
significant product or environmental claims.

4. The goal of integration is to ensure that, when a corporation is used, the combined corporate and
individual taxes paid will be same as those paid by an individual receiving the same income
directly. For eligible dividends, the enhanced gross up and tax credit procedures are based on the
assumption of a combined federal/provincial corporate tax rate of 27.54 percent. For non-eligible
dividends, the gross up and tax credit procedures are based on the assumption of a combined
federal/provincial corporate tax rate of 13.79 percent. If the actual combined rate exceeds these
rates, it will discourage the use of a corporation. If the actual combined rate is less than these rates,
use of a corporation becomes more attractive.

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The other assumption that is inherent in the integration system is that the combined
federal/provincial dividend tax credit will be equal to the gross up. For eligible dividends, the
federal credit is equal to 6/11 of the gross up. For the combined credit to equal the gross up, the
provincial credit must be equal to 5/11 of the gross up. For non-eligible dividends, the federal
credit is equal to 8/11 of the gross up. For the combined credit here to equal the gross up, the
provincial credit must be equal to 3/11 of the gross up. If the provincial credit exceeds these values,
the combined credit exceeds the notional corporate taxes and makes the use of a corporation more
attractive. Alternatively, if the provincial credit is less than these values, the credit does not
compensate for corporate taxes paid and this discourages the use of a corporation.

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5. For income splitting to be an effective tax planning strategy, there must be significant differences in
the income levels of individuals in a related group. Income splitting is based on the idea that some
amount of income will be transferred from individuals in a high tax bracket to individuals in a low
tax bracket. This will create a savings based on the difference between the tax rates applicable to
the two individuals. A typical situation would be a parent in the 29 or 33 percent federal tax
bracket, with adult children with little or no income. Note, however, that income splitting does not
work if the income transferred to the individual in the low tax bracket is subject to the Tax On Split
Income (TOSI).

6. Until the business becomes profitable, it would be best to continue operations as a proprietorship.
The major reason for this advice is that, if he continues to operate as a proprietorship, he can deduct
his losses against his other sources of income (e.g., investment income). In contrast, if he
incorporates the business, he will have to carry the losses forward until such time as the business
becomes profitable and cannot use the loss personally. In addition, if he plans on the business
making charitable contributions, if he does not incorporate, he will be able to claim a personal tax
credit for the contributions. In contrast, if he incorporates, such contributions will have to be
carried forward to be deducted when the business becomes profitable.

7. The effect of a provincial tax holiday for a Canadian controlled private corporation is to reduce the
overall tax rate on the first $500,000 of active business income to 10 percent (38% - 10% - 18% +
0%). This is 3.79 percent below the 13.79 percent rate that is assumed in the integration provisions
and, as a consequence, the tax deduction associated with salary payments would be less significant.
Without considering other factors, the presence of a provincial tax holiday would favour the use of
dividend payments to the owner-manager over the use of salary compensation.

8. For integration to work for a large public company, the combined federal/provincial tax rate on
corporations must be 27.54 percent. In addition, the provincial dividend tax credit for eligible
dividends must be equal to 5/11 of the dividend gross up.

9. Bonusing down is a tax planning technique that involves paying deductible salary amounts to an
owner-manager in order to reduce a CCPC’s active business income to the amount that is eligible
for the small business deduction. The advantage of bonusing down is that the personal taxes paid
on the salary will sometimes be less than the corporate tax on income in excess of the small
business deduction, combined with the taxes paid by the owner-manager when the after tax income
is distributed to him as dividends.

10. If Ms. Copeland receives the dividends directly, the effective tax rate will be 26.4 percent
{[(Dividends)(138%)(29% + 12%)] - [(Dividends)(38%)(6/11 + 25%)]}. Given that her
investments are in large public companies, if she incorporates, the dividends would be subject to
Part IV tax at a rate of 38-1/3 percent. This means that there is no tax deferral through the use of a
corporation in this situation.

With respect to tax savings, the 38-1/3 percent Part IV tax would be refunded and the full amount of
dividends received by the corporation could be paid out to Ms. Copeland. The tax that she would

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pay would be exactly the same as if she had received the dividends directly. This means that there
would be no tax savings through the use of a corporation in this situation.

11. When a corporation is used, there are two levels of taxation. Taxes are assessed at the corporate
level and again at the personal level. If the individual does not require all of the income for his
personal needs and can leave some part of the income in the corporation, the second level of
taxation can be delayed. However, whether or not this will be beneficial depends on the combined
federal/provincial tax rate on the corporation. If this combined rate is less than the rate applicable
to the individual on the direct receipt of income, the deferral will be beneficial. If the combined rate
is higher, the deferral will not be beneficial.

12. With respect to combined federal/provincial corporate tax rates, rates that are higher than 27.54
percent make the use of a corporation less desirable, while rates that are less than 27.54 percent
make incorporation more desirable.

With respect to the combined federal/provincial dividend tax credit, a credit that is larger than the
dividend gross up will make incorporation more desirable, while a credit that is smaller than the
dividend gross up will make the use of a corporation less desirable.

13. For each dollar of non-eligible dividends received, the individual must add a gross up of $0.16 to
Taxable Income. For individuals in the lowest federal tax bracket, the federal tax on this amount
will be $0.1740 [($1.16)(15%)]. However, there will be a federal credit against this tax payable
equal to 8/11 of the gross up, or $0.1164 [(8/11)($0.16)]. This means that, as long as an individual
is in the lowest federal tax bracket, the increase in tax associated with one dollar of non-eligible
dividends received can be calculated as follows:

Federal Tax Payable On Grossed Up Dividend $.1740

Federal Dividend Tax Credit ( .1164)

Increase In Federal Tax Payable $.0576

As compared to an increase in federal tax of $0.15 for each one dollar increase in interest income,
there is only a $0.0576 increase in federal tax for each one dollar increase in dividends received.
This means that dividend income uses up an individual’s available tax credits at a much slower rate
than other types of income. For example, while one dollar of interest income will use up one dollar
[($1.00)($.15 ÷ $.15)] of an individual’s personal tax credit base of $11,809, one dollar of non-
eligible dividends received will use up only $0.384 of this base [($1.00)($.0576 ÷ $.15)]. This
means that, in comparison with other types of income, a much larger amount of dividends can be
received before an individual’s tax credits are absorbed and taxes will have to be paid.

14. Ms. Simsung could establish a new corporation and transfer all or part of her investments to that
entity. In return, she would receive a combination of debt which pays interest at the prescribed rate

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(currently 2 percent), along with preferred shares which would have the votes that control the
corporation. Her children could then purchase non-voting shares with the right to receive the
income from the investments. Depending on the amount of such income, the income could be
received on a tax free basis. Alternatively, if Ms. Simsung continues to hold the investments, this
income would be taxed at maximum rates. Note, however, that this strategy does not work if her
children will be subject to the Tax On Split Income (TOSI)

15. Unlike the situation with publicly traded companies, the owner-manager is subject to few
constraints on the use of the corporate assets. In effect, he is in a position to provide significant
benefits to himself and other related individuals without review by internal and external auditors or
concern about the financial effects on unrelated shareholders. This allows the owner-manager much
more flexibility in designing a compensation package.

16. This would not be a good idea. To begin, the value of the pool would be included in your friend’s
income on the same basis as the payment of an equivalent amount of salary. However, as the pool
would be a benefit under ITA 15(1), its cost would not be deductible to his company. The friend
would be better off either paying sufficient salary to finance the pool (while he would pay taxes on
the salary, the amount paid would be deductible to the company) or, alternatively, paying sufficient
dividends to finance the pool (while the dividends could not be deducted by the corporation, they
would be taxed more favourably than the taxable benefit resulting from the construction of the
pool).

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17. The two required exceptions can be selected from the following:

 The general rule does not apply when the loan is in the ordinary course of the corporation’s
business.

 The general rule does not apply when the loan is repaid within one year after the end of the
taxation year of the lender or creditor in which the loan was made or the indebtedness arose.

 The general rule does not apply to indebtedness between non-resident persons. This means
that, if both the corporation and the shareholder receiving the loan were non-residents, the
principal amount of any loan would not have to be included in income.

18. In order to make a convincing case that the loan was received by the owner-manager in his capacity
as an employee, the same type of loan must be extended to all employees with similar duties and
responsibilities. If the loan is particularly large, or on particularly favourable terms, the owner-
manager may not wish to extend this privilege. In addition, in some cases the business may not
have other senior employees or any other employees at all. This could make it impossible to make
the case for receipt of the loan as an employee. The CRA, in cases where a private corporation has
few employees with which to make a comparison, looks to what is standard or accepted practice
within a given industry in deciding whether a loan is received in an employment capacity.

19. There are two advantages to having an employee benefit, rather than a shareholder benefit:

 The principal amount does not have to be included in John’s income when the loan is made.

 If the loan is an employee loan, for the first five years of the loan, the benefit calculation rate
will go no higher than the prescribed rate that prevailed when the loan was made.

20. The required two examples can be selected from the following items listed in the text:

 Registered Pension Plans Within prescribed limits, a corporation can deduct contributions to
Registered Pension Plans in the year of contribution. These contributions will not become
taxable to the employee until they are received as a pension benefit, resulting in an effective tax
deferral arrangement.

 Deferred Profit Sharing Plans In a fashion similar to Registered Pension Plans, amounts that
are currently deductible to the corporation are deferred with respect to inclusion in the
employee’s Taxable Income.

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 Provision Of Private Health Care Plans The premiums paid by the corporation for such
benefits as dental plans can be deducted in full by the corporation and will not be considered a
taxable benefit to the employee. This can generate a significant tax savings.

 Stock Options Stock options provide employees with an incentive to improve the performance
of the enterprise. In addition, taxation of any benefits resulting from the options is deferred
until they are exercised or sold (for a full discussion of the deferral of stock option benefits, see
Chapter 3). Further, the value of the employment benefit received is enhanced by the fact that,
in general, one-half of the amount can be deducted in the calculation of Taxable Income.

Other examples may be acceptable.

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21. The required three factors could be chosen from the following:

 Corporate Tax Payable - Salary’s deductibility is not currently important if there is no Tax
Payable.

 The added costs of CPP, EI, and payroll taxes discourage the use of salary.

 Dividends do not provide an addition to Earned Income for RRSP purposes.

 Dividends do not provide an addition to Earned Income for deductible child care purposes.

 Dividends reduce a CNIL balance.

 Salary can provide CPP and Canada Employment tax credits to the owner-manager.

22. As dividends use up available tax credits at a much slower rate than is the case with salary, the
payment of all compensation in the form of dividends may result in unused tax credits for the
current taxation year. As most of these credits are non-refundable, if they are not used during the
current year they will be lost. Given this, it may be beneficial to pay a combination of salary and
dividends that is sufficient to use up all of the individual’s non-refundable tax credits.

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TIF Solution Fifteen - 2

1. False.

Corporate losses cannot be used against an individual’s other sources of income.

2. True.

3. False.

The higher credit makes using a corporation more attractive.

4. False.

It is a procedure that is used to avoid having amounts of active business income in excess of
amounts eligible for the small business deduction taxed at high corporate rates.

5. True.

6. False.

If he has the corporation build the pool, he will have a taxable benefit equal to the cost of the
pool. While his taxes on this amount are likely to be similar to those that would be paid on
an equivalent amount of salary, the difference is that the corporation can deduct the cost of
the salary. In contrast, the corporation will not be able to deduct the shareholder benefit.

7. False.

Shareholder loans do not have to be included in Net Income For Tax Purposes if the
corporation makes loans in the ordinary course of their business as the Royal Bank does.

8. True.

9. True.

10. False.

Salary increases the Earned Income base for making RRSP contributions. Dividends do not
increase this base.

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11. False.

Higher corporate rates favour the direct receipt of income.

12. True.

As charitable donations are a deduction for a corporation, they would have a value of $0.12 on
the dollar to a corporation that is taxed at 12 percent. In contrast, donations made by
individuals create a federal credit against Tax Payable of $0.15, $0.29 or $0.33 on the
dollar, all of which are higher than the combined rate of $0.12. There would be additional
credits at the provincial level for individuals.

13. False.

Income splitting refers to procedures designed to divide an individual’s income between a

group of related individuals.

14. False.

A low provincial dividend tax credit favours the use of salary.

15. True.

16. False.

Only individuals with no other source of income can receive this amount of dividends tax free.

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TIF Solution Fifteen - 3

The Decision To Incorporate

1. B. The use of a corporation will always result in deferral of taxes on income that is left in
the corporation. For some types of corporate income, the corporate tax rate may be higher than
the rate applicable to the individual.

2. B. The ability to absorb business losses against employment income.

3. B. The taxpayer has significant personal assets and investment income, and does not need
all of the cash from her business in order to pay day to day living expenses.

4. D. The corporation is a CCPC earning active business income.

5. D. Dividend payments may be deferred until after a shareholder has retired; a capital
gains deduction may be available if conditions are met; and active business income under
$500,000 is eligible for a lower tax rate.

Tax Reduction and Deferral

6. A. Joan’s financial risk is limited to $1,150,000.

7. A. Incorporating a CCPC earning only Active Business Income eligible for the small
business deduction.

8. C. Because if the income over $500,000 remains in the company it will not benefit from
the small business deduction, and therefore the after tax retention on this excess income in the
company will be lower than it would be on paying a salary to Ms. Rothstein.

9. B John could protect himself from being held personally liable if a client sustained
injuries by falling overboard.

10. C. All of the federal corporate taxes paid on the dividends would be refunded when all of
the dividends received by the corporation are paid out to the individual.

11.

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C. Incorporation will result in a deferral of taxes to the extent profits can be left in the corporation.

12. A. There can be a small tax advantage associated with incorporation. C is incorrect as the
individual needs all of the earnings so there is no deferral.

13. C. There will be tax deferral because of the small business deduction.

Provincial Taxes and Integration

14. C. Differing federal dividend tax rates for eligible and non-eligible dividends.

15. B. The combined federal/provincial tax rate on corporations is less than the combined
federal/provincial tax rate on individuals.

16. C. The combined federal/provincial tax rate on individuals.

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Tax Free Dividends

17. D. For individuals in the lowest tax bracket, dividends always use up tax credits at a
slower rate than other types of income.

Income Splitting
18. B. Income splitting can only be accomplished by using a corporation.

Shareholder Loans
19. A. A loan to an owner-manager to allow him to purchase a personal residence. The loan
does not have a specific repayment date.

20. i. C. The amount of the loan of $30,000 must be added to the shareholder’s
income as the loan is going to be outstanding on two consecutive corporate year ends. No
imputed interest will be added to income.

ii. F. The imputed interest of $450 [(9/12)(2%)($30,000)] will be added to income.

However, as the proceeds of the loan were used to make an income producing investment,
the imputed interest will be deductible under ITA 20(1)(c) through ITA 80.5. The net
effect on Taxable Income is nil.

iii. C. The amount of the loan of $30,000 must be added to the shareholder’s income as the
loan is going to be outstanding on two consecutive corporate year ends. No imputed
interest will be added to income. Since the shareholder is not an employee, there is no
exception for a housing loan.

21. A. $5,000 in 2018. ITA 15(2) taxes the amount of the loan to the recipient of the loan. In
this case, Albert Jay is taxed on $5,000 in 2018 and his son would be taxed on $2,000 for 2018,
as the loans were still outstanding on January 31, 2020.

22. C. Jacquie’s 2018 Taxable Income is:

Grossed Up Non-Eligible Dividend [($1,100)(116%)] $1,276.00

ITA 80.4 Interest Benefit

[($10,000)(4%)(90/365)] $98.63

[($10,000)(3%)(91/365)] 74.79 173.42

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ITA 20(1)(c) Interest Deduction

[($10,000 - $2,000)(4%)(90/365)] ($78.90)

[($10,000 - $2,000)(3%)(91/365)] ( 59.84) ( 138.74)

Total $1,310.68

23. C. It must be repaid within one year of the end of the fiscal year in which it was made.

24. A. Martin will have to include $350,000 in his 2017 Net Income For Tax Purposes.

25. D. The corporation purchases life insurance on the life of the shareholder in order to
ensure that the company has the necessary funds to deal with a sudden unexpected death of the
shareholder.

Management Compensation
26. D. Salary payments.

27. C. A desire to eliminate a large CNIL balance.

28. C. The corporation has Taxable Income in excess of $500,000.

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29. B. He should take the salary because he will have more left after tax. Since the Company
is not a CCPC, it is not eligible for the small business deduction. The fact that the company
will pay dividends that are eligible for the enhanced gross up and tax credit procedures will not
compensate Larry for corporate taxes paid at a 32 percent rate (the rate assumed for the
enhanced credit is 27.54 percent).

30. D. The best solution is to take the funds out as salary so that she can maximize her
contribution to her RRSP.

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TIF Solution Fifteen - 4

Exam Exercise Solution Fifteen - 1
(Use Of A Corporation For Tax Deferral And Savings)
Mr. Lee’s combined tax rate on income earned by the unincorporated business is 49 percent (33% +
16%). If he does incorporate, all of the $98,000 will be eligible for the small business deduction. This
means that it will be taxed at a rate of 13 percent (38% - 10% - 18% + 3%).
Mr. Lee’s tax rate on non-eligible dividend income is 40.8 percent [(116%)(49%) - (8/11 + 3/11)(16%)].
Using these tax rates, the relevant calculations are as follows:

With Without

Corporation Corporation

Business Income $98,000 $98,000

Tax Rate 13% 49%

Tax Payable $12,740 $48,020

Business Income $98,000 $98,000

Tax Payable ( 12,740) ( 48,020)

Maximum Non-Eligible Dividend Payable $85,260 N/A

Personal Tax On Dividends [(40.8%)($85,260)] ( 34,786) N/A

Income Retained By Mr. Lee $50,474 $49,980

There is clearly a significant amount of tax deferral with respect to income left in the corporation. His
Tax Payable on direct receipt of the $98,000 of business income would be $48,020, far higher than the
$12,740 that would be paid by the corporation.
After tax retention with the use of a corporation would be $50,474. This is $494 more than the $49,980
that would be retained through direct receipt of this income. You should advise your client that, in
addition to providing the possibility of tax deferral, using a corporation will also have a modest overall
tax benefit.

Exam Exercise Solution Fifteen - 2

(Use Of A Corporation For Tax Deferral And Savings)
Ms. Ho’s tax rate on income earned by her unincorporated business is given as 51 percent. If she
chooses to incorporate, all of the income earned by the corporation will be eligible for the small business
deduction and will be taxed at a rate of 14 percent (38% - 10% - 18% +4%). Ms. Ho’s tax rate on non-
eligible dividend income is 44 percent [(116%)(51%) - (8/11 + 20%)(16%)].
Using these tax rates, the relevant calculations are as follows:

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With Without

Corporation Corporation

Business Income $142,000 $142,000

Tax Rate 14% 51%

Tax Payable $ 19,880 $ 72,420

Business Income $142,000 $142,000

Tax Payable ( 19,880) ( 72,420)

Maximum Non-Eligible Dividend Payable $122,120 N/A

Personal Tax On Dividends [(44%)($122,120)] ( 53,733) N/A

Income Retained By Ms. Ho $ 68,387 $ 69,580

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If Ms. Ho’s business continues to be unincorporated, taxes will be $72,420, more than three times the
amount of tax that would be paid at the corporate level if she decides to incorporate. There is clearly
significant tax deferral on income that is not removed from the corporation.
However, there is a tax cost if the income is removed from the corporation. The cost is $1,193, $69,580
without the corporation, compared to $68,387 with the corporation.

Exam Exercise Solution Fifteen - 3 (Incorporation Of Interest Income)

Ms. MacDonald’s combined tax rate on interest income earned outside the corporation is 51 percent
(33% + 18%). If she incorporates, the interest income will not be eligible for the small business
deduction or the general rate reduction and it will be subject to the ART. This means that, if the
investments are transferred to a corporation, the interest will be taxed at a rate of 52-2/3 percent (38% -
10% + 10-2/3% + 14%).
Ms. MacDonald’s tax rate on non-eligible dividends received is 43.5 percent [(116%)(51%) - (8/11 +
25%)(16%)].
Using these tax rates, a comparison of the income retained with and without the use of a corporation is
as follows:

With Without

Corporation Corporation

Interest Income $143,000 $143,000

Tax Rate 52-2/3% 51%

Tax Payable $ 75,313 $ 72,930

Interest Income $143,000 $143,000

Tax Payable ( 75,313) ( 72,930)

Net Corporate Income Before Dividend Refund $ 67,687 N/A

Maximum Dividend Refund (See Note) 42,075

Maximum Dividend Payable $109,762

Personal Tax On Dividends [(43.5%)($109,762)] ( 47,746)

Income Retained By Ms. MacDonald $ 62,016 $ 70,070

RDTOH Balance [(30-2/3%)($143,000)] $43,853

Note The refund is the lesser of 38-1/3 percent of dividends paid and the balance in the RDTOH
account. The after tax funds would support a dividend of $109,762 ($67,687 ÷ .61667), including a

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potential dividend refund of $42,075 [(38-1/3%)($109,762)]. The refund would be the lesser figure
of $42,075.

As the corporate tax rate is higher than the 51 percent rate applicable to the direct receipt of interest
income, the corporation does not provide any deferral on amounts left within the corporation. In this
case, incorporation requires prepayment of taxes.
Using a corporation, she would be left with $62,016 in after tax funds. If she does not incorporate, the
$143,000 in interest income would be taxed at 51 percent, leaving an after tax amount of $70,070. The
tax cost of incorporation is $8,054 ($70,070 - $62,016).

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Exam Exercise Solution Fifteen - 4 (Incorporation Of Interest Income)

Victor’s personal tax rates are 51 percent on interest income and 42.7 percent [(116%)(51%) - (8/11 +
30%)(16%)] on non-eligible dividends. The corporate tax rate on investment income will be 51-2/3
percent (38% - 10% + 10-2/3% + 13%).
Using these tax rates, a comparison of the income retained with and without the use of a corporation is
as follows:

With Without

Corporation Corporation

Interest Income $210,000 $210,000

Tax Rate 51-2/3% 51%

Tax Payable $108,500 $107,100

Interest Income $210,000 $210,000

Tax Payable ( 108,500) ( 107,100)

Net Corporate Income Before Dividend Refund $101,500 N/A

Maximum Dividend Refund (See Note) 63,095

Maximum Dividend Payable $164,595

Personal Tax On Dividends [(42.7%)($164,595)] ( 70,282)

Income Retained By Mr. Vice $ 94,313 $102,900

RDTOH Balance [(30-2/3%)($210,000)] $64,400

Note The dividend refund is the lesser of 38-1/3 percent of dividends paid and the balance in the
RDTOH account. The available cash would support a dividend of $164,595 ($101,500 ÷ .61667),
resulting in a potential dividend refund of $63,095 [(38-1/3%)($164,595)]. The lesser of the two
figures is $63,095.

As the corporate rate of 51-2/3 percent is higher than Victor’s personal rate of 51 percent, the use of a
corporation provides requires prepayment of taxes and no deferral.
If the interest income is flowed through the corporation, there is a tax cost of $8,587 ($102,900 -
$94,313). Clearly, transferring Victor’s interest bearing investments to a corporation would not be a
wise move.

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Exam Exercise Solution Fifteen - 5 (Incorporation Of Interest And Dividends)

Direct Receipt
If the income is received directly, the total Tax Payable will be as follows:

Non-Eligible Dividends Received ($39,000 + $75,000)$114,000

Gross Up At 16 Percent 18,240

Taxable Dividends $132,240

Interest Income 36,500

Taxable Income $168,740

Personal Tax Rate (33% + 16%) 49%

Tax Payable Before Dividend Tax Credit $ 82,683

Dividend Tax Credit [(8/11 + 25%)($18,240)] ( 17,825)

Personal Tax Payable $ 64,858

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The after tax retention can be calculated as follows:

Cash Received ($39,000 + $75,000 + $36,500) $150,500

Tax Payable (See Calculation) ( 64,858)

After Tax Retention - Direct Receipt $ 85,642

Transfer To Corporation
The corporate tax rate on investment income will be 50-2/3 percent (38% - 10% + 10-2/3% + 12%). If
the investments are transferred to a corporation, the corporate taxes will be as follows:

Part IV Tax On Dividends Received

[(38-1/3%)($39,000) + $20,000] $34,950

Tax On Interest Income [($36,500)(50-2/3%)] 18,493

Corporate Tax Payable Before Dividend Refund $53,443

As this Tax Payable is less than the $64,858 that would be paid on the direct receipt of income, the use
of a corporation would provide for a deferral of taxes. However, as the client needs all of the income
produced by these investments, the use of a corporation to defer taxes is not relevant.
As this would be a new corporation, it would have no RDTOH balance at the beginning of the year. The
RDTOH balance prior to the dividend refund would be calculated as follows:

Part IV Addition $34,950

Part I Addition [(30-2/3%)($36,500)] 11,193

RDTOH Balance $46,143

The dividend refund would be the lesser of 38-1/3 percent of dividends paid and the balance in the
RDTOH account. The cash available after corporate taxes is $97,057 ($150,500 - $53,443). This would
support a dividend of $157,390 ($97,057 ÷ .61667), with a potential dividend refund of $60,333 [(38-
1/3%)($157,390)]. However, as the RDTOH balance is less than this, the refund would be $46,143.

After Tax Corporate Cash $ 97,057

Dividend Refund (RDTOH Balance) 46,143

Non-Eligible Dividends Received $143,200

Gross Up At 16 Percent 22,912

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Taxable Dividends $166,112

Personal Tax Rate 49%

Tax Before Dividend Tax Credit $ 81,395

Dividend Tax Credit [(8/11 + 25%)($22,912)] ( 22,391)

Personal Tax Payable $ 59,004

After tax retention with the use of a corporation would be $84,196 ($143,200 - $59,004). This is $1,446
less than the $85,642 that would be retained through direct receipt of this income.
You should advise your client that using a corporation would result in an overall tax cost, making it not
advisable to transfer her assets to a corporation.

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Exam Exercise Solution Fifteen - 6 (Incorporation Of Interest And Dividends)

Direct Receipt Of Income

If the income is received directly, the total Tax Payable will be as follows:

Non-Eligible Dividends Received

($102,000 + $96,000) $198,000

Gross Up At 16 Percent 31,680

Taxable Dividends $229,680

Interest Income 71,000

Taxable Income $300,680

Personal Tax Rate 49%

Tax Payable Before Dividend Tax Credit $147,333

Dividend Tax Credit [(8/11 + 3/11)($31,680)] ( 31,680)

Personal Tax Payable $115,653

The after tax retention can be calculated as follows:

Cash Received ($71,000 + $102,000 + $96,000) $269,000

Tax Payable ( 115,653)

After Tax Retention - Direct Receipt $153,347

Flowed Through A Corporation

The corporate tax rate on investment income will be 50-2/3 percent (38% - 10% + 10-2/3% + 12%). If
the investments are transferred to a corporation, the corporate taxes will be as follows:

Part IV Tax On Dividends Received

[(38-1/3%)($102,000) + $23,000] $62,100

Tax On Interest Income [($71,000)(50-2/3%)] 35,973

Corporate Tax Payable Before Dividend Refund $98,073

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As this Tax Payable is smaller than the $115,653 that would be paid on the direct receipt of income, the
use of a corporation provides for deferral of taxes. However, as the individual needs all of the income
produced by these investments, the use of a corporation to defer taxes is not an issue.
As this would be a new corporation, it would have no RDTOH balance at the beginning of the year. The
RDTOH balance prior to the dividend refund would be calculated as follows:

Part IV Addition $62,100

Part I Addition [(30-2/3%)($71,000)] 21,773

RDTOH Balance $83,873

The dividend refund is the lesser of the balance in the RDTOH account and 38-1/3 percent of dividends
paid. The available cash of $170,927 ($269,000 - $98,073) would support a dividend of $277,177
($170,927 ÷ .61667), including a potential dividend refund of $106,250 [(38-1/3%)($277,177)].
However, this amount is larger than the RDTOH balance and, given this, the refund would be $83,873.

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Personal tax payable on these dividends would be calculated as follows:

After Tax Corporate Cash $170,927

Dividend Refund (RDTOH Balance) 83,873

Non-Eligible Dividends Received $254,800

Gross Up At 16 Percent 40,768

Taxable Dividends $295,568

Personal Tax Rate 49%

Tax Before Dividend Tax Credit $144,828

Dividend Tax Credit [(8/11 + 3/11)($40,768)] ( 40,768)

Personal Tax Payable $104,060

After tax retention with the use of a corporation would be $150,740 ($254,800 - $104,060). This is
$2,607 ($153,347 - $150,740) less than the amount that Max would have retained on the direct receipt of
income. You should advise Max that transferring his investments to a corporation has a tax cost.

Exam Exercise Solution Fifteen - 7 (Incorporation Of Capital Gains)

Direct Receipt Of Income Ms. Peterson’s personal tax rate would be 51 percent (33% + 18%). Based
on this, the after tax amount retained on direct receipt of income can be calculated as follows:

Capital Gain $142,000

Inclusion Rate 1/2

Taxable Capital Gain $ 71,000

Rate 51%

Personal Taxes At 51 Percent $ 36,210

Cash From Capital Gain $142,000

Personal Taxes ( 36,210)

After Tax Retention - Direct Receipt $105,790

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Flowed Through A Corporation The corporation’s tax rate on investment income would be 54-2/3
percent (38% - 10% + 10-2/3% + 16%). Based on this, the maximum distribution that can be made to
Ms. Peterson would be calculated as follows:

Capital Gain $142,000

Inclusion Rate 1/2

Taxable Capital Gain $ 71,000

Corporate Tax Payable At 54-2/3 Percent ( 38,813)

Available For Non-Eligible Dividend $ 32,187

Dividend Refund (See Note) 20,008

Non-Eligible Dividend Received $ 52,195

RDTOH Balance [(30-2/3%)($71,000)] $ 21,774

Note The dividend refund is the lesser of the balance in the RDTOH account and 38-1/3
percent of the dividends paid. The available cash of $32,187 would support a dividend of
$52,195 ($32,187 ÷ .61667), which includes a dividend refund of $20,008 [(38-1/3%)
($52,195)]. The lesser of the two figures is $20,008.

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Ms. Peterson’s tax rate on non-eligible dividend income is 43.2 percent [(116%)(51%) - (8/11 + 3/11)
(16%)]. Based on this, the net after tax retention when a corporation is used would be as follows:

Tax Free Capital Dividend Received [(1/2)($142,000)] $ 71,000

Non-Eligible Dividend Received 52,195

Tax Payable On Non-Eligible Dividend Received

[(43.2%)($52,195)] ( 22,548)

After Tax Retention - With Corporation $100,647

As this is less than the after tax cash retained of $105,790 on the direct receipt of the income, the use of
a corporation to hold these investments is not an appropriate choice. Note that, as the client needs all of
the income produced by these investments, the use of a corporation to defer taxes is not an issue.

Exam Exercise Solution Fifteen - 8 (Incorporation Of Capital Gains)

Direct Receipt Of Income Based on his personal tax rate of 52 percent, the amount retained on the
direct receipt of income would be as follows:

Capital Gain [($640,000 - $420,000)] $220,000

Inclusion Rate 1/2

Taxable Capital Gain $110,000

Rate 52%

Personal Taxes At 52 Percent $ 57,200

Cash From Capital Gain $220,000

Personal Taxes ( 57,200)

After Tax Retention - Direct Receipt $162,800

Flowed Through A Corporation The corporation’s tax rate on investment income would be 52-2/3
percent (38% - 10% + 10-2/3% + 14%). Based on this, the maximum distribution that can be made to
Mr. Barkin would be calculated as follows:

Capital Gain ($640,000 - $420,000) $220,000

Inclusion Rate 1/2

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Taxable Capital Gain $110,000

Corporate Tax Payable At 52-2/3% ( 57,933)

Available For Non-Eligible Dividend $ 52,067

Dividend Refund (See Note) 32,366

Non-Eligible Dividend Received $ 84,433

RDTOH Balance [(30-2/3%)($110,000)] $ 33,733

Note The dividend refund is the lesser of the balance in the RDTOH account and 38-1/3
percent of the dividends paid. The available cash of $52,067 would support a dividend of
$84,433 ($52,067 ÷ .61667), including a dividend refund of $32,366 [(38-1/3%)($84,433)].
The lesser of the two figures is $32,366.

Mr. Barkin’s tax rate on non-eligible dividend income is 44.7 percent [(116%)(52%) - (8/11 + 25%)
(16%)]. Based on this, the net after tax retention when a corporation is used would be as follows:

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Tax Free Capital Dividend Received $110,000

Non-Eligible Dividend Received 84,433

Tax Payable On Non-Eligible Dividend Received

[(44.7%)($84,433)] ( 37,742)

After Tax Retention - With Corporation $156,691

As the corporate taxes of $57,933 are higher than the $57,200 that would be paid on direct receipt of the
income, the use of a corporation does not provide tax deferral.
With respect to tax savings, the $156,691 of after tax cash retained with the use of a corporation is less
than the $162,800 that was retained when the gain was realized at the personal level. There is, in fact, a
tax cost of $6,109 ($162,800 - $156,691) associated with the use of a corporation.

Exam Exercise Solution Fifteen - 9 (Shareholder Loans)

The $25,000 loan is the same as any other employee loan and is exempt from inclusion in income under
ITA 15(2). However, it is an interest free loan and will result in a current year taxable benefit for Ms.
Thiessen of $375 [($25,000)(2% - Nil)(9/12)]. Because Ms. Thiessen received the loan in her capacity
as an employee, the benefit can be calculated under ITA 80.4(1). This means that for the first five years
of the loan, the benefit calculation will use a rate no higher than the prescribed rate that prevailed when
the loan was made.
The $15,000 loan is unavailable to other employees and will be subject to the general rule under ITA
15(2) as Ms. Thiessen is a specified employee. However, there is an exception for the one-quarter of the
loan that will be repaid prior to the end of the following taxation year of the corporation. This means
that, while three-quarters of the loan, or $11,250, will have to be included in income in the current year,
the remaining one-quarter, or $3,750, can be left out of income. However, this latter amount will attract
a current year taxable benefit of $56.25 [($3,750)(2% - Nil)(9/12)].
This means the total income for the current year is $11,681.25 ($375 + $11,250 + $56.25).

Exam Exercise Solution Fifteen - 10 (Shareholder Loans)

As the $30,000 vehicle loan is available to all employees, it will not be included in Mr. Baxter’s Net
Income For Tax Purposes. However, as the loan is interest free, there will be a taxable benefit of $600
[($30,000)(2% - Nil)(12/12)]. Some portion of this taxable benefit may be deductible as it relates to the
acquisition of an automobile to be used in employment duties.
With respect to the housing loan, such loans are not available to all employees and, because none of the
loan will be repaid prior to the Company’s second taxation year end, all of the $250,000 will be included
in Mr. Baxter’s income. Because all of the loan has been included in Mr. Baxter’s Net Income For Tax
Purposes, there will be no taxable benefit related to imputed interest on the housing loan.

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Exam Exercise Solution Fifteen - 11 (Salary Compensation)

If the full $197,000 is paid out as salary, it will be deductible and will reduce the Company’s Taxable
Income to nil. This means that no corporate taxes will be paid. This salary payment will result in Ms.
Cloister having Taxable Income of $197,000. Given this, her Tax Payable will be calculated as follows:

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Combined Tax On First $144,489 ($29,877 + $15,500)$ 45,377

Combined Tax On Remaining $52,511 ($197,000 - $144,489)

At 41% (29% + 12%) 21,530

Combined Tax Payable Before Credits $66,907

Personal Tax Credits (Given) ( 3,375)

Personal Tax Payable $63,532

Based on the preceding Tax Payable, Ms. Cloister’s after tax retention would be $133,468 ($197,000 -
$63,532), ignoring CPP contributions and the Canada employment credit.

Exam Exercise Solution Fifteen - 12 (Salary Compensation)

If all of the income is paid out as deductible salary, the Company will pay no taxes. The salary payment
will result in Mr. Lisgar having Net Income For Tax Purposes and Taxable Income of $325,000. The
Tax Payable on this income would be calculated as follows:

Combined Tax On First $205,842 ($47,670 + $27,000)$ 74,670

Combined Tax On Remaining $119,158 ($325,000 - $205,842)

At 49% (33% + 16%) 58,387

Combined Tax Payable Before Credits $133,057

Personal Tax Credits (Given) ( 4,550)

Personal Tax Payable $128,507

Based on these calculations, Mr. Lisgar will have after tax retention of $196,493 ($325,000 - $128,507).
This result ignores CPP contributions, as well as the Canada employment tax credit.

Exam Exercise Solution Fifteen - 13 (Dividend Compensation)

As dividends are not deductible for tax purposes, corporate taxes will have to be paid prior to the
payment of any dividends. All of the $197,000 would be eligible for the small business deduction and
the applicable rate would be 13 percent (38% - 10% - 18% + 3%). Given this, the maximum dividend
that could be paid would be calculated as follows:

Corporate Taxable Income $197,000

Corporate Taxes At 13 Percent ( 25,610)

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Funds Available For Dividends $171,390

Personal taxes on this dividend would be calculated as follows:

Non-Eligible Dividends Received $171,390

Gross Up At 16 Percent 27,422

Taxable Dividends $198,812

Combined Tax On First $144,489 ($29,877 + $15,500)$ 45,377

Combined Tax On Remaining $54,323 ($198,812 - $144,489)

At 41% (29% + 12%) 22,272

Combined Tax Payable Before Credits $ 67,649

Personal Tax Credits (Given) ( 3,375)

Dividend Tax Credit [(8/11 + 3/11)($27,422)] ( 27,422)

Personal Tax Payable $ 36,852

The after tax retention would be equal to $134,538 ($171,390 - $36,852).

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Exam Exercise Solution Fifteen - 14 (Dividend Compensation)

As dividends are not deductible for tax purposes, corporate taxes will have to be paid prior to the
payment of any dividends. All of the income would be eligible for the small business deduction and
Lisgar’s corporate tax rate is 14 percent (38% - 10% - 18% + 4%). Given this, the maximum dividend
that could be paid is calculated as follows:

Corporate Taxable Income $325,000

Corporate Taxes At 14 Percent ( 45,500)

Funds Available For Dividends $279,500

Mr. Lisgar’s personal taxes on this income would be calculated as follows:

Non-Eligible Dividends Received $279,500

Gross Up At 16 Percent 44,720

Taxable Dividends $324,220

Combined Tax On First $205,842 ($47,670 + $27,000) $ 74,670

Combined Tax On Remaining $118,378

($324,220 - $205,842) At 49% (33% + 16%) 58,005

Combined Tax Payable Before Credits $132,675

Personal Tax Credits (Given) ( 4,550)

Dividend Tax Credit [(8/11 + 25%)($44,720)] ( 43,704)

Personal Tax Payable $ 84,421

The after tax retention would be $195,079 ($279,500 - $84,421).

Exam Exercise Solution Fifteen - 15 (Salary Vs. Dividends)

Salary Alternative As the available cash is less than Taxable Income, some corporate taxes will have
to be paid since there is insufficient cash to pay a salary equivalent to Taxable Income. To determine
the maximum salary that can be paid (X), it is necessary to solve the following equation:

X = $17,300 - [($23,600 - X)(15%)]

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X = $16,188

Corporate taxes of $1,112 [(15%)($23,600 - $16,188)] would have to be paid. The total cash outflow
equals the cash available of $17,300 ($16,188 + $1,112).
Given this salary, Ms. Ramsden would be subject to the following personal Tax Payable:

Tax Payable Before Credits [(15% + 11%)($16,188)] $4,209

Available Tax Credits (Given) ( 4,120)

Personal Tax Payable On Salary $ 89

Given the preceding Tax Payable, Ms. Ramsden’s after tax retention on salary would be $16,099
($16,188 - $89).

Dividend Alternative As dividends are not deductible, corporate taxes would have to be paid on the
full $23,600. These taxes would be $3,540 [(15%)($23,600)], leaving an amount available for dividends
of $13,760 ($17,300 - $3,540). As no individual taxes would be payable on this amount of dividends,
the full $13,760 would be retained.
Given these calculations, it is clear that the preferred approach is to pay the maximum salary. Note,
however, some combination of dividends and salary may provide an even better result.

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Exam Exercise Solution Fifteen - 16 (Salary Vs. Dividends)

Salary Alternative If all of the $35,200 in cash is removed as salary, no corporate taxes will be paid.
In fact, the removal of this amount of cash as salary will create a loss of $700 ($35,200 - $34,500) for
the Company which can be carried back to claim a refund of $91 [(13%)($700)]. If Bryan receives the
$35,200 as salary, his after tax retention can be calculated as follows:

Salary Received $35,200

Tax Payable [(51%)($35,200)] ( 17,952)

After Tax Amount Retained - Salary $17,248

Dividend Alternative If all of the $35,200 is paid out as dividends, there would be corporate Tax
Payable on the $34,500 of Taxable Income. The amount available as a dividend would be calculated as
follows:

Available Cash $35,200

Tax Payable [(13%)($34,500)] ( 4,485)

Funds Available For Dividend $30,715

Bryan’s tax rate on non-eligible dividends would be 44.3% [(116%)(51%) - (8/11 + 20%)(16%)]. Given
this, his after tax retention of the dividend income would be calculated as follows:

Non-Eligible Dividends Received $30,715

Tax Payable On Dividends [(44.3%)($30,715)] ( 13,607)

After Tax Retention - Dividends $17,108

The dividend alternative provides after tax retention of $17,108. As this is $140 ($17,248 - $17,108)
less than the amount retained with the salary alternative, the salary alternative is preferable. The $91 tax
refund to the corporation due to the salary would reinforce this conclusion.

Exam Exercise Solution Fifteen - 17 (Salary Vs. Dividends)

Required Salary Mr. Hughes’ combined tax rate on additional salary is 49 percent (33% + 16%). In
order to have $17,000 in after tax funds, he would have to receive salary of $33,333 [$17,000 ÷ (1
- .49)].

Tax Cost Of Salary The net tax cost of paying salary can be calculated as follows:

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Personal Tax On Receipt Of Salary [(49%)($33,333)] $16,333

Tax Savings To Corporation [(14%)($33,333)] ( 4,667)

Net Tax Cost Of Salary $11,666

Required Dividend Mr. Hughes’ tax rate on non-eligible dividends is 41.5 percent [(116%)(49%) -
(8/11 + 23%)(16%)]. In order to have $17,000 in after tax funds, he would have to receive dividends of
$29,060 [$17,000 ÷ (1 - .415)].

Tax Cost Of Dividend As the dividend payment would not be deductible, its payment would not
change corporate taxes. This means that the tax cost would be the $12,060 [(41.5%)($29,060)] in
personal taxes that Mr. Hughes would pay on the dividends received.

Conclusion As the tax cost of the dividend alternative is $394 ($12,060 - $11,666) higher, salary should
be paid.

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Exam Exercise Solution Fifteen - 18 (Salary Vs. Dividends)

Required Salary Miriam’s combined tax rate is 51 percent on any additional salary. Given this, in
order to retain $50,000, she will need salary of $102,041 [$50,000 ÷ (1 - 51%)].

Tax Cost Of Salary The net tax cost of paying salary can be calculated as follows:

Personal Tax On Receipt Of Salary [(51%)($102,041)] $52,041

Tax Savings To Corporation [(14%)($102,041)] ( 14,286)

Net Tax Cost Of Salary $37,755

Required Dividend Miriam’s tax rate on non-eligible dividends is 43.2 percent [(116%)(51%) - (8/11+
3/11)(16%)]. In order to have $50,000 in after tax funds, she would have to receive dividends of
$88,028 [$50,000 ÷ (1 - .432)].

Tax Cost Of Dividend As the dividend payment would not be deductible, its payment would not
change corporate taxes. This means that the tax cost would be the $38,028 [(43.2%)($88,028)] in
personal taxes that Miriam would pay on the dividends received.

Conclusion As the net tax cost associated with the payment of dividends is larger, the salary alternative
would have the lower tax cost.

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TIF Solution Fifteen - 5A

The correct definitions for each of the listed key terms are as follows:

A. 5

B. 9

C. 1

D. 10

E. 4

F. 8

G. 6

H. 3

The two unused definitions are as follows:

Aggregate Investment Income = 7

General Rate Income Pool (GRIP) = 2

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TIF Solution Fifteen - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.

The correct definitions for each of the listed key terms are as follows:

A. 8

B. 13 (not 2)

C. 1

D. 14 (not 7)

E. 6 (not 12)

F. 11 (not 4)

G. 9

H. 5

The two unused definitions are as follows:

Aggregate Investment Income = 10

General Rate Income Pool (GRIP) = 3

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TIF Solution Fifteen - 6

Part A - Direct Personal Investment
Ms. Naidu’s marginal tax rate is 45 percent (29% + 16%). If Ms. Naidu invests the $175,000 as an
individual, the after tax return can be calculated as follows:

Interest Income (All Taxable) $5,250

Interest Received $5,250

Personal Tax Payable At 45 Percent ( 2,363)

After Tax Retention $2,887

Part B - Investment Through Private Company

If Ms. Naidu invests the $175,000 through her private company, any dividends paid will be non-eligible.
The after tax return would be as follows:

Interest Income $5,250

Corporate Taxes At 50-2/3 Percent ( 2,660)

Net Corporate Income Before Dividend Refund $2,590

Maximum Dividend Refund (See Note) 1,610

Maximum Non-Eligible Dividend Payable $4,200

Gross Up At 16 Percent 672

Taxable Dividend $4,872

Personal Tax Rate 45%

Personal Tax Payable Before Dividend Tax Credit $2,192

Dividend Tax Credit [(8/11 + 30%)($672)] ( 690)

Personal Tax Payable $1,502

Dividends Received $4,200

Personal Tax Payable ( 1,502)

After Tax Retention $2,698

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Note The available cash would support a dividend of $4,200 ($2,590 ÷ .61667), including a
dividend refund of $1,610 [(38-1/3%)($4,200)]. As this is equal to the $1,610 [(30-2/3%)
($5,250)] balance in the RDTOH, this amount of dividends can be paid.

The difference between the two alternatives is $189 ($2,887 - $2,698) in favour of direct personal
investment.

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TIF Solution Fifteen - 7

Part A - Direct Personal Investment
Carol’s marginal tax rate is 43 percent (29% + 14%). If she invests the $600,000 as an individual, the
after tax return can be calculated as follows:

Interest Income [(4%)($600,000)] $24,000

Personal Tax Payable [(43%)($24,000)] ( 10,320)

After Tax Retention - Direct Receipt $13,680

Part B - Investment Through Private Company

The combined federal/provincial tax rate on the investment income of the corporation is 51-2/3 percent
(28% + 13% + 10-2/3%). Given this, Carol’s after tax return would be calculated as follows:

Interest Income $24,000

Corporate Taxes At 51-2/3 Percent ( 12,400)

Net Corporate Income Before Dividend Refund $11,600

Maximum Dividend Refund (See Note) 7,210

Maximum Non-Eligible Dividend Payable $18,810

Gross Up At 16 Percent 3,010

Taxable Dividend $21,820

Personal Tax Rate 43%

Personal Tax Payable Before Dividend Tax Credit $ 9,383

Dividend Tax Credit [(8/11 + 24%)($3,010)] ( 2,911)

Personal Tax Payable $ 6,472

Dividends Received $18,810

Personal Tax Payable ( 6,472)

After Tax Retention - With Corporation $12,338

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Note The available cash would support a dividend of $18,810 ($11,600 ÷ .61667), including a
dividend refund of $7,210 [(38-1/3%)($18,810)]. As this is less than the $7,360 [(30-2/3%)
($24,000)] balance in the RDTOH, this amount of dividends can be paid. There is additional
refundable tax of $150 ($7,360 - $7,210) that is available, but only on the payment of
additional dividends.

The difference between the two alternatives is $1,342 ($13,680 - $12,338) in favour of direct personal
investment. Transferring the debt security to a CCPC would not be an appropriate alternative in this
situation.

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TIF Solution Fifteen - 8

Part A - Direct Personal Investment
Carol’s marginal tax rate is 43 percent (29% + 14%). If she invests the $600,000 as an individual, the
after tax return can be calculated as follows:

Eligible Dividends Received [($600,000)(5%)] $30,000

38 Percent Gross Up 11,400

Taxable Dividend $41,400

Personal Tax Rate 43%

Personal Tax Payable Before Dividend Tax Credit $17,802

Dividend Tax Credit [(6/11 + 24%)($11,400)] ( 8,954)

Personal Tax Payable $ 8,848

Dividends Received $30,000

Personal Tax Payable ( 8,848)

After Tax Retention - Direct Receipt $21,152

Part B - Investment Through Private Company

If Carol invests the $600,000 through her private company, the eligible dividends received would be
classified as portfolio dividends, subject to Part IV tax at 38-1/3 percent. There would also be an
addition to the corporation’s GRIP account of $30,000 (notice that eligible dividends are not multiplied
by 72 percent for the GRIP addition). The after tax retention on the flow through the corporation would
be as follows:

Eligible Dividends Received $30,000

Part IV Tax At 38-1/3 Percent (Portfolio Dividends) ( 11,500)

Earnings Retained By Corporation $18,500

Refund When Dividends Paid 11,500

Eligible Dividends Paid (See Note) $30,000

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Note The available cash would support a dividend refund of $30,000 ($18,500 ÷ .61667),
including a refund of $11,500 [(38-1/3%)($30,000)]. This refund is available as the balance in
the RDTOH account is also $11,500 [(38-1/3%)($30,000)].

As the dividend payment is equal to the GRIP balance, the full amount of $30,000 can be
designated as eligible for the enhanced gross up and tax credit procedure.

At this point, the corporation has paid no net amount of taxes and will be paying exactly the same
amount of eligible dividends that it received. This will result in Carol paying exactly the same amount
of taxes that she would have paid on direct receipt of the dividends. With the use of a corporation, the
after tax retention would be identical to the after tax retention resulting from direct receipt of the
dividends.

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TIF Solution Fifteen - 9

Approach 1
Joan Wells’ share of the partnership income would $165,000 [(20%)($825,000)]. The Tax Payable on
this income would be calculated as follows:

Tax Payable On First $144,489 ($29,877 + $17,900) $ 47,777

Tax Payable On Next $20,511 ($165,000 - $144,489)

At 45 Percent (29% + 16%) 9,230

Tax Payable Before Credits $57,007

Personal Tax Credits - Given ( 3,920)

Personal Tax Payable $53,087

The total after tax income is $111,913 ($165,000 - $53,087).

Approach 2
The total corporate taxes would be calculated as follows:

First $100,000 At 14 Percent $14,000

Remaining $65,000 At 29 Percent 18,850

Total Corporate Tax Payable $32,850

If all of the after tax income is paid out, the resulting dividend will be $132,150 ($165,000 - $32,850).
As $65,000 of the corporation’s income was taxed at the general rate, there would be a GRIP balance of
$46,800 [(72%)($65,000)]. This means that of the total dividend of $132,150, $46,800 could be
designated as eligible, with the remaining $85,350 ($132,150 - $46,800) being non-eligible. Based on
this, Joan’s Taxable Income would be as follows:

Eligible Dividend $ 46,800

Gross Up On Eligible Dividend At 38 Percent 17,784

Non-Eligible Dividend 85,350

Gross Up On Non-Eligible Dividend At 16 Percent 13,656

Personal Taxable Income $163,590

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Based on this Taxable Income, her Tax Payable would be as follows:

Tax Payable On First $144,489 ($29,877 + $17,900) $ 47,777

Tax Payable On Remaining $19,101 ($163,590 - $144,489)

At 45 Percent (29% + 16%) 8,595

Tax Payable Before Credits $56,372

Personal Tax Credits - Given ( 3,920)

Dividend Tax Credits

[(6/11 + 38%)($12,312)] ($11,394)

[(8/11 + 22%)($13,656)] ( 12,936) ( 24,330)

Personal Tax Payable $28,122

The total after tax income is $104,028 ($46,800 + $85,350 - $28,122).

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Approach 3
The corporate tax payable would be calculated as follows:

Share Of The Partnership Income [(20%)($825,000)] $165,000

Salary Paid ( 65,000)

Corporate Taxable Income $100,000

Small Business Rate 14%

Corporate Tax Payable $ 14,000

This would leave $86,000 ($165,000 - $65,000 - $14,000) for the payment of dividends. Since no
income was taxed at the general rate, the GRIP balance would be nil. This means that the total dividend
of $86,000 would be non-eligible. Joan’s Taxable Income would be calculated as follows:

Salary ($165,000 - $100,000) $ 65,000

Non-Eligible Dividend 86,000

Gross Up On Non-Eligible Dividend At 16 Percent 13,760

Personal Taxable Income $164,760

Based on this Taxable Income, Joan’s Tax Payable would be calculated as follows:

Tax Payable On First $144,489 ($29,877 + $17,900) $ 47,777

Tax Payable On Remaining $20,271 ($164,760 - $144,489)

At 45 Percent 9,122

Tax Payable Before Credits $56,899

Personal Tax Credits - Given ( 3,920)

Dividend Tax Credit [(8/11 + 22%)($13,760)] ( 13,034)

Personal Tax Payable $39,945

The total after tax income is $111,055 ($65,000 + $86,000 - $39,945).

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Evaluation
The after tax amount retained for each of the three approaches is as follows:

Approach 1 (Joins Partnership As Individual) $111,913

Approach 2 (All Dividends) 104,028

Approach 3 (Salary And Dividends) 111,055

In this analysis, Approach 1 is the best approach. In addition to providing a marginally higher amount
of after tax retention, it is also the least complicated approach in that it does not require the formation of
a corporate structure. We would note that the lower result in Approach 2 reflects the fact that a
significant amount of corporate income was taxed at the general corporate rate.
Other factors to consider:

 If the effect of CPP was considered, she would pay two times the annual maximum in Approach
1, no CPP in Approach 2 and in Approach 3 both Joan and her corporation would pay less than the
annual maximum. Paying CPP would allow her to receive CPP payments in the future, but would
incur a liability at the present time.

 If the Canada employment credit was considered, it would only be applicable in Approach 3.

 If she wanted to contribute to an RRSP or deduct child care costs, she would need earned income.
Dividends are not a component of earned income for either purpose.

 If Joan wanted to participate in the Employment Insurance program on a voluntary basis, it would
only be available to her in Approach 1 as a self-employed individual.

 Depending on the province, there could be additional payroll costs that her corporation would
have to pay in Approach 3.

 Although an advantage of incorporation is the availability of the lifetime capital gains deduction,
given the current situation, it is questionable whether her corporation could be sold for much of a
gain given how important her personal services are to its value.

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TIF Solution Fifteen - 10

Investments Owned Directly
If Ryan continues to own the investments directly, his total Taxable Income will be as follows:

Employment Income $110,000

Interest Income 11,000

Eligible Dividends ($20,000 + $4,000) 24,000

Gross Up On Eligible Dividends [($24,000)(38%)] 9,120

Taxable Capital Gains [(1/2)($10,000 + $3,500)] 6,750

Net And Taxable Income $160,870

The Taxes Payable on this income would be calculated as follows:

Tax Payable On First $144,489 ($29,877 + $13,500) $43,377

Tax Payable On Remaining $16,381 ($160,870 - $144,489)

At 41 Percent (29% + 12%) 6,716

Taxes Payable Before Credits $50,093

Personal Tax Credits (Given) ( 4,141)

Dividend Tax Credit [(6/11 + 35%)($9,120)] ( 8,167)

Personal Taxes Payable $37,785

After payment of these taxes, Ryan would retain cash of $120,715 ($110,000 + $11,000 + $24,000 +
$13,500 - $37,785).

Investments Held By Corporation

If all of the investments are transferred to a corporation, the Taxable Income of the corporation would be
as follows:

Interest Income $11,000

Eligible Dividends Received ($20,000 + $4,000) 24,000

Taxable Capital Gains [(1/2)($10,000 + $3,500)] 6,750

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Net Income For Tax Purposes $41,750

Eligible Dividends Received ( 24,000)

Taxable Income $17,750

With the subtraction of the eligible dividends received, Taxable Income would be equal to aggregate
investment income, resulting in no addition to the Company’s GRIP from this source. However, there
would be an addition to its GRIP equal to $24,000, 100 percent of the eligible dividends received.
The company’s taxes payable would be calculated as follows:

Tax Payable On Taxable Income [(52-2/3%)($17,750)] $ 9,348

Part IV Tax Payable [(38-1/3%)($20,000 + $4,000)] 9,200

Corporate Taxes Payable $18,548

The end of the year balance in the RDTOH account would be calculated as follows:

Part I Refundable* $ 5,443

Part IV Refundable (Amount Paid) 9,200

RDTOH - End Of Year $14,643

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*This amount would be the least of:

 $5,443 = 30-2/3% Of Aggregate Investment Income [(30-2/3%)($11,000 + $6,750)]

 $5,443 = 30-2/3% Of Taxable Income [(30-2/3%)($17,750)]

 $9,348 = Part I Tax Payable

The amount of cash available to the corporation for paying dividends to Ryan would be calculated as
follows:

Investment Income Received

($11,000 + $24,000 + $13,500) $48,500

Corporate Taxes Paid ( 18,548)

Cash Available $29,952

Tax Free Capital Dividend ( 6,750)

Cash Available For Taxable Dividend $23,202

Dividend Refund (See Note) 14,423

Taxable Dividend $37,625

Eligible Dividend (GRIP Balance) ( 24,000)

Non-Eligible Dividend $13,625

Note The available cash would support a dividend of $37,625 ($23,202 ÷ .61667), including a
dividend refund of $14,423 [(38-1/3%)($37,625)]. As this is less than the $14,643 balance in
the RDTOH, this amount of dividends can be paid. This will leave a balance in the RDTOH of
$220 ($14,643 - $14,423).

The after tax results with the use of a corporation would be as follows:

Employment Income $110,000

Eligible Dividend 24,000

Gross Up On Eligible Dividend At 38 Percent 9,120

Non-Eligible Dividend 13,625

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Gross Up On Non-Eligible Dividends At 16 Percent 2,180

Taxable Income $158,925

Tax Payable On First $144,489 ($29,877 + $13,500) $43,377

Tax Payable On Remaining $14,436 ($158,925 - $144,489)

At 41 Percent (29% + 12%) 5,919

Taxes Payable Before Credits $49,296

Personal Tax Credits (Given) ( 4,141)

Eligible Dividend Tax Credit [(6/11 + 35%)($9,120)] ( 8,167)

Non-Eligible Dividend Tax Credit

[(8/11 + 25%)($2,180)] ( 2,130)

Personal Taxes Payable $34,858

Ryan’s after tax retention would be as follows:

Employment Income $110,000

Capital Dividend Received 6,750

Dividends Received Subject To Tax

($24,000 + $13,625) 37,625

Total Cash Receipts $154,375

Personal Taxes Payable ( 34,858)

After Tax Cash Retention - With Corporation $119,517

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Conclusion
In terms of after tax amounts of cash retained, the use of a corporation results in $119,517 of cash
retained, while holding the investments directly results in $120,715 of case retained. This $1,198
difference would clearly make holding the investments directly the preferable alternative, particularly
when the additional costs of incorporation are taken into consideration.

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TIF Solution Fifteen - 11

Part A - Tax Consequences
Loan 1 - Taxable Benefit
As such loans are available to all employees, Hannah can claim that she has received the loan in her
capacity as an employee. This means that the $200,000 principal does not have to be included in her
2018 Net Income For Tax Purposes. However, as the loan is interest free, there will be a taxable benefit
included in Hannah’s Net Income For Tax Purposes as follows:

2018 [($200,000)(2%)(10/12)] $3,333.33

2019 [($200,000)(2%)(2/12) + ($200,000 - $100,000)(2%)(10/12)] $2,333.33

2020 [($200,000 - $100,000)(2%)(2/12)] $333.33

Loan 2 - Principal In Income

While the term of the loan is consistent with the loans being given to other employees, the principal
amount is far in excess of anything being provided to other employees. Given this, it is clear that the
loan is being extended to Hannah as the sole shareholder, not as an employee.
This means that the $185,000 principal amount would have to be included in her 2018 Net Income For
Tax Purposes. When the loan is repaid in 2023, the $185,000 can be deducted from her Net Income For
Tax Purposes.
As the principal amount is included in her income, there will be no taxable benefit for imputed interest
associated with the loan.

Loan 3 - Taxable Benefit

As the loan is repaid prior to December 31, 2019 (the second corporate year end), the principal amount
does not have to be included in Hannah’s 2018 Net Income For Tax Purposes. However, as it is interest
free, there will be a taxable benefit for imputed interest as follows:

2018 [(2%)($40,000)(6/12)] $400

2019 [(2%)($40,000)(6/12)] $400

Although the loan is being used to pay for medical expenses that will qualify for the medical expense tax
credit, interest, or imputed interest on loans to fund medical expenses is not an allowable medical
expense.

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Loan 4 - Principal In Income

As this loan is not repaid prior to December 31, 2019 (the second corporate year end), it has to be
included in Hannah’s 2018 Net Income For Tax Purposes.
In 2020, the year it is repaid, the $100,000 can be deducted from her Net Income For Tax Purposes.
As the principal amount is included in her income, there will be no taxable benefit for imputed interest
associated with the loan.

Loan 5 - No Effect
This loan is repaid prior to its inclusion in a second corporate Balance Sheet. As a consequence, the
principal amount does not have to be included in Hannah’s 2018 Net Income For Tax Purposes.
As the interest rate of 3 percent on the loan is higher than the prescribed rate, there will be no imputed
interest benefit.

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Part B - Tax Planning Issues

Loan 1
There are no issues here in that the loan is structured to be consistent with other loans to employees.
This allows Hannah to receive a home loan on an interest free basis and, because she has received it as a
result of her employee status, she does not have to include the principal in her Net Income For Tax
Purposes.

Loan 2
As the loan must be included in her Net Income For Tax Purposes, it is not good tax planning for
Hannah to pay any interest. The interest will be taxed at the corporate level, likely at the unfavourable
rates applicable to investment income due to the size and terms of the loan.
As the car is used only for personal purposes, she cannot deduct any of the interest paid. If she paid no
interest on the loan, her tax situation would not be changed and the corporation would pay less taxes.

Loan 3
The fact that the loan was interest free resulted in Hannah having a taxable benefit. If she had paid
interest at the prescribed rate, the benefit could have been reduced or eliminated. However, the
corporation would be taxed on the interest and she cannot deduct or claim it as a medical expense.
Whether making the loan on an interest free basis represents good tax planning depends on whether the
corporation’s tax rate on investment income is higher than the tax rate applicable to Hannah. If it is
higher, using an interest free rate could represent good tax planning.

Loan 4
As the principal of the loan must be included in income, the tax planning question is whether it would
have been more appropriate to simply pay an equivalent amount of salary to Hannah. The advantage of
the loan is that it can be repaid and deducted in future years. In contrast, salary cannot be returned to the
corporation, but it is deductible to the corporation as salary.
Given that the principal of the loan is included in Hannah’s income, making the loan interest free is the
appropriate choice.

Loan 5
It was clearly not appropriate to pay interest at a rate higher than the prescribed rate. The extra 1 percent
did not reduce Hannah’s imputed interest benefit as it would be nil with a 2 percent interest rate. In
addition, it will be taxed at the corporate level and Hannah cannot deduct the interest.
There is also the question of whether any interest should have been paid on the loan. Making it interest
free would create a taxable benefit for Hannah. However, it would eliminate the need to pay corporate
taxes on the interest received. As discussed under the comments on Loan 3, the answer to this question
depends on the relative tax rates for Hannah as compared to the rate applicable to investment income
received by the corporation.

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TIF Solution Fifteen - 12

Part A - Tax Consequences
Loan 1
As such loans are available to all employees, Ms. Copps can claim that she has received the loan in her
capacity as an employee. This means that the $150,000 principal does not have to be included in her
2018 Net Income For Tax Purposes. However, as the rate on the loan is below the prescribed rate, there
will be a taxable benefit included in Ms. Copps’ Net Income For Tax Purposes.
The amount to be accrued for 2018 is $1,375 [($150,000)(2% - 1%)(11/12)].
For 2019, the amount is $812.50
[($150,000)(2% - 1%)(1/12) + ($150,000 - $75,000)(2% - 1%)(11/12)].
For 2020, the amount is $62.50 [($150,000 - $75,000)(2% - 1%)(1/12)].

Loan 2
While the term of the loan and the applicable interest rate are consistent with the loans being given to
other employees, the principal amount is far in excess of anything being provided to other employees.
Given this, it is clear that the loan is being extended to Ms. Copps as the sole shareholder, not as an
employee.
This means that the $349,000 principal amount would have to be included in her 2018 Net Income For
Tax Purposes. When the loan is repaid in 2023, the $349,000 can be deducted from her Net Income For
Tax Purposes.
As the principal amount is included in her income, there will be no taxable benefit for imputed interest
associated with the loan.

Loan 3
As the loan is repaid prior to October 31, 2019 (the second corporate year end), the principal amount
does not have to be included in Ms. Copps’ 2018 Net Income For Tax Purposes. However, as it is
interest free, there will be a taxable benefit for imputed interest.
For 2018, the amount will be $408 [(2%)($35,000)(7/12)].
For 2019, the benefit will be $292 [(2%)($35,000)(5/12)].

Loan 4
As this loan is not repaid prior to October 31, 2019 (the second corporate year end), it has to be included
in Ms. Copps’ 2018 Net Income For Tax Purposes.
In 2020, the year it is repaid, the $100,000 can be deducted from Ms. Copp’s Net Income For Tax
Purposes.
As the principal amount is included in her income, there will be no taxable benefit for imputed interest
associated with the loan.

Loan 5
This loan is repaid prior to its inclusion in a second corporate Balance Sheet. As a consequence, the
principal amount does not have to be included in Ms. Copps’ 2018 Net Income For Tax Purposes.

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As the interest rate of 3 percent on the loan is higher than the prescribed rate, there will be no imputed
interest benefit.

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Part B - Tax Planning Issues

Loan 1
There are no issues here in that the loan is structured to be consistent with other loans to employees.
This allows Ms. Copps to receive a home loan at a very favourable rate and, because she has received it
as a result of her employee status, she does not have to include the principal in her Net Income For Tax
Purposes.

Loan 2
As the loan must be included in her Net Income For Tax Purposes, it is not good tax planning for Ms.
Copps to pay any interest. The interest will be taxed at the corporate level, likely at the unfavourable
rates applicable to investment income due to the size and terms of the loan.
As the car is used only for personal purposes, she cannot deduct any of the interest paid. If she had paid
no interest on the loan, her tax situation would not be changed and the corporation would pay less taxes.

Loan 3
The fact that no interest is paid on the loan results in a taxable benefit for Ms. Copps. If she had paid
interest, the benefit would be reduced. However, the corporation would be taxed on the interest
received.
Whether making the loan on an interest free basis represents good tax planning depends on whether the
corporation’s tax rate is higher than the rate applicable to Ms. Copps. If it is higher, using an interest
free loan could represent good tax planning.

Loan 4
As the principal of the loan must be included in income, the tax planning question is whether it would
have been more appropriate to simply pay an equivalent amount of salary to Ms. Copps. The advantage
of the loan is that it can be repaid and deducted in future years. In contrast, salary cannot be returned to
the corporation, but it can be deducted by the Company for tax purposes.
Given that the principal of the loan is included in Ms. Copp’s income, making the loan interest free is
the appropriate choice.

Loan 5
It was clearly not appropriate to pay interest at a rate higher than the prescribed rate. The extra 1 percent
did not reduce Mr. Copps’ imputed interest benefit. In addition, it will be taxed at the corporate level.
There is also the question of whether any interest should have been paid on the loan. Making it interest
free would create a taxable benefit for Ms. Copps. However, it would eliminate the need to pay
corporate taxes on the interest received. As discussed under the comments on Loan 3, the answer to this
question depends on the relative tax rates for Ms. Copps as compared to the rate applicable to
investment income received by the corporation.

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TIF Solution Fifteen - 13

Required Salary
Given her personal tax rate of 52 percent, a salary of $52,083 [($25,000  (1 - .52)] would be required
to provide Jeannette with an additional $25,000 in after tax funds.

Tax Cost Of Salary Alternative

The net tax cost of this alternative would be calculated as follows:

Personal Taxes On Salary [(52%)($52,083)] $27,083

Tax Savings To Corporation [(14%)($52,083)] ( 7,292)

Net Tax Cost Of Salary Alternative $19,791

Required Dividend
Jeannette’s tax rate on non-eligible dividends would be calculated as follows:

{[(116%)(52%)] - [(8/11 + 29%)(16%)]} = 44.04%

This gives after tax retention of dividend income in the amount of 55.96 percent (1 - .4404). This means
a dividend of $44,675 ($25,000  .5596) will be required to provide an additional $25,000 of after tax
funds.

Tax Cost Of Dividend Alternative

The personal Tax Payable on the dividend would be calculated as follows:

Non-Eligible Dividends Received $44,675

Gross Up At 16 Percent 7,148

Taxable Income $51,823

Tax Rate 52%

Tax Payable Before Dividend Tax Credit $26,948

Dividend Tax Credit [(8/11 + 29%)($7,148)] ( 7,271)

Personal Tax Payable On Dividend Alternative $19,677

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Subtracting the Tax Payable of $19,677 from the dividends received of $44,675 gives the required
$24,988 in after tax funds (the $2 shortfall is a rounding error).
As the dividend payment would not be deductible, its payment would not change corporate taxes. This
means that the only tax cost would be the $19,677 in personal taxes that Jeanette would pay on the
dividends received.

Conclusion
The salary alternative has a net tax cost which is $114 ($19,791 - $19,677) higher than the tax cost of
paying dividends. The dividend alternative would have the lower tax cost.
Since Jeanette has already received a salary of $232,000, CPP contributions and the Canada employment
credit are not relevant to this analysis as they would have already been accounted for and would not
affect the conclusion.

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TIF Solution Fifteen - 14

Part A - Taxes And Salary
The combined federal/provincial tax rate applicable to Wasal Inc. would be 13 percent
(38% - 10% - 18% + 3%).
As the corporation’s Taxable Income exceeds the amount of cash available, the maximum amount of
salary that can be paid (X) must be determined using the following simple equation:

X = $54,000 - [(13%)($135,000 - X)]

Solving this equation for X indicates that the maximum salary that can be paid is $41,897.
This can be verified by the following calculation:

Corporate Taxable Income Before Salary $135,000

Maximum Salary ( 41,897)

Corporate Taxable Income After Salary $ 93,103

Corporate Rate 13%

Corporate Tax Payable $ 12,103

Payment of this amount of taxes will leave $41,897 ($54,000 - $12,103) available for the payment of
salary.
With this amount of salary, Waylon would have the following amount of after tax cash:

Salary Payment $41,897

Tax Before Credits [(15% + 8%)($41,897)] ($9,636)

Personal Tax Credits (Given) 4,200 ( 5,436)

After Tax Cash Retained (All Salary) $36,461

Part B - All Dividends

As dividend payments are not deductible to the Company, taxes of $17,550 [(13%)($135,000)] will have
to be paid. This leaves a maximum of $36,450 ($54,000 - $17,550) to be used for the payment of non-
eligible dividends. When this is paid, the after tax retention by Waylon will be as follows:

Non-Eligible Dividends Received $36,450

Gross Up [(16%)($36,450)] 5,832

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Taxable Dividends $42,282

Personal Tax Rate (15% + 8%) 23%

Tax Payable Before Credits $ 9,725

Personal Tax Credits (Given) ( 4,200)

Dividend Tax Credit [(8/11 + 32%)($5,832)] ( 6,108)

Tax Payable Nil

As there is no Tax Payable, Waylon will retain all of the $36,450 in dividends.

Part C - Possible Improvement

While the Tax Payable for Waylon is nil in Part B, subtracting personal and dividend tax credits from
the tax balance gives a negative figure of $583. This means that the all dividend approach leaves unused
tax credits. While not conclusive, this suggests that there may be a better solution than either all salary
or all dividends.

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Part D - Salary/Dividend Combination

To examine the possibility of an optimum solution using both salary and dividends, consider the result
that occurs when $1,000 in salary is paid in lieu of some dividends. Because the deductible salary
payment would reduce corporate taxes, dividends would only have to be decreased by $870 [($1,000)(1
- 0.13)]. The tax effects of this switch can be calculated as follows:

Increase In Salary $1,000.00

Decrease In Dividend [($1,000)(1 - .13)] ( 870.00)

Decrease In Dividend Gross Up [(16%)($870.00)] ( 139.20)

Decrease In Waylon’s Taxable Income ($ 9.20)

Personal Tax Rate 23%

Decrease In Tax Payable Before Dividend Tax Credit ($ 2.12)

Decrease In Dividend Tax Credit [(8/11 + 32%)($139.20)] 145.78

Net Increase In Personal Tax Payable $ 143.66

The rate on a $1,000 increase in salary is 14.366 percent ($143.66 ÷ $1,000). Applying this rate to the
unused credits of $583 (see Part C), gives a required increase in salary of $4,058 ($583 ÷ .14366).
Payment of this amount of salary would result in corporate Tax Payable as follows:

Corporate Taxable Income Before Salary $135,000

Salary ( 4,058)

Corporate Taxable Income After Salary $130,942

Corporate Rate 13%

Corporate Tax Payable $ 17,022

Based on available cash of $54,000, the amount of dividend that could be paid is as follows:

Cash Available $54,000

Corporate Tax Payable ( 17,022)

Salary Payment ( 4,058)

Available For Dividends $32,920

After tax retention at the personal level would be calculated as follows:

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Non-Eligible Dividends Received $32,920

Gross Up [(16%)($32,920)] 5,267

Taxable Dividends $38,187

Salary 4,058

Waylon’s Taxable Income $42,245

Personal Tax Rate (15% + 6%) 23%

Tax Payable Before Credits $ 9,716

Personal Tax Credits (Given) ( 4,200)

Dividend Tax Credit [(8/11 + 32%)($5,267)] ( 5,516)

Tax Payable Nil

Amounts Received ($32,920 + $4,058) $36,978

Personal Tax Payable Nil

After Tax Cash Retained (Salary And Dividends) $36,978

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The comparative results for the three alternatives are as follows:

All Salary $36,461

All Dividends $36,450

Salary/Dividend Combination $36,978

The combination of salary and dividends will produce the maximum after tax cash retention for Waylon.
It is a $517 ($36,978 - $36,461) improvement over the all salary solution and a $528 ($36,978 -
$36,450) improvement over the all dividend solution.

Part E - Other Factors

Other factors that might be considered include:

 The Canada employment tax credit was ignored in the calculations as it is not a credit against
provincial taxes. However, it would allow the first $1,195 of salary to be received with a nil federal
tax cost.

 If the effect of CPP was considered, both Waylon and Wasal Inc. would pay CPP contributions if
salary was paid. Paying CPP contributions would allow him to receive CPP payments in the future,
but would require both a personal and a corporate cash outflow at the present time.

 If Wasal Inc. has benefits for employees, such as a private health services plan, this could make
being an employee (by taking salary) more advantageous.

 Dividend payments are not Earned Income for purposes of making RRSP contributions or
deducting child care costs.

 If Waylon has a CNIL balance, dividend payments will serve to reduce this constraint on the
lifetime capital gains deduction.

 Waylon should consider declaring a bonus (a form of salary) to be paid after the end of the
calendar year if he does not require the cash immediately. This would defer the personal taxes
without affecting corporate taxes as long as the bonus was paid within 180 days of December 31.

 Though not relevant in this problem, some provinces have payroll taxes which could be incurred.

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TIF Solution Fifteen - 15

Part A - All Salary
As salary payments can be deducted by the corporation, the entire $24,200 can be paid as salary. Given
this deduction, no taxes would be paid by the Company for the year. With a salary payment of $24,200,
Ms. Stickle’s after tax cash balance would be as follows:

Salary Payment $24,200

Tax Before Credits [(25%)($24,200)] ($6,050)

Personal Tax Credits (Given) 3,423 ( 2,627)

After Tax Cash Retained (All Salary) $21,573

Part B - All Dividends

The tax rate for Stickle Ltd. would be 14% (38% - 10% - 18% + 4%). As dividend payments are not
deductible to the Company, taxes of $3,388 [(14%)($24,200)] will have to be paid, leaving a maximum
of $20,812 to be used for the payment of dividends. When this is paid, the after tax retention by Ms.
Stickle will be as follows:

Non-Eligible Dividends Received $20,812

Gross Up [(16%)($20,812)] 3,330

Taxable Dividends $24,142

Personal Tax Rate 25%

Tax Payable Before Credits $ 6,036

Personal Tax Credits (Given) ( 3,423)

Dividend Tax Credit [(8/11 + 30%)($3,330)] ( 3,421)

Tax Payable Nil

Dividends Received $20,812

Tax Payable Nil

After Tax Cash Retained (All Dividends) $20,812

Part C - Possible Improvement

While Ms. Stickle’s Tax Payable is nil in Part B, subtracting personal and dividend tax credits from the
tax balance gives a negative figure of $808. This means that the all dividend approach leaves unused tax

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credits. While not conclusive, this suggests that there may be a better solution than either all salary or
all dividends.

Part D - Salary/Dividend Combination

To examine the possibility of an optimum solution using both salary and dividends, consider the result
that occurs when $1,000 in salary is paid in lieu of some dividends. Because the deductible salary
payment would reduce corporate taxes, dividends would only have to be decreased by $860 [($1,000)(1
- 0.14)]. The tax effects of this switch can be calculated as follows:

Increase In Salary $1,000.00

Decrease In Dividend [($1,000)(1 - .14)] ( 860.00)

Decrease In Dividend Gross Up [(16%)($860.00)] ( 137.60)

Increase In Ms. Stickle’s Taxable Income $ 2.40

Personal Tax Rate 25%

Increase In Tax Payable Before Dividend Tax Credit $ 0.60

Decrease In Dividend Tax Credit [(8/11+ 30%)($137.60)] 141.35

Net Increase In Personal Tax Payable $ 141.95

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The rate on a $1,000 increase in salary is 14.195 percent ($141.95 ÷ $1,000). Applying this rate to the
unused credits of $808 (see Part C), gives a required increase in salary of $5,692 ($808 ÷ .14195).
Based on this payment of salary, corporate taxes and funds available for dividend payments would be
calculated as follows:

Pre-Salary Corporate Taxable Income $24,200

Salary ( 5,692)

Corporate Taxable Income $18,508

Corporate Tax [(14%)($18,508)] ( 2,591)

Available For Dividends $15,917

After tax retention at the personal level would be calculated as follows:

Non-Eligible Dividends Received $15,917

Gross Up [(16%)($15,917)] 2,547

Taxable Dividends $18,464

Salary 5,692

Ms. Stickle’s Taxable Income $24,156

Personal Tax Rate 25%

Tax Payable Before Credits $ 6,039

Personal Tax Credits (Given) ( 3,423)

Dividend Tax Credit [(8/11 + 30%)($2,547)] ( 2,616)

Tax Payable Nil

Amounts Received ($5,692 + $15,917) $21,609

Personal Tax Payable Nil

After Tax Cash Retained (Salary And Dividends) $21,609

The comparative results for the three alternatives are as follows:

All Salary $21,573

All Dividends $20,812

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Salary/Dividend Combination $21,609

The combination of salary and dividends will produce the maximum after tax cash retention for Ms.
Stickle. It is a $36 ($21,609 - $21,573) improvement over the all salary solution and a $797 ($21,609 -
$20,812) improvement over the all dividend solution.

Part E - Other Factors

Other factors that might be considered include:

 The Canada employment tax credit was ignored in the calculations as it is not a credit against
provincial taxes. However, it would allow the first $1,195 of salary to be received with a nil federal
tax cost.

 If the effect of CPP was considered, both Ms. Stickle and Stickle Ltd. would pay CPP
contributions if salary was paid. Paying CPP contributions would allow her to receive CPP
payments in the future, but would require both a personal and a corporate cash outflow at the
present time.

 If Stickle Ltd. has benefits for employees, such as a private health services plan, this could make
being an employee (by taking salary) more advantageous.

 Dividend payments are not Earned Income for purposes of making RRSP contributions or
deducting child care costs.

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 If she has a CNIL balance, dividend payments will serve to reduce this constraint on the lifetime
capital gains deduction.

 Ms. Stickle should consider declaring a bonus (a form of salary) to be paid after the end of the
calendar year if she does not require the cash immediately. This would defer the personal taxes
without affecting corporate taxes as long as the bonus was paid within 180 days of December 31.

 Though not relevant in this problem, some provinces have payroll taxes which could be incurred.

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Chapter Sixteen Test Item File Solutions

TIF Solution Sixteen - 1

1. The owner of an existing unincorporated business will usually have assets that have been used in
the business for some period of time. Because a corporation is a separate taxable entity, the transfer
of these assets to a corporation will be considered a disposition for proceeds equal to their fair
market value. If these fair market values exceed the tax values for the assets (adjusted cost base or
UCC), the result could be capital gains and/or recapture. In the absence of ITA 85(1), the resulting
tax cost could significantly discourage the transfer of unincorporated businesses to corporations.

2. As listed in the text, the entities are as follows:

 The transferor may be an individual who wishes to incorporate his proprietorship.

 The transferor may be a corporation that wishes to transfer some of its assets to a different
corporation.

 The transferor may be a trust that wishes to transfer some of its assets to a corporation.

 The transferor may be a partner who wishes to incorporate his partnership interest.

3. Eligible assets are defined under ITA 85(1.1). These assets are depreciable and non-depreciable
capital property, eligible capital property, resource property, and inventories other than those of real
property. Items specifically excluded from this definition are:

 inventories of real estate; and

 real property owned by a non-resident (unless used in a business carried on in Canada).

The basic idea behind the omission of transfers of real property inventories from the coverage of
Section 85 is to prevent a real estate dealer from transferring inventories to a corporation, where
they might subsequently qualify for capital gains treatment. This provision does, of course, have
serious tax implications. Further, these implications are complicated by the fact that, in many
situations, a transferor may be uncertain as to whether a particular real property is a capital asset
and eligible for transfer at an elected value or, alternatively, an inventory item that is ineligible.

With respect to real property owned by non-residents, ITA 2(3) indicates that non-residents will be
taxed on gains resulting from the disposition of such “Taxable Canadian Property”. This taxation
might be avoided if the property was transferred on a tax free basis to a Canadian corporation.

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4. The importance of listing all of the assets to be transferred lies in the fact that, unless a transferred
asset is listed, the transfer will take place at fair market value. This can result in capital gains or
recapture that will be subject to current taxation.

5. The elected transfer price is important in that it usually establishes three important values. These
are:

 The deemed proceeds of disposition for the property given up by the transferor.

 The adjusted cost base of the consideration received by the transferor.

 The adjusted cost base of the property transferred to the corporation.

6. Boot is a slang term for non-share consideration received by the transferor. This is typically either
cash or debt. However, it could also be other financial or non-financial assets. Its significance lies
in the fact that, if the amount does not exceed the elected values for the transferred assets, it can be
received by the transferor on a tax free basis. Boot also serves as a floor value for amounts to be
elected with respect to individual assets.

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7. The general rules applicable to the elected value in a Section 85 rollover can be described as
follows:

Ceiling Value Fair market value of the asset transferred to the corporation.

Floor Value The floor value will be equal to the greater of:

 the fair market value of the non-share consideration (boot) given to the transferor in return
for the assets transferred; and

 the tax values (adjusted cost base or UCC) of the assets transferred.

8. When accounts receivable are transferred as a component of a complete business, any loss will be
treated as a capital loss. This means that only one-half of the total amount is deductible. In
addition, that one-half is only deductible to the extent the taxpayer has capital gains. To solve this
problem, an election can be made under ITA 22 which will allow the transferor to deduct any loss
on the transfer as a fully deductible business loss. As a taxpayer cannot use both ITA 22 and ITA
85, it is generally preferable to use ITA 22 and exclude any receivables from the ITA 85 election.

9. Affiliated persons are defined in the text as follows:

A. An individual is affiliated to another individual only if that individual is his spouse or

common-law partner.

B. A corporation is affiliated with:

1.

a person who controls the corporation;

2.

each member of an affiliated group of persons who controls the corporation; and

3.

the spouse or common-law partner of a person listed in (1) or (2).

C. Two corporations are affiliated if:

1.

each corporation is controlled by a person, and the person by whom one corporation is
controlled is affiliated with the person by whom the other corporation is
controlled;

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2.

one corporation is controlled by a person, the other corporation is controlled by a

group of persons, and each member of that group is affiliated with that person; or

3.

each corporation is controlled by a group of persons, and each member of each group
is affiliated with at least one member of the other group.

The required three examples can be selected from examples presented in this definition (e.g., an
individual and his spouse).

10. The problem here is that the wording of the transfer price rules for depreciable assets requires the
floor to be based on the least of the cost of each individual asset, fair market value of each
individual asset, but UCC for the class as a whole. This determination has to be made with respect
to each asset in the class, with the resulting figures summed for purposes of the election floor.
Given this, the sum of the individual asset values may exceed the UCC for the class as a whole.
When this value for the individual assets is subtracted from the balance in the class, the result will
be taxable recapture. To avoid this result, ITA 85(1)(e.1) allows the assets to be transferred one at a
time. When this approach is taken, the “least of” rule cannot produce recapture as, if the individual
asset values exceed the class value, the class value will be subtracted.

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11. The total adjusted cost base of the consideration received would be equal to the sum of the elected
values for the assets that were transferred to the corporation. This total consideration would first be
allocated to any non-share consideration in an amount equal to its fair market value (as non-share
consideration is the floor for all elected values, the total elected value could not be less than the fair
market value of the non-share consideration). If an amount of the total consideration remained after
the allocation to non-share consideration, it would be allocated to any preferred shares to the extent
of the fair market value of these shares. If a further amount remained after the preferred shares have
been allocated an amount equal to their fair market value, this residual would be allocated to the
common shares.

12. If the transferor had simply sold the asset for an amount in excess of the UCC value, the difference
between the UCC and the capital cost would be treated as fully taxable recapture. If the transferee
was allowed to treat the transferor’s UCC as his capital cost, in a later sale of the property, this
difference would be treated as a capital gain, only one-half of which is taxable. The requirement
that the transferee retain the transferor’s capital cost prevents this from happening and ensures that
the transfer does not result in less taxation in the hands of the transferee.

13. In these circumstances, the capital cost for CCA purposes will be equal to the transferor’s capital
cost, plus one-half of any capital gain recognized by the transferor as a result of the transfer.

14. The PUC reduction is calculated by subtracting any excess of the elected value over non-share
consideration from the increase in legal stated capital that resulted from the issuance of shares by
the transferee.

15. The total PUC reduction is divided among the multiple classes of shares on the basis of their
relative fair market values. The resulting amounts are then subtracted from the legal stated capital
of each class of shares to calculate the PUC.

16. To achieve the desired goals (i.e., no current taxation combined with a maximum withdrawal of
cash), he should elect to transfer the assets at their tax values. This will permit him to take out cash
equal to the elected value without incurring any current taxation. If he follows this course of action,
the PUC and the adjusted cost base of the new shares will be equal to nil.

17. The basic problem here is that, while the Income Tax Act is prepared to accept other family
members sharing in the future growth of assets, it attempts to prevent any retroactive sharing of
asset growth that occurred prior to the transfer of the assets under Section 85. If such retroactive
gifts occur, they will generate immediate capital gains for the transferor and, in so doing, eliminate
some of the tax advantages of the rollover procedure.

To avoid this problem, it is essential that the transferor take back from the corporation an amount of
consideration that is equal to the fair market value of the assets transferred. The usual type of
arrangement is as follows:

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 The transferor will take back non-share consideration equal to the tax values of the property
transferred.

 In addition, the transferor will take back share consideration for the difference between the fair
market value and the tax values of the assets transferred.

To accomplish income splitting, the share consideration taken back by the transferor will normally
be preferred, or non-growth, shares. This will permit the other family members to subscribe to the
common, or growth, shares, and, thereby, participate in the future growth of the assets transferred to
the corporation. As the transferor will receive consideration equal to the full fair market value of
the existing business, the new common shares can be issued at nominal values.

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18. Mr. Lawson’s plan would not be an effective method of avoiding taxation on the transfer of these
assets. There are two reasons for this. First, in order to use Section 85, the assets must be
transferred to a Canadian corporation, rather than a U.S. one, as suggested by Mr. Lawson.
However, if he were to establish a Canadian corporation, Mr. Lawson would have to deal with his
second problem. This is the fact that Section 85 does not apply to real property owned by a non-
resident. In short, Mr. Lawson cannot use Section 85 in his circumstances.

19. A gifting situation can arise if the fair market value of the assets transferred to a transferee
corporation exceed the fair market value of the consideration received from the transferee
corporation. For the gifting rules to apply, a related party would have to have an equity interest in
the transferee corporation. If this gifting situation arises, the tax consequence to the transferor
would be that the amount of the gift would be added to the elected value, resulting in a need to
recognize income on the transfer in the amount of the gift. For the related party, he would have an
increase in his equity interest in the transferee corporation with no corresponding increase in his tax
value. On a subsequent disposition of the equity interest, this additional amount would be subject to
taxation.

20. An ITA 15(1) shareholder benefit will arise in a Section 85(1) rollover if the transferor takes back
total consideration that has a fair market value that exceeds the fair market value of the assets that
he has transferred.

21. The objective of the legislation that is contained in ITA 84.1 is to prevent an individual from
removing resources from a corporation in a form that will result in a capital gain, without an arm’s
length disposition of his interest in the corporation. The usual goal here is for the taxpayer to make
use of the lifetime capital gains deduction. In effect, when this is attempted, ITA 84.1 acts to
convert certain capital gains into deemed dividends that are not eligible for the lifetime capital gains
deduction.

22. The capital gains stripping rules are designed to deal with situations where a corporation is selling
shares of an investee corporation. Because dividends can be received by a corporation on an
essentially tax free basis, attempts will be made to structure the sale in a manner that will convert an
accrued capital gain into a tax free dividend payment. ITA 55(2) serves to restrict such
conversions.

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TIF Solution Sixteen - 2

1. True.

2. True.

3. False.

The transferred business can also be a corporation or a trust. In addition, the transferee
corporation does not have to be a new corporation.

4. True.

5. False.

Consideration can also include non-share consideration other than cash, as well as preferred
shares.

6. True.

7. False.

The term refers only to non-share consideration and this would exclude both preferred and
common shares.

8. False.

9. True.

10. False.

The capital cost for CCA purposes will be the transferor’s capital cost, plus one-half of any
capital gain that results from the transfer.

11. False

Any required PUC reduction will be allocated to preferred and common shares using a pro-rata
allocation based on their relative fair market value.

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12. True.

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TIF Solution Sixteen - 3

General Rules For Transfer
1. D. Prepayments.

2. B. Redeemable preferred shares.

3. B. A transferee must be a Canadian corporation.

4. A. The consideration given to the transferor must include shares of the corporation.

5. D. The assumption of transferor debt by the transferee.

6. A. A shareholder of a corporation wishes to transfer property with a fair market value of

$150,000 and a cost of $100,000 to his corporation.

Transfer Prices - Detailed Rules

7. C. Recapture of CCA.

8. D. Mary will have to report a capital gain of $5,000 and recapture of $37,500.

9. C. The fair market value of the assets transferred to the corporation.

10. B. The acquiring corporation will be able to deduct a bad debts reserve after the transfer.
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11. C. $100,000.

12. B. Will be disallowed and allocated to the ACB of the shares in the tax records of Ali
Holdings Ltd.

13. A. Will be disallowed and kept in the tax records of the transferor to be recognized when
the corporation is subject to an acquisition of control or is wound up.

14. D. A taxable capital gain of $25,000, recapture of $36,000 and the capital cost of the
asset to the transferee will be $125,000.

15. C. Section 85(1) does not apply. The proceeds of the disposition are deemed to be the
UCC amount, thereby disallowing the terminal loss.

16. A. Elected amount = $200,000 + $50,000 = $250,000

ACB = $250,000 - $200,000 - $50,000 = Nil

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Allocation Of The Elected Value

17. A. $175,000.

18. B. $60,000 and Nil.

19. A. $320,000 [$360,000 - ($180,000 - $140,000)].

20. C. $200,000 ($100,000 + $100,000).

21. B. $60,000 ($150,000 - $40,000 - $50,000).

22. D. To ensure the goodwill is included in the election, and also ensure that the transfer of
goodwill is not considered a gift.

23. B. $150,000; $500,000; $28,000

24. C. $105,000

25. A. $12,000. The PUC reduction will be $180,000 [$192,000 - ($20,000 - $8,000)]. This
leaves a PUC of $12,000 ($192,000 - $180,000).

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Gift To A Related Person - Section 85

26. B. The property has a fair market value that exceeds the greater of the fair market value
of the consideration received and the elected value.

27. A. $15,000 [$150,000 - $135,000]

28. D. Elected amount = $55,000 + [$85,000 - ($55,000 + $20,000) gift] = $65,000

ACB = $55,000 - $55,000 = Nil

Excess Consideration
29. A. The fair market value of the property transferred is less than the consideration
received.

30. D. $162,500 [(300,000-200,000) + (1/2) (200,000-75,000)]

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Dividend Stripping
31. B. The subject corporation must be associated with the purchaser corporation. They must
be connected, not associated.

32. B. An ITA 84.1(1) deemed dividend of $750,000. The PUC reduction will be $150,000,
leaving the shares with a PUC of nil. Given this, the deemed dividend totals $750,000
($150,000 + $850,000 - $100,000 - $150,000).

Capital Gains Stripping

33. D. The corporation selling the shares must be a private company.

34. D. A taxable capital gain of $ 407,500 and a dividend of $60,000 TCG = (1/2)($950,000
- $75,000 -$60,000) = $407,500] and [safe income amount of $60,000]

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TIF Solution Sixteen - 4

Exam Exercise Solution Sixteen - 1
(Elected Value For Non-Depreciable Property)

Inventories The $47,000 amount is both the floor and the ceiling, making this the only possible elected
value. The transfer would result in a loss of $8,000 ($55,000 - $47,000), an amount that would be fully
deductible as a business loss (ITA 23).
Land The floor would be the boot of $122,000 and the ceiling would be the fair market value of
$275,000. Electing the minimum amount would result in a taxable capital gain of $19,500 [($122,000 -
$83,000)(1/2)].

Exam Exercise Solution Sixteen - 2

(Elected Value For Non-Depreciable Property)

Land The ceiling would be the fair market value of $322,000 and the floor would be the boot of
$160,000. Electing the minimum value of $160,000 would result in a taxable capital gain of $6,500
[(1/2)($160,000 - $147,000)].

Inventories The $23,000 amount is both the floor and the ceiling, making this the only possible elected
value. Electing the minimum amount would result in a loss of $2,000 ($23,000 - $25,000). The loss
would be fully deductible under ITA 23.

Exam Exercise Solution Sixteen - 3 (Elected Value For Depreciable Property)

Class 1 Property The range would be from a floor of $246,000 (the boot) to a ceiling of $390,000 (fair
market value). Election of the $246,000 floor value would result in recapture of $57,000 ($191,000 -
$134,000) and a taxable capital gain of $27,500 [($246,000 - $191,000)(1/2)].
Class 8 Property The range for the Class 8 asset would be from a floor of $11,000 (the boot) to a
ceiling of $15,000 (fair market value). Electing the minimum value of $11,000 would result in recapture
of $1,000 ($11,000 - $10,000).

Exam Exercise Solution Sixteen - 4 (Elected Value For Depreciable Property)

Class 1 Property The ceiling would be the fair market value of $263,000 and the floor would be the
$122,000 UCC. The UCC should be elected for the transfer, as there will be no tax consequences.
Note, however, an additional $22,000 ($122,000 - $100,000) in boot could have been received on the
transfer without resulting in any tax consequences.
Class 8 Property With respect to the Class 8 property, the fair market value is less than the UCC. In
this case, ITA 13(21.2) indicates that ITA 85 does not apply and, if the asset is transferred to the
corporation, the proceeds of disposition are deemed to be the UCC amount of $52,000. There will be no

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tax consequences associated with the transfer and the corporation will retain the transferor’s original
capital cost of $81,000.
While a terminal loss could have been recognized if the property had been transferred to an arm’s length
taxpayer, it would have been disallowed in this case because Joan’s corporation is an affiliated person.

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Exam Exercise Solution Sixteen - 5 (ACB Of Consideration Received)

The adjusted cost base amounts would be calculated as follows:

Elected Value $86,800

ACB Of Note (Fair Market Value) ( 71,400)

ACB Of All Shares $15,400

ACB Of Preferred Shares* ( 15,400)

ACB Of Common Shares (Residual) Nil

*Remainder available as it is less than the fair market value of $74,200.

Exam Exercise Solution Sixteen - 6 (ACB Of Consideration Received)

The adjusted cost base amounts would be calculated as follows:

Elected Value $220,000

ACB Of Note (Fair Market Value) ( 110,000)

ACB Of All Shares $110,000

ACB Of Preferred Shares (Fair Market Value) ( 90,000)

ACB Of Common Shares (Residual) $ 20,000

Exam Exercise Solution Sixteen - 7 (PUC Reduction - Section 85)

The adjusted cost base amounts would be calculated as follows:

Elected Value $91,200

ACB Of Note (Fair Market Value) ( 66,400)

Available For Shares $24,800

ACB Of Preferred Shares* ( 24,800)

ACB Of Common Shares (Residual) Nil

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*Remainder available as it is less than the fair market value of $77,600.

The total PUC reduction would be calculated as follows:

Increase In Legal Stated Capital ($77,600 + $43,200) $120,800

Less The Excess Of:

Total Elected Value ($91,200)

Over The Non-Share Consideration 66,400 ( 24,800)

PUC Reduction $ 96,000

Note that this reduction is equal to the deferred gain on the election of $96,000 ($187,200 - $91,200).
The PUC reduction would be allocated on the basis of fair market values as follows:

Preferred Stock [($96,000)($77,600 ÷ $120,800)] $61,669

Common Stock [($96,000)($43,200 ÷ $120,800)] 34,331

Total PUC Reduction $96,000

Subsequent to applying this reduction, the remaining PUC of the two classes of shares would be as
follows:

Preferred Stock Common Stock

Legal Stated Capital $77,600 $43,200

PUC Reduction (From Preceding) ( 61,669) ( 34,331)

Total PUC $15,931 $ 8,869

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Note that the sum of these two figures equals $24,800 ($15,931 + $8,869), the total adjusted cost base of
the preferred and common shares, as well as the difference between the elected value of $91,200 and the
total non-share consideration of $66,400.

Exam Exercise Solution Sixteen - 8 (PUC Reduction - Section 85)

The adjusted cost base amounts would be calculated as follows:

Elected Value $111,000

ACB Of Cash ( 21,000)

Available For Shares $ 90,000

ACB Of Preferred Shares (Fair Market Value) ( 50,000)

ACB Of Common Shares (Residual) $ 40,000

The total PUC reduction would be calculated as follows:

Increase In Legal Stated Capital ($50,000 + $271,000) $321,000

Less The Excess Of:

Total Elected Value ($111,000)

Over The Non-Share Consideration 21,000 ( 90,000)

PUC Reduction $231,000

Note that this reduction is equal to the deferred gain on the election of $321,000 ($342,000 - $111,000).
The PUC reduction would be allocated on the basis of fair market values as follows:

Preferred Stock [($231,000)($50,000 ÷ $321,000)] $ 35,981

Common Stock [($231,000)($271,000 ÷ $321,000)] 195,019

Total PUC Reduction $231,000

Subsequent to applying this reduction, the remaining PUC of the two classes of shares would be as
follows:

Preferred Stock Common Stock

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Legal Stated Capital $50,000 $271,000

PUC Reduction (From Preceding) ( 35,981) ( 195,019)

Total PUC $14,019 $ 75,981

Note that the sum of these two figures equals $90,000 ($14,019 + $75,981), the total adjusted cost base
of the preferred and common shares, as well as the difference between the elected value of $111,000 and
the total non-share consideration of $21,000.

Exam Exercise Solution Sixteen - 9

(Transfers Under Section 85 - Tax Consequences)
The tax consequences to Mr. Wild and the corporation can be described as follows:

 Mr. Wild will have a taxable capital gain of $20,000 [(1/2)($160,000 - $120,000)].

 Mr. Wild will have recapture of CCA of $22,000 ($120,000 - $98,000).

 Mr. Wild will be holding shares with an adjusted cost base of nil (elected value of $160,000, less
non-share consideration of $160,000). The PUC of the shares would also be nil (legal stated capital
of $20,000, less a PUC reduction of $20,000).

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 The corporation will have a depreciable asset with a capital cost of $160,000 and a deemed
capital cost for CCA and recapture purposes, of $140,000 [$120,000 + (1/2)($160,000 - $120,000)].

Exam Exercise Solution Sixteen - 10

(Transfers Under Section 85 - Tax Consequences)
Part 1 The adjusted cost base of all of the consideration will total the elected value of $375,000. It will
be allocated as follows:

Elected Value $375,000

Non-Share Consideration ($115,000 + $85,000) ( 200,000)

Adjusted Cost Base Of All Shares $175,000

Adjusted Cost Base Of Preferred Shares (FMV) ( 100,000)

Adjusted Cost Base Of Common Shares (Residual) $ 75,000

Part 2 The PUC of the shares issued must be reduced as follows:

Increase In Legal Stated Capital ($100,000 + $1,210,000)$1,310,000

Less The Excess Of:

Elected Value ($375,000)

Over The Non-Share Consideration 200,000 ( 175,000)

PUC Reduction $1,135,000

This PUC reduction would be split between the preferred and common shares on the basis of their fair
market values:

Preferred Stock [($100,000/$1,310,000)($1,135,000)]$ 86,641

Common Stock [($1,210,000/$1,310,000)($1,135,000)] 1,048,359

Total PUC Reduction $1,135,000

Subsequent to applying this reduction, the remaining PUC of the two classes of shares would be as
follows:

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Preferred Stock Common Stock

Legal Stated Capital $100,000 $1,210,000

PUC Reduction (From Preceding) ( 86,641) ( 1,048,359)

Total PUC $ 13,359 $ 161,641

Part 3 The tax consequences of the preferred stock redemption would be as follows:

Proceeds Of Redemption $100,000

PUC Of The Preferred Shares ( 13,359)

ITA 84(3) Deemed Dividend (Non-Eligible) $ 86,641

Proceeds Of Redemption $100,000

ITA 84(3) Deemed Dividend ( 86,641)

ITA 54 Deemed Proceeds Of Disposition $ 13,359

Adjusted Cost Base ( 100,000)

Capital Loss ($ 86,641)

Inclusion Rate 1/2

Allowable Capital Loss ($ 43,321)

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The grossed up non-eligible dividend of $100,504 [(116%)($86,641)] would qualify for a federal
dividend tax credit of $10,082 [(8/11)(16%)($86,641)]. The allowable capital loss is only deductible
against taxable capital gains.

Exam Exercise Solution Sixteen - 11 (Gift To Related Party - Section 85)

As Mr. Rosen transferred property with a post-reassessment fair market value of $100,000 and received
consideration with a fair market value of $87,750 ($67,500 + $20,250), he has made a gift to his
daughter of $12,250 ($100,000 - $87,750). The tax consequences for Mr. Rosen and his daughter are as
follows:

Deemed Elected Value = Deemed Proceeds Of Disposition

($67,500 + $12,250) $79,750

Adjusted Cost Base ( 67,500)

Capital Gain $12,250

Inclusion Rate 1/2

Taxable Capital Gain $ 6,125

Elected Value (Original) $67,500

Non-Share Consideration ( 67,500)

Adjusted Cost Base Of Preferred Shares Nil

The required PUC reduction and resulting PUC would be calculated as follows:

Increase In Legal Stated Capital $20,250

Less Excess Of:

Deemed Elected Value ($79,750)

Over Non-Share Consideration 67,500 ( 12,250)

PUC Reduction $ 8,000

PUC Of Preferred Shares ($20,250 - $8,000) $12,250

The fair market value of the common shares is $12,750 ($100,000 + $500 - $67,500 - $20,250).
The sale of the shares for their fair market value would result in the following:

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Preferred Common

Proceeds (Fair Market Value) $20,250 $12,750

Adjusted Cost Base Nil ( 500)

Capital Gain $20,250 $12,250

Inclusion Rate 1/2 1/2

Taxable Capital Gain $10,125 $ 6,125

If the property had simply been sold for its $100,000 post-reassessment fair market value, there would
have been a $16,250 [(1/2)($100,000 - $67,500)] taxable capital gain. In the procedures that were used,
there is a $6,125 taxable capital gain on the ITA 85(1) transfer, along with a $10,125 taxable capital gain
on the sale of the preferred shares. This is the same $16,250 amount that would have occurred on the
direct sale of the non-depreciable capital property.
Unfortunately, because the common shares have increased in value by the amount of the gift with no
corresponding increase in the adjusted cost base, there is an additional $6,125 taxable capital gain (one-
half the amount of the gift) on the sale of the daughter’s common shares.

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Exam Exercise Solution Sixteen - 12 (Gift To Related Party - Section 85)

As Mr. Blunt transferred property with a post-reassessment fair market value of $475,000 and received
consideration with a fair market value of $400,000 ($150,000 + $250,000), he has made a gift to his
daughter of $75,000 ($475,000 - $400,000). The tax consequences for Mr. Blunt and his daughter are as
follows:

Deemed Elected Value = Deemed Proceeds Of Disposition

($250,000 + $75,000) $325,000

Adjusted Cost Base ( 250,000)

Capital Gain $ 75,000

Inclusion Rate 1/2

Taxable Capital Gain $ 37,500

Elected Value (Original) $250,000

Non-Share Consideration ( 250,000)

Adjusted Cost Base Of Preferred Shares Nil

The required PUC reduction and resulting PUC would be calculated as follows:

Increase In Legal Stated Capital $150,000

Less Excess Of:

Deemed Elected Value ($325,000)

Over Non-Share Consideration 250,000 ( 75,000)

PUC Reduction $ 75,000

PUC Of Preferred Shares ($150,000 - $75,000) $75,000

The fair market value of the common shares is $75,100 ($475,000 + $100 - $250,000 - $150,000).
The sale of the shares for their fair market value would result in the following:

Preferred Common

Proceeds (Fair Market Value) $150,000 $75,100

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Adjusted Cost Base Nil ( 100)

Capital Gain $150,000 $75,000

Inclusion Rate 1/2 1/2

Taxable Capital Gain $ 75,000 $37,500

If the property had simply been sold for its post-reassessment fair market value of $475,000, there would
have been a $112,500 [(1/2)($475,000 - $250,000)] taxable capital gain. In the procedures that were
used, there is a $37,500 taxable capital gain on the ITA 85(1) transfer, along with a $75,000 taxable
capital gain on the sale of the preferred shares. This is the same $112,500 amount that would have
occurred on the direct sale of the non-depreciable capital property.
Unfortunately, because the common shares have increased in value by the amount of the gift with no
corresponding increase in the adjusted cost base, there is an additional $37,500 taxable capital gain (one-
half the amount of the gift) on the sale of the daughter’s common shares.

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Exam Exercise Solution Sixteen - 13 (Benefit To Transferor - Section 85)

By electing to transfer at the fair market value of $224,000, Mrs. Keanings will have a taxable capital
gain of $44,000 [(1/2)($224,000 - $136,000)].
There is an ITA 15(1) shareholder benefit calculated as follows:

Fair Market Value Of Total Consideration

($193,000 + $90,000) $283,000

Fair Market Value Of Property ( 224,000)

ITA 15(1) Shareholder Benefit $ 59,000

The total effect on Net Income For Tax Purposes is as follows:

Taxable Capital Gain $ 44,000

Shareholder Benefit 59,000

Total Addition To Net Income For Tax Purposes $103,000

The ITA 15(1) benefit of $59,000 would be added to the adjusted cost base of the preferred shares,
resulting in the following adjusted cost base:

Elected Value $224,000

ACB Of Note (Fair Market Value) ( 193,000)

Available For Shares $ 31,000

ITA 15(1) Shareholder Benefit 59,000

ACB Of Preferred Shares $ 90,000

There will be a PUC reduction calculated as follows:

Increase In Legal Stated Capital $90,000

Less Excess, If Any, Of:

Total Elected Value ($224,000)

Over The Non-Share Consideration 193,000 ( 31,000)

ITA 85(2.1) PUC Reduction $59,000

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This will leave a PUC of $31,000 ($90,000 - $59,000). As this is equal to the $31,000 ($224,000 -
$193,000) increase in net assets, there is no ITA 84(1) deemed dividend.

Exam Exercise Solution Sixteen - 14 (Benefit To Transferor - Section 85)

By electing to transfer at the fair market value of $415,000, Ms. Stuart will have a taxable capital gain of
$72,500 [(1/2)($415,000 - $270,000)].
There is also an ITA 15(1) shareholder benefit calculated as follows:

Fair Market Value Of Total Consideration

($380,000 + $170,000) $550,000

Fair Market Value Of Property ( 415,000)

ITA 15(1) Shareholder Benefit $135,000

The total effect on Net Income For Tax Purposes is as follows:

Taxable Capital Gain $ 72,500

Shareholder Benefit 135,000

Total Addition To Net Income For Tax Purposes $207,500

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The ITA 15(1) benefit of $135,000 would be added to the adjusted cost base of the preferred shares,
resulting in the following adjusted cost base:

Elected Value $415,000

ACB Of Note (Fair Market Value) ( 380,000)

Available For Shares $ 35,000

ITA 15(1) Shareholder Benefit 135,000

ACB Of Preferred Shares $170,000

There will be a PUC reduction calculated as follows:

Increase In Legal Stated Capital $170,000

Less Excess, If Any, Of:

Total Elected Value ($415,000)

Over The Non-Share Consideration 380,000 ( 35,000)

ITA 85(2.1) PUC Reduction $135,000

This will leave a PUC of $35,000 ($170,000 - $135,000). As this is equal to the $35,000 ($415,000 -
$380,000) increase in net assets, there is no ITA 84(1) deemed dividend.

Exam Exercise Solution Sixteen - 15 (Dividend Stripping)

Mr. Stack (an individual) has sold shares of a subject corporation to a purchasing corporation, both
corporations do not deal with Mr. Stack at arm’s length, and the two corporations are connected
subsequent to the sale. As a consequence, ITA 84.1 is applicable. Given this, the tax consequences of
this transaction to Mr. Stack are as follows:

Increase In Legal Stated Capital $309,000

Less Excess, If Any, Of:

PUC And ACB Of Subject Shares ($132,000)

Over The Non-Share Consideration 390,000 Nil

PUC Reduction $309,000

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PUC Of New Shares ($309,000 - $309,000) Nil

Increase In Legal Stated Capital $309,000

Non-Share Consideration 390,000

Total $699,000

Less The Sum Of:

PUC And ACB Of Subject Shares ($132,000)

PUC Reduction ( 309,000) ( 441,000)

ITA 84.1 Deemed Dividend (Non-Eligible) $258,000

Elected Proceeds Of Disposition For Subject Shares $699,000

ITA 84.1 Deemed Dividend ( 258,000)

Proceeds For Capital Gains Purposes $441,000

ACB Of Subject Shares ( 132,000)

Capital Gain $309,000

Inclusion Rate 1/2

Taxable Capital Gain $154,500

ACB Of New Shares ($699,000 - $390,000) $309,000

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The grossed up non-eligible dividend of $299,280[(116%)($258,000)] would qualify for a federal

dividend tax credit of $30,022 [(8/11)(16%)($258,000)]. In addition, there would be a taxable capital
gain of $154,500 that would be eligible for the lifetime capital gains deduction. If Mr. Stack claims the
deduction, he may need to pay alternative minimum tax.

Exam Exercise Solution Sixteen - 16 (Capital Gains Stripping)

In the absence of ITA 55(2), the results for Foral would be as follows:

Proceeds Of Redemption $940,000

Paid Up Capital Of Preferred Shares ( 125,000)

ITA 84(3) Deemed Dividend $815,000

Proceeds Of Disposition $940,000

ITA 84(3) Dividend ( 815,000)

Adjusted Proceeds Of Disposition $125,000

Adjusted Cost Base ( 25,000)

Capital Gain Nil

As the ITA 84(3) dividend can be deducted in the determination of Foral’s Taxable Income, the
Company would have succeeded in disposing of the Martin shares without tax consequences.
However, as the redemption was in conjunction with a disposition of the property to an arm’s length
purchaser, ITA 55(2) alters this result. ITA 55(2)(a) would deem $587,000 ($815,000, less $228,000, 80
percent of the Safe Income of $285,000) of the ITA 84(3) dividend to not be a dividend ITA 55(2)(b)
would then deem the $587,000 to be proceeds of disposition. The result for Foral would be a capital
gain determined as follows:

Adjusted Proceeds Of Disposition $125,000

Deemed Proceeds Of Disposition 587,000

Total Proceeds Of Disposition $712,000

Adjusted Cost Base ( 125,000)

Capital Gain $587,000

Inclusion Rate 1/2

Taxable Capital Gain $293,500

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There would be a tax free dividend of the Safe Income of $228,000 [(80%)($285,000)] and a taxable
capital gain of $293,500.

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TIF Solution Sixteen - 5A

The correct definitions for each of the listed key terms are as follows:

A. 10

B. 6

C. 7

D. 2

E. 1

F. 8

G. 5

H. 9

The two unused definitions are as follows:

Terminal Loss = 4

Transferor = 3

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TIF Solution Sixteen - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.

The correct definitions for each of the listed key terms are as follows:

A. 13 (not 2)

B. 8 (not 14)

C. 10

D. 3

E. 1 (not 9)

F. 11 (not 5)

G. 7

H. 12

The two unused definitions are as follows:

Terminal Loss = 6

Transferor = 4

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TIF Solution Sixteen - 6

Part A - Transfer Under ITA 85(1)
As the $807,000 elected value was equal to the tax value of the property, there would be no tax
consequences associated with the rollover. The tax consequences of selling the common stock would be
calculated as follows:

Total Elected Value $ 807,000

Non-Share Consideration Nil

Adjusted Cost Base - Common Stock (Residual) $ 807,000

Proceeds Of Disposition $1,200,000

Adjusted Cost Base - Common Stock ( 807,000)

Capital Gain $ 393,000

Inclusion Rate 1/2

Taxable Capital Gain $ 196,500

Part B - Comparison To Direct Sale

The tax consequences of selling the property directly would be as follows:

Land Building

Proceeds Of Disposition $300,000 $900,000

Adjusted Cost Base/Capital Cost ( 225,000) ( 725,000)

Capital Gain $ 75,000 $175,000

Inclusion Rate 1/2 1/2

Taxable Capital Gain $ 37,500 $ 87,500

Based on these calculations, the overall tax effect of the direct sale would be as follows:

Taxable Capital Gain On Land $ 37,500

Taxable Capital Gain on Building 87,500

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Recapture On Building ($725,000 - $582,000) 143,000

Total Tax Effect $268,000

The reason for the difference lies in the type of income that the two approaches produce. The total
amount of income, before consideration of preferential treatment, that you would expect on this
transaction is $393,000 ($1,200,000 - $807,000). When ITA 85(1) is used, this full amount is received
as a capital gain, resulting in an income inclusion of $196,500. In contrast, with the direct sale, only
$250,000 ($75,000 + $175,000) of the total income is received as a capital gain, with the remaining
$143,000 ($393,000 - $250,000) being received as fully taxable recapture. The result is a higher amount
included in income under the direct sale alternative.
There is nothing illegal about this result. However, the CRA might view this situation as an avoidance
transaction and attempt to apply GAAR to these results.

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TIF Solution Sixteen - 7

Case One - Land
A. The range of values would be between the adjusted cost base of $423,000 and the fair market value
of $647,000.

B. Using the minimum $423,000 adjusted cost base for the transfer would result in no income being
recognized.

C. The adjusted cost base of the preferred stock would be calculated as follows:

Elected Value $423,000

Non-Share Consideration ( 47,000)

Adjusted Cost Base - Preferred Shares $376,000

The PUC reduction would be calculated as follows:

Increase In Legal Stated Capital $600,000

Less The Excess, If Any, Of:

Elected Value ($423,000)

Over The Non-Share Consideration 47,000 ( 376,000)

PUC Reduction $224,000

This would leave the PUC of the preferred stock at $376,000 ($600,000 - $224,000).

There is no ITA 84(1) dividend in this case as the increase in the fair market value of the net assets
exceeds the increase in PUC. There is no ITA 15(1) benefit as the fair market value of the
consideration received equals the fair market value of the asset transferred.

Case Two - Inventories

A. The range of values would be between the $70,000 in non-share consideration and the fair market
value of $87,400.

B. Using the minimum $70,000 value would create business income of $6,800 ($70,000 - $63,200).

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C. The adjusted cost base of the common stock would be calculated as follows:

Elected Value $70,000

Non-Share Consideration ( 70,000)

Adjusted Cost Base - Common Shares Nil

The PUC reduction would be calculated as follows:

Increase In Legal Stated Capital $17,400

Less The Excess, If Any, Of:

Elected Value ($70,000)

Over The Non-Share Consideration 70,000 ( Nil)

PUC Reduction $17,400

This would leave the PUC of the common shares at nil ($17,400 - $17,400).

There is no ITA 84(1) dividend in this case as the increase in the fair market value of the net assets
exceeds the increase in PUC. There is no ITA 15(1) benefit as the fair market value of the
consideration received equals the fair market value of the assets transferred.

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Case Three - Depreciable Assets

A. The range would be between the non-share consideration of $100,000 and the fair market value of
$124,000.

B. Using the $100,000 value would result in business income (recapture) of $47,008 ($100,000 -
$52,992).

C. The adjusted cost base of the preferred and common stock would be calculated as follows:

Elected Value $100,000

Non-Share Consideration ( 100,000)

Adjusted Cost Base - Preferred And Common Shares Nil

The PUC reduction on the preferred and common shares would be calculated as follows:

Increase In Legal Stated Capital ($10,000 + $14,000) $24,000

Less The Excess, If Any, Of:

Elected Value ($100,000)

Over The Non-Share Consideration 100,000 ( Nil)

PUC Reduction $24,000

The PUC of both the preferred and common shares would be nil ($24,000 - $24,000).

There is no ITA 84(1) dividend in this case as the increase in the fair market value of the net assets
exceeds the increase in PUC. There is no ITA 15(1) benefit as the fair market value of the
consideration received equals the fair market value of the assets transferred.

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TIF Solution Sixteen - 8

Part A - Adjusted Cost Base Of Consideration
The adjusted cost base for each item of consideration, under the three alternatives, would be calculated
as follows:

Alternative

One Two Three

Elected Transfer Price $400,000 $400,000 $400,000

ACB - Boot ( 150,000) ( 375,000) ( 300,000)

Available For Preferred

And Common Stock $250,000 $ 25,000 $100,000

ACB - Preferred Stock ( 150,000) ( 25,000) N/A

ACB - Common Stock (Residual) $100,000 N/A $100,000

Part B - Legal Stated Capital And PUC

The legal stated capital for the two classes of shares would be as follows:

Alternative

One Two Three

Preferred Stock $150,000 $300,000 Nil

Common Stock 375,000 Nil $375,000

Total Legal Stated Capital $525,000 $300,000 $375,000

The required PUC reduction would be calculated as follows:

Alternative

One Two Three

Increase In Legal Stated Capital

- All Shares (A) $525,000 $300,000 $375,000

Elected Amount $400,000 $400,000 $400,000

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Non-Share Consideration ( 150,000) ( 375,000) ( 300,000)

Elected Amount, Less Boot (B) $250,000 $ 25,000 $100,000

Required PUC Reduction (A - B) $275,000 $275,000 $275,000

Alternative One In Alternative One, the PUC reduction would have to be split between the two classes
of shares on the basis of their relative fair market values. The relevant calculation would be as follows:

Preferred Shares: [($275,000)($150,000 ÷ $525,000)] = $78,571

Common Shares: [($275,000)($375,000 ÷ $525,000)] = $196,429

This would leave a PUC of $71,429 ($150,000 - $78,571) for the preferred shares, and a PUC of
$178,571 ($375,000 - $196,429) for the common shares.

Alternative Two In Alternative Two, the entire PUC reduction of $275,000 would be allocated to the
preferred shares, leaving a PUC of $25,000 ($300,000 - $275,000).

Alternative Three In Alternative Three, the entire PUC reduction of $275,000 would be allocated to
the common stock, leaving a PUC of $100,000 ($375,000 - $275,000).

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TIF Solution Sixteen - 9

Case A
Immediate Tax Consequences As the elected values for the land and building are equal to their tax
costs, there are no immediate tax consequences resulting from the transfer.

Tax Cost Of The Land And Building The tax cost of the land (adjusted cost base) would be the
elected value of $280,000. The tax cost of the building (UCC) would be the elected value of $391,000.
Note, however, the new corporation would retain the old capital cost of $500,000, with the $109,000
difference being treated as deemed CCA.

ACB Of Shares The ACB of the shares issued by the corporation would be calculated as follows:

Elected Value ($280,000 + $391,000) $671,000

Fair Market Value Of Non-Share Consideration Nil

ACB Of Shares $671,000

PUC Of Shares The required PUC reduction and resulting PUC would be calculated as follows:

Legal Stated Capital Of Shares $1,200,000

Less Excess, If Any, Of:

Elected Value ($671,000)

Over The Non-Share Consideration Nil ( 671,000)

PUC Reduction $ 529,000

PUC Of Shares ($1,200,000 - $529,000) $ 671,000

Case B
Immediate Tax Consequences As the elected value for the land of $425,000 exceeds the $280,000
adjusted cost base of the land, there is a taxable capital gain of $72,500 [(1/2)($425,000 - $280,000)].
As the elected value of the building is equal to its tax cost, there are no immediate tax consequences
associated with the transfer of the building.

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Tax Cost Of The Land And Building The tax cost of the land (adjusted cost base) would be the
elected value of $425,000. The tax cost of the building (UCC) would be the elected value of $391,000.
Once again, the new corporation would retain the old capital cost of $500,000, with the $109,000
difference being treated as deemed CCA.

ACB Of Shares The ACB of the shares issued by the corporation would be calculated as follows:

Elected Value ($425,000 + $391,000) $816,000

Fair Market Value Of Non-Share Consideration Nil

ACB Of Shares $816,000

PUC Of Shares The required PUC reduction and resulting PUC would be calculated as follows:

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Legal Stated Capital Of Shares $1,200,000

Less Excess, If Any, Of:

Elected Value ($816,000)

Over The Non-Share Consideration Nil ( 816,000)

PUC Reduction $ 384,000

PUC Of Shares ($1,200,000 - $384,000) $ 816,000

Case C
Immediate Tax Consequences As the elected value for the land of $425,000 exceeds the $280,000
adjusted cost base of the land, there is a taxable capital gain of $72,500 [(1/2)($425,000 - $280,000)].
As the elected value of the building is equal to its tax cost, there are no immediate tax consequences
associated with the transfer of the building.

Tax Costs Of The Land And Building The tax cost of the land (adjusted cost base) would be the
elected value of $425,000. The tax cost of the building (UCC) would be the elected value of $391,000.
Note, however, that the new corporation would retain the old capital cost of $500,000, with the
$109,000 difference being treated as deemed CCA.

ACB Of Shares The ACB of the shares issued by the corporation would be calculated as follows:

Elected Value ($425,000 + $391,000) $816,000

Fair Market Value Of Non-Share Consideration ( 816,000)

ACB Of Shares Nil

PUC Of Shares The required PUC reduction and resulting PUC would be calculated as follows:

Legal Stated Capital Of Shares $384,000

Less Excess, If Any, Of:

Elected Value ($816,000)

Over The Non-Share Consideration 816,000 Nil

PUC Reduction $384,000

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PUC Of Shares ($384,000 - $384,000) Nil

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TIF Solution Sixteen - 10

Income Generated By The Transfer
This transaction will affect Mr. Nelson’s current year income as follows:

UCC For Class $189,600

Dispositions - Lesser Of:

 Capital Cost = $225,000

 Proceeds Of Disposition (Elected Value) = $265,000 ( 225,000)

Negative Balance ($ 35,400)

Recapture Of CCA 35,400

UCC Nil

Proceeds Of Disposition (Elected Value) $265,000

Capital Cost Of Property ( 225,000)

Capital Gain $ 40,000

Inclusion Rate 1/2

Taxable Capital Gain $20,000

Allowable Capital Loss On Stock Sale [(1/2)($40,000)] ( 20,000)

Net Taxable Capital Gain Nil

Mr. Nelson will have business income of $35,400, the recapture of CCA. The $20,000 taxable capital
gain from the ITA 85 transfer will be completely offset by the $20,000 allowable capital loss on the
stock sale, resulting in no addition to Net Income For Tax Purposes in the current year.

Adjusted Cost Base Of Consideration

The adjusted cost base of the consideration received by Mr. Nelson would be as follows:

Total Elected Value $265,000

Adjusted Cost Base Of Boot (Fair Market Value) ( 150,000)

Available For Share Consideration $115,000

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Adjusted Cost Base Of Preferred Stock ( 50,000)

Adjusted Cost Base Of The Common Stock (Residual) $ 65,000

Capital Cost Of Transferred Property

The capital cost, for CCA and recapture purposes, would be calculated as follows:

Capital Cost To Transferor $225,000

Proceeds Of Disposition To Transferor $265,000

Capital Cost - Property Transferred ( 225,000)

Excess $ 40,000

Fraction 1/2 20,000

Capital Cost To Transferee For CCA Purposes $245,000

The adjusted cost base of the property for capital gains purposes is the elected value of $265,000.

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Paid Up Capital
The total PUC for the two classes of shares would be calculated as follows:

Increase In Legal Stated Capital ($50,000 + $116,000)$166,000

Less Excess Of:

Elected Amount ($265,000)

Over The Non-Share Consideration 150,000 ( 115,000)

Reduction In PUC $ 51,000

The PUC reduction would be allocated on the basis of fair market values as follows:

Preferred Stock [($51,000)($50,000 ÷ $166,000)] $15,361

Common Stock [($51,000)($116,000 ÷ $166,000)] 35,639

Total PUC Reduction $51,000

Subsequent to applying this reduction, the remaining PUC of the two classes of shares would be as
follows:

Preferred Stock Common Stock

Legal Stated Capital $50,000 $116,000

PUC Reduction (From Preceding) ( 15,361) ( 35,639)

Total PUC $ 34,639 $ 80,361

Note that the total PUC of $115,000 ($34,639 + $80,361) is equal to the total adjusted cost base of
$115,000 ($50,000 + $65,000).

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TIF Solution Sixteen - 11

Part A - Tax Consequences Of Transfer
With respect to the land, the $220,000 elected value will be both the proceeds of disposition to Ms.
Bond and the adjusted cost base to the corporation. As the elected value is equal to Ms. Bond’s adjusted
cost base, there will be no tax consequences resulting from the transfer.
The elected value and proceeds of disposition for the building is its original cost, an amount that is in
excess of its UCC. This will result in Ms. Bond having to report recapture of $105,000 ($730,000 -
$625,000). However, with the elected value at Ms. Bond’s original cost for the building, both the capital
cost and the UCC will be the elected value of $730,000.

Part B - Adjusted Cost Base Of The Consideration

The adjusted cost base of all consideration received by Ms. Bond will be the total elected value of
$950,000. It will be allocated as follow:

Total Elected Value $950,000

Total Non-Share Consideration

($400,000 Old Debt + $500,000 New Debt) ( 900,000)

Adjusted Cost Base Of Common Shares $ 50,000

Part C - PUC Of The New Shares

The calculation of PUC would be as follows:

Increase In Legal Stated Capital (Fair Market Value) $590,000

Less Excess Of:

Elected Amount ($950,000)

Over The Total Non-Share Consideration 900,000 ( 50,000)

Reduction In PUC $540,000

The PUC of the common shares would be reduced to $50,000 ($590,000 - $540,000).

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Part D - Sale Of Common Shares

The increase in Net Income For Tax Purposes from a sale of the shares for $650,000 would be as
follows:

Proceeds Of Disposition $650,000

Adjusted Cost Base ( 50,000)

Capital Gain $600,000

Inclusion Rate 1/2

Taxable Capital Gain $300,000

As Taxable Income consequences are not required, the effect of the lifetime capital gains deduction has
not been considered.

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Part E - Tax Consequences Of Redemption

The tax consequences of a redemption for $650,000 would be as follows:

Proceeds From Redemption $650,000

PUC ( 50,000)

ITA 84(3) Deemed Dividend (Non-Eligible) $600,000

There would be no capital gain on this redemption as shown in the following calculation:

Redemption Proceeds $650,000

ITA 84(3) Deemed Dividend ( 600,000)

Deemed Proceeds Of Disposition $ 50,000

Adjusted Cost Base ( 50,000)

Capital Gain Nil

The amount to be included in Net Income For Tax Purposes would be $696,000, the $600,000 deemed
non-eligible dividend grossed up by 16 percent.
There would also be a federal dividend tax credit of $69,818 [(8/11)(16%)($600,000)].

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TIF Solution Sixteen - 12

Part A - Receivables And Temporary Investments
If the Accounts Receivable are transferred under ITA 85, no election can be made under ITA 22. As a
result, the $7,000 ($168,000 - $161,000) loss will be a capital loss, which will be disallowed under ITA
40(2)(g) because the transfer is to a corporation controlled by the transferor. The appropriate treatment
would be to exclude the Accounts Receivable from the ITA 85 election. This would permit the use of
the ITA 22 election that would allow the $7,000 loss to be treated as a fully deductible business loss. As
ITA 22 is a joint election, the corporation would have to include the $7,000 in income, but could then
deduct actual bad debts as they occur. If no election is made, the receivables will be recorded on the
corporation’s books at their fair market value. If a different amount is collected, the result will be a
capital gain or a capital loss.
With respect to the Temporary Investments, ITA 40(2)(g) would deny the $9,000 ($58,000 - $49,000)
capital loss on a transfer to a controlled corporation, without regard to whether the transfer is made
under the provisions of ITA 85. This means that there is no point in transferring these investments to the
corporation. Mr. Griffeth could continue to hold the securities personally or, alternatively, sell them to
an arm’s length party. The allowable capital loss on such a sale would be immediately deductible,
provided that Mr. Griffeth has available sufficient taxable capital gains. If he does not, he might wish to
structure the ITA 85 rollover in such a fashion that $9,000 in capital gains are generated by the transfer.

Part B - Minimum Elected Values

The minimum elected values would be as follows:

Accounts Receivable $ 161,000

Temporary Investments 49,000

Inventories 310,000

Furniture And Fixtures 71,000

Machinery 275,000

Land 210,000

Building 579,000

Goodwill 1

Total Elected Value $1,655,001

Part C - Adjusted Cost Base Of The Consideration

The adjusted cost base of the non-share consideration would be its fair market value which, in the case
of debt, would be its face value of $1,224,000 ($1,120,000 in new debt, plus $104,000 of old debt
assumed). Given this, the allocations to preferred stock and common stock would be as follows:

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Total Elected Value $1,655,001

Non-Share Consideration ( 1,224,000)

Available For Common And Preferred Shares $ 431,001

ACB Of Preferred Stock (Fair Market Value) ( 300,000)

ACB Of Common Stock (Residual) $ 131,001

(The following paragraph is not required.)

As Mr. Griffeth will control the new corporation, the capital losses of $7,000 on Accounts Receivable
and $9,000 on Temporary Investments will be disallowed under ITA 40(2)(g). The disallowed losses
will be added to the tax cost of the assets on Griffeth Ltd.’s books. This means the Accounts Receivable
will have a tax cost of $168,000 and the Temporary Investments will have a tax cost of $58,000 for
Griffeth Ltd. Any bad debt losses on the Accounts Receivable will be capital losses.

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Part C - PUC Of The Preferred And Common Shares

The PUC calculation would begin with the legal stated values of the shares. These were $300,000 for
the preferred stock and $903,000 for the common stock. ITA 85(2.1) would require a reduction in this
total as follows:

Total Increase In Legal Stated Capital Of Shares

($300,000 + $903,000) $1,203,000

Less Excess Of:

Total Elected Value ($1,655,001)

Over The Total Non-Share Consideration 1,224,000 ( 431,001)

Reduction In PUC $ 771,999

The PUC reduction would be allocated on the basis of fair market values as follows:

Preferred Stock [($771,999)($300,000 ÷ $1,203,000)]$192,518

Common Stock [($771,999)($903,000 ÷ $1,203,000)] 579,481

Total PUC Reduction $771,999

Subsequent to applying this reduction, the remaining PUC of the two classes of shares would be as
follows:

Preferred Stock Common Stock

Legal Stated Capital $300,000 $903,000

PUC Reduction (From Preceding) ( 192,518) ( 579,481)

Total PUC $107,482 $323,519

The total PUC of $431,001 ($107,481 + $323,519) is equal to the difference between the elected value
of $1,655,001 and the non-share consideration of $1,224,000. It is also equal to the total adjusted cost
base of the two classes of shares ($300,000 + $131,001).

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Part D(1) - Tax Consequences Of Sale

The tax consequences for Mr. Griffeth on the sale of the preferred and common stock would be as
follows:

Preferred Common

Stock Stock

Proceeds Of Disposition $300,000 $903,000

Adjusted Cost Base (Part C) ( 300,000) ( 131,001)

Capital Gain Nil $771,999

Inclusion Rate N/A 1/2

Taxable Capital Gain Nil $386,000

Part D(2) - Tax Consequences Of Redemption

The tax consequences for Mr. Griffeth on the redemption of the preferred stock and common stock
would be as follows:

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Preferred Common

Stock Stock

Proceeds Of Redemption $300,000 $903,000

PUC (Part C) ( 107,482) ( 323,519)

ITA 84(3) Deemed Dividend (Non-Eligible) $192,518 $579,481

Redemption Proceeds $300,000 $903,000

ITA 84(3) Deemed Dividend ( 192,518) ( 579,481)

Deemed Proceeds Of Disposition $107,482 $323,519

Adjusted Cost Base ( 300,000) ( 131,001)

Capital Gain (Loss) ($192,518) $192,518

Mr. Griffeth would have a deemed non-eligible dividend of $771,999 ($192,518 + $579,481). This is
also the amount of the gain that was deferred through the use of Section 85 ($2,427,000 - $1,655,001).
The grossed up non-eligible dividend of $895,519 [(116%)($771,999)] would qualify for a federal
dividend tax credit of $89,833 [(8/11)(16%)($771,999)].
There is a net capital gain of nil ($192,518 - $192,518).

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TIF Solution Sixteen - 13

Part A - Tax Consequences Of Transfer
With respect to the land, the $300,000 elected value will be both the proceeds of disposition to Ms.
Manson and the adjusted cost base to the corporation. As the elected value is greater than Ms. Manson’s
adjusted cost base, there will be a taxable capital gain of $62,500 [(1/2)($300,000 - $175,000)]
The elected value and proceeds of disposition for the building is $700,000, an amount that is less than its
capital cost of $745,000, but more than its UCC of $690,000. This will result in Ms. Manson having to
report recapture of $10,000 ($700,000 - $690,000). The corporation’s tax value will be $700,000.
However, the corporation will retain the original capital cost of $745,000 for recapture and capital gains
calculations. The $45,000 difference will be deemed to be CCA taken.

Part B - Adjusted Cost Base Of The Consideration

The adjusted cost base of all consideration received by Ms. Manson will be the total elected value of
$1,000,000 ($300,000 + $700,000). It will be allocated as follow:

Total Elected Value $1,000,000

Total Non-Share Consideration

($375,000 Assumed Mortgage + $625,000 New Debt) ( 1,000,000)

Adjusted Cost Base Of Common Shares Nil

Part C - PUC Of The New Shares

The calculation of PUC would be as follows:

Increase In Legal Stated Capital (Fair Market Value) $400,000

Less Excess Of:

Elected Amount ($1,000,000)

Over The Total Non-Share Consideration 1,000,000 Nil

Reduction In PUC $400,000

The PUC of the common shares would be reduced to Nil ($400,000 - $400,000).

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Part D - Sale Of Common Shares

The increase in Net Income For Tax Purposes from a sale of the shares for $400,000 would be as
follows:

Proceeds Of Disposition $400,000

Adjusted Cost Base Nil

Capital Gain $400,000

Inclusion Rate 1/2

Taxable Capital Gain $200,000

As Taxable Income consequences are not required, the effect of the lifetime capital gains deduction has
not been considered.

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Part E - Tax Consequences Of Redemption

The tax consequences of a redemption for $400,000 would be as follows:

Proceeds From Redemption $400,000

PUC Nil

ITA 84(3) Deemed Dividend (Non-Eligible) $400,000

There would be no capital gain on this redemption as shown in the following calculation:

Disposition Proceeds $400,000

ITA 84(3) Deemed Dividend ( 400,000)

Deemed Proceeds Of Disposition Nil

Adjusted Cost Base Nil

Capital Gain Nil

The amount to be included in Net Income For Tax Purposes would be the grossed up amount of
$464,000 [(116%)($400,000)].
While it is not required by the problem as it does not influence the calculation of Net Income For Tax
Purposes, there would be a federal dividend tax credit of $46,545 [(8/11)(16%)($400,000)].

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TIF Solution Sixteen - 14

Part A - Receivables And Temporary Investments
If the Accounts Receivable are transferred under ITA 85, no election can be made under ITA 22. As a
result, the $8,000 ($120,000 - $112,000) loss will be a capital loss, which will be disallowed under ITA
40(2)(g) because the transfer is to a corporation controlled by the transferor. The appropriate treatment
would be to exclude the Accounts Receivable from the ITA 85 election. This would permit the use of
the ITA 22 election that would allow the $8,000 loss to be treated as a fully deductible business loss. As
ITA 22 is a joint election, the corporation would have to include the $8,000 in income, but could then
deduct actual bad debts as they occur.
With respect to the Temporary Investments, ITA 40(2)(g) would deny the $5,000 ($42,000 - $37,000)
capital loss on a transfer to a controlled corporation, without regard to whether the transfer is made
under the provisions of ITA 85. This means that there is no point in transferring these investments to the
corporation. Ms. Delmor could continue to hold the securities personally or, alternatively, sell them to
an arm’s length party. The allowable capital loss on such a sale would be immediately deductible,
provided that Ms. Delmor has available sufficient taxable capital gains. If she does not, she might wish
to structure the ITA 85 rollover in such a fashion that $5,000 in capital gains are generated by the
transfer.

Part B - Minimum Elected Values

The minimum elected values would be as follows:

Accounts Receivable $ 112,000

Temporary Investments 37,000

Inventories 220,000

Class 8 Depreciable Assets (See Note) 53,000

Machinery 197,000

Land 150,000

Building 416,000

Goodwill 1

Total Elected Value $1,185,001

Note The minimum elected value for a depreciable property, under ITA 85(1)(e), is the least of
the UCC for the class, the cost of the individual property, and the fair market value of the
individual property. For the two Class 8 assets, these amounts would be as follows:

Asset A (Least Of $53,000, $27,000, And $32,500) $27,000

Asset B (Least Of $53,000, $33,000, And $29,000) 29,000

Total $56,000

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If this amount is used, the result will be recapture of $3,000 ($56,000 - $53,000). However,
ITA 85(1)(e.1) allows the assets to be transferred one at a time in order to avoid this result.
Therefore, if Asset A is transferred first, the UCC balance will be $26,000 ($53,000 -
$27,000). This means that when Asset B is transferred, the least amount will be the UCC of
$26,000 and, when this is subtracted, the UCC balance will be nil and no recapture will arise on
the transfer.

Part C - Adjusted Cost Base Of The Consideration

The adjusted cost base of the non-share consideration would be its fair market value which, in the case
of debt, would be its face value of $872,000 ($800,000 in new debt, plus $72,000 of old debt assumed).
Given this, the allocations to preferred stock and common stock would be as follows:

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Total Elected Value $1,185,001

Non-Share Consideration ( 872,000)

Available For Common And Preferred Shares $ 313,001

ACB Of Preferred Stock (Fair Market Value) ( 200,000)

ACB Of Common Stock (Residual) $ 113,001

(The following paragraph is not required.)

As Ms. Delmor will control the new corporation, the capital losses of $8,000 on Accounts Receivable
and $5,000 on Temporary Investments will be disallowed under ITA 40(2)(g). The disallowed losses
will be added to the tax cost of the assets on Delmor Inc.’s books. This means the Accounts Receivable
will have a tax cost of $120,000 and the Temporary Investments will have a tax cost of $42,000 for
Delmor Inc. Any bad debt losses on the Accounts Receivable will be capital losses.

Part C - PUC Of The Preferred And Common Shares

The PUC calculation would begin with the legal stated values of the shares. These were $200,000 for
the preferred stock and $677,000 for the common stock. ITA 85(2.1) would require a reduction in this
total as follows:

Total Increase In Legal Stated Capital Of Shares

($200,000 + $677,000) $877,000

Less Excess Of:

Total Elected Value ($1,185,001)

Over The Total Non-Share Consideration 872,000 ( 313,001)

Reduction In PUC $563,999

The PUC reduction would be allocated on the basis of fair market values as follows:

Preferred Stock [($563,999)($200,000 ÷ $877,000)] $128,620

Common Stock [($563,999)($677,000 ÷ $877,000)] 435,379

Total PUC Reduction $563,999

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Subsequent to applying this reduction, the remaining PUC of the two classes of shares would be as
follows:

Preferred Stock Common Stock

Legal Stated Capital $200,000 $677,000

PUC Reduction (From Preceding) ( 128,620) ( 435,379)

Total PUC $ 71,380 $241,621

The total PUC of $313,001 ($71,380 + $241,621) is equal to the difference between the elected value of
$1,185,001 and the non-share consideration of $872,000. It is also equal to the total adjusted cost base
of the two classes of shares ($200,000 + $113,001).

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Part D - Tax Consequences Of Redemption

The tax consequences for Ms. Delmor on the redemption of the preferred stock and common stock
would be as follows:

Preferred Common

Stock Stock

Redemption Proceeds $200,000 $677,000

PUC (Part C) ( 71,380) ( 241,621)

ITA 84(3) Deemed Dividend (Non-Eligible) $128,620 $435,379

Redemption Proceeds $200,000 $677,000

ITA 84(3) Deemed Dividend ( 128,620) ( 435,379)

Deemed Proceeds Of Disposition $ 71,380 $241,621

Adjusted Cost Base ( 200,000) ( 113,001)

Capital Gain (Loss) ($128,620) $128,620

Ms. Delmor would have a deemed non-eligible dividend of $563,999 ($128,620 + $435,379). This is
also the amount of the gain that was deferred through the use of Section 85 ($1,749,000 - $1,185,001).
The grossed up non-eligible dividend of $654,239 [(116%)($563,999)] would qualify for a federal
dividend tax credit of $65,629 [(8/11)(16%)($563,999)].
There is a net capital gain of nil ($128,620 - $128,620).

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TIF Solution Sixteen - 15

Part A
As the fair market value of the consideration received by Ms. Chadwick was less than the reassessed fair
market value of the assets transferred, it would appear that Ms. Chadwick was inadvertently attempting
to make a gift to a related party, Biff. Making this a reasonable conclusion is the fact that Biff is the
only common shareholder of the new corporation.
ITA 85(1)(e.2) requires that any gift amount be added to the elected value with the total being used as
the deemed proceeds of disposition without any increase in the adjusted cost base of the shares received.
The amount of the gift and the tax consequences of the transfer to Ms. Chadwick would be calculated as
follows:

Fair Market Value Of Assets Transferred

($12,500,000 + $500,000) $13,000,000

Less The Greater Of:

Fair Market Value Of Consideration Received = $12,500,000

($850,000 + $1,150,000 + $6,000,000+ $4,500,000)

Elected Value = $9,820,000 ( 12,500,000)

Gift To Biff $ 500,000

Based on the reassessment, the $500,000 will be added to the value of the land resulting in a taxable
capital gain calculated as follows:

Deemed Elected Value = Deemed Proceeds Of Disposition

($9,820,000 + $500,000) $10,320,000

Tax Values Of Assets Transferred ( 9,820,000)

Capital Gain $ 500,000

Inclusion Rate 1/2

Taxable Capital Gain $ 250,000

The adjusted cost base of the preferred shares received by Ms. Chadwick would be calculated as
follows:

Elected Value (Original) $9,820,000

Non-Share Consideration ($850,000 + $1,150,000 + $6,000,000) ( 8,000,000)

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Adjusted Cost Base Of Preferred Shares $1,820,000

The required PUC reduction and resulting PUC for the preferred shares received by Ms. Chadwick
would be calculated as follows:

Increase In Legal Stated Capital $4,500,000

Excess, If Any Of:

Deemed Elected Value

($9,820,000 + $500,000) ($10,320,000)

Over Non-Share Consideration 8,000,000 ( 2,320,000)

PUC Reduction $2,180,000

PUC Of Preferred Shares ($4,500,000 - $2,180,000) $2,320,000

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Part B
The tax consequences to Ms. Chadwick of having her shares redeemed would be as follows:

Proceeds Of Redemption $4,500,000

PUC Of Shares ( 2,320,000)

ITA 84(3) Deemed Dividend $2,180,000

This deemed dividend would be grossed up to $2,528,800 [(116%)($2,180,000)] of Taxable Income and
will generate a federal dividend tax credit of $253,673 [(8/11)(16%)($2,180,000)].
In addition to the ITA 84(3) deemed dividend, there will also be a taxable capital gain calculated as
follows:

Proceeds Of Disposition $4,500,000

ITA 84(3) Deemed Dividend ( 2,180,000)

Adjusted Proceeds Of Disposition $2,320,000

Adjusted Cost Base Of Shares ( 1,820,000)

Capital Gain $ 500,000

Inclusion Rate 1/2

Taxable Capital Gain $ 250,000

Part C
If Biff Bangor sells his shares for $550,000, the tax consequences would be as follows:

Proceeds Of Disposition $550,000

Adjusted Cost Base Of Shares ( 5,000)

Capital Gain $545,000

Inclusion Rate 1/2

Taxable Capital Gain $272,500

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Economic Analysis (Not Required)

If Ms. Chadwick had simply sold her business assets for their reassessed fair market value, she would
have had a combination of business income and capital gains totalling $3,180,000 ($13,000,000 -
$9,820,000). Using the procedures described above, the result has the same $3,180,000 ($500,000
capital gain on the transfer, plus the deemed dividend of $2,180,000 resulting from the redemption, plus
the $500,000 capital gain resulting from the redemption). While the composition of the income is
different, the overall result is the same.
However, there is an impact on Biff. The $500,000 gift was added to the value of his shares with no
corresponding increase in the adjusted cost base of the shares. In effect, this has become a component of
the $545,000 capital gain that was recorded when he sold his shares.
At the time of the rollover, Biff’s shares had a fair market value of $505,000, his investment of $5,000,
plus the $500,000 gift. While the post rollover gain of $45,000 ($550,000 - $505,000) had nothing to do
with the gift, $500,000 of the gain could have been avoided. In effect, this gain is being taxed twice,
once in Biff’s hands and once in Ms. Chadwick’s hands.
Overall, the procedures used in this situation resulted in Ms. Chadwick being taxed on the same amount
of income as would have been the case without the ITA 85(1) rollover. In addition, Biff paid taxes on
an additional capital gain of $500,000 ($250,000 taxable amount) that would not have occurred if Ms.
Chadwick had taken the time to determine the correct fair market value for the land and had proper
documentation of the value.

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TIF Solution Sixteen - 16

Part A
The problem does not provide the elected value that will provide for the required $100,000 capital gain.
As Mr. Graber also wants to maximize his non-share consideration, the minimum elected value would
be $5,143,000, the tax value of the assets. This would result in no current additions to his Net Income
For Tax Purposes.
In order to use the $100,000 net capital loss carry forward, the transfer must create a $100,000 capital
gain. In general, one would first look to land for increasing the elected value, reflecting the fact that a
capital gain can be created on the land without triggering recapture. However, as the fair market value
of the land is only $40,000 more that the tax value ($1,300,000 - $1,260,000), only a $40,000 capital
gain can be created through an allocation to that asset.
In order to create an additional $60,000 ($100,000 - $40,000) capital gain, he will have to elect a value
of $1,620,000 ($1,560,000 + $60,000) for the depreciable assets, or elect a value of $2,560,000
($2,500,000 + $60,000) for the building.
Either election will create, in addition to the desired capital gain, recapture of CCA. In the case of the
building, the recapture amount would be $137,000 ($1,560,000 - $1,423,000). In the case of the
building, the recapture amount would be $40,000 ($2,500,000 - $2,460,000). The building would
clearly be the preferable alternative for the allocation.
Based on this analysis, the total elected value and the amount of non-share consideration would be
calculated as follows:

Depreciable Assets (Tax Value) $1,423,000

Land ($1,260,000 + $40,000) 1,300,000

Building ($2,500,000 + $60,000) 2,560,000

Total Elected Value $5,283,000

Based on the preceding calculation for the elected values, it appears that Mr. Graber has received
consideration in excess of the fair market value of the assets transferred:

Non-Share Consideration (Equal To Elected Value) $5,283,000

Redeemable Preferred Shares 1,000,000

Total Consideration Received $6,283,000

Fair Market Value Of Assets Transferred ( 5,650,000)

ITA 15(1) Shareholder Benefit $ 633,000

The total immediate tax consequences of the transfer would be as follows:

Capital Gain On Land ($1,300,000 - $1,260,000) $ 40,000

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Capital Gain On Building ($2,560,000 - $2,500,000) 60,000

Capital Gain At Transfer $100,000

Inclusion Rate 1/2

Taxable Capital Gain $ 50,000

Recapture On Building ($2,500,000 - $2,460,000) 40,000

ITA 15(1) Shareholder Benefit 633,000

Increase In Net Income For Tax Purposes $723,000

Net Capital Loss Carry Forward Deducted ( 50,000)

Increase In Taxable Income $673,000

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The adjusted cost base of the preferred shares would be calculated as follows:

Total Elected Value $5,283,000

Non-Share Consideration ( 5,283,000)

Available For Shares Nil

ITA 15(1) Shareholder Benefit $ 633,000

Adjusted Cost Base Of Preferred Shares $ 633,000

The PUC of the preferred shares would be calculated as follows:

Increase In Legal Stated Capital $1,000,000

Less The Excess, If Any, Of:

Elected Value ($5,283,000)

Over The Non-Share Consideration 5,283,000 Nil

PUC Reduction $1,000,000

PUC ($1,000,000 - $1,000,000) Nil

Part B
The tax values for the assets transferred can be described as follows:

Depreciable Assets The tax cost for these assets will be the elected value of $1,423,000.
However, they will retain their original capital cost of $1,560,000 for recapture and capital
gains calculations. The $137,000 difference will be deemed to be CCA taken.

Land The adjusted cost base of the land will be the elected value of $1,300,000. (Note that the
rules in ITA 13(7)(e) to limit the capital cost on non-arm’s length transfers do not apply to
non-depreciable assets.)

Building For capital gains purposes, the capital cost of the building will be the elected value of
$2,560,000. However, as a capital gain was triggered on the transfer, under ITA 13(7)(e), the
capital cost for CCA purposes would be calculated as follows:

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Transferor’s Cost $2,500,000

Elected Transfer Price $2,560,000

Transferor’s Cost ( 2,500,000)

Capital Gain $ 60,000

Taxable Portion 1/2 30,000

Capital Cost To The Transferee For CCA Purposes $2,530,000

Part C-1 Sale Of Shares

If the shares were sold for $1,000,000, the results would be as follows:

Proceeds Of Disposition $1,000,000

Adjusted Cost Base ( 633,000)

Capital Gain $ 367,000

Inclusion Rate 1/2

Taxable Capital Gain $ 183,500

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Part C-2 Redemption Of Shares

Alternatively, if the shares were redeemed, the results would be:

Proceeds Of Redemption $1,000,000

PUC Nil

ITA 84(3) Deemed Dividend $1,000,000

For inclusion in Net Income For Tax Purposes, the ITA 84(3) dividend will be grossed up to $1,160,000
[(116%)($1,000,000)].
A federal dividend tax credit of $116,364 [(8/11)(16%)($1,000,000)] will also be generated.
The redemption will also result in a capital loss as follows:

Proceeds Of Disposition $1,000,000

ITA 84(3) Deemed Dividend ( 1,000,000)

Adjusted Proceeds Of Disposition Nil

Adjusted Cost Base ( 633,000)

Capital Loss ($ 633,000)

Inclusion Rate 1/2

Allowable Capital Loss ($ 316,500)

The allowable capital loss could only be deducted to the extent of Mr. Graber’s 2018 taxable capital
gains.

Note To Instructors While this issue is not covered in the text, ITA 40(3.6) deems this capital
loss, because it involves a taxpayer selling shares to an affiliated corporation, would be deemed
to be nil. You may or may not wish to elaborate on this point.

As a further point, notice that the total income of $367,000 resulting from the sale is the same as the
total income resulting from the redemption ($1,000,000 - $633,000). However, because of the higher
tax rate on dividends vs. capital gains, as well as the possibility that Mr. Graber cannot use any, or all, of
his allowable capital loss in 2018, the redemption result is much less favourable from a tax point of
view.
Also note that the total income (ignoring tax features) that will be recognized by Mr. Graber is
$1,040,000. This can be calculated as follows:

Capital Gain At Transfer $ 100,000

Recapture At Transfer 40,000

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ITA 15(1) Shareholder Benefit At Transfer 633,000

Capital Gain Or Dividend Resulting

From Sale Or Redemption Of Shares 367,000

Total Income $1,140,000

This is an economically correct result as supported by the following calculation:

Potential Gain At Transfer

($5,650,000 - $5,143,000) $ 507,000

Excess Consideration Received 633,000

Total Economic Benefit $1,140,000

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TIF Solution Sixteen - 17

Part A - Absence Of ITA 84.1
Without ITA 84.1, Mr. Johnston could rollover the shares in Johnston Home Furnishings (JHF,
hereafter) to Johnston Investments (JI, hereafter) at the elected value of $978,000, receiving non-share
consideration for this full amount. This would result in a capital gain of $500,000 ($978,000 -
$478,000), all of which could be eliminated by using the lifetime capital gains deduction. In the absence
of ITA 84.1, there would be no tax consequences resulting from the transfer of the shares.

Part B - Application Of ITA 84.1

Mr. Johnston is a Canadian resident and JHF is a corporation resident in Canada. In addition, Mr.
Johnston does not deal at arm’s length with JI, and JI is, immediately after the transfer of the JHF shares,
connected with JHF. As a consequence, ITA 84.1 is applicable. This means that there will be a
reduction of the PUC of the JI shares, calculated under ITA 84.1(1)(a) as follows:

Increase In Legal Stated Capital Of JI $3,007,000

Less The Excess, If Any, Of:

Greater Of PUC And ACB Of JHF Shares $ 478,000

Over The Fair Market Value Of Boot ( 978,000) Nil

Reduction In PUC $3,007,000

PUC After Reduction ($3,007,000 - $3,007,000) Nil

There would also be a deemed dividend on this transaction, calculated under ITA 84.1(1)(b) as follows:

Increase In Legal Stated Capital Of JI $3,007,000

Fair Market Value Of Non-Share Consideration 978,000

Total $3,985,000

Less:

PUC Of JHF Shares ($ 478,000)

Reduction In PUC ( 3,007,000) ( 3,485,000)

ITA 84.1(1)(b) Deemed Dividend (Non-Eligible) $ 500,000

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The adjusted cost base of the JI shares would be calculated as follows:

Elected Value $978,000

Non-Share Consideration ( 978,000)

Adjusted Cost Base - JI Common Shares Nil

As shown in the following calculation, there would be no capital gain or loss on the disposition of JHF
shares:

Elected Value $978,000

Less: ITA 84.1 Deemed Dividend ( 500,000)

Deemed Proceeds Of Disposition For JHF Shares (ITA 54) $ 478,000

Adjusted Cost Base ( 478,000)

Capital Gain Nil

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If the JI shares were later redeemed at their fair market value of $3,007,000 ($3,985,000 - $978,000), the
results would be as follows:

Redemption Proceeds $3,007,000

PUC Nil

ITA 84(3) Deemed Dividend (Non-Eligible) $3,007,000

Redemption Proceeds $3,007,000

ITA 54 Reduction For ITA 84(3) Deemed Dividend ( 3,007,000)

Deemed Proceeds Of Disposition Nil

Adjusted Cost Base Nil

Capital Gain Nil

The overall economic effect of all of these transactions would be as follows:

ITA 84.1(1)(b) Deemed Dividend $ 500,000

ITA 84(3) Deemed Dividend 3,007,000

Total Deemed Dividends $3,507,000

The deemed non-eligible dividends would result in taxable dividends of $4,068,120 [(116%)
($3,007,000)], which would qualify for a federal dividend tax credit of $408,087 [(8/11)(16%)
($3,507,000)].

(The following paragraphs are not required.)

If Mr. Johnston had simply sold the original JHF shares for their fair market value, the sale would have
resulted in a capital gain of $3,507,000 ($3,985,000 - $478,000). However, the application of ITA 84.1
on the rollover to JI has resulted in this full amount being treated as deemed dividends.
Whether any portion of the capital gain would qualify for the lifetime capital gains deduction would
depend on whether JHF was a qualified small business corporation and whether Mr. Johnston had a
cumulative net investment loss (CNIL).

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TIF Solution Sixteen - 18

Part A
As a dividend has been paid in conjunction with a disposition of property to an arm’s length party, ITA
55(2) is applicable. This legislation is designed to prevent capital gains strips. As a result, the following
calculation is required for the dividend received by Shipley:

Dividends Received From Shapley $1,555,000

Dividend Attributable To Safe Income (Tax Free) ( 462,000)

Amount Deemed By ITA 55(2)(a) To Not Be A Dividend

And By ITA 55(2)(c) To Be A Capital Gain $1,093,000

Inclusion Rate 1/2

Taxable Capital Gain $ 546,500

As shown, $462,000 of the funds would be received by Shipley as a dividend from safe income and
could be deducted under ITA 112, resulting in no tax cost. However, the remainder would be converted
to a taxable capital gain of $546,500.

Part B
In the absence of ITA 55(2), the results for Shipley would be as follows:

Proceeds Of Redemption $2,450,000

Paid Up Capital Of Preferred Shares ( 895,000)

ITA 84(3) Deemed Dividend $1,555,000

Proceeds Of Disposition $2,450,000

ITA 84(3) Dividend ( 1,555,000)

Adjusted Proceeds Of Disposition $ 895,000

Adjusted Cost Base ( 895,000)

Capital Gain Nil

As the ITA 84(3) dividend can be deducted in the determination of Shipley’s’ Taxable Income, the
Company would have succeeded in disposing of the Shapley shares without tax consequence.

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However, as the redemption was in conjunction with a disposition of the property to an arm’s length
purchaser, ITA 55(2) alters this result. ITA 55(2)(a) would deem $1,093,000 ($1,555,000, less the Safe
Income of $462,000) of the ITA 84(3) dividend to not be a dividend. ITA 55(2)(b) would then deem the
$1,093,000 to be proceeds of disposition. The result would be a capital gain determined as follows:

Adjusted Proceeds Of Disposition $ 895,000

Deemed Proceeds Of Disposition 1,093,000

Total Proceeds Of Disposition $1,988,000

Adjusted Cost Base ( 895,000)

Capital Gain $1,093,000

Inclusion Rate 1/2

Taxable Capital Gain $ 546,500

The overall result would be the same as in Part A. That is, a $462,000 tax free dividend and a taxable
capital gain of $546,500.

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Chapter Seventeen Test Item File Solutions

TIF Solution Seventeen - 1

1. The usual situation in which ITA 85.1 is applied involves a shareholder of a Canadian corporation
(Corporation A) who wishes to sell his shares, on an arm’s length basis, to another Canadian
corporation (Corporation B). ITA 85.1 allows the shareholder to exchange his shares in
Corporation A for shares of Corporation B, with the transaction taking place at the adjusted cost
base of the Corporation A shares. That is, the proceeds of disposition for the Corporation A shares
will be their adjusted cost base, and this will also be the cost of these shares to the acquiring
company. The major tax advantage is the fact that any gain on the Corporation A shares is deferred
until such time as the Corporation B shares are sold.

2. The basic rules are that the vendor is deemed to have (1) disposed of the exchanged shares for
proceeds of disposition equal to their adjusted cost base, and (2) acquired the shares of the
purchaser at a cost to the vendor equal to the adjusted cost base to the vendor of the exchanged
shares immediately before the exchange.

3. The required three can be chosen from the following:

 The vendor’s shares must be held as capital property.

 The vendor and purchaser must be dealing with each other at arm’s length.

 The vendor, or persons with whom he does not deal at arm’s length, cannot control the
purchaser immediately after the exchange. Likewise, they cannot own shares having a fair
market value in excess of 50 percent of the total fair market value of the purchasing
corporation’s outstanding shares.

 The vendor and purchaser cannot have filed an election under ITA 85 with respect to the
exchanged shares.

 The vendor must not have received any consideration, other than shares of the purchaser, in
return for the shares given up in the exchange.

4. The vendor opts out by recording the share exchange at fair market value. This will result in the
vendor including the resulting capital gain or loss in their income tax return. Note that, unlike a
transfer under Section 85, the only value that can be used in opting out is the fair market value of
the shares exchanged. A lower value cannot be elected.

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5. Under ITA 86, Mr. Barris could exchange his common shares in Barris Ltd. for some combination
of non-share consideration and redeemable preferred shares, with a total fair market value equal to
the $3 million fair market value of the common shares. As long as the non-share consideration does
not exceed the $50,000 PUC and adjusted cost base of the common shares, there would be no
immediate tax consequences to Mr. Barris. As the preferred shares now represent 100 percent of
the value of Barris Ltd., common shares could be sold to the children for a nominal amount of
consideration. In order for Mr. Barris to retain control, the preferred shares should be voting and, if
the common shares are also voting, the number of preferred shares should exceed the number of
common shares issued.

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6. The required two conditions can be selected from the following:

 The original owner’s shares must be capital property to the owner. They cannot be part of an
inventory of securities that is being held for trading purposes.

 The transaction must result in an exchange of all of the outstanding shares of a particular class
that are owned by the transferor.

 The share exchange must be integral to a reorganization of the capital of the corporation.

 The transferor must receive shares of the capital stock of the corporation.

7. The required three provisions could be selected from the following:

 The preferred shares must be redeemable at the option of the shareholder.

 The preferred shares should be entitled to a dividend at a reasonable rate.

 The corporation must guarantee that dividends will not be paid on any other class of
shares, if the payment would result in the corporation having insufficient net assets to
redeem the preferred shares at their specified redemption price.

 The preferred shares must become cumulative if the fair market value of the net assets of
the corporation falls below the redemption value of the preferred shares, or if the
corporation is unable to redeem the shares on a call for redemption.

 The preferred shares should have preference on liquidation of the corporation.

8. The adjusted cost base of the new shares issued in an ITA 86(1) reorganization would be equal to
the adjusted cost base of the old shares redeemed, less any non-share consideration. However, if a
gift is involved, ITA 86(2) is applicable. In this case, the adjusted cost base of the new shares will
be equal to the adjusted cost base of the old shares, reduced by the sum of any non-share
consideration plus the amount of the gift.

9. The paid up capital (PUC) of new shares issued in either an ITA 86(1) or and ITA 86(2
reorganization would be equal to their legal stated capital, less a PUC reduction. This reduction
calculation would start with the legal stated capital of the shares. From this total, the formula
requires the subtraction of any excess of the PUC of the old shares over any non-share consideration
received. If the non-share consideration exceeds the old PUC, the reduction will be equal to the

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legal stated capital, resulting in a PUC of nil. This calculation is not altered by the presence of a
gift to a related party.

10. The proceeds of redemption are equal to the sum of any non-share consideration received, plus the
PUC of the new shares issued to redeem the old shares. The proceeds of disposition are equal to the
sum of any non-share consideration received, plus the adjusted cost base of the new shares issued to
redeem the old shares. In those cases where the PUC and adjusted cost base of the old shares are
equal, the amount of both proceeds will be equal.

11. The initial PUC is equal to the legal stated capital of the new shares issued. However, this value is
subject to a PUC reduction equal to the legal stated capital of the new shares, reduced by the excess,
if any, of the PUC of the old shares over the non-share consideration provided in the redemption.
This reduction value is subtracted from the legal stated capital to arrive at a final figure for the PUC
of the new shares. In those cases where the non-share consideration equals or exceeds the PUC of
the old shares, the PUC reduction is equal to the legal stated capital of the new shares, resulting in a
final figure for PUC of nil.

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12. The basic condition for a gift to be present is that the fair market value of the old shares exceeds the
sum of the fair market value of the new shares and the fair market value of the non-share
consideration received. In addition, a related party must be in a position to benefit from this
difference. This would generally require that the related party be holding common shares in the
reorganized corporation.

13. The modifications can be described as follows:

 Under ITA 86(2)(e), the cost to the taxpayer of the new shares will be equal to the cost of the
old shares, less the sum of the non-share consideration plus the gift. This compares to a cost
for the new shares under ITA 86(1)(b) equal to the cost of the old shares, less any non-share
consideration.

 Under ITA 86(2)(c), the proceeds of the disposition for capital gains purposes on the old shares
will be equal to the lesser of the non-share consideration plus the gift, and the fair market value
of the old shares. This compares to the proceeds of disposition under ITA 86(1)(c), which is
equal to the cost of the new shares, plus any non-share consideration.

 Under ITA 86(2)(d), any capital loss resulting from the disposition of the old shares will be
deemed to be nil. There is no such restriction under ITA 86(1).

14. As described in the text, the major advantages of using ITA 86(1) are as follows:

 An ITA 86(1) share reorganization may be simpler to implement than a Section 85 rollover as it
does not involve setting up a new corporation.

 The corporate law steps are easier, only requiring shares to be exchanged, and possibly new
share classes to be formed.

 The use of ITA 86(1) does not require an election to be filed with the CRA.

15. The required two conditions can be selected from the following:

 All of the predecessor corporations must be taxable Canadian corporations.

 All shareholders of the predecessor corporations must receive shares of the amalgamated
corporation due to the amalgamation.

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 All of the assets and liabilities of the predecessor corporations, other than intercompany
balances, must be transferred to the amalgamated corporation in the amalgamation.

 The transfer cannot simply be a normal purchase of property, or involve the distribution of
assets on the winding-up of a corporation. It must be supported by corporate legislation which
identifies the transaction as an amalgamation.

16. The shareholders of the predecessor corporations are deemed to have disposed of their shares for
proceeds equal to the adjusted cost base of the shares. In addition, they are deemed to have
acquired the shares of the amalgamated company at the same value.

17. ITA 88(1) deals with the wind-up of a subsidiary in which the parent company owns 90 percent or
more of the voting shares. It is a rollover provision that allows the subsidiary assets to be
transferred to the parent, essentially at tax values. ITA 88(2) deals with all other corporate wind
ups. It is not a rollover provision.

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18. The limits on the asset bump up are described in the text as follows:

 The basic amount of the bump-up is found in ITA 88(1)(d)(i) and (i.1). This amount is the
excess of the adjusted cost base of the subsidiary shares held by the parent, over the sum of:

 the tax values of the subsidiary’s net assets at the time of the winding-up; and

 dividends paid by the subsidiary to the parent since the time of the acquisition (including
capital dividends).

 ITA 88(1)(d)(ii) further limits the amount that can be recognized to the excess of the fair
market value of the subsidiary’s non-depreciable capital property over their tax values at the
time the parent acquired control of the subsidiary.

19. Under ITA 88(1), which applies when the parent owns 90 percent or more of each class of the
subsidiary’s shares, there is a provision that allows some part of any excess of the cost of the
subsidiary, over the underlying tax values of its assets to be recognized in the tax records of the
combined company. More specifically, any excess of the fair market value of non-depreciable
property over its cost at the time that the subsidiary was acquired can be included in the transfer, to
the extent that the value is supported by the price paid for the shares. This same provision is also
available under ITA 87, but only in those cases where the parent owns 100 percent of the
subsidiary’s shares. This means that the only real difference with respect to the availability of this
“bump-up” is that its applicability is more limited under ITA 87, since it can only be used when
ownership is 100 percent.

A second difference between these two provisions involves the use of loss carry forwards. In the
case of an ITA 87 amalgamation, loss carry forwards can be used immediately after the
amalgamation transaction takes place. In the case of an ITA 88(1) wind-up, subsidiary loss carry
forwards will not become available until the first taxation year of the parent that begins after the
date that the wind-up period commences.

A third difference is that, in an amalgamation, CCA can be claimed in the last year of the
predecessor corporations and the first year of the amalgamated corporation. In the case of a wind-
up under ITA 88(1), the subsidiary will not be able to take CCA in the year of the wind-up.

A final difference is that, in an amalgamation, both predecessor companies have a deemed year end.
In the ITA 88(1) wind-up, the parent company does not have a deemed year end.

20. The components may consist of the following amounts:

 Tax-free PUC amounts.

 Tax-free capital dividends.

 Taxable dividends, including any balance in the RDTOH.

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 Proceeds of disposition for the shares.

21. The conversion transaction involves a disposition of a debt security, along with the acquisition of
common shares. The proceeds of disposition for the debt security would be the more valuable
common shares and, in the absence of a special provision, the result would be a capital gain.
However, relief is found in ITA 51(1). ITA 51(1)(c), deems such exchanges not to be a
disposition. Given that there is no disposition, no gain will be recognized. Going with this, ITA
51(1)(d) deems the cost of the acquired shares to be equal to the cost of the shares or debt given up.
These provisions, in effect, permit a tax free exchange of the two types of securities.

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22. The three exceptions are as follows:

 In cases where the payment relates to past employment with the payor, the receipt will be
treated by the recipient as employment income.

 When certain types of intangible capital property is being sold and the payor and the recipient
jointly elect in prescribed form, the payment can be treated by the recipient as a disposition of a
Class 14.1 asset.

 In a situation where a restrictive covenant is sold in conjunction with an eligible interest, the
amount received can be added to the proceeds of disposition.

23. The failure to allocate a value to leaseholds in the purchase agreement, and the resulting allocation
of these values to goodwill, has the following effects:

Vendor If the proceeds are allocated to the lease, any excess over the tax value of the lease
(usually nil) will be treated as a capital gain, only one-half of which would be taxable. Provided a
CCPC is involved, this gain will be a component of investment income. This means that while it
will be subject to ART and not eligible for the GRR, a large portion of the Part I tax paid will be
refundable.

If the proceeds are allocated to goodwill, the transaction will be treated as a disposition of a Class
14.1 asset. The lesser of these proceeds and the capital cost of the goodwill will be subtracted from
any balance in that Class. However, the capital cost of internally generated goodwill will generally
be nil. This means that there will be a capital gain equal to the proceeds of disposition, less the
capital cost of nil. One-half of this amount will be taxable.

Purchaser If the value is allocated to goodwill, the cost will be added to Class 14.1 which it will
be subject to declining balance CCA at a rate of 5 percent. In contrast, an allocation to a leasehold
interest would result in the amount being subject to CCA at a rate based on the remaining life of the
lease. In most cases, this will provide a faster write off than the use of the 5 percent rate applicable
to Class 14.1

24. Accounts Receivable In general terms, the sale of accounts receivable is treated as a capital
transaction. This means that losses are capital in nature. However, any bad debt reserve from the
previous year must be brought into income. There is a joint election available under ITA 22 that
will allow the vendor to fully deduct bad debt losses, provided the purchaser agrees to include bad
debt recoveries in income.

Inventory Gains and losses on the sale of inventories would be included in full in the computation
of Net Income For Tax Purposes.

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Depreciable Assets The situation here is fairly complex and involves a number of possibilities.
They can be outlined as follows:

1. If the proceeds exceed the capital cost, the excess will be treated as a capital gain. In addition,
the difference between the UCC and the capital cost will be included in income as recapture of
CCA.

2. If the proceeds are less than the balance in the UCC of the class and there are no other assets in
the class, the deficiency will be fully deductible as a terminal loss.

3. If the proceeds are less than the capital cost but more than the UCC balance, the excess will be
treated as recapture.

Goodwill If goodwill is present when the assets are sold, some amount of the consideration
received for the going concern will be allocated to that asset. This allocated amount will treated as
proceeds of disposition for a Class 14.1 asset and, the lesser of this amount and the capital cost of
the goodwill will be subtracted from any Class 14.1 balance. As the capital cost of goodwill will
most commonly be nil, the result will be that the entire proceeds of disposition will be treated as a
capital gain.

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The purchaser of the going concern will add the allocated cost of the goodwill to Class 14.1 where it
will be subject to CCA on a 5 percent declining balance basis. The half-year rule is applicable to
this Class.

25. The three reasons can be selected from the following:

 In acquiring assets, the purchaser acquires a completely new, and usually higher, set of tax
values for the assets transferred. This will result in higher CCA claims and/or lower gains on
future dispositions.

 Goodwill can be recognized when assets are acquired. The CCA deductions related to Class
14.1 are not available if shares are acquired.

 If shares are acquired, all of the assets must be acquired. If redundant assets are present, they
can be left out of an acquisition of assets.

 If shares are acquired, the purchaser may become responsible for any future tax reassessments.
While this exposure could occur because the purchased corporation continues to operate, it is
usually covered in the buy and sell agreement for the transaction. This agreement is normally
written to protect the purchaser from future problems in this area.

 If shares are acquired, the purchaser may become responsible for potential non-tax liabilities
related to product or environmental liabilities. However, this is another issue that is normally
dealt with in the buy and sell agreement.

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TIF Solution Seventeen - 2

1. True.

2. True.

3. True.

4. False.

5. False

6. False

The two items listed would be the proceeds of redemption. To arrive at the proceeds of
disposition, any deemed dividend would be subtracted from their sum.

7. False.

Such a transfer cannot be made under ITA 86(1).

8. False.

The only requirement is that he transfer all of the shares that he owns of a particular class.

9. True.

10. False.

Such gifts may occur when the fair market value of the shares received is less than the fair
market value of the shares given up.

11. False.

They can be used immediately.

12. True.

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13. False.

ITA 88(1) can only be used when there is 90 percent or greater ownership of the subsidiary.

14. False.

The excess will be treated as an ITA 84(2) deemed dividend.

15. True.

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TIF Solution Seventeen - 3

Share For Share Exchange - ITA 85.1
1. C. The vendor can receive a combination of shares and non-share consideration in return
for the shares he is giving up.

2. C. ITA 85.1 - Share for share exchange.

3. C. The vendor can receive cash equal to an amount of the PUC of the shares tax-free.

4. B. Ms. Takase will be deemed to have disposed of her Takase Ltd. shares for an amount
equal to their ACB. There will not be a capital gain to report on this disposition.

5. B. $28,000, her ACB for the Zoom shares.

Exchange Of Shares In A Reorganization - ITA 86

6. B. $560,000.

The calculation of this amount would be as follows:

Increase In Legal Stated Capital $700,000

PUC - Old Shares [(70%)($2,300,000)] ($1,610,000)

Non-Share Consideration 1,050,000 ( 560,000)

PUC Reduction $140,000

This will leave a PUC of $560,000 ($700,000 - $140,000)

7. A. All of the outstanding shares of the particular class must be exchanged. This is not
required. The only requirement is that all of the shares of that class that are held by the
transferor must be exchanged.

8. D. Voting rights.

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9. B. The PUC of the new shares will be equal to their legal stated capital.

10. A. Nil. The adjusted cost base would be the $600,000 adjusted cost base of the old
shares, less the $600,000 in non-share consideration received.

11. C. The adjusted cost base will be nil, the cost of the old shares, less the sum of the non-
share consideration and the gift ($960,000 - $500,000 - $460,000).

12. A. Mamma Mia could restructure the ownership of her company, which would result in
no immediate tax consequence for herself, with future growth accruing to her son.

13. B. A reorganization of share capital

Amalgamations - ITA 87 And 88(1)

14. D. The depreciable capital property of the predecessor companies will be carried forward
to the tax records of the amalgamated company at UCC values.

15. B. By bringing together a profitable and an unprofitable company, an amalgamation can

result in a faster write off of capital assets through CCA deduction.

16. B. The bump up is only available in a wind up when the parent company owns 100
percent of the subsidiary.

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17. A. All the predecessor corporations must be Canadian controlled private corporations.

18. A. RDTOH of a public company. Public companies do not have an RDTOH.

19. C. The shareholders must receive non-share consideration that is equal to the adjusted
cost base of their shares.

20. D. If the parent owns more than 90% of the shares of each class of capital stock of the
subsidiary, it will be possible to combine the companies using either ITA 87 or ITA 88(1).

21. C. Parent Inc. will be able to utilize the non-capital loss against profits from the same
business in which the loss was incurred beginning in the 2018 taxation year. The net capital
loss cannot be utilized by Parent Inc.

22. B. All of the predecessor corporations must be Canadian controlled private corporations.

Winding Up Of 90 Percent Owned Subsidiary - ITA 88(1)

23. B. Both the subsidiary and the parent will have a deemed year end.

24. B. LRIP balances will only flow through to the parent if the subsidiary was a CCPC.

25. B. November 30, 2019.

26. B. The bump up gives partial recognition to the fact that the cost of acquiring a subsidiary
usually exceeds both the carrying value and the sum of the fair values of the acquired
identifiable assets.

Winding Up Of Canadian Corporation - ITA 88(2)

27. A. Deemed dividend on winding-up of $405,000 ($450,000 - $45,000). This is made up
of a capital dividend of $51,000 and a taxable non-eligible dividend of $354,000.

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28. A. Jasmine will receive dividends subject to tax of $1,500,000 ($2,000,000 - $100,000 -
$400,000), as well as a taxable capital gain of $25,000 [($2,000,000 - $1,900,000 - $50,000)
(1/2)], when she receives the $2,000,000 distribution.

29. D. $101,000 [PUC ($1,000) + CDA ($100,000)]

Convertible Properties
30. B. No capital gain.

31. D. The exchange must not involve any consideration other than the securities being
exchanged.

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Sale Of An Incorporated Business

32. C. The ability to recognize the acquired company’s goodwill.

33. A. Nancy will realize a capital gain of $1,866,667, resulting in a taxable capital gain of
$933,334. She will pay $466,667 in taxes, leaving her with $2,000,000.

The supporting calculation is:

X - [(X - $600,000)(1/2)(50%)] = $2,000,000

X - (0.25X - $150,000) = $2,000,000

0.75X + $150,000 = $2,000,000

0.75X = $1,850,000

X = $2,466,667

34. B. Linden will report a taxable capital gain of $212,500, and there will be a $212,500
addition to the capital dividend account.

35. C. Yamaguchi will be held liable for future tax reassessments of Ito Inc.

36. D. The corporation may be subject to taxes on business income and capital gains.

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TIF Solution Seventeen - 4

Exam Exercise Solution Seventeen - 1 (Share For Share Exchange)
The transaction involves a share for share exchange that meets the conditions of ITA 85.1. Unless Mr.
Forbes opts out of this rollover provision in his income tax return, the tax consequences of this
transaction for him would be as follows:

 Mr. Forbes would be deemed to have disposed of his Forbes Ltd. shares at a value equal to their
adjusted cost base of $540,000. As a consequence, there would be no capital gain on the
disposition.

 Mr. Forbes would be deemed to have acquired his Megopolis Ltd. shares at a cost equal to the
adjusted cost base of the Forbes Ltd. shares, or $540,000.

 The adjusted cost base of the Forbes Ltd. shares that have been acquired by Megopolis Ltd. would
be deemed to be the lesser of their fair market value and their paid up capital. In this case, the
$540,000 paid up capital amount is the lower figure.

 The PUC of the Megopolis Ltd. shares that have been issued to Mr. Forbes would be $540,000,
the PUC of the Forbes Ltd. shares that were given up.

Exam Exercise Solution Seventeen - 2 (Share For Share Exchange)

This transaction involves a share for share exchange that meets the conditions of ITA 85.1. Unless Mr.
Gage opts out of this rollover provision in his income return, the tax consequences of this transaction
would be as follows:

 Mr. Gage would be deemed to have disposed of his Farnum Ltd. shares at their adjusted cost base
of $700,000.

 Mr. Gage would be deemed to have acquired his Gross Enterprises shares at a cost equal to the
$700,000 adjusted cost base of the Farnum Ltd. shares.

 The adjusted cost base of the Farnum Ltd. shares that have been acquired by Gross Enterprises
would be deemed to be the lesser of their fair market value of $1,200,000 and their paid up capital.
In this case, the $400,000 paid up capital amount is the lower figure.

 The PUC of the Gross Enterprises shares that have been issued to Mr. Gage would be $400,000,
the PUC of the Farnum Ltd. shares that were given up.

Exam Exercise Solution Seventeen - 3 (Exchange Of Shares In Reorganization)

The required PUC reduction on the redeemable preferred shares would be calculated as follows:

Increase In Legal Stated Capital $1,575,000

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Less The Excess, If Any, Of:

PUC Of Common Shares ($1,375,000)

Over The Non-Share Consideration 1,375,000 Nil

PUC Reduction $1,575,000

This means that the redeemable preferred shares would have a PUC of nil ($1,575,000 - $1,575,000).
The adjusted cost base of the redeemable preferred shares would be calculated as follows:

Adjusted Cost Base Of Common Shares $1,375,000

Non-Share Consideration ( 1,375,000)

Adjusted Cost Base Of Redeemable Preferred Shares Nil

Because Laura took back cash equal to her PUC and ACB, there would be no ITA 84(3) deemed
dividend and no capital gain or loss. These calculations would be as follows:

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PUC Of New Shares Nil

Plus Non-Share Consideration $1,375,000

Proceeds Of Redemption Under ITA 84(5)(d) $1,375,000

PUC Of Old Shares ( 1,375,000)

ITA 84(3) Deemed Dividend Nil

Adjusted Cost Base Of New Shares Nil

Plus Non-Share Consideration $1,375,000

Proceeds Of Disposition Under ITA 86(1)(c) $1,375,000

ITA 84(3) Deemed Dividend Nil

Adjusted Proceeds $1,375,000

Adjusted Cost Base Of Old Shares ( 1,375,000)

Capital Gain (Loss) Nil

Exam Exercise Solution Seventeen - 4 (Exchange Of Shares In Reorganization)

The required PUC reduction on the redeemable preferred shares would be calculated as follows:

Increase In Legal Stated Capital $700,000

Less The Excess, If Any, Of:

PUC Of Common Shares ($200,000)

Over The Non-Share Consideration 200,000 Nil

PUC Reduction $700,000

This means that the redeemable preferred shares would have a PUC of nil ($700,000 - $700,000).
The adjusted cost base of the redeemable preferred shares would be calculated as follows:

Adjusted Cost Base Of Common Shares $200,000

Non-Share Consideration ( 200,000)

Adjusted Cost Base Of Redeemable Preferred Shares Nil

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Because Mr. Red took back cash equal to his PUC and ACB, there would be no ITA 84(3) deemed
dividend and no capital gain or loss. These calculations would be as follows:

PUC Of New Shares Nil

Plus Non-Share Consideration $200,000

Proceeds Of Redemption Under ITA 84(5)(d) $200,000

PUC Of Old Shares ( 200,000)

ITA 84(3) Deemed Dividend Nil

Adjusted Cost Base Of New Shares Nil

Plus Non-Share Consideration $200,000

Proceeds Of Disposition Under ITA 86(1)(c) $200,000

ITA 84(3) Deemed Dividend Nil

Adjusted Proceeds $200,000

Adjusted Cost Base Of Old Shares ( 200,000)

Capital Gain (Loss) Nil

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Exam Exercise Solution Seventeen - 5 (Exchange Of Shares In Reorganization)

The required PUC reduction on the redeemable preferred shares would be calculated as follows:

Increase In Legal Stated Capital $440,000

Less The Excess, If Any, Of:

PUC Of Common Shares ($400,000)

Over The Non-Share Consideration 480,000 Nil

PUC Reduction $440,000

This means that the redeemable preferred shares would have a PUC of nil ($440,000 - $440,000).
The adjusted cost base of the redeemable preferred shares would be calculated as follows:

Adjusted Cost Base Of Common Shares $500,000

Non-Share Consideration ( 480,000)

Adjusted Cost Base Of Redeemable Preferred Shares $ 20,000

Because the non-share consideration was greater than the PUC of the old shares, the resulting ITA 84(3)
deemed dividend and the capital loss would be calculated as follows:

PUC Of New Shares Nil

Plus Non-Share Consideration $480,000

Proceeds Of Redemption Under ITA 84(5)(d) $480,000

PUC Of Old Shares ( 400,000)

ITA 84(3) Deemed Dividend (Non-Eligible) $ 80,000

Adjusted Cost Base Of New Shares $ 20,000

Plus Non-Share Consideration 480,000

Proceeds Of Disposition Under ITA 86(1)(c) $500,000

ITA 84(3) Deemed Dividend ( 80,000)

Adjusted Proceeds $420,000

Adjusted Cost Base Of Old Shares ( 500,000)

Capital Gain (Loss) ($ 80,000)

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Inclusion Rate 1/2

Allowable Capital Loss ($ 40,000)

Exam Exercise Solution Seventeen - 6 (Exchange Of Shares In Reorganization)

The required PUC reduction on the redeemable preferred shares would be calculated as follows:

Increase In Legal Stated Capital $750,000

Less The Excess, If Any, Of:

PUC Of Common Shares ($700,000)

Over The Non-Share Consideration 700,000 Nil

PUC Reduction $750,000

This means that the redeemable preferred shares would have a PUC of nil ($750,000 - $750,000).

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The adjusted cost base of the redeemable preferred shares would be calculated as follows:

Adjusted Cost Base Of Common Shares $400,000

Non-Share Consideration ( 700,000)

Adjusted Cost Base Of Redeemable Preferred Shares Nil

While there is no ITA 84(3) deemed dividend in this problem, there is a taxable capital gain. The
relevant calculations are as follows:

PUC Of New Shares Nil

Plus Non-Share Consideration $700,000

Proceeds Of Redemption Under ITA 84(5)(d) $700,000

PUC Of Old Shares ( 700,000)

ITA 84(3) Deemed Dividend (Non-Eligible) Nil

Adjusted Cost Base Of New Shares $ Nil

Plus Non-Share Consideration 700,000

Proceeds Of Disposition Under ITA 86(1)(c) $700,000

ITA 84(3) Deemed Dividend Nil

Adjusted Proceeds $700,000

Adjusted Cost Base Of Old Shares ( 400,000)

Capital Gain $300,000

Inclusion Rate 1/2

Taxable Capital Gain $150,000

Exam Exercise Solution Seventeen - 7 (Gift To A Related Party)

Mr. Doyen gave up shares with a fair market value of $2,688,000 [(80%)($3,360,000)] in return for
consideration of $2,310,000 ($630,000 + $1,680,000). As his son holds the remaining common shares,
it would appear that there is a gift to the son of $378,000 ($2,688,000 - $2,310,000). This means that
ITA 86(2) is applicable.
The PUC reduction on the new shares would be calculated as follows:

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Increase In Legal Stated Capital $1,680,000

Less The Excess Of:

PUC Of Common Shares [(80%)($525,000)] ($420,000)

Over The Non-Share Consideration 630,000 Nil

PUC Reduction $1,680,000

This means that the redeemable preferred shares would have a PUC of nil ($1,680,000 - $1,680,000).
Under ITA 86(2)(e), the adjusted cost base of the redeemable preferred shares would be calculated as
follows:

Adjusted Cost Base Of Mr. Doyen’s Common Shares $ 420,000

Deduct:

Non-Share Consideration ($630,000)

Gift ( 378,000) (1,008,000)

Adjusted Cost Base Of Preferred Shares Nil

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The calculation of the deemed dividend and capital gain would be as follows:

PUC Of New Shares Nil

Plus Non-Share Consideration $630,000

Proceeds Of Redemption Under ITA 84(5)(d) $630,000

PUC Of Old Shares ( 420,000)

ITA 84(3) Deemed Dividend (Non-Eligible) $210,000

Proceeds Of Disposition Under ITA 86(2)(c) - Lesser Of:

 Fair Market Value Of Shares Given Up

[(80%)($3,360,000)]= $2,688,000

 Non-Share Consideration Plus Gift

($630,000 + $378,000) = $1,008,000 $1,008,000

Less ITA 84(3) Deemed Dividend ( 210,000)

Adjusted Proceeds $ 798,000

Adjusted Cost Base Of Old Shares ( 420,000)

Capital Gain $ 378,000

Inclusion Rate 1/2

Taxable Capital Gain $189,000

The taxable non-eligible dividend would be $243,600 [(116%)($210,000)]. The taxable dividend would
qualify for a federal dividend tax credit of $24,436 [(8/11)(16%)($210,000)].

Exam Exercise Solution Seventeen - 8 (Gift To A Related Party)

Ms. Hutch gave up shares with a fair market value of $1,380,000 [(60%)($2,300,000)] in return for
consideration of $1,180,000 ($350,000 + $830,000). As her common-law partner, Jane, holds the
remaining common shares, it would appear that there is a gift to Jane of $200,000 ($1,380,000 -
$1,180,000). This means that ITA 86(2) is applicable.
The PUC reduction on the new shares would be calculated as follows:

Increase In Legal Stated Capital $830,000

Less The Excess Of:

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PUC Of Common Shares [(60%)($500,000)] ($300,000)

Over The Non-Share Consideration 350,000 Nil

PUC Reduction $830,000

This means that the redeemable preferred shares would have a PUC of nil ($830,000 - $830,000).
Under ITA 86(2)(e), the adjusted cost base of the redeemable preferred shares would be calculated as
follows:

Adjusted Cost Base Of Ms. Hutch’s Common Shares $300,000

Deduct:

Non-Share Consideration ($350,000)

Gift ( 200,000) ( 550,000)

Adjusted Cost Base Of Preferred Shares Nil

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The calculation of the deemed dividend and capital gain would be as follows:

PUC Of New Shares Nil

Plus Non-Share Consideration $350,000

Proceeds Of Redemption Under ITA 84(5)(d) $350,000

PUC Of Old Shares ( 300,000)

ITA 84(3) Deemed Dividend (Non-Eligible) $ 50,000

Proceeds Of Disposition Under ITA 86(2)(c) - Lesser Of:

 Fair Market Value Of Shares Given Up

[(60%)($2,300,000)]= $1,380,000

 Non-Share Consideration Plus Gift

($350,000 + $200,000) = $550,000 $550,000

Less ITA 84(3) Deemed Dividend ( 50,000)

Adjusted Proceeds $500,000

Adjusted Cost Base Of Old Shares ( 300,000)

Capital Gain $200,000

Inclusion Rate 1/2

Taxable Capital Gain $100,000

The taxable non-eligible dividend would be $58,000 [(116%)($50,000)]. The taxable dividend would
qualify for a federal dividend tax credit of $5,818 [(8/11)(16%)($50,000)].

Exam Exercise Solution Seventeen - 9 (ITA 87 Amalgamation)

As Winner Ltd. has a clear majority of the shares in Combo Inc., it would appear that they have acquired
control of Loser Inc. As the acquisition of control rules would be applicable, there would be a deemed
year end for both Companies that coincides with the amalgamated year end. The non-capital loss carry
forward of Loser Inc. will be flowed through to the amalgamated company, Combo Inc. However,
because of the acquisition of control, the net capital loss cannot be used. In addition, for the non-capital
loss to be used, Combo Inc. would have to continue the business in which the loss occurred. Further, the
loss carry forward could only be applied against profits in that business.

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Exam Exercise Solution Seventeen - 10 (ITA 87 Amalgamation)

As the shareholders of Core own a majority of the shares in Hubcore, there has been an acquisition of
control and the acquisition of control rules would be applicable. This means that Hub’s allowable
capital loss cannot be carried forward after the acquisition of control. However, to the extent that
Hubcore has profits in Hub’s line of business, the non-capital loss carry forward can be deducted. This
means that $52,000 of the $85,000 non-capital loss carry forward could be deducted by Hubcore,
leaving a non-capital loss carry forward from 2018 of $33,000 ($85,000 - $52,000).

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Exam Exercise Solution Seventeen - 11 (Winding-Up Of 90 Percent Subsidiary)

Under ITA 88(1), a limited bump-up in the value of non-depreciable assets is available. The basic limit
would be calculated as follows:

Adjusted Cost Base Of Intell Inc. Shares $1,800,000

Tax Values Of Intell Inc.’s Net Assets

At Winding-Up ($750,000 - $112,500) ( 637,500)

Dividends Paid By Intell Since Acquisition Nil

Excess $1,162,500

However, this basic amount cannot exceed the difference between the fair market value of the non-
depreciable assets at the time of the share acquisition and their tax cost at that time. This amount would
be $195,000 ($405,000 - $210,000). The bump-up in the Land value is limited to that amount, resulting
in the following tax values for Intell’s assets at the time of the ITA 88(1) winding-up:

Cash $180,000

Land ($210,000 + $195,000) 405,000

Depreciable Assets - At UCC 360,000

Total Assets $945,000

Exam Exercise Solution Seventeen - 12 (Winding-Up Of 90 Percent Subsidiary)

Under ITA 88(1), a limited bump-up in the value of non-depreciable assets is available. The basic limit
would be calculated as follows:

Adjusted Cost Base of Columbia Inc. shares $2,750,000

Tax Values Of Columbia Inc. Net Assets

At Winding-Up ( 2,200,000)

Dividends Paid By Columbia Inc. Since Acquisition ( 300,000)

Excess $ 250,000

The other limit is the excess of the fair market value of the non-depreciable assets at the time of
acquisition and their tax cost at that time. This amount would be $350,000 ($750,000 - $400,000).
The bump-up would be $250,000, the lesser of these figures. This gives a value for the land of $650,000
($400,000 + $250,000).
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Exam Exercise Solution Seventeen - 13 (Winding-Up Of 90 Percent Subsidiary)

Under ITA 88(1), a limited bump-up in the value of non-depreciable assets is available. The basic limit
would be calculated as follows:

Adjusted Cost Base of Island Inc. shares $2,750,000

Tax Values Of Island Inc. Net Assets

At Winding-Up ( 2,200,000)

Dividends Paid By Island Inc. Since Acquisition ( 300,000)

Excess $ 250,000

However, this excess amount cannot exceed the difference between the fair market value of the non-
depreciable assets at the time of the share acquisition and their tax cost at that time. This amount would
be $150,000 ($350,000 - $200,000).
As a result, the ACB of the land would be equal to its original cost to Island Inc. of $200,000 plus the
bump up of $150,000. The taxable capital gain is [(1/2)($1,600,000 - $350,000)] = $625,000.

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Exam Exercise Solution Seventeen - 14 (Winding-Up Of A Canadian Corporation)

Given the size of the proceeds, the balance in the RDTOH account will clearly be less than one-third of
the dividends to be declared. Given this, the required calculations are as follows:

Available Cash $2,854,500

Dividend Refund (RDTOH Balance) 155,100

Total Distribution $3,009,600

Paid Up Capital ( 290,400)

ITA 84(2) Deemed Dividend $2,719,200

Capital Dividend Account (Election Required) ( 85,800)

Dividend Subject To Tax $2,633,400

The remaining dividend subject to tax will qualify for the usual gross up and tax credit procedures for
non-eligible dividends. The taxable dividend would be $3,054,744 [(116%)($2,633,400)] and the
related federal dividend tax credit would be $306,432 [(8/11)(16%)($2,633,400)]. As a disposition of
shares has occurred, we must also determine whether there is a capital gain or loss. The calculations are
as follows:

Total Distribution To Shareholders $3,009,600

ITA 84(2) Deemed Dividend ( 2,719,200)

Deemed Proceeds Of Disposition $ 290,400

Adjusted Cost Base Of Shares ( 290,400)

Capital Gain Nil

Exam Exercise Solution Seventeen - 15 (Winding-Up Of A Canadian Corporation)

Given the size of the proceeds, the balance in the RDTOH account will clearly be less than one-third of
the dividends to be declared. Given this, the required calculations are as follows:

Available Cash $700,000

Dividend Refund (RDTOH Balance) 20,000

Total Distribution $720,000

Paid Up Capital ( 1,000)

ITA 84(2) Deemed Dividend $719,000

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Capital Dividend ( 100,000)

Dividend Subject To Tax $619,000

Eligible Amount (GRIP Balance) ( 30,000)

Non-Eligible Amount $589,000

The eligible dividend would be grossed up to a taxable amount of $41,400 [(138%)($30,000)]. The
related federal dividend tax credit would be $6,218 [($30,000(38%)(6/11)].
The non-eligible dividend would be grossed up to a taxable amount of $683,240 [(116%)($589,000)].
The related federal dividend tax credit would be $68,538 [(8/11)(16%)($589,000)].

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TIF Solution Seventeen - 5A

The correct definitions for each of the listed key terms are as follows:

A. 8

B. 5

C. 6

D. 3

E. 7

F. 10

G. 9

H. 2

The two unused definitions are as follows:

Exchange Of Shares In A Reorganization (ITA 86) = 4

Winding-Up Of A Canadian Corporation = 1

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TIF Solution Seventeen - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.
The correct definitions for each of the listed key terms listed below.

A. 11 (not 7)

B. 8

C. 9

D. 4 (not 2)

E. 10

F. 14

G. 12 (not 5)

H. 3 (not 13)

The two unused definitions are as follows:

Exchange Of Shares In A Reorganization (ITA 86) = 6

Winding-Up Of A Canadian Corporation = 1

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TIF Solution Seventeen - 6

Note To Instructor To answer this problem, a basic understanding of Section 85 rollovers is

required. This is covered in Chapter 16.

Part A - ITA 85.1 Applies

In order to determine the consequences of the ITA 85.1 transaction, we must evaluate the results of the
ITA 85(1) transaction. The adjusted cost base of the shares issued as part of the ITA 85(1) rollover
would be calculated as follows:

Elected Value $1,234,000

Adjusted Cost Base Of Non-Share Consideration ( 600,000)

Available For Common And Preferred Shares $ 634,000

Adjusted Cost Base Of The Preferred Shares

(Limited To Fair Market Value) ( 634,000)

Adjusted Cost Base Of Common Shares Nil

There would also be a PUC reduction, calculated as follows:

Increase In Legal Stated Capital ($634,000 + $898,000)$1,532,000

Less: The Excess Of

Total Elected Value $1,234,000

Over Non-Share Consideration ( 600,000) ( 634,000)

Required PUC Reduction $ 898,000

The PUC of the shares, after the allocation of the $898,000 PUC reduction, would be as follows:

PUC Of Preferred Stock

= [$634,000 - ($634,000 ÷ $1,532,000)($898,000)] = $262,373

PUC Of Common Stock

= [$898,000 - ($898,000 ÷ $1,532,000)($898,000)] = $371,627

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Note that the total PUC of the preferred and common shares is equal $634,000 ($262,373 + $371,627),
the same value as the total adjusted cost base of the preferred and common shares.
Based on these calculations, the tax consequences of the redemption of the preferred shares would be as
follows:

Proceeds Of Redemption $634,000

PUC Of Preferred Shares ( 262,373)

ITA 84(3) Deemed Dividend $371,627

Proceeds Of Disposition $634,000

ITA 84(3) Deemed Dividend ( 371,627)

Adjusted Proceeds Of Disposition $262,373

Adjusted Cost Base Of Preferred Shares ( 634,000)

Capital Loss ($371,627)

Inclusion rate 1/2

Allowable Capital Loss ($185,814)

The non-eligible dividend would be grossed up to $431,087 [(116%)($371,627)], and would create a
federal dividend tax credit of $43,244 [(8/11)(16%)($371,627)].

Using these values for the common shares of Sheets Inc., if John does not opt out of ITA 85.1, the tax
consequences would be as follows:

 John would be deemed to have disposed of his Sheets Inc. common shares at a value equal to
their adjusted cost base of nil. Given this, there would be no capital gain on the disposition.

 John would be deemed to have acquired the shares of Linens Ltd. at a cost equal to nil, the
adjusted cost base of his Sheets Inc. common shares.

 The PUC of the Linens Ltd. shares that have been issued to John would be $371,627, the PUC of
the Sheets Inc. common shares that were given up.

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Part A - Opting Out Of ITA 85.1

The total fair market value of the Sheets Inc. common shares is $1,300,000. In order to opt out of ITA
85.1, John will have to include a taxable capital gain of $650,000 [(1/2)($1,300,000 - Nil)] in his 2018
tax return. This has the advantage of absorbing his $185,814 current allowable capital loss on his
preferred shares, as well as his $300,000 net capital loss carry forward. However, it will result in his
being required to pay taxes on the remaining $164,186 ($650,000 - $185,814 - $300,000). Because all
of his shares are involved in the exchange, he has no choice as to the amount of the gain to be
recognized.

Part B - ACB For Linens Ltd.

The adjusted cost base of the Sheets Inc. common shares on the books of Linens Ltd. would be
$371,627, the lesser of their $1,300,000 fair market value and their $371,627 PUC.

Part C - Alternative Solutions

Given the allowable capital loss resulting from the preferred share redemption and his net capital loss
carry forward, John would like to have a taxable capital gain of $485,814 ($185,814 + $300,000) in
order to utilize these losses. There are two possible alternatives that would produce this gain.

Alternative One John could use ITA 85(1) to exchange the shares at an elected value of
$971,628. This would result in the required taxable capital gain of $485,814 [(1/2)($971,628 -
Nil)]. Note that this would leave the adjusted cost base of the acquired Linens Ltd. shares at
the elected value of $971,628. This compares to nil if ITA 85.1 is used.

Alternative Two Each of the common shares of Sheets Inc. has a fair market value of $130
($1,300,000  10,000) and an adjusted cost base of nil. This means that each share of Sheets
Inc. sold to Linens Ltd. would generate a taxable capital gain of $65 [(1/2)($130)] per share. In
order to generate a total taxable capital gain of $485,810, John could simply sell 7,474
($485,814  $65) of the shares to Linen Ltd. without using a rollover provision. This would
result in a taxable capital gain of $485,810 [($65)(7,474)], slightly more than the amount
required to absorb both the current allowable capital loss and the net capital loss carry forward.
The remaining 2,526 (10,000 - 7,474) common shares of Sheets Inc. could then be exchanged
for Linen Ltd. shares on a tax free basis under either ITA 85(1) or ITA 85.1.

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TIF Solution Seventeen - 7

The fair market value of the business is $12,013,000 , which is composed of tangible assets of
$11,625,000, plus goodwill of $1,500,000, less the bank loan of $1,112,000.
The “exchange of shares in a reorganization” that Ms. Farrow referred to is provided for under ITA
86(1). In order to implement this rollover and achieve Ms. Farrow’s goals, Woody should invest $5,000
in exchange for new common shares in Farrow Ltd.
At this point, Ms. Farrow can exchange, on a tax free basis, her existing common shares for new
preferred shares with a redemption value of $12,013,000. In order for Ms. Farrow to retain control of
Farrow Ltd., the preferred shares should be voting shares.
Under ITA 86(1), this exchange would have no immediate tax consequences. After this exchange, the
adjusted cost base and PUC of the new preferred shares would be calculated as follows:

Adjusted Cost Base Of Shares Given Up $600,000

Less: Non-Share Consideration Nil

Adjusted Cost Base Of Preferred Shares $600,000

Legal Stated Capital - Preferred Shares $12,013,000

Less Excess, If Any, Of:

PUC - Shares Given Up ($600,000)

Non-Share Consideration Nil ( 600,000)

Required PUC Reduction $11,413,000

PUC - Preferred Shares ($12,013,000 - $11,413,000) $600,000

Ms. Farrow’s preferred shares will not participate in the future growth of the Farrow Ltd. This means
that all of the future growth in this company will accrue to her son Woody who is holding the only
common shares in the Company.
Subsequent to these transactions, the August 1, 2018 Balance Sheet would be as follows:

Farrow Ltd.

Shareholders’ Equity

As At August 1, 2018

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Tangible Assets At Tax Values

($11,625,000 + $5,000) $11,630,000

Bank Loan $ 1,112,000

Preferred Shares (Paid Up Capital) 600,000

Common Shares 5,000

Retained Earnings 9,913,000

Total $11,630,000

Note that Ms. Farrow’s potential capital gain of $11,413,000 ($12,013,000 - $600,000) has not
disappeared. If her preferred shares are sold for the fair market value of $12,013,000, with the adjusted
cost base of the shares being $600,000, there would be a capital gain of $11,413,000. Alternatively, if
the preferred shares are redeemed, their PUC is $600,000, which would result in an ITA 84(3) deemed
dividend of $11,413,000 (there is no capital gain in this solution). The procedure described above will
simply defer the potential gain until the new preferred shares are sold or redeemed.

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TIF Solution Seventeen - 8

Part A (Rollover To Corporation)
The adjusted cost base of the common shares issued on January 1, 2013 would be calculated as follows:

Elected Value $1,373,000

Non-Share Consideration ( 1,000,000)

Adjusted Cost Base Of Common Shares $ 373,000

The PUC of these shares would be calculated as follows:

Legal Stated Capital $650,000

Excess Of, If Any, Of

Total Elected Value ($1,373,000)

Over Non-Share Consideration 1,000,000 ( 373,000)

Required PUC Reduction $277,000

PUC Of Common Shares ($650,000 - $277,000) $373,000

Part A (Share-For-Share Exchange)

The adjusted cost base of the preferred shares would be calculated as follows:

Adjusted Cost Base Of Shares Given Up $373,000

Non-Share Consideration ( 906,000)

Adjusted Cost Base Of Preferred Shares Nil

The PUC of the preferred shares would be calculated as follows:

Legal Stated Capital $5,500,000

Excess, If Any, Of

PUC Of Shares Given Up ($373,000)

Over Non-Share Consideration 906,000 Nil

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Required PUC Reduction $5,500,000

PUC Of Preferred Shares ($5,500,000 - $5,500,000) Nil

The ITA 84(3) deemed dividend would be calculated as follows:

PUC Of Preferred Shares $ Nil

Non-Share Consideration 906,000

Proceeds Of Redemption $906,000

PUC Of Shares Given Up ( 373,000)

ITA 84(3) Deemed Dividend (Non-Eligible) $533,000

As a result of the share-for-share exchange, the amount to be included in Marian’s Net Income For Tax
Purposes would be the grossed up dividend of $618,280 [(116%)($533,000)]. In addition, there would
be a federal dividend tax credit of $62,022 [8/11)(16%)($533,000)].

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The exchange would not result in a capital gain as shown in the following calculation:

Adjusted Cost Base Of Preferred Shares $ Nil

Non-Share Consideration 906,000

Proceeds Of Disposition $906,000

ITA 84(3) Deemed Dividend (Non-Eligible) ( 533,000)

Adjusted Proceeds Of Disposition $373,000

Adjusted Cost Base Of Shares Given Up ( 373,000)

Capital Gain Nil

Part B
The results of having Home Software Inc. redeem her preferred shares would be as follows:

Proceeds Of Redemption $5,500,000

PUC Of Preferred Shares Nil

ITA 84(3) Deemed Dividend (Non-Eligible) $5,500,000

As a result of the redemption, the amount to be included in Marian’s Net Income For Tax Purposes
would be the grossed up dividend of $6,380,000 [(116%)($5,500,000)]. In addition, there would be a
federal dividend tax credit of $640,000 [(8/11)(16%)($5,500,000)].
As was the case with the share-for-share exchange, where will be no capital gain on the redemption:

Proceeds Of Disposition $5,500,000

ITA 84(3) Deemed Dividend (Non-Eligible) ( 5,500,000)

Adjusted Proceeds Of Disposition Nil

Adjusted Cost Base Of Preferred Shares Nil

Capital Gain Nil

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TIF Solution Seventeen - 9

Part A

Gift To James Derek owns 80 percent (12,000  15,000) of the Nome Industries shares. His gift to
James would be calculated as follows:

Fair Market Value Of Old Common Shares

[(80%)($1,500,000)] $1,200,000

Fair Market Value Of Consideration:

Non-Share Consideration ($200,000)

Preferred Shares (Fair Market Value) ( 800,000) ( 1,000,000)

Gift $ 200,000

It is fair to assume that this amount is a gift to James, as he is the only other holder of common shares in
Nome Ltd.

PUC Of New Preferred Shares The PUC reduction required under ITA 86(2.1) would be calculated as
follows:

Legal Stated Capital Of New Shares $800,000

Less The Excess, If Any, Of:

PUC Of Old Shares [(12,000)($60)] ($720,000)

Over The Non-Share Consideration 200,000 ( 520,000)

PUC Reduction $280,000

PUC Of Preferred Shares ($800,000 - $280,000) $520,000

Adjusted Cost Base Of New Preferred Shares This amount would be calculated as follows:

Adjusted Cost Base Of Old Shares [(12,000)($85)] $1,020,000

Deduct:

Non-Share Consideration ($200,000)

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Gift ( 200,000) ( 400,000)

Adjusted Cost Base Of New Shares $ 620,000

ITA 84(3) Dividend For the purposes of determining any ITA 84(3) deemed dividend on the
redemption of the old shares, the proceeds of redemption would be as follows:

PUC Of New Preferred Shares $520,000

Non-Share Consideration 200,000

Proceeds Of Redemption $720,000

As shown in the following calculation, there would be no ITA 84(3) dividend:

Proceeds Of Redemption $720,000

PUC Of Old Shares ( 720,000)

ITA 84(3) Dividend Nil

Capital Loss For the purposes of determining any capital gain or loss on the redemption of the old
common shares, the proceeds of disposition would be the lesser of the $1,200,000 fair market value of
the old common shares and the following amount:

Non-Share Consideration $200,000

Gift 200,000

Proceeds Of Disposition $400,000

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As shown in the following calculation, there would be a capital loss:

Proceeds Of Disposition $ 400,000

ITA 84(3) Deemed Dividend Nil

Adjusted Proceeds Of Disposition $ 400,000

Adjusted Cost Base Of Old Shares ( 1,020,000)

Capital Gain (Loss) ($ 620,000)

This capital loss would be disallowed by ITA 86(2)(d), resulting in no immediate tax consequences for
Derek Blume.

Part B
This transaction will not alter the total fair market value of the Company. However, the value of the
common shares will increase by the $200,000 amount of the gift. There will be no corresponding
increase in the amount of the tax cost of these shares and, as a consequence, this value will be taxed
when James sells the common shares or they are redeemed. As this value will also be taxed in the hands
of Derek Blume, there will be double taxation on this $200,000 amount.

Part C
If Derek’s preferred shares were redeemed at their fair market value of $800,000, the tax consequences
would be as follows:

Redemption Proceeds $800,000

PUC ( 520,000)

ITA 84(3) Deemed Dividend (Non-Eligible) $280,000

The gross up amount of the dividend will be $324,800 [(116%)($280,000)]. It will generate a federal
dividend tax credit of $32,582 [(8/11)(16%)($280,000)].

Redemption Proceeds $800,000

ITA 84(3) Deemed Dividend (Non-Eligible) ( 280,000)

Adjusted Proceeds Of Disposition $520,000

Adjusted Cost Base ( 620,000)

Capital Loss ($100,000)

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If Derek had simply sold his shares, there would have been a capital gain of $180,000 ($1,200,000 -
$1,020,000). The net result of this redemption is the same $180,000 ($280,000 in dividends - $100,000
capital loss). However, as noted in Part B, his son James will be paying taxes on an additional $200,000
capital gain because of the increased fair market value of his shares which results from the gift.
A further problem is the form of the income. On the straight sale of shares, the $180,000 would have
been a capital gain, only one-half of which would be taxable. The inappropriate use of ITA 86 has
resulted in a $280,000 dividend which will be taxed at higher rates, offset by a $100,000 capital loss
which is only one-half deductible. Although capital losses can generally be deducted only to the extent
of available capital gains, if Derek’s cancer treatment is unsuccessful, the capital loss will be deductible
against other income in the year of death or the immediately preceding year.
Although the special rule for capital losses at death is tax advantageous, it is unlikely that Derek would
want to be in the position to take advantage of it.

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TIF Solution Seventeen - 10

Part A - Gift Calculation
The fair market value of the common shares exchanged was $2,625,000 [(75%)($3,500,000)]. As this
amount is equal to the $2,625,000 ($2,000,000 + $625,000) total of cash and preferred shares received,
there is no gift to a related party.

Part B - PUC Of Preferred Shares

Since Mr. Martinez purchased the shares directly from Ms. Cruz, the paid up capital of the common
shares remains at $465,000. The PUC of the preferred shares would be calculated as follows:

Increase In Legal Stated Capital $2,000,000

Less The Excess, If Any, Of:

PUC Of Common Shares

[(75%)($465,000)] ($348,750)

Over The Non-Share Consideration 625,000 Nil

PUC Reduction $2,000,000

PUC Of Preferred Shares ($2,000,000 - $2,000,000) Nil

Part C - Adjusted Cost Base Of Preferred Shares

The adjusted cost base of the preferred shares would be calculated as follows:

Adjusted Cost Base Of Common Shares [(75%)($1,340,000)] $1,005,000

Non-Share Consideration ( 625,000)

Adjusted Cost Base Of Preferred Shares $ 380,000

Part D - Proceeds Of Redemption And Disposition For Common Shares

The Proceeds Of Redemption would be calculated as follows:

Non-Share Consideration $625,000

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PUC Of Preferred Shares Nil

Proceeds Of Redemption [ITA 84(5)(d)] $625,000

The Proceeds Of Disposition would be calculated as follows:

Adjusted Cost Base Of Preferred Shares $ 380,000

Non-Share Consideration 625,000

Proceeds Of Disposition [ITA 86(1)(c)] $1,005,000

Part E - Tax Consequences Of Sale And Exchange Of Shares

The sale of shares to his daughter would result in a taxable capital gain calculated as follows:

Proceeds Of Disposition $875,000

Adjusted Cost Base [(25%)($1,340,000)] ( 335,000)

Capital Gain $540,000

Inclusion Rate 1/2

Taxable Capital Gain $270,000

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The exchange of shares would have tax consequences as follows:

Proceeds Of Redemption $625,000

PUC Of Common Shares [(75%)($465,000)] ( 348,750)

ITA 84(3) Deemed Dividend (Non-Eligible) $276,250

Proceeds Of Disposition $1,005,000

ITA 84(3) Deemed Dividend ( 276,250)

Adjusted Proceeds Of Disposition $ 728,750

Adjusted Cost Base Of Common Shares [(75%)($1,340,000)] ( 1,005,000)

Capital Loss ($ 276,250)

Inclusion Rate 1/2

Allowable Capital Loss ($ 138,125)

The overall tax consequences of the sale to his daughter and exchange of shares would be as follows:

Taxable Dividend [($276,250)(116%)] $320,450

Net Taxable Capital Gain ($270,000 - $138,125) 131,875

Income Inclusion $452,325

The deemed non-eligible dividend would qualify for a federal dividend tax credit of $32,145 [(8/11)
(16%)($276,250)].

Part F - Tax Consequences Of Preferred Share Redemption

The tax consequences of the immediate redemption of the preferred shares would be as follows:

Proceeds Of Redemption $2,000,000

PUC Of Preferred Shares Nil

ITA 84(3) Deemed Dividend (Non-Eligible) $2,000,000

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Proceeds Of Disposition $2,000,000

ITA 84(3) Deemed Dividend (Non-Eligible) ( 2,000,000)

Adjusted Proceeds Of Disposition Nil

Adjusted Cost Base Of Preferred Shares ( 380,000)

Capital Loss ($ 380,000)

Inclusion Rate 1/2

Allowable Capital Loss ($ 190,000)

The deemed non-eligible dividend would be grossed up to $2,320,000 [(16%)($2,000,000)]. It would

qualify for a federal dividend tax credit of $232,727 [(8/11)(16%)($2,000,000)]
Assuming Mr. Martinez has no other taxable capital gains in the year, there is a net capital loss carry
over of $58,125 ($270,000 - $138,125 - $190,000).

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TIF Solution Seventeen - 11

Part A - Funds Available For Distribution
The taxable capital gains and active business income (recapture) at the corporate level can be calculated
as follows:

Taxable Active Business

Asset Capital Gains Income

Inventories Nil Nil

Taxable Capital Gains:

On Land [(1/2)($2,600,000 - $942,450)] $ 828,775 Nil

On Building [(1/2)($1,846,000 - $1,160,000)] 343,000

Recapture On Building ($1,160,000 - $723,640) $436,360

Totals $1,171,775 $436,360

As the active business income is less than the $500,000 annual business limit, there will be no addition
to the General Rate Income Pool Balance. The taxable capital gains are not eligible for addition to the
GRIP balance.
Taxable Income will be $1,608,135 ($1,171,775 + $436,360). Tax Payable on this amount will be
calculated as follows:

Federal Tax On Investment Income [(28% + 10-2/3%)($1,171,775)] $453,086

Federal Tax On Business Income [(10.5%)($436,360)] 45,818

Federal Part I Tax Payable $498,904

Provincial Tax On Investment Income [(14%)($1,171,775)] 164,049

Provincial Tax On Business Income [(3%)($436,360)] 13,091

Total Tax Payable $676,044

The balance in the RDTOH is calculated as follows:

Balance Prior To Asset Dispositions $ 32,345

Addition - The Least Of:

 [(30-2/3%)($1,171,775)] = $359,344

 [(30-2/3%)($1,608,135 - $436,360)] = $359,344

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 Federal Part I Tax Payable = $498,904 359,344

Ending RDTOH $391,689

The amount available for distribution to Mr. Korngold, after the payment of the liabilities and the taxes
at the corporate level, can be calculated as follows:

Fair Market Values:

Inventories $ 48,650

Land 2,600,000

Building 1,846,000

Gross Proceeds $4,494,650

Liabilities ( 313,260)

Tax Payable ( 676,044)

Dividend Refund (Note) 344,818

Funds Available For Distribution $3,850,164

Note The dividend refund is equal to the balance in the RDTOH account. As will be shown in
a subsequent calculation, the taxable dividends paid on the winding-up will be well in excess of
the amount required to use the full balance in the RDTOH account.

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With respect to the capital dividend account, the final balance is calculated as follows:

Balance Before Dispositions $ 326,470

Disposition Of Land 828,775

Disposition Of Building 343,000

Ending Balance $1,498,245

Part B - Components Of Distribution

Assuming an election has been made to declare the maximum capital dividend, the taxable dividend
component of the total distribution to Mr. Korngold can be calculated as follows:

Distribution To Mr. Korngold $3,850,164

Paid Up Capital ( 625,000)

ITA 84(2) Deemed Dividend $3,225,164

Capital Dividend (Balance In Account) ( 1,498,245)

Deemed Dividend Subject To Tax (Non-Eligible) $1,726,919

As Korngold has no GRIP balance, all of this dividend will be non-eligible. The taxable amount will be
$2,003,226 [(116%)($1,726,919)]. This dividend will qualify for a federal dividend tax credit of
$200,951 [(8/11)(16%)($1,726,919]

Part B - Capital Gain

With respect to capital gains, ITA 54 indicates that the proceeds of disposition for purposes of
determining any capital gain on the disposition of shares does not include any amount paid out as ITA
84(2) dividends. Given the preceding calculation, the capital gain to Mr. Korngold would be calculated
as follows:

Actual Distribution To Mr. Korngold $3,850,164

ITA 84(2) Deemed Dividend ( 3,225,164)

Deemed Proceeds Of Disposition $ 625,000

Adjusted Cost Base For Shares ( 625,000)

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Capital Gain Nil

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TIF Solution Seventeen - 12

Part A - After Tax Funds At Corporate Level

Taxable Income And Tax Payable

Tax Payable resulting from the sale of assets can be calculated as follows:

Active Business Taxable

Income Capital Gains

Accounts Receivable ($195,000 - $215,000) ($20,000) Nil

Land [(1/2)($193,875 - $132,000)] Nil $30,938

Recapture On Building ($550,000 - $492,000) 58,000 Nil

Goodwill [($56,250 - Nil)(1/2)] Nil 28,125

Totals $38,000 $59,063

Total Taxable Income would be $97,063 ($38,000 + $59,063). The Tax Payable on this amount would
be calculated as follows:

Federal Tax On:

Business Income [(38% - 10% - 18.0%)($38,000)] $ 3,800

Investment Income [(38% - 10% + 10-2/3%)($59,063)] 22,838

Part I Federal Tax Payable $26,638

Provincial Tax On Business Income [(3%)($38,000)] 1,140

Provincial Tax On Investment Income [(13%)($59,063)] 7,678

Total Tax Payable $35,456

Capital Dividend Account

The balance in the capital dividend account would be calculated as follows:

Opening Balance $ 63,000

Addition From Sale Of Land 30,938

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Addition From Sale Of Goodwill 28,125

Closing Balance $122,063

RDTOH Balance
The balance in the RDTOH account would be calculated as follows:

Opening Balance $31,000

Add: Least Of:

30-2/3% Of Investment Income [(30-2/3%)($59,063)] = $18,113

30-2/3% Of Taxable Income, Less Amount Eligible For

Small Business Deduction [(30-2/3%)($97,063 - $38,000)] = $18,113

Part I Federal Tax Payable = $26,638 18,113

Closing Balance $49,113

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Funds Available For Distribution

Given the preceding calculation, the after tax funds available for distribution would be calculated as
follows:

Purchase Price, Plus Cash ($984,000 + $50,000) $1,034,000

Corporate Tax Payable ( 35,456)

Balance Before Dividend Refund $ 998,544

Dividend Refund (RDTOH Balance) 49,113

After Tax Distribution $1,047,657

The dividend refund is equal to the balance in the RDTOH account. As will be shown in a
subsequent calculation, the taxable dividends paid on the winding-up will be well in excess of
the amount required to use the full balance in the RDTOH account.

Part B - After Tax Retention By Mr. Pellerin

Taxable Dividend
Assuming an election has been made to declare the maximum capital dividend, the taxable dividend
component of the distribution can be analyzed as follows:

Total Distribution $1,047,657

Paid Up Capital ( 600,000)

ITA 84(2) Deemed Dividend $ 447,657

Capital Dividend (Balance In Account) ( 122,063)

Deemed Dividend Subject To Tax (Non-Eligible) $ 325,594

For capital gains purposes, the redemption of shares that occurred as part of the winding-up would not
have any tax effect. This is demonstrated by the following calculation:

Proceeds Of Redemption $1,047,657

ITA 84(2) Deemed Dividend ( 447,657)

Proceeds Of Disposition Under ITA 54 $ 600,000

Adjusted Cost Base ( 600,000)

Capital Gain Nil

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Personal Tax Payable

The PUC amount, as well as the capital dividend, would be received by Mr. Pellerin on a tax free basis.
Tax Payable on the deemed non-eligible dividend would be calculated as follows:

Deemed Dividend Subject To Tax $325,594

Gross Up Of 16 Percent 52,095

Taxable Dividend $377,689

Personal Tax Rate (33% + 16%) 49%

Tax Before Dividend Tax Credit $185,068

Dividend Tax Credit [(8/11 + 3/11)($52,095)] ( 52,095)

Personal Tax Payable $132,973

After Tax Retention

Given the preceding calculations, the after tax cash available to Mr. Pellerin would be calculated as
follows:

Total Distribution $1,047,657

Personal Tax Payable ( 132,973)

After Tax Cash Retained $ 914,684

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TIF Solution Seventeen - 13

Sale Of Assets
This calculation requires two steps. First, we must determine the after tax proceeds that will be
available at the corporate level subsequent to the sale of the assets. Then, a second stage analysis is
required to determine the amount that will be retained by Paulo after he pays all of the taxes that are due
on the proceeds that are distributed to him.

Calculation Of Corporate Income On Asset Dispositions

Net Income For Tax Purposes on the disposition of assets would be as follows:

Active Business Taxable

Asset Income (Loss) Capital Gains

Accounts Receivable (Note 1) ($ 33,600)

Inventories ($676,250 - $623,400) 52,850

Land [(1/2)($403,000 - $326,000)] $ 38,500

Building:

($983,200 - $396,400) 586,800

[(1/2)($1,265,000 - $983,200)] 140,900

Recapture On Equipment ($297,600 - $285,400) 12,200

Goodwill [(1/2)($624,000)] 312,000

Taxable Amounts $618,250 $491,400

Note 1 The loss on the Accounts Receivable is a business loss because the ITA 22 election was
made. The amount of the loss is the tax value of $312,500, less the fair market value of $278,900.

Taxable Income And Tax Payable

Based on the preceding analysis, Titano Ltd. would have Taxable Income calculated as follows:

Net Income For Tax Purposes ($618,250 + $491,400) $1,109,650

Non-Capital Loss Carry Forward ( 62,000)

Net Capital Loss Carry Forward (Less Than $491,400) ( 86,350)

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Taxable Income From Sale Of Assets $ 961,300

Basic Federal Tax [(38%)($961,300)] $365,294

Federal Tax Abatement [(10%)($961,300)] ( 96,130)

Small Business Deduction (Note 2) ( 90,000)

ART (Note 3) 43,205

General Rate Reduction [(13%)($961,300 - $500,000 - $405,050)] ( 7,313)

Part I Tax Payable $215,056

Provincial Taxes:

[(4%)($500,000)] 20,000

[(13%)($961,300 - $500,000)] 59,969

Corporate Tax Payable $295,025

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Note 2 The small business deduction is equal to 18.0 percent of the least of:

 Active Business Income $618,250

 Taxable Income $961,300

 Annual Business Limit $500,000

The small business deduction is equal to $90,000 [(18.0%)($500,000)].

Note 3 Aggregate Investment Income is calculated as follows:

Taxable Capital Gains $491,400

Net Capital Loss Deducted ( 86,350)

Aggregate Investment Income $405,050

ART is equal to 10-2/3% of the lesser of:

 Aggregate Income = $405,050

 Taxable Income Less The Amount Eligible For The Small Business
Deduction = $461,300 ($961,300 - $500,000)

ART is equal to $43,205 [(10-2/3%)($405,050)].

GRIP Balance
The GRIP balance can be calculated as follows:

Taxable Income $961,300

Amount Eligible For The Small Business Deduction ( 500,000)

Aggregate Investment Income ( 405,050)

Subtotal $ 56,250

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Rate 72%

GRIP Balance $ 40,500

RDTOH Balance
As there is no opening balance in the RDTOH, the closing balance would be equal to the addition for the
year. This addition would be the least of:

30-2/3 Percent Of Investment Income [(30-2/3%)($405,050)] $124,215

30-2/3 Percent Of Taxable Income, Less The Amount Eligible For

The Small Business Deduction [(30-2/3%)($961,300 - $500,000)]$141,465

Part I Federal Tax Payable $215,056

The least of these three figures and the balance in the RDTOH account is $124,215.

Funds Available For Distribution

The funds available for distribution would be calculated as follows:

Total Fair Market Value Of Assets (From Statement) $3,582,350

Current Liabilities Assumed ( 426,250)

Loan From Shareholder Assumed ( 186,400)

Proceeds Of Disposition $2,969,700

Corporate Tax Payable ( 295,025)

Dividend Refund (Note 4) 124,215

Funds Available For Distribution $2,798,890

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Note 4 Technically, the dividend refund is the lesser of the $124,215 balance in the RDTOH
account and 38-1/3 percent of taxable dividends paid. However, given the size of the
distribution in this example, it is clear that $124,215 will be the lower figure.

Capital Dividend Account Balance

The balance in the capital dividend account would be calculated as follows:

Opening Balance $ 94,550

Non-Taxable One-Half Of Capital Gains

(From Table Calculating Corporate Income

On Asset Dispositions) 491,400

Closing Balance $585,950

Taxable Dividends Resulting From Distribution

Assuming an election has been made to declare the maximum capital dividend and the maximum
eligible dividend, the taxable dividend component of the total distribution to Paulo can be calculated as
follows:

Funds Available For Distribution $2,798,890

Paid Up Capital ( 168,000)

ITA 84(2) Deemed Dividend $2,630,890

ITA 83(2) Capital Dividend (Balance In Account) ( 585,950)

Deemed Dividend Subject To Tax $2,044,940

Eligible Dividend (Must Be Designated As Such) ( 40,050)

Non-Eligible Dividend (Remainder) $2,004,890

As shown in the following calculation, Paulo will not have a capital gain on the disposition of his shares:

Amount Distributed $2,798,890

ITA 84(2) Deemed Dividend ( 2,630,890)

Deemed Proceeds Of Disposition $ 168,000

Adjusted Cost Base Of Shares ( 168,000)

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Capital Gain Nil

Personal Tax Payable

As there is no capital gain and the capital dividend is received tax free, the personal Tax Payable on the
dividend subject to tax would be calculated as follows:

Eligible Dividends $ 40,500

Gross Up Of 38 Percent 15,390

Non-Eligible Dividends 2,004,890

Gross Up Of 16 Percent 320,782

Taxable Amount Of Dividends $2,381,562

Combined Tax Rate (33% + 16%) 49%

Tax Payable Before Dividend Tax Credit $1,166,966

Dividend Tax Credits:

Eligible Dividends [(6/11 + 32%)($15,390)] ( 13,319)

Non-Eligible Dividends [(8/11 + 25%)($320,782)] ( 313,492)

Personal Tax Payable $ 840,155

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Sale Of Shares
This relatively simple calculation is as follows:

Proceeds From The Sale Of Shares $2,700,000

Adjusted Cost Base ( 168,000)

Capital Gain $2,532,000

Inclusion Rate 1/2

Taxable Capital Gain $1,266,000

Tax Rate (33% + 16%) 49%

Tax Payable $ 620,340

Conclusion
The after tax proceeds from the two alternative dispositions can be calculated as follows:

Sale Of Shares Sale Of Assets

Proceeds Available $2,700,000 $2,798,890

Personal Tax Payable ( 620,340) ( 840,155)

After Tax Retention $2,079,660 $1,958,735

The conclusion is very clear. The cash retained from the sale of shares is $120,925 ($2,079,660 -
$1,958,735) larger than the cash retained from selling the assets and distributing the net proceeds. In
addition, if Paulo could convert his Titano Ltd. shares to qualified small business corporation shares and
fully use his lifetime capital gains deduction, this result would be even more favourable to the sale of
shares.
The full $2,796,390 could be left in the business for further operations as an investment company as
Paulo travels the world. However, given the current rate of taxation on the investment income of
corporations, it is not likely that this would be an attractive alternative.

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Chapter Eighteen Test Item File Solutions

TIF Solution Eighteen - 1

1. There is a deeming rule applicable to partnerships that requires that it calculate business income,
property income, and capital gains as if it was a person resident in Canada. Once these amounts are
determined, they are allocated on a source-by-source basis to the members of the partnership as per
the terms of the partnership agreement. As the partners are taxable entities (e.g., individuals,
corporations, or trusts) the allocated amounts will be included in their Net Income For Tax
Purposes.

2. The three elements are:

1. There must be two or more persons (taxable entities) involved.

2. These persons must be carrying on a business.

3. The business must be carried on with a view to making a profit.

3. The points that could be listed here include:

 the initial and ongoing partner contributions and ownership percentage of each partner,

 the responsibilities of each partner and the division of work between the partners ,

 how income and drawings will be allocated and how much compensation is to be paid,

 signing authority on the partnership bank accounts and required approval for purchases,

 procedures for bringing in new partners, and

 procedures to deal with the withdrawal or death of a partner, or the sale of the business .

4. The descriptions of the three basic types of partnerships are as follows:

General Partnership In a general partnership, all partners have unlimited liability for
partnership debts.

Limited Partnership A limited partnership has at least one general partner who has unlimited
liability for the debts of the partnership. Other partners, referred to as limited partners, are only
responsible to the extent of their actual and promised contributions to the partnership.

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Limited Liability Partnership Members of limited liability partnerships have unlimited

liability for most types of partnership debt. There is, however, an important exception.
Members of limited liability partnerships are not personally liable for obligations arising from
the wrongful or negligent action of:

 their professional partners; or

 the employees, agents or representatives of the partnership who are conducting partnership
business.

5. Factors that could be listed here include:

 co-venturers contractually do not have the power to bind other co-venturers;

 co-venturers retain ownership of property contributed to the undertaking;

 co-venturers are not jointly and severally liable for debt of the undertaking;

 co-venturers share gross revenues, not profits; and

 while partnerships may be formed for the same purpose as a joint venture, they are usually of
longer duration and involve more than a single undertaking.

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6. The basic difference is that, if an arrangement is considered to be a joint venture rather than a
partnership, there will be no separate calculation of income at the organization level. Each
participant in the joint venture will make their own calculation of income. In contrast, a partnership
must make a separate calculation of Net Income For Tax Purposes and this figure must be used by
all of the partners.

7. The general rules are as follows:

 If any member of the partnership is an individual or a professional corporation, the partnership

must have a December 31 year end.

 Otherwise, any fiscal period can be used as long as it does not end more than 12 months after it
begins.

There is an exception to the calendar year requirement that allows the use of a non-calendar fiscal
year in situations where all of the partnership members are individuals and an election is filed prior
to the end of the partnership’s first fiscal year.

8. In the absence of a special rule, partnerships could not deduct CCA. However, the Income Tax Act
provides a special provision. For purposes of determining income, a partnership is considered to
own the property of the partnership.

9. Partnership income may include business income, property income (interest, dividends, rents), and/
or capital gains. These amounts will be allocated to the partners as the same types of income. This
means that they will retain the tax rules associated with these types of income. For example:

 When partnership dividends are allocated to partners who are individuals, the allocated
amounts will be subject to the usual gross up and tax credit procedures.

 When partnership capital gains are allocated to partners, only one-half the allocated
amount will be taxable.

10. The CRA does not permit the deduction of salaries to partners in the determination of Net Business
Income at the partnership level. As they are deducted in the determination of accounting Net
Income, they are added back to accounting Net Income to arrive at Net Business Income. Any
salary paid to a partner is considered a priority allocation of Net Business Income to that specific
partner.

11. Whether an adjustment is needed depends on the accounting procedures used. As GAAP for
partnerships does not deal with drawings, such amounts may or may not have been deducted in the
accounting statements. If there were deducted in the accounting statements, they will need to be
added back in the calculation of business income for tax purposes. Alternatively, if they have not
been deducted in the accounting statements, no adjustment is required.

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12. Charitable donations cannot be deducted in the determination of Net Business Income at the
partnership level. As they are usually deducted in the determination of accounting Net Income, they
must be added back to this figure to determine the partnership’s Net Business Income. While the
question does not require this information, these amounts will be allocated to the partners to be used
either as a deduction (corporations) or as a basis for a tax credit (individuals).

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13. The tax rules require that CCA be deducted at the partnership level. For no CCA to be deducted in
determining an individual partner’s income, no CCA can be deducted at the partnership level. This
means that the other partners should only agree to this request if they are willing to have their
partnership income increased by having no CCA deducted at the partnership level. They may or
may not be willing to agree to this.

14. Accounting net income will include gains on the sale of capital assets as calculated under GAAP.
These amounts will be deducted in determining the net business income of the partnership. They
will not, however, be replaced by the taxable capital gains. These latter amounts are not part of the
partnership’s net business income. They will be subject to a separate allocation to the individual
partners in order to retain their tax characteristics.

15. In the absence of a provision in the partnership agreement, partnership law will require that profits
be shared in equal fixed ratios.

16. There are two ways the interest can be acquired:

 The interest can be acquired directly from a current partner or partners by purchasing all or part
of their interest.

 The interest can be acquired directly from the partnership by transferring assets to this
organization.

17. The treatment of each of the items is as follows:

Capital Contributions Capital contributions are added to the adjusted cost base of the
partnership interest in the period in which they are made.

Partner’s Share Of Partnership Net Business Income Each partner’s share of partnership
Net Business Income is added to the partner’s adjusted cost base on the first day of the year
following the year in which the income was earned by the partnership.

Partner’s Drawings Partner’s drawings are deducted from the adjusted cost base of the
partnership interest in the year in which they are made.

18. One-half of a partner’s share of the partnership’s capital gains (i.e., the partner’s share of the net
taxable capital gains) will be included in his Net Income For Tax Purposes in the year in which the
gains are realized. The partner’s share of the partnership’s capital gains (i.e. 100 percent) will be

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added to the adjusted cost base of his partnership interest on the first day of the following taxation
year.

19. The partner’s share of the partnership dividends will be included in his Net Income For Tax
Purposes in the year in which the dividends are received by the partnership. The partner will gross
up the allocated amount and be entitled to a dividend credit against Tax Payable. The partner’s
share of the partnership dividends will be added to the adjusted cost base of his partnership interest
on the first day of the following taxation year. This amount will not include the gross up.

20. For most capital assets, the negative amount will have to be included in income and added back to
the adjusted cost base of the asset. However, for partnership interests, the Income Tax Act makes an
exception. As a consequence, as long as the partner is an active general partner, the amount does
not have to be included in income unless there is a disposal of the partnership interest while the
negative amount is present.

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21. A limited partnership is one that has at least one limited partner and one general partner. As defined
in most provincial legislation, a limited partner is one whose liability for the debts of the Partnership
is limited to the amount of his contribution to the Partnership, and who is not permitted to
participate in the management of the Partnership. A partner whose liability is limited under
partnership law is considered a limited partner for income tax purposes.

22. Stated simply, the at-risk rules are designed to ensure that a limited partner does not receive tax
deductions or tax credits that exceed the amount that he has “at risk”. In very simplified terms, the
“at risk” amount is the amount of the partner’s actual investment, not including amounts owed to
the limited partnership.

23. A Canadian partnership is defined in ITA 201 as follows:

In this subdivision, “Canadian partnership” means a partnership all of the members of which
were, at any time in respect of which the expression is relevant, resident in Canada.

This is an important classification in that, in order to qualify for the various rollovers of partnership
property, the partnership must meet this definition.

24. The incorporation of a partnership without incurring current taxation requires the use of two
rollovers. The first (under ITA 85(2)), allows eligible partnership property to be transferred to a
taxable Canadian corporation for either shares or a combination of shares and other consideration.
The transfer takes place at elected values which can include the tax cost of the property, thereby
avoiding current Taxable Income at the partnership level.

At this point, the partnership is holding shares in the corporation and the partners are continuing to
hold their partnership interests. The second rollover (under ITA 85(3)) then provides for a transfer
at tax values of the partnership’s holding of the corporation’s shares to the partners in return for
their partnership interests.

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TIF Solution Eighteen - 2

1. False.

While partnerships are not taxable entities for income tax purposes, they are taxable entities for
GST/HST purposes.

2. False.

Participants in joint ventures may have a significantly different Tax Payable than would be the
case if they were considered to be partners.

3. True.

4. True.

5. False.

Interest on capital contributions cannot be deducted.

6. True.

7. True.

8. False. Salaries paid to partners are never deductible.

9. True.

10. False.

Charitable donations are allocated to the partners on the basis of the partnership agreement.

11. False.

While only one-half of allocated capital gains will be included in a partner’s Net Income For
Tax Purposes, 100 percent of such gains will be added to the partner’s adjusted cost base.

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12. True.

13. True.

14. True.

15. False.

A rollover treatment is available where all of the property of a Canadian partnership that has
ceased to exist is transferred to a new Canadian partnership. A further condition is that all
of the members of the new partnership must have been members of the old partnership.

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TIF Solution Eighteen - 3

Partnership Characteristics
1. B. Limited partners cannot participate in the management of the company.

2. A. One of the partners must be an individual.

3. B. Partners are jointly and severally liable for partnership debt and wrongful acts of other
partners.

4. B. General partners are a separate legal entity from the business.

5. A. Partners may be able to reduce their personal income taxes if the business has losses in
the start-up years.

6. C. 3 and 4.

Co-Ownership, Joint Ventures and Syndicates

7. D. While partners share the profit of the partnership, joint venturers share the gross
revenues of the joint venture.

8. A. When profits or losses are accounted for individually.

9. D. Co-venturers do not have the power to bind other co-venturers contractually.

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10. D. A syndicate.

Partnership Income, Losses And Tax Credits

11. B. $228,000.

12. A. Martin will be allocated charitable donations of $1,800 [(30%)($6,000)]. He will

include on his tax return:

 taxable capital gains of [(30%)(1/2)($42,000)] $6,300

 a federal dividend tax credit of [(30%)(8/11)(16%)($15,000)] $ 524

 a charitable donations tax credit of

[(15%)($200) + (29%)($1,800 - $200)] $ 494

13. C. $229,560 {[50%][$490,000 + (16%)($32,000) - (1/2)($96,000) + $12,000]}.

14. C. $59,000 [(50%)($130,000) – (50%)($5,000) - $3,500)]

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15. B. $222,000 + $120,000 - $1,500 - $100,000 = $240,500

16. C. Business losses of a partnership cannot be allocated to the partners for them to deduct
against other sources of income.

Partnership Interest
17. D. Her share of the dividend gross up on dividends received by the partnership during the
year.

18. A. The ACB of Joe’s partnership interest is $23,000, calculated as follows:

Opening ACB $59,000

Drawings ( 10,000)

Share Of Net Business Loss ( 25,000)

Share Of Charitable Donations ( 1,000)

ACB $23,000

19. D. The ACB of Sarah’s partnership interest is $60,000, calculated as follows:

Opening ACB $40,000

Drawings ( 15,000)

Share Of Business Income - No CCA Adjustment

[(50%)($50,000)] 25,000

Share Of Capital Gains [(50%)(2)($10,000)] 10,000

ACB $60,000

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20. A. Each sister will have a taxable capital gain of $2,500. [1/2][$15,000 – (20%)
($50,000)]

21. C. $34,000. [($215,000 - $5,000)(40%) - $50,000]

Net business income of the partnership for tax purposes is $215,000 {[$200,000 + (1/2)($20,000) +
$5,000]}. Jabari’s 40 percent share of the income is reduced by his share of the charitable donation and
100 percent of his withdrawals.

22. C. The adjusted cost base is nil. Kasinda will report partnership business income of
$100,000. [$100,000 = (25%)($400,000)]

23. A. If Blue Grass pays $20,000 directly to each of the original partners, the adjusted cost
base of the partnership interest of both Red Bush and Green Tree would decrease by $20,000
each. Each partner is selling one third of their $60,000 interest. This will reduce their adjusted
cost base by $20,000 [(1/3)($60,000)].

24. B. Blue Grass pays $30,000 directly to both of the original partners. This will result in a
$10,000 capital gain ($30,000 - $20,000).

25. C. [(1/2)($65,000 + $8,000 (add negative) - $2,000)] = $35,500

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26. C. Interest on funds borrowed by a partner to make a capital contribution.

Limited Partnerships and Limited Partners

27. C. $60,000 [$200,000 + (25%)($40,000) - ($200,000 - $50,000)]

28. A. Mayumi, a partner in an engineering firm, entitled to 50% of the profits and
responsible for 50% of losses. This is the only choice where the partner does not have some
type of special guarantee from the partnership that limits their financial liability.

29. B. The objective of the rules is to prevent taxpayers from receiving tax deductions or tax
credits in excess of the amount that they are in a position to lose on their investment.

30. C. To ensure that the tax deductions available to limited partners do not exceed the
amount they have at-risk.

31. B. It has an indefinite carry forward period, cannot be carried back, and can only be used
against limited partnership income from the same limited partnership.

32. C. His limited partnership loss can be carried forward indefinitely and carried back 3
years. There is no carry back.

Transfer of Property To And From A Partnership

33. B. A decrease of $15,000 ($155,000 - $140,000).

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34. C. Aba will have disposed of the truck for $35,000 resulting in recapture. The adjusted
cost base of her partnership interest will be $30,000. The partnership will have acquired the
truck for $35,000.

35. B. Aissa will have disposed of the land for $95,000 resulting in a taxable capital gain of
$25,000. The ACB of her partnership interest will be $95,000. The partnership will have
acquired the land for $95,000.

36. B. A decrease of $78,900. [(35%)($88,000-$62,000)-$88,000]

37. C. Inventory of real property.

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TIF Solution Eighteen - 4

Exam Exercise Solution Eighteen - 1 (Partnership Income - Accrual Basis)
The following amounts would be added to Ms. Winter’s Net Income For Tax Purposes:

Business Income [(40%)($80,000)] $32,000

Taxable Capital Gains [(40%)(1/2)($23,000)] 4,600

Eligible Dividends [(40%)($8,500)] 3,400

Gross Up [(38%)($3,400)] 1,292

Total $41,292

In addition Ms. Winters would be eligible for a federal dividend tax credit of $705 [(6/11)($1,292)].
The fact that she withdrew $25,000 during the year has no immediate tax consequences.

Exam Exercise Solution Eighteen - 2 (Partnership Income - Accrual Basis)

The following amounts would be added to Mr. Bonner’s Net Income For Tax Purposes:

Business Income [(25%)($140,000)] $35,000

Taxable Capital Gains [(25%)(1/2)($18,000)] 2,250

Eligible Dividends [(25%)($41,000)] 10,250

Gross Up [(38%)($10,250)] 3,895

Total $51,395

In addition Mr. Bonner would be eligible for a federal dividend tax credit of $2,125 [(6/11)($3,895)].
The fact that he withdrew $15,000 during the year has no immediate tax consequences.

Exam Exercise Solution Eighteen - 3 (Partnership Net Business Income)

The ID Partnership’s Net Business Income would be calculated as follows:

Accounting Net Income $312,000

Add:

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Salary To I $42,000

Interest To D 17,000

Amortization Expense 41,000

Donations 4,200 104,200

$416,200

Deduct:

Maximum CCA ($63,000)

Accounting Gain On Sale Of Land ( 31,000) ( 94,000)

Net Business Income $322,200

Priority Allocations To Salaries And

Interest ($42,000 + $17,000) ( 59,000)

Residual To Be Allocated 55:45 $263,200

The allocation of this Net Business Income to the two partners would be as follows:

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Partner I Partner D

Priority Allocation For Salary $ 42,000 N/A

Priority Allocation For Interest N/A $17,000

Allocation Of Residual

[(55%)($263,200)] 144,760

[(45%)($263,200)] 118,440

Total Business Income Allocation $186,760 $135,440

While not required, you might note that a taxable capital gain of $15,500 [(1/2)($31,000)], as well as the
charitable donations of $4,200, would be allocated to the partners on a 55:45 basis.

Exam Exercise Solution Eighteen - 4 (Partnership Net Business Income)

The Keisha Partnership’s Net Business Income would be calculated as follows:

Accounting Net Income $625,000

Additions

Non-Deductible Meals And Entertainment

[(50%)($32,000)] $16,000

Loss On Sale Of Investments 48,000

Golf Club Dues 25,000

Amortization Expense 62,000 151,000

Deductions

CCA ($47,000)

Terminal Loss ( 31,000) ( 78,000)

Net Business Income $698,000

Each partner would be allocated $349,000 [(50%)($698,000)].

While not required, you might note that the capital loss will be allocated to the partners on a 50:50 basis.
However, they can deduct it only to the extent that they have offsetting capital gains.

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Exam Exercise Solution Eighteen - 5 (Partnership Income Allocations)

The MP Partnership’s Net Business Income would be calculated as follows:

Accounting Net Income $78,000

Amortization Expense = CCA Nil

Eligible Dividends ( 6,500)

Accounting Gain On Sale Of Land ( 16,000)

Net Business Income $55,500

The addition to Net Income For Tax Purposes for each of the two partners would be calculated as
follows:

Partner M Partner P

Net Business Income [(50%)($55,500)] $27,750 $27,750

Eligible Dividends [(50%)($6,500)] 3,250 3,250

Gross Up [(38%)($3,250)] 1,235 1,235

Taxable Capital Gain [(50%)(1/2)($16,000)] 4,000 4,000

Net Income For Tax Purposes Addition $36,235 $36,235

While not required, you might note that each partner would be eligible for a federal dividend tax credit
of $674 [(6/11)($1,235)].

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Exam Exercise Solution Eighteen - 6 (Partnership Income Allocations)

The Barton Partnership’s Net Business Income would be calculated as follows:

Accounting Net Income $242,000

Eligible Dividends ( 14,000)

Accounting Gain On Sale Of Investments ( 52,000)

Net Business Income $176,000

The addition to Net Income For Tax Purposes for each of the two partners would be calculated as
follows:

Sam (40%) Sherri (60%)

Net Business Income = $176,000 $70,400 $105,600

Eligible Dividends = $14,000 5,600 8,400

Gross Up

[(38%)($5,600)] 2,128

[(38%)($8,400)] 3,192

Taxable Capital Gain = $26,000

[(1/2)($52,000)] 10,400 15,600

Net Income For Tax Purposes Addition $88,528 $132,792

While this is not required, you might note that each partner would be eligible for a federal dividend tax
credit equal to 6/11 of their respective gross ups.

Exam Exercise Solution Eighteen - 7

(Allocations To Partners - Related Tax Credits)
The allocation of the amounts would be as follows:

Partner P (40%) Partner U (60%)

Charitable Donations = $4,200 $1,680 $2,520

Political Contributions = $900 360 540

Dividends = $2,700 1,080 1,620

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Using these allocations, the tax credits for the two partners would be calculated as follows:

Partner P

Charitable Donations

[(15%)($200) + (29%)($1,680 - $200)] $459

Political Contributions [(3/4)($360)] 270

Dividends [(6/11)(38%)($1,080)] 224

John’s Credits $953

Partner U

Charitable Donations

[(15%)($200) + (29%)($2,520 - $200)] $ 703

Political Contributions [(3/4)($400) + (1/2)($140)] 370

Dividends [(6/11)(38%)($1,620)] 336

Partner U’s Credits $1,409

These amounts would serve to reduce the Tax Payable of each of the two partners for the year ending
December 31, 2018.

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Exam Exercise Solution Eighteen - 8

(Allocations To Partners - Related Tax Credits)
The allocation of the amount would be as follows:

John (60%) Jill (40%)

Charitable Donations = $4,500 $2,700 $1,800

Political Contributions = $600 360 240

Dividends = $14,000 8,400 5,600

Using these allocations, the tax credits for the two partners would be calculated as follows:

John

Charitable Donations

[(15%)($200) + (29%)($2,700 - $200)] $ 755

Political Contributions [(3/4)($360)] 270

Dividends [(6/11)(38%)($8,400)] 1,741

John’s Credits $2,766

Jill

Charitable Donations

[(15%)($200) + (29%)($1,800 - $200)] $ 494

Political Contributions [(3/4)($240)] 180

Dividends [(6/11)(38%)($5,600)] 1,161

Jill’s Credits $1,835

These amounts would serve to reduce the Tax Payable of each of the two partners for the year ending
December 31, 2018.

Exam Exercise Solution Eighteen - 9 (Admission Of A Partner)

Natasha and Felicia will each have a disposition of one-third of their partnership interests for $124,000.
As the adjusted cost base of the interest sold is $49,600 [(1/3)($148,800)], Natasha and Felicia will each
have a $37,200 [(1/2)($124,000 - $49,600)] taxable capital gain.

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The capital account balances and the ACBs after Kyra’s admission will be:

Natasha Felicia Kyra

Opening Capital Accounts $148,800 $148,800 Nil

Adjustment For Kyra’s Admission ( 49,600) ( 49,600) $ 99,200

Ending Capital Accounts

(Accounting Values) $ 99,200 $ 99,200 $ 99,200

ACB Of Partnership Interest $ 99,200 $ 99,200 $248,000

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Exam Exercise Solution Eighteen - 10 (Admission Of A Partner)

Jerry and Joan will each have a disposition of one-third of their partnership interests for $130,000. As
the adjusted cost base of the interest sold is $70,000 [(1/3)($210,000)], they will each have a taxable
capital gain of $30,000 [(1/2)($130,000 - $70,000)].
The capital account balances and the ACBs after John’s admission would be calculated as follows:

Jerry Joan John

Opening Capital Accounts $210,000 $210,000 Nil

Adjustment For John’s Admission ( 70,000) ( 70,000) $140,000

Ending Capital Accounts

(Accounting Values) $140,000 $140,000 $140,000

ACB Of Partnership Interest $140,000 $140,000 $260,000

Exam Exercise Solution Eighteen - 11

(Adjusted Cost Base Of Partnership Interest)
The ACB of Roberta’s partnership interest on December 31, 2018 and January 1, 2019 would be
determined as follows:

Original Capital Contribution $ 52,500

Additional Contribution [ITA 53(1)(e)] 30,240

Drawing ( 16,800)

ACB - December 31, 2018 $ 65,940

Adjustment For 2018 Income

[(40%)($48,720 + $13,020 + $196,140)] 103,152

ACB - January 1, 2019 $169,092

Roberta’s inclusion in Net Income For Tax Purposes would be as follows:

Taxable Capital Gain [(1/2)($48,720)] $ 24,360

Dividends Received 13,020

Gross Up On Eligible Dividends [(38%)($13,020)] 4,948

Net Business Income 196,140

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Subtotal $238,468

Roberta’s Share Of Profits 40%

Inclusion In 2018 Net Income For Tax Purposes $ 95,387

Note that this is not the same $103,152 that was added to the ACB of Roberta’s partnership interest to
reflect her share of 2018 partnership income.

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Exam Exercise Solution Eighteen - 12

(Adjusted Cost Base Of Partnership Interest)
The adjusted cost base of Xena’s partnership interest on December 31, 2018 and January 1, 2019 would
be determined as follows:

Original Capital Contribution $125,000

Additional Contribution 75,000

Drawing ( 40,000)

ACB - December 31, 2018 $160,000

Adjustment For 2018 Income

[(60%)($435,000 + $26,000 + $31,000)] 295,200

ACB - January 1, 2019 $455,200

Xena’s inclusion in Net Income For Tax Purposes would be as follows:

Net Business Income $435,000

Taxable Capital Gain [(1/2)($31,000)] 15,500

Dividends Received 26,000

Gross Up On Eligible Dividends [(38%)($26,000)] 9,880

Subtotal $486,380

Xena’s Share Of Profits 60%

Inclusion In 2018 Net Income For Tax Purposes $291,828

Note that this is not the same $295,200 that was added to the adjusted cost base of Xena’s partnership
interest to reflect her share of 2018 partnership income.

Exam Exercise Solution Eighteen - 13 (Limited Partnership Losses)

The required calculations are as follows:

ACB Of Partnership Interest $235,000

Share Of Partnership Income For 2018 Nil

Subtotal $235,000

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Amounts Owed To The Partnership ($173,000)

Other Amounts Intended To

Reduce Investment Risk

(General Partner Guarantee) ( 62,000) ( 235,000)

At-Risk Amount - December 31, 2018 Nil

As the at-risk amount is nil, none of the loss can be deducted in 2018. The limited partnership loss at
the end of 2018 is 100 percent of the $81,400 loss allocation.

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Exam Exercise Solution Eighteen - 14 (Limited Partnership Losses)

The required calculations are as follows:

ACB Of Partnership Interest $450,000

Share Of Partnership Income For 2018 Nil

Subtotal $450,000

Amounts Owed To The Partnership ($200,000)

Other Amounts Intended To

Reduce Investment Risk

(General Partner Guarantee) ( 100,000) ( 300,000)

At-Risk Amount - December 31, 2018 $150,000

As the at-risk amount is $150,000, all of the $132,000 loss can be deducted in 2018. The limited
partnership loss at the end of 2018 is nil ($132,000 - $132,000).

Exam Exercise Solution Eighteen - 15

(Transfers From Partner To Partnership - No Rollover)
Part A Martha is considered to have disposed of the land for $180,000, resulting in a $60,300 [(1/2)
($180,000 - $59,400)] taxable capital gain. She is also considered to have made a capital contribution of
$180,000 that will be added to the ACB of her partnership interest. HP will be considered to have
acquired the land for $180,000.

Part B Martha will have the same $60,300 taxable capital gain as in Part A and HP will be considered
to have acquired the land for $180,000. The capital contribution and the addition to the ACB of the
partnership interest is $135,000. This is the difference between the fair market value of the land
transferred to HP of $180,000 and the $45,000 in other consideration received by Martha on the property
transfer.

Part C Martha will have the same $60,300 taxable capital gain as in Part A and HP will be considered
to have acquired the land for $180,000. No capital contribution is made. As Martha withdrew $21,600
($201,600 - $180,000) more from HP than she transferred in, Martha will be considered to have made a
net withdrawal. The ACB of her partnership interest will be reduced by $21,600.

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Exam Exercise Solution Eighteen - 16

(Transfers From Partner To Partnership - No Rollover)
Part A Ethan is considered to have disposed of the land for its fair market value of $220,000, resulting
in a taxable capital gain of $60,000 [(1/2)($220,000 - $100,000). This capital contribution will increase
the adjusted cost base of her partnership interest by $220,000. The adjusted cost base of the land to CP
will be $220,000.

Part B Ethan is considered to have disposed of the land for its fair market value of $220,000, resulting
in a taxable capital gain of $60,000 [(1/2)($220,000 - $100,000)]. However, as he has received $60,000
in cash, the adjusted cost base of his partnership interest will only be increased by $160,000 ($220,000 -
$60,000). The adjusted cost base of the land to CP will be $220,000.

Part C Once again, Ethan will have a taxable capital gain of $60,000 and CP will have acquired the
land for $220,000. However, as Ethan has received an amount in excess of the fair market value of the
land, there will be no increase in the adjusted cost base of his partnership interest. Rather, this value will
be reduced by the $30,000 ($250,000 - $220,000) excess of the cash payment over the fair market value
of the land. In effect, this $30,000 will be treated as a drawing.

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Exam Exercise Solution Eighteen - 17 (Transfers From Partnership To Partners)

ITA 98(2) deems Trident to have disposed of the debenture bonds for their fair market value of
$611,750, resulting in a $44,000 ($611,750 - $567,750) capital gain. One-tenth of the capital gain, or
$4,400, will be allocated to Lamar. One-half of this amount, or $2,200, will be a taxable capital gain
that he will include in his income for 2018. Lamar will also be considered to have acquired his share of
the debenture bonds for $61,175.
The adjusted cost base of his partnership interest on December 31, 2018 and on January 1, 2019 is
calculated as follows:

Partnership Adjusted Cost Base Prior To The Distribution$75,800

Drawings [(10%)($611,750)] ( 61,175)

Adjusted Cost Base - December 31, 2018 $14,625

Allocated Capital Gain [(10%)(($611,750 - $567,750)] 4,400

Adjusted Cost Base - January 1, 2019 $19,025

Exam Exercise Solution Eighteen - 18 (Transfers From Partnership To Partners)

The distribution will be treated as a disposition of the securities at their fair market value of $475,000.
This means that the Partnership will have a capital gain of $225,000 ($475,000 - $250,000). Of this
amount, $56,250 [(25%)($225,000)] will be allocated to Patricia. She will have a taxable capital gain of
$28,125 [(1/2)($56,250)] which will be included in her 2018 Net Income For Tax Purposes. The
adjusted cost base of the securities received will be $118,750 [(25%)($475,000)].
The adjusted cost base of her partnership interest on December 31, 2018 and on January 1, 2019 is
calculated as follows:

Partnership Adjusted Cost Base Prior To The Distribution$180,000

Drawings [(25%)($475,000)] ( 118,750)

Adjusted Cost Base - December 31, 2018 $ 61,250

Allocated Capital Gain [(25%)(($475,000 - $250,000)] 56,250

Adjusted Cost Base - January 1, 2019 $117,500

Exam Exercise Solution Eighteen - 19

(Transfers From Partner To Partnership - Rollover)
Using the ITA 85(1) rollover provision, the property would be transferred at the $146,000 ACB of the
land. Given this, the transfer would not result in any current income for Sol. The cost of the land to the
partnership would be the $146,000 elected value for the transfer. This same amount would be added to
the adjusted cost base of Sol’s partnership interest.

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Exam Exercise Solution Eighteen - 20

(Transfers From Partner To Partnership - Rollover)
Using the ITA 85(1) rollover provision, the property would be transferred at the $250,000 adjusted cost
base of the land. Given this, the transfer would not result in any current income for Sarah. The cost of
the land to the partnership would be the $250,000 elected value for the transfer. This same amount
would be added to the adjusted cost base of Sarah’s partnership interest.

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TIF Solution Eighteen - 5A

The correct definitions for each of the listed key terms are as follows:

A. 7

B. 9

C. 4

D. 8

E. 10

F. 3

G. 6

H. 1

The two unused definitions are as follows:

Joint Venture = 5

Limited Partner = 2

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TIF Solution Eighteen - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.
The correct definitions for each of the listed key terms listed below.

A. 10 (not 12)

B. 13 (not 2)

C. 5

D. 11

E. 14

F. 4 (not 8)

G. 7

H. 1

The three unused definitions are as follows:

Joint Venture = 6

Limited Partner = 3

Partnership = 9

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TIF Solution Eighteen - 6

Basis For Conclusion
The following three partnership elements must be met for a partnership to exist:

1. Is there a business?

2. Is the business carried on for profit?

3. Is the business carried on in common by two or more persons?

In both Cases, a business definitely exists. The partnership concept of a business is much broader than
that of the ITA. Any commercial undertaking will generally qualify. The repair business qualifies as a
business under partnership law.

Case A
Although there is a business being carried on for profit, a partnership does not exist in Case A. There
must be an intention to operate the business together. The existence of a partnership agreement, while
helpful, is not determinative since actions often speak louder than words. However, only John has made
real contributions to, and managed, the business. Furthermore, John does not hold himself out as a
partner or the business a partnership, as the bank accounts and the business registration is in his name
only.

Case B
It appears that Janet’s involvement in the repair business is significant enough that the “in common”
element is satisfied in Case B. Although the business is not yet profitable, there is a potential for profit.
In the initial or start-up years many businesses experience losses, yet profit expectations remain. As a
result, a partnership exists in Case B.

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TIF Solution Eighteen - 7

Part A - Income Inclusion

The calculation of the partnership’s Net Business Income for tax purposes that will be allocated is as
follows:

Net Business Income For Accounting Purposes (From Statement) $514,989

Additions:

Previous Year End Work-In-Process Nil

Amortization Expense 26,360

Business Meals And Entertainment [(1/2)($16,432)] 8,216

Charitable Donations 3,850

Interest On George’s Capital Contribution 4,780

Salaries To Partners ($60,000 + $40,000) 100,000 143,206

Subtotal $658,195

Deductions:

Current Year End Work-In-Process (See Note) ($27,010)

Maximum CCA ( 32,164) ( 59,174)

Net Business Income For Tax Purposes $599,021

Priority Allocations For Salary And Interest ($4,780 + $100,000) ( 104,780)

Residual To Be Allocated 65:35 $494,241

NOTE Reflecting the five year phase out of the billed basis of revenue recognition, for 2018,
only 80 percent of the unbilled work-in-process can be excluded from income. This amount is
$27,010 [(80%)($33,763)].

Additional inclusions related to partnership activities would be as follows:

Taxable Capital Gains [(1/2)($16,848)] $8,424

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Eligible Dividends Received 9,432

Gross Up [(38%)($9,432)] 3,584

Grossed Up Eligible Dividends $13,016

The total inclusion in each brother’s Net Income For Tax Purposes would be calculated as follows:

Mark George

Net Business Income To Be Allocated:

Priority Claim - Salaries $ 60,000 $ 40,000

Priority Claim - Interest 4,780

Mark [(65%)($494,241)] 321,257

George [(35%)($494,241)] 172,984

Taxable Capital Gains [(100%)($8,424)] 8,424

Grossed Up Eligible Dividends [(50%)($13,016)] 6,508 6,508

Inclusion In Net Income For Tax Purposes $387,765 $232,696

Part B - Tax Credits

Charitable Donations

Each of the brothers would be allocated $1,925 [(50%)($3,850)] of the charitable donations. This would
provide a federal tax credit of $530 [(15%)($200) + (29%)($1,925 - $200)] assuming this is their only
charitable donation and neither is eligible for the first-time super donor’s credit.

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Dividends

Each of the brothers will be allocated one-half of the eligible dividends. Given this, they will each have
a tax credit of $977 [(1/2)(38%)($9,432)(6/11)].

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TIF Solution Eighteen - 8

Part A - Income Inclusion

The calculation of the partnership’s Net Business Income is as follows:

Net Business Income (From Statement) $380,000

Additions:

Previous Year End Work-In-Process Nil

Amortization 32,000

Business Meals And Entertainment [(1/2)($14,000)] 7,000

Charitable Donations 13,000

Salaries To Partners [(2)($150,000)] 300,000 352,000

$732,000

Deductions:

Current Year End Work-In-Process (See Note) ($44,800)

Maximum CCA ( 41,000) ( 85,800)

Net Business Income $646,200

NOTE Reflecting the five year phase out of the billed basis of revenue recognition, for 2018, only
80 percent of the unbilled work-in-process can be excluded from income. This amount is $44,800
[(80%)($56,000)].

Additional inclusions related to partnership activities would be as follows:

Taxable Capital Gains [(1/2)($8,000)] $ 4,000

Eligible Dividends Received 16,000

Gross Up [(38%)($16,000)] 6,080

Total Other Sources Of Income $26,080

The total inclusion in each brother’s Net Income For Tax Purposes would be calculated as follows:

Sam Allen

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Net Business Income [(50%)($646,200)] $323,100 $323,100

Other Sources Of Income

Sam [(20%)($26,080)] 5,216

Allen [(80%)($26,080)] 20,864

Inclusion In Net Income For Tax Purposes $328,316 $343,964

Part B - Tax Credits

Charitable Donations

Each of the brothers would be allocated $6,500 [(50%)($13,000)] of the charitable donations. This
would provide a federal tax credit of $1,857 [(15%)($200) + (29%)($6,500 - $200)] assuming this is
their only charitable donation.

Dividends

As Sam was allocated only 20 percent of the dividends, his federal dividend tax credit will be $663
[(20%)(6/11)($6,080)].
Allen’s credit will be $2,653 [(80%)(6/11)($6,080)].

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TIF Solution Eighteen - 9

Part A - Net Business Income From The Partnership
As the problem requires the minimum business income, we can assume the partners use the ITA 34
election to report Taxable Income on a billed basis. Net Business Income from the partnership is as
follows:

Accounting Income For The Period $245,515

Additions:

Partners’ Salaries $174,000

Interest On Capital Contributions 5,000

Meals And Entertainment [(50%)($16,432)] 8,216 187,216

$432,731

Deductions:

Work In Progress (Note) ($132,094)

CCA:

Class 8 [(1/2)(20%)($41,300)] ( 4,130)

Class 50 [(1/2)(55%)($12,400)] ( 3,410)

Class 12 [(1/2)(100%)($9,600)] ( 4,800) ( 144,434)

Net Business Income $288,297

Priority Allocation For Salaries And Interest ($174,000 + $5,000) ( 179,000)

Residual To Be Allocated 50:50 $109,297

NOTE Reflecting the five year phase out of the billed basis of revenue recognition, for 2018,
only 80 percent of the unbilled work-in-process can be excluded from income. This amount is
$132,094 [(80%)($165,117)].

While the partnership agreement refers to salaries and interest, these amounts will be treated as business
income in the tax returns of the partners. The amount that would be included in each partner’s 2018
individual tax return would be calculated as follows:

Salary $ 87,000

Interest [(1/2)($5,000)] 2,500

Share Of Residual Partnership Income [(1/2)($109,297)] 54,649

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Total Business Income Allocation $144,149

Part B - Deductible Expenses Incurred Personally

The partners may also be able to deduct the following expenses, if they have incurred them personally:

 Any interest expense related to financing their capital contribution of $50,000 each.

 The business portion of any car expenses.

 Any promotion expenses, subject to the 50 percent limitation on meals and entertainment.

 Despite paying rent at the partnership level, there could be expenses for an 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.

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Part C - ACB Of Partnership Interest

The ACB of each partnership interest is as follows:

Capital Contribution $ 50,000

Drawings ($87,000 + $2,500) ( 89,500)

Negative ACB - December 31, 2018 ($ 39,500)

Allocation Of Partnership Income For 2018 144,149

ACB - January 1, 2019 $104,649

The Income Tax Act allows general partners to carry forward a negative ACB, without taking the capital
gain into income as is required in most circumstances. This deferral is applicable until the partner
disposes of his interest, either through a sale or as the result of a deemed disposition at death.

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TIF Solution Eighteen - 10

Matt’s Federal Tax Payable
The Net Business Income of the partnership would be calculated as follows:

Operating Income $549,000

Additions:

Amortization Expense $12,000

One-Half Meals And Entertainment 11,500

Charitable Donations 17,000 40,500

Deductions:

CCA ( 19,000)

Net Business Income $570,500

Matt’s Taxable Income and share of charitable donations for the year ending December 31, 2018 would
be calculated as follows:

Partnership Share Taxable Income

Partnership Business Income $570,500 1/2 $285,250

Taxable Capital Gain [(1/2)($14,000)] 7,000 1/2 3,500

Partnership Dividends Received 8,000 1/2 4,000

Dividends Received Personally N/A 34,000

Gross Up On Dividends Received

[(38%)($4,000 + $34,000)] N/A 14,440

Taxable Income $341,190

Charitable Donations $17,000 1/2 $8,500

Based on the preceding calculations, Matt’s 2018 federal Tax Payable would be as follows:

Tax On The First $205,842 $47,670

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Tax On Additional $135,348 ($341,190 - $205,842)] At 33% 44,665

Tax Payable Before Credits $92,335

Basic Personal Credit [(15%)($11,809)] ( 1,771)

Dividend Tax Credit [(6/11)($14,440)] ( 7,876)

Charitable Donations (See Note) ( 2,769)

Federal Tax Payable $79,919

Note The charitable donations tax credit would be calculated as follows:

[(15%)(A)] + [(33%)(B)] + [(29%)(C)], where

A =$200

B =The Lesser Of:

 $8,500 - $200 = $8,300

 $341,190 - $205,842 = $135,348

C = Nil [$8,500 - ($200 + $8,300)]

The charitable donation credit would be equal to $2,769, calculated as [(15%)($200)] + [(33%)
($8,300)].

Taxable Capital Gain From Sale Of Partnership Interest

The adjusted cost base of Matt’s partnership interest on January 1, 2019 would be calculated as follows:

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Partnership Share ACB

Capital Contribution N/A $280,000

2017 Partnership Business Income $180,000 1/2 90,000

2017 Drawings N/A ( 23,000)

2018 Drawings N/A ( 290,000)

December 31, 2018 $ 57,000

2018 Partnership Business Income $570,500 1/2 285,250

2018 Capital Gain 14,000 1/2 7,000

2018 Partnership Dividends Received 8,000 1/2 4,000

2018 Charitable Donations ( 17,000) 1/2 ( 8,500)

January 1, 2019 Adjusted Cost Base $344,750

Given this calculation, the taxable capital gain on Matt’s sale of the partnership interest would be
calculated as follows:

Proceeds Of Disposition $535,000

Adjusted Cost Base ( 344,750)

Capital Gain $190,250

Inclusion Rate 1/2

Taxable Capital Gain $ 95,125

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TIF Solution Eighteen - 11

Part A - Adjusted Cost Base
The adjusted cost base of Larry’s partnership interest would be calculated as follows:

Initial Capital Contribution $180,000

Additional Capital Contribution 70,000

Total Capital Contribution $250,000

Drawings ( 48,000)

Net Business Income [(1/3)($209,114)] 69,705

Capital Gains To Curly And Larry [(50%)($16,534)] (Note) 8,267

Dividends To Moe N/A

Charitable Donations [(1/3)($7,260)] ( 2,420)

Adjusted Cost Base - January 1, 2019 $277,552

Note Only the taxable one-half of the capital gain is included in the partner’s income on the
flow through of capital gains realized by a partnership. However, the remaining one-half is
included in the assets of the partnership and, in the absence of a special provision to deal with
this situation, the realization of this amount would be added to any capital gain realized on the
disposition of the partnership interest. Given this, the full amount of Larry’s share of realized
capital gains is added to the partnership adjusted cost base.

Part B - Taxable Capital Gain On Disposition

Given the preceding calculation, the gain on the disposition of the partnership interest can be calculated
as follows:

Proceeds Of Disposition $300,000

Adjusted Cost Base:

From Preceding Calculation ($277,552)

Legal And Accounting Fees ( 1,500) ( 279,052)

Capital Gain $ 20,948

Inclusion Rate 1/2

Taxable Capital Gain $ 10,474

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This amount would be included in Larry’s Net Income For Tax Purposes for 2019 as a taxable capital
gain. He would not include any partnership income for January as he was not allocated any of this
income.

Part C - Effect On Other Partners

The fact that each partner paid $150,000 to Larry in return for one-half of his interest means that both
Moe and Curly would have a $150,000 increase in the adjusted cost base of their partnership interests.

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TIF Solution Eighteen - 12

Note We would remind you that in calculating the adjusted cost base of the partnership interest, a
partner’s share of either a loss or a gain is not added until the first day of the following taxation year.

At-Risk Amount On December 31, 2018

Adjusted Cost Base - December 31, 2018 $65,000

Add: Share Of Partnership Income (Not Losses) For 2018

[(12%)($63,000 + $31,000 + $53,000)] 17,640

Subtotal $82,640

Amounts Owed To The Partnership

($65,000 - $5,000 - $10,000) ($50,000)

Other Amounts That Reduce Risk ( 5,000) ( 55,000)

At-Risk Amount - December 31, 2018 $27,640

As the agreement effectively guarantees a value of no less than $5,000, even if the market value of the
partnership interest is nil, this amount is not at risk and reduces the at-risk amount.

Limited Partnership Loss For The Year

Share Of 2018 Partnership Business Loss [(12%)($510,000)] ($61,200)

At-Risk Amount - December 31, 2018 27,640

Limited Partnership Loss For 2018 ($33,560)

Deductible Loss For The Year

Share Of 2018 Partnership Business Loss [(12%)($510,000)] ($61,200)

Limited Partnership Loss For 2018 33,560

Deductible Loss For 2018 ($27,640)

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Limited Partnership Loss Carry Forward

There is a limited partnership loss carry forward of $33,560 at the end of 2018.

Adjusted Cost Base

The share of partnership income that is added to the at-risk amount is the amount that will be added to
the ACB. It does not include the dividend gross up and it is not reduced by the non-taxable half of the
capital gain.

Adjusted Cost Base - December 31, 2018 $65,000

Share Of Partnership Income For 2018

[(12%)($63,000 + $31,000 + $53,000)] 17,640

Loss Deducted For 2018 ( 27,640)

Adjusted Cost Base - January 1, 2019 $55,000

At Risk Amount On January 1, 2019

As of January 1, 2019, the at-risk amount would be nil ($27,640 - $27,640).

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TIF Solution Eighteen - 13

2018 Results

The required amounts would be calculated as follows:

ACB Of Partnership Interest - December 31, 2018 $150,000

Add: Share Of 2018 Partnership Income (Not Loss)

[(30%)($50,000)] 15,000

Subtotal $165,000

Amounts Owed To The Partnership ( 100,000)

Other Amounts That Reduce Risk ( 60,000)

At-Risk Amount - December 31, 2018 $ 5,000

Share Of 2018 Loss [(30%)($975,000) ($292,500)

At-Risk Amount - December 31, 2018 5,000

Limited Partnership Loss - December 31, 2018 ($287,500)

Share Of 2018 Loss [(30%)($975,000) ($292,500)

Limited Partnership Loss - December 31, 2018 287,500

Deductible Loss For 2018 ($ 5,000)

There is a limited partnership loss carry forward of $287,500 ($292,500 - $5,000).

2019 Results

ACB Of Partnership Interest - December 31, 2018 $150,000

2018 Capital Gain 15,000

Loss Deducted For 2018 ( 5,000)

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ACB Of Partnership Interest - January 1, 2019 $160,000

Add: Share Of 2019 Partnership Income (Not Loss) Nil

Subtotal $160,000

Amounts Owed To The Partnership Nil

Other Amounts That Reduce Risk ( 60,000)

At-Risk Amount - December 31, 2019 $100,000

Share of 2019 Loss [(30%)($180,000)] ($ 54,000)

Limited Partnership Loss Carry Forward ( 287,500)

At-Risk Amount - December 31, 2019 100,000

Limited Partnership Loss - December 31, 2019 ($241,500)

Share of 2019 Loss [(30%)($180,000)] ($ 54,000)

Limited Partnership Loss Carry Forward ( 287,500)

Limited Partnership Loss - December 31, 2019 241,500

Deductible Loss For 2019 ($100,000)

This will leave a limited partnership loss carry forward of $241,500 ($287,500 + $54,000 - $100,000).

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2020 Results

ACB Of Partnership Interest - December 31, 2019 $160,000

Loss Deducted For 2019 ( 100,000)

ACB Of Partnership Interest - January 1, 2020 $ 60,000

Add: Share Of 2020 Partnership Income Nil

Subtotal $ 60,000

Amounts Owed Partnership Nil

Other Amounts That Reduce Risk Nil

At Risk Amount - December 31, 2020 $ 60,000

Limited Partnership Loss Carry Forward ($241,500)

At-Risk Amount - December 31, 2020 60,000

Limited Partnership Loss - December 31, 2020 ($181,500)

Limited Partnership Loss Carry Forward ($241,500)

Limited Partnership Loss - December 31, 2020 181,500

Deductible Loss For 2020 ($ 60,000)

This will leave a limited partnership loss carry forward of $181,500 ($241,500 - $60,000).

Economic Analysis The following calculations will serve to explain the results that have been
calculated in the preceding table:

2018 Loss [(30%)($975,000)] $292,500

2019 Loss [(30%)($180,000)] 54,000

Total Loss For 2018 Through 2020 $346,500

2018 Investment ( 50,000)

2018 Capital Gain [(30%)($50,000)] ( 15,000)

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2019 Investment ( 100,000)

Undeducted Loss Carry Forward $181,500

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TIF Solution Eighteen - 14

Part A - Adjusted Cost Base Of Consideration
Cash The ACB of the cash would be its face value. These amounts would be $620,000 for Howard,
$377,000 for Jones, and $203,000 for Delaney.

ACB Of Preferred Shares With respect to the preferred shares received, ITA 85(3)(e) indicates that
their ACB will be the lesser of:

 Their fair market value, which would be $300,000 for each of the three partners.

 The ACB of their partnership interests, reduced by the amount of non-share consideration
received.

This latter value would be calculated as follows for the three partners:

Howard Jones Delaney

ACB $1,173,000 $930,000 $756,000

Cash Received ( 620,000) ( 377,000) ( 203,000)

Balance $ 553,000 $553,000 $553,000

For all three partners, the lower figure is the fair market value of $300,000, therefore this would be the
ACB of the preferred shares.

ACB Of Common Shares Under ITA 85(3)(f), the ACB of the common shares would be the ACB of
the partnership interest, less the value of the non-share consideration received and the value assigned to
the preferred shares. These amounts would be calculated as follows:

Howard Jones Delaney

ACB - Partnership Interest $1,173,000 $930,000 $756,000

Cash Received ( 620,000) ( 377,000) ( 203,000)

ACB - Preferred Shares ( 300,000) ( 300,000) ( 300,000)

ACB Of Common Shares $ 253,000 $253,000 $253,000

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Part B - Capital Gain Or Loss

As the non-share consideration had a value that was less than the value of the assets transferred, there
will be no immediate gain or loss on this rollover. This can be demonstrated with the following
calculation:

Howard Jones Delaney

Proceeds Of Disposition:

Cash $ 620,000 $377,000 $203,000

Preferred Shares 300,000 300,000 300,000

Common Shares 253,000 253,000 253,000

Total Proceeds $1,173,000 $930,000 $756,000

ACB ( 1,173,000) ( 930,000) ( 756,000)

Capital Gain (Loss) Nil Nil Nil

From an economic point of view the gain is still present. We have deferred recording it for tax purposes
by placing a value on the common shares of $759,000 [(3)($253,000)]. This is $1,041,000 below their
current fair market value of $1,800,000. Note that $1,041,000 is also the difference between the
$3,900,000 fair market value of the total consideration given and the $2,859,000 value for the total ACB
of the partnership interests.

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TIF Solution Eighteen - 15

Shelly’s Federal Tax Payable
The Net Business Income of the partnership would be calculated as follows:

Operating Income $424,000

Additions:

Amortization Expense $ 9,000

One-Half Meals And Entertainment 5,500

Charitable Donations 23,000 37,500

Deductions:

CCA ($14,000)

Unbilled Work In Progress (See Note) ( 57,600) ( 71,600)

Net Business Income $389,900

NOTE Reflecting the five year phase out of the billed basis of revenue recognition, for 2018,
only 80 percent of the unbilled work-in-process can be excluded from income. This amount is
$57,600 [(80%)($72,000)]

Shelly’s Taxable Income and share of charitable donations would be calculated as follows:

Partnership Share Taxable Income

Partnership Business Income $389,900 1/2 $194,950

Taxable Capital Gain [(1/2)($6,000)] 3,000 1/2 1,500

Partnership Dividends Received 13,000 1/2 6,500

16% Gross Up On Dividends Received N/A 1,040

Taxable Income $203,990

Charitable Donations $23,000 1/2 $11,500

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Based on the preceding calculation, Shelly’s federal Tax Payable would be calculated as follows:

Tax On The First $144,489 $29,877

Tax On Additional

$59,501 ($203,990 - $144,489) At 29 Percent 17,255

Tax Payable Before Credits $47,132

Basic Personal Credit [(15%)($11,809)] ( 1,771)

Dividend Tax Credit [(8/11)($1,040)] ( 756)

Charitable Donations Credit (See Note) ( 3,307)

Federal Tax Payable $41,298

Note As none of Shelly’s Taxable Income is in the 33 percent bracket, that rate is not relevant
to the determination of the charitable donations tax credit. Given this, the credit is $3,307
[(15%)($200) + (29%)($11,500 - $200)].

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Taxable Capital Gain From Sale Of Partnership Interest

The adjusted cost base of Shelly’s partnership interest on January 1, 2019 would be calculated as
follows:

Partnership Share ACB

Capital Contribution N/A $235,000

2017 Partnership Business Income $225,000 1/2 112,500

2017 Drawings N/A ( 72,000)

2018 Drawings N/A ( 187,000)

December 31, 2018 $ 88,500

2018 Partnership Business Income $389,900 1/2 194,950

2018 Capital Gain 6,000 1/2 3,000

2018 Partnership Dividends Received 13,000 1/2 6,500

2018 Charitable Donations ( 23,000) 1/2 ( 11,500)

January 1, 2019 Adjusted Cost Base $281,450

Given this calculation, the taxable capital gain on Shelly’s sale of the partnership interest would be
calculated as follows:

Proceeds Of Disposition $435,000

Adjusted Cost Base ( 281,450)

Capital Gain $153,550

Inclusion Rate 1/2

Taxable Capital Gain $ 76,775

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Chapter Nineteen Test Item File Solutions

TIF Solution Nineteen - 1

1. The roles of these persons can be described as follows:

 The settlor is the person who contributes assets to the trust.

 The trustee is the person who manages the trust. This would normally include the selection of
investments as well as implementing other provisions of the trust agreement (e.g., distributions
to beneficiaries).

 A beneficiary is a person who will receive the capital or income benefits that are distributed by
the trust.

2. This characteristic is of particular importance in the case of deceased individuals. Property

distributions made in a deceased person’s will can be challenged by a disgruntled beneficiary. A
surviving spouse can re-direct assets after they have been bequeathed. The use of a trust makes
challenges or variances for the deceased’s wishes much more difficult.

3. From a general legal perspective, a trust is not a separate entity. However, for tax purposes, the
Income Tax Act deems that a trust is deemed to be an individual. This means that a trust will have a
Net Income For Tax Purposes, Taxable Income, and Tax Payable, all of which must be included in
a separate tax return.

4. When an individual dies and bequeaths his property through a will, immediate distribution of all of
his property may not be possible. During the period between an individual’s death and the time that
all of his property is distributed to his beneficiaries, it is possible that some income will accrue on
the estate property held by the executor. The deceased person’s income to the date of death will be
included in his final tax return. However, the income earned by the estate during the period that it is
administered by the executor cannot be allocated to either the deceased person or to his
beneficiaries directly. To solve this problem, the Act requires that the income of the estate be
included in a trust return (T3). As the rules for filing a return for this “estate” are the same as those
applicable to a trust, the Act treats these two terms as synonyms.

5. As described in the CRA’s Trust Guide, the three characteristics that must be established with
certainty are:

1. the intent on the part of the settlor to create a trust;

2. the identity of the property to be placed in the trust; and

3. the identity of the beneficiary or beneficiaries of the trust.

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6. While there are several other possibilities, the ones that are described in the Chapter are as follows:

Administration Of Assets A trust can be used to provide for administration of assets by someone
other than the beneficiary.

Protection From Creditors A trust can be used to protect assets from the claims of creditors.

Privacy Assets that are in a trust when an individual dies, or placed in a testamentary trust as the
result of the individual’s death, are not subject to probate, a process where the results are available
to the public.

Avoiding Changes In Beneficiaries As trusts are difficult to change, placing assets in a trust
ensures that they will ultimately be given to the intended beneficiaries.

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7. As defined in the Income Tax Act, a personal trust is either a testamentary trust or, alternatively, an
inter vivos trust in which no beneficial interest was acquired by paying consideration to either the
trust or the settlor of the trust.

8. The basic model treats the various participants as follows:

Settlor The transfer of property to the trust is, in general, considered to be a disposition. Possible
tax consequences include capital gains, capital losses, recapture, and terminal losses. There are
rollovers available for certain types of trusts such as alter ego trusts.

Trust Income that is left in the trust is, in general, subject to tax at the maximum 33 percent federal
tax rate that is applicable to individuals. The major exception to this general rules is a Graduated
Rate Estate (GRE). GREs can use the same graduated rate schedule that is applicable to
individuals. To the extent that this income is distributed to beneficiaries, it will be taxed in the
hands of these individuals and deducted in determining the Taxable Income of the GRE.

Beneficiaries The beneficiaries are, in general, taxed on income that distributed by the trust.
Capital property, in general, is distributed by the trust to beneficiaries at the trust’s tax cost.

9. The term testamentary trust refers to a trust that arises upon, and as a consequence of, the death of
an individual. In contrast, an inter vivos trust refers to any personal trust other than a testamentary
trust. Stated alternatively, an inter vivos (Latin for “among the living”) trust is a trust created
during the lifetime of the settlor.

For inter vivos trusts and most testamentary trusts, the Tax Payable on all of the income that is left
in the trust is calculated using the 33 percent maximum federal rate that is applicable to individuals.
However, estate assets that have not been transferred to beneficiaries can be designated as a
Graduated Rate Estate (GRE). Such GREs will calculate Tax Payable using the schedule of
graduated rates used by individuals. A GRE may continue for up to 36 months after the individual
whose estate assets are included has died.

10. For a trust to be classified as a qualifying spousal trust, the following conditions must be met:

 The transferor’s spouse is entitled to receive all of the income of the trust arising before the
spouse or common-law partner’s death.

 No person other than the spouse may receive or benefit from any of the income or capital of the
trust, prior to the death of the spouse or common-law partner.

The major tax advantage of a spousal trust over other types of trusts is the fact that property can be
transferred to this type of trust on a rollover basis. That is, the transfer will be recorded at tax
values with no tax consequences accruing to the settlor.

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The two significant non-tax reasons for using a qualifying spousal trust are:

 The trust can provide for the appropriate management of the transferred assets, particularly
when these assets include an active business.

 The trust can ensure that the assets are distributed in the manner desired by the settlor. While
qualification requires that the transferred assets must “vest indefeasibly” with the spouse, the
trust document can specify who the assets should be distributed to after the spouse or common-
law partner dies. This could ensure, for example, that the assets are ultimately distributed only
to the settlor’s children if the spouse has remarried.

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11. The following conditions must be met in order to establish an alter ego trust:

 The settlor must be 65 years of age or over.

 The settlor is entitled to receive all of the income of the trust that arises during the settlor’s
lifetime.

 No person other than the settlor can receive or make use of the capital or income of the trust
during the settlor’s lifetime.

The major tax advantage of these arrangements is that assets can be transferred into such trusts on a
tax free basis. An additional tax feature is the possibility of establishing the trust in a low tax rate
province, thereby minimizing the taxes that will arise at the time of death.

With respect to the non-tax advantage of such arrangements, the basic feature is that the assets in
the trust will not be part of the settlor’s estate at the time of death. This means that these assets will
not have to go through the probate process, a process that can be both costly and time consuming.

12. There are two major reasons why an individual might elect out of the rollover provision that is
available on transfers to a joint spousal trust. The first is that he may have accumulated loss carry
forwards or anticipates capital losses that could be used to eliminate the capital gains on the assets
transferred. The second is that the transferred assets may include a property that qualifies for the
lifetime capital gains deduction. If this is the case, that deduction could be used to eliminate all or
part of the taxation that arises on the transfer.

13. In general, ITA 107(2) provides a tax free rollover of trust assets to a capital beneficiary. That is,
the proceeds to the trust are deemed to be the trust’s tax cost (i.e., adjusted cost base or UCC), with
this amount also being recorded by the recipient beneficiary. The major exceptions to this rollover
are as follows:

 Transfers from a qualifying spousal or common-law partner trust to anyone other than a spouse
or common-law partner.

 Transfers from an alter ego trust to anyone other than the individual who settled the trust.

 Transfers from a joint spousal or common-law partner trust to anyone other than the settlor or
the spouse or common-law partner.

In the case of these exceptions, the transfer will be recorded by the trust and the beneficiary at fair
market value, usually resulting in a gain or loss in the trust.

14. This rule requires that there be a deemed disposition and reacquisition of trust capital property every
21 years. The disposition is deemed to be at fair market value, resulting in the recognition of any
accrued gains on the assets. Like corporations, trusts have an unlimited life. In the absence of this
rule, capital gains could accrue for an unlimited period of time inside the trust. This rule is
designed to limit the accrual period.

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15. The preferred beneficiary election is only available if:

 the beneficiary is claiming the disability tax credit; or

 the beneficiary is 18 years of age or older, is claimed by another individual as a dependant,

and does not have income that exceeds the base for the beneficiary’s personal tax credit.

As such individuals usually have very little income, the objective of this provision is to allow the
relevant amounts to be taxed at low rates, while not transferring the funds to an individual who
might not be able to use them in an appropriate manner (e.g., a mentally infirm child).

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16. The text describes two reasons for making such a designation:

Instalment Avoidance While there is a legislative requirement that inter vivos trusts and
testamentary trusts, other than those designated graduated rate estates, pay instalments, it appears
that the CRA will waive these requirements on an administrative basis.

Use Of Trust Losses A trust cannot allocate losses to beneficiaries. This means that the only way
that an unused current year trust loss can be used is through a carry over to another year. With
many trusts, this cannot happen under normal circumstances because they are required to distribute
all of their income to beneficiaries, resulting in a nil Net Income For Tax Purposes. A solution to
this problem is to designate sufficient income as having not been paid to absorb the loss carry
forward. This can satisfy the legal requirement to distribute the income, while simultaneously
creating sufficient Net Income For Tax Purposes to utilize the loss carry forward to save the
beneficiaries taxes.

Prior to 2016, this provision could be used to lower tax rates. This would be the case when the tax
rate applicable to the trust income was lower than the rate applicable to the relevant beneficiary.
However, as of 2016, this provision can only be used to eliminate trust losses. It cannot be used to
create positive amounts of Taxable Income in the trust.

17. A discretionary trust is one in which the trustees are given the power to decide the amounts that will
be allocated to each of the beneficiaries, usually on an annual basis. In contrast, a non-discretionary
trust is one in which the amounts and timing of allocations to income and capital beneficiaries are
specified in the trust agreement.

18. If the trust distributes all of the capital gain to a beneficiary, there will be no tax consequences for
the trust. The beneficiary will be taxed on one-half of the capital gain.

If the trust does not distribute the gain, one-half will be subject to tax within the trust, with the
remaining one-half becoming part of the trust’s capital balance. As part of the capital balance, this
one-half of the gain can be distributed on a tax free basis to beneficiaries.

19. The income paid to the widow and son will be taxed in their hands in the year paid and will be
deductible to the trust.

For the first 36 months after the decedent’s death, the earnings that are accumulating in the GRE
will be taxed in the trust using the same schedule of progressive rates that is applicable to
individuals. After that period, any income that remains in the trust will be taxed at the maximum
federal rate of 33 percent that is applicable to individuals.

There is no income attribution to deceased individuals.

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20. If a trust is considered to be reversionary, any income generated by property that the settlor has
transferred to the trust will be attributed to him, rather than to the intended beneficiaries. This
would include capital gains resulting from a disposition of trust property.

21. While the term is not defined in the Income Tax Act, the term is usually applied to a personal trust
that has been established with members of the settlor’s family as beneficiaries. The usual objective
of such trusts is income splitting.

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22. The required three can be selected from the following that were described in the text:

Intent Of The Testator The foremost goal of estate planning is to ensure that the wishes of
the testator (a person who has died and left a will) are carried out. This will involve ensuring
that the assets left by the testator are distributed at the appropriate times and to the specified
beneficiaries.

Preparation Of A Final Will The major document in the estate planning process is the final
will. It should be carefully prepared to provide detailed instructions for the disposition of
assets, investment decisions to be made, and the extent to which trusts will be used.

Preparation Of A Living Will Equally important to the preparation of a final will, a living
will provides detailed instructions regarding investments and other personal decisions in the
event of physical or mental incapacity at any point in a person’s lifetime.

Ensuring Liquidity A plan should be established to provide for liquidity at the time of death.

Simplicity While the disposition of a large estate will rarely be simple, effective estate
planning should ensure that the plan can be understood by the testator and all beneficiaries of
legal age.

Avoidance Of Family Disputes If equitable treatment of beneficiaries is a goal of the testator,

efforts should be made to ensure that all beneficiaries believe that they have been treated in an
equitable manner.

Expediting The Transition The procedures required in the settlement of an estate should be
designed to expedite the process.

22. The two major disadvantages are as follows:

 If the current market value of the property exceeds its tax value, a gift will be treated as a
disposition, resulting in the creation of Taxable Income at the time of the gift.

 If the property is an ongoing business, the individual making the gift will lose control of the
property.

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TIF Solution Nineteen - 2

1. False.

The trustee(s) hold the formal legal title to the trust property.

2. True.

3. False.

While it is generally advisable to have a trust agreement in writing, oral agreements can be
used to establish a trust.

4. True.

5. True.

6. False.

Only individuals who are 65 or older can establish an Alter Ego trust.

7. False.

There are several rollovers that can be used to transfer assets at tax value (e.g., transfers to a
spousal trust).

8. True.

Such transfers are usually made at the trust’s tax cost. An exception would be a transfer of
assets out of an Alter Ego trust to someone other than the settlor.

9. False.

All of the income of an inter vivos trust is taxed at the maximum federal rate of 33 percent.

10. True.

11. False.

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While the identity of the beneficiaries is an essential characteristic, their respective income
allocations are not.

12. True.

13. False.

They are taxed at a flat rate of 33 percent at the federal level.

14. False.

Both income and capital gains will be attributed back to the spouse who is the settlor.

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TIF Solution Nineteen - 3

Basic Concepts
1. D. Amounts earned in these trusts are not subject to the income attribution rules.

2. B. The individual beneficiaries must be named. Naming individual beneficiaries is not

necessary as long as the beneficiaries are members of an identifiable group (e.g., the settlor’s
children).

3. B. The trustee will hold formal legal title to the trust property.

4. B. The trust return is due 90 days after the trust’s year end.

Classification Of Trusts
5. A. 1, 2 and 4

6. C. A trust can be used to avoid the income attribution rules applicable to a spouse. In
general, it is not possible to avoid the income attribution rules by transferring assets to a trust in
favour of a spouse.

7. B. A spousal trust created to benefit a spouse.

8. D. An alter ego trust.

9. B. The settlor must be 65 years of age or older. There is no age requirement for the
settlor.

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10. D. When assets are transferred out of an alter ego trust to anyone other than the settlor,
the proceeds of disposition to the trust will be the fair market value of the assets transferred.

Taxation Of Trusts
11. C. Martin will report a taxable capital gain of $65,000 [(1/2)($300,000 - $170,000)]. The
trust will have no income. Shorty will report dividends received of $21,000 which must be
grossed up and will claim the dividend tax credit.

12. B. Anika should transfer the property to a common-law partner trust.

13. A. In 2017, a rollover would allow Diego to transfer his property to the trust tax free. In
2018, when the trust transfers the property to his son, the trust will include a taxable capital
gain of $200,000 [(1/2)($800,000 - $400,000)] in income as it is an alter ego trust.

14. B. In 2017, there will be no rollover available, and Emilio will include a taxable capital
gain of $175,000 [(1/2)($750,000 - $400,000)] in income. In 2018, when the trust transfers the
property to his daughter, there will be a rollover available, and the trust will not report any
income.

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Net Income For Tax Purposes Of A Trust

15. E. Items B and C.

16. C. The difference between the fair market value and the cost of assets transferred to a
capital beneficiary. While there are some exceptions to this, such transfers are recorded at tax
values and do not generate any income for the trust.

17. C. $15,800. This would be calculated as follows:

Dividends Received $20,000

Gross-Up On Dividends [($20,000)(38%)] 7,600

Interest Income ($10,000 - $5,000) 5,000

Interest Expense ( 1,000)

Taxable Income - Trust $31,600

Mrs. Allen’s Percentage 50%

Taxable Income - Mrs. Allen $15,800

18. B. $13,000. [$8,000 + $5,000]

19. C. A trust can deduct amounts allocated to, but not distributed to, a preferred beneficiary.

Income Allocations To Beneficiaries

20. A. $69,000 [(138%)($50,000)]

21. A. $249,000. This would be calculated as follows:

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Non-eligible dividends received $200,000

Gross-Up on Non-eligible Dividends [($200,000)(17%)] 34,000

Taxable capital gain [(1/2)($30,000)] 15,000

Income Increase $249,000

Tax Payable Of Personal Trusts

22. D. Charitable donation tax credit = [(15%)($200) + (33%)($14,800)] = $4,914

Trust TP = [(33%)($150,000 - $105,000) - $4,914 = $9,936

23. B. The Taxable Income is the same amount for Maria and the Meryk trust.

Income Attribution
24. C. Any capital gains that are retained in the trust will not be attributed back to Mr. Holt.

25. A. Mandeep will have a taxable capital gain of $77,500 and will have attributed interest
income of $7,000.

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Purchase Or Sale Of An Interest In A Trust

26. D. Tim has acquired a capital interest in the trust with an adjusted cost base of
$1,050,000. Jerry will report a taxable capital gain of $337,500 {[1/2][$1,050,000 - (50%)
($750,000)]}.

27. A. Aida has acquired a capital interest in the trust, and her ACB will be $350,000.
Fatima will report a taxable capital gain of $112,500. {[1/2][$350,000 – (50%)($250,000)]}

Tax Planning
28. B. $9,871 [(33%)($45,000) – (15%)($45,000 - $11,809)]

29. B. $8,971 [(33%)($40,000) – (15%)($40,000 - $11,809)]

30. C. The trust will be subject to lower tax rates, and can be used to split income with the
settlor.

Estate Freeze
31. B. The use of Section 85 to implement the estate freeze can avoid immediate tax
consequences.

32. B. To allow future appreciation in a valuable asset or assets to appreciate for the benefit
of specific related parties.

33. B. A transfer of capital assets with accrued gains to a corporation using ITA 85.

34. B. The use of ITA 85 does not require a corporation to be in place prior to the freeze.

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TIF Solution Nineteen - 4

Exam Exercise Solution Nineteen - 1 (Establishing A Trust)

Case A While Martin has signed the agreement, it does not appear that the property has been
transferred. This means that no trust has been created.

Case B “Prison inmates in Virginia” cannot be considered to be an identifiable class. As a

consequence, there is no certainty as to beneficiaries and no trust would be created by her transfer.

Case C While Ms. Morgan has transferred property, it is not clear that her intention was to create a
trust. No trust would be created by this transfer.

Exam Exercise Solution Nineteen - 2 (Basic Taxation Of Trusts)

With respect to Jerry’s transfer of his securities to the trust, the transaction would be deemed to take
place at fair market value. This would result in a taxable capital gain to Jerry of $25,000 [(1/2)
($570,000 - $520,000)]. There would be no tax consequences to James or the trust as a result of this
transfer.
As the trust distributed all of its income during the year, none of the interest would be taxed in the trust.
All of the interest would be included in James’ income and, because he is an adult, there would be no
income attribution to Jerry.
Under ITA 107(2), the transfer from the trust to James on January 1, 2019 would take place at the trust’s
tax cost of $570,000. There would be no tax consequences for Jerry, James, or the trust as a result of
this transfer. However, as James’ adjusted cost base is $570,000, the sale at the fair market value of
$615,000 would result in a taxable capital gain of $22,500 [(1/2)($615,000 - $570,000)].

Exam Exercise Solution Nineteen - 3

(Basic Taxation Of Trusts With Income Attribution)
When Martha transfers the securities to the trust in 2018, she will recognize a taxable capital gain of
$75,000 [(1/2)($500,000 - $350,000)].
With respect to the eligible dividends, as Jane is under 18 years of age, they will be attributed back to
Martha. This will result in an income inclusion of $69,000 [($50,000)(138%)] and provide Martha with
a federal dividend tax credit of $10,364 [(6/11)(38%)($50,000)].
The securities will be transferred to Jane at an adjusted cost base of $500,000. This means that, when
she sells them, she will record a taxable capital gain of $25,000 [(1/2)($550,000 - $500,000)]. Note that
there is no income attribution of the capital gains.

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Exam Exercise Solution Nineteen - 4 (Transfer To Common-Law Partner Trust)

As there is a rollover available on transfers to a qualifying common-law partner trust, the accrued
$303,000 gain ($723,000 - $420,000) will not be recognized until his common-law partner or the
common-law partner trust eventually disposes of the portfolio. The common-law partner trust acquires
the portfolio at an adjusted cost base of $420,000, which will be David’s adjusted cost base if the trust
transfers the portfolio to him.

Exam Exercise Solution Nineteen - 5 (Transfer To Common-Law Partner Trust)

As a rollover is available on transfers to a qualifying common-law partner trust, there would be no tax
consequences for Lara at the time of the transfer. However, the adjusted cost base of the securities in
the trust would be $675,000, Lara’s adjusted cost base.
The securities would be transferred out of the trust to Portia at the same $675,000 value. This means
that when she sells the securities for $950,000, she will have a taxable capital gain of $137,500 [(1/2)
($950,000 - $675,000)].

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Exam Exercise Solution Nineteen - 6 (Transfers To Trusts)

In those cases where a taxable capital gain will be recognized at transfer, the amount of the gain will be
$200 [(1/2)($2,500 - $2,100)].

Taxable Capital Adjusted Cost

Scenario Gain (Settlor) Base (Trust)

1. Inter vivos trust for adult child $200 $2,500

2. Testamentary spousal trust Nil 2,100

3. Joint common-law partner trust Nil 2,100

4. Inter vivos qualifying spousal trust Nil 2,100

5. Inter vivos trust for minor child 200 2,500

6. Testamentary trust for friend 200 2,500

7. Alter ego trust Nil 2,100

Exam Exercise Solution Nineteen - 7 (Transfers To Trusts)

In those cases where a taxable capital gain will be recognized at transfer, the amount of the gain will be
$5,000 [(1/2)($30,000 - $20,000)].

Taxable Capital Adjusted Cost

Scenario Gain (Settlor) Base (Trust)

1. Joint spousal trust Nil $20,000

2. Inter vivos trust for business partner $5,000 30,000

3. Testamentary trust for 22 year old son 5,000 30,000

4. Testamentary qualifying spousal trust Nil 20,000

5. Alter ego trust Nil 20,000

6. Inter vivos trust for a minor child 5,000 30,000

Exam Exercise Solution Nineteen - 8 (Spousal Trusts And Income Allocation)

Transfer At Death Because of the available rollover to a qualifying spousal trust, the trust will be
deemed to have acquired the depreciable asset at a capital cost of $224,000 and UCC of $147,200. The
$76,800 difference between the capital cost and the UCC would be deemed to be CCA. The fair market
value at Mark’s death is not relevant to the transfer.

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Sale By Trust The tax consequences of the sale by the trust would be calculated as follows:

Proceeds Of Disposition $243,200

Capital Cost ( 224,000)

Capital Gain $ 19,200

Inclusion Rate 1/2

Taxable Capital Gain $ 9,600

Capital Cost $224,000

UCC At Sale ($147,200 - $15,400) ( 131,800)

Recapture Of CCA $ 92,200

All of the income from the sale can be allocated to Mark’s spouse. This would be the taxable capital
gain of $9,600 and the recaptured CCA of $92,200. As a result, the trust would have nil Tax Payable.

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Exam Exercise Solution Nineteen - 9 (Spousal Trusts And Income Allocation)

Transfer At Death Because of the available rollover to a qualifying spousal trust, the trust will be
deemed to have acquired the depreciable asset at a capital cost of $150,000 and UCC of $140,000. The
$10,000 difference between the capital cost and the UCC would be deemed to be CCA. The fair market
value at Martine’s death is not relevant to the transfer.

Sale By Trust The tax consequences of the sale by the trust would be calculated as follows:

Proceeds Of Disposition $205,000

Capital Cost ( 150,000)

Capital Gain $ 55,000

Inclusion Rate 1/2

Taxable Capital Gain $ 27,500

Capital Cost $150,000

UCC At ($140,000 - $20,000) ( 120,000)

Recapture Of CCA $ 30,000

All of the income from the sale can be allocated to Martine’s spouse. This would be the taxable capital
gain of $27,500 and the recaptured CCA of $30,000. As a result, the trust would have nil Tax Payable.

Exam Exercise Solution Nineteen - 10 (Flow Through To Beneficiaries)

The income allocation would be as follows:

Received Paid To Retained

By Trust Francine By Trust

Eligible Dividends $367,000 $210,000 $157,000

Non-Eligible Dividends From CCPC 108,000 108,000 Nil

Capital Gain 47,000 47,000 Nil

Totals $522,000 $365,000 $157,000

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The Net Income For Tax Purposes of the trust would be calculated as follows:

Eligible Dividends $157,000

Gross Up Of Eligible Dividends At 38 Percent 59,660

Net Income For Tax Purposes - Trust $216,660

The Net Income For Tax Purposes for Francine would be as follows:

Eligible Dividends From Canadian Corporations $210,000

Gross Up At 38 Percent 79,800

Non-Eligible Dividends From CCPC 108,000

Gross Up At 16 Percent 17,280

Taxable Capital Gains [(1/2)($47,000)] 23,500

Net Income For Tax Purposes - Francine $438,580

The dividend tax credit that will be available to the trust is $32,542 [(6/11)($59,660)]. Francine’s
dividend tax credits will be $43,527 [(6/11)($79,800)] on the eligible dividends and $12,567 [(8/11)
($17,280)] on the non-eligible amounts.

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Exam Exercise Solution Nineteen - 11 (Flow Through To Beneficiaries)

The income allocation would be as follows:

Received Paid To Retained

By Trust Marcin By Trust

Eligible Dividends $ 50,000 $ 37,500 $12,500

Non-Eligible Dividends From CCPC 200,000 150,000 50,000

Capital Gain 30,000 22,500 7,500

Totals $280,000 $210,000 $70,000

The Net Income For Tax Purposes of Marcin and the trust would be calculated as follows:

Marcin Trust

Eligible Dividends $37,500 $12,500

Gross-Up On Eligible Dividends At 38% 14,250 4,750

Non-Eligible Dividends 150,000 50,000

Gross-Up On Non-Eligible

Dividends At 16% 24,000 8,000

Capital Gain 22,500 7,500

Non-Taxable Half Of Capital Gain ( 11,250) ( 3,750)

Net Income for Tax Purposes $237,000 $ 79,000

Exam Exercise Solution Nineteen - 12 (Inter Vivos Trusts - Tax Payable)

Taxable Income and federal Tax Payable for the trust in Part A would be calculated as follows:

Non-Eligible Dividends Received $35,500

Deduction For Distribution To Beneficiary ( 24,500)

Net Dividend Income $11,000

Dividend Gross Up (16 Percent) 1,760

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Taxable Income For The Trust $12,760

Federal Tax Rate (Inter Vivos Trust) 33%

Federal Tax Before Credits $ 4,211

Federal Dividend Tax Credit [(8/11)($1,760)] ( 1,280)

Federal Tax Payable - Trust (Part A) $ 2,931

Since in Part B, all of the dividends are paid to the beneficiary, the trust would have a Taxable Income
and federal Tax Payable of nil.
Taxable Income and federal Tax Payable for the son would be calculated as follows:

Part A Part B

Non-Eligible Dividend Income From The Trust $24,500 $35,500

Dividend Gross Up (16 Percent) 3,920 5,680

Taxable Income For The Son $28,420 $41,180

Federal Tax Rate 15% 15%

Federal Tax Before Credits $ 4,263 $ 6,177

Basic Personal Credit [(15%)($11,809)] ( 1,771) ( 1,771)

Federal Dividend Tax Credit [(8/11)(Gross Up)] ( 2,851) ( 4,131)

Federal Tax Payable - Son Nil $ 275

By leaving $11,000 in dividends in the trust, $2,656 ($2,931 - $275) in avoidable taxes were paid.

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Exam Exercise Solution Nineteen - 13 (Inter Vivos Trusts - Tax Payable)

The required calculations are as follows:

Eligible Dividends Received $100,000

Gross-Up On Eligible Dividends [($100,000)(38%)] 38,000

Net Income for Tax Purposes and Taxable Income - Trust$138,000

Flat Rate For Inter Vivos Trusts 33%

Tax Before Credits $ 45,540

Dividend Tax Credit [(6/11)($38,000)] ( 20,727)

Federal Tax Payable - Trust $ 24,813

Exam Exercise Solution Nineteen - 14 (Testamentary Trusts - Tax Payable)

As this is a graduated rate estate, the calculation of its Tax Payable will be based on the same graduated
rate schedule that is used by individuals.
The Net Income for Tax Purposes and Taxable Income for both Marta and the trust would be the same
as the dividends received are allocated 50:50. The required calculations are as follows:

Non-Eligible Dividends [(50%)($200,000)] $100,000

Gross-Up On Non-Eligible Dividends [($100,000)(16%)]16,000

Net Income for Tax Purposes and Taxable Income $116,000

The federal Tax Payable for Marta and the trust would be calculated as follows:

Marta Trust

Tax On First $93,208 $16,544 $16,544

26 Percent Of $22,792

($116,000 - $93,208) 5,926 5,926

Tax Payable Before Credits $22,470 $22,470

Basic Personal Credit [(15%)($11,809)] ( 1,771) N/A

Age Credit [(15%)($7,333)] ( 1,100) N/A

Dividend Tax Credit [(8/11)($16,000)] ( 11,636) ( 11,636)

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Federal Tax Payable $ 7,963 $ 10,834

Exam Exercise Solution Nineteen - 15 (Income Attribution)

Income on the bonds is subject to the attribution rules to the extent that the income is allocated to
Martine’s spouse, Michael, or to their minor daughter, Rachel. This means that two-thirds of the interest
will be attributed back to Martine. With respect to the capital gain, the attribution rules do not apply on
transfers to minors. This means that only Michael’s one-third share of the gain will be attributed back to
Martine.
The increase in Taxable Income for Martine and the trust’s beneficiaries are calculated as follows:

Attributed

Michael Rachel Dirk To Martine

Interest Income ($108,000 ÷ 3) $36,000 $36,000 $36,000 Nil

Interest Attribution To Martine ( 36,000) ( 36,000) Nil $72,000

Taxable Capital Gain

[(1/2)($36,000) ÷ 3] 6,000 6,000 6,000 Nil

Capital Gain Attribution To Martine ( 6,000) Nil Nil 6,000

Increase In Taxable Income Nil $6,000 $42,000 $78,000

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Exam Exercise Solution Nineteen - 16 (Income Attribution)

The dividend income is subject to the attribution rules to the extent that the income is allocated to
Devon’s spouse, Connie, and to their minor son, Marvin. This means that two-thirds of the dividends
will be attributed back to Devon. As well, Connie’s share of the taxable capital gain is attributed back to
Devon.
The increase in Taxable Income for Devon and the trust’s beneficiaries are calculated as follows:

Attributed

Connie Marvin Diane To Devon

Eligible Dividends ($72,900 ÷ 3) $24,300 $24,300 $24,300 Nil

Dividend Attribution To Devon ( 24,300) ( 24,300) Nil $48,600

Net Dividends Nil Nil $24,300 $48,600

Dividend Gross Up At 38 Percent Nil Nil 9,234 18,468

Taxable Capital Gain

[(1/2)($16,200) ÷ 3] 2,700 2,700 2,700 Nil

Capital Gain Attribution To Devon ( 2,700) Nil Nil 2,700

Increase In Taxable Income Nil $ 2,700 $36,234 $69,768

Exam Exercise Solution Nineteen - 17 (Sale Of A Capital Interest)

With respect to Sarah, she has acquired a capital interest for consideration of $204,500. This will be the
adjusted cost base of the interest she has acquired.
With respect to Mary, she has disposed of a capital asset for proceeds of disposition of $204,500. Since
she did not purchase the interest in the trust, her adjusted cost base as usually determined would be nil.
However, for this disposition, the adjusted cost base of the capital interest is the greater of nil and the
cost amount as determined under ITA 108(1). The cost amount would be $156,000, one-half of the
$312,000 tax cost of the assets in the trust. The result would be a taxable capital gain of $24,250 [(1/2)
($204,500 - $156,000)].

Exam Exercise Solution Nineteen - 18 (Sale Of A Capital Interest)

Billy has acquired a capital interest for consideration of $210,000. This would be the adjusted cost base
of his interest.
Correspondingly, Bart has disposed of his capital interest for consideration of $210,000. This would be
his proceeds of disposition. His adjusted cost base as usually determined would be nil. However, for
this disposition, the adjusted cost base of the capital interest is the greater of nil and the cost amount as
determined under ITA 108(1). This cost amount would be $150,000 [(1/2)($300,000)]. Given this, Bart
will have a taxable capital gain of $30,000 [(1/2)($210,000 - $150,000)].

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Exam Exercise Solution Nineteen - 19 (Family Trusts)

As Fred’s other income places him in the maximum federal tax bracket of 33 percent, his federal tax
savings resulting from transferring the assets to the family trust would be $49,500 [($150,000)(33%)].
The federal tax that would be payable on the additional $50,000 received by each of the triplets is as
follows:

Tax On First $46,605 $6,991

Tax On Additional $3,395 ($50,000 - $46,605) At 20.5 Percent 696

Tax Before Credit $7,687

Personal Credit [(15%)($11,809)] ( 1,771)

Federal Tax Payable $5,916

The total tax paid by the triplets would be $17,748 [($5,916)(3)]. This is $31,752 ($49,500 - $17,748)
per year less in federal taxes than the amount that would be paid by Fred without the trust.

Exam Exercise Solution Nineteen - 20 (Family Trusts)

With her employment income in excess of $250,000, any additional income that is received by Darlene
will be taxed at a federal rate of 33 percent. This means that, on $120,000 of interest income, she would
pay federal taxes of $39,600 [(33%)($120,000)].
If she establishes the family trust, each of her sons will receive income of $60,000. The federal Tax
Payable on this amount would be calculated as follows:

Tax On First $46,605 $ 6,991

Tax On Additional $13,395 ($60,000 - $46,605) At 20.5 Percent 2,746

Tax Before Credit $9,737

Personal Credit [(15%)($11,809)] ( 1,771)

Federal Tax Payable $ 7,966

The total tax paid by the sons would be $15,932 [(2)($7,966)]. This is $23,668 ($39,600 - $15,932) less
than the federal taxes that Darlene would have paid on the $120,000 of interest income if received by
her.

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TIF Solution Nineteen - 5A

The correct definitions for each of the listed key terms are as follows:

A. 9

B. 1

C. 2

D. 6

E. 7

F. 8

G. 4

H. 10

The two unused definitions are as follows:

Executor = 5

Inter Vivos Trust = 3

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TIF Solution Nineteen - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.
The correct definitions for each of the listed key terms listed below.

A. 12

B. 1 (not 11)

C. 3 (not 13)

D. 7 (not 2)

E. 8

F. 10

G. 5 (not 9)

H. 14

The two unused definitions are as follows:

Executor = 6

Inter Vivos Trust = 4

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TIF Solution Nineteen - 6

Case A
Rollover - In the usual situation with transfers to an alter ego trust, there is a rollover at tax cost. An
election is available to forego the rollover in which case fair market values would apply. If no election
is made, the solution is as follows:

1. The deemed proceeds for the settlor would be the tax cost of $75,400, resulting in no gain or loss
on the transfer.

2. The trust acquires the property at a deemed cost of $75,400.

3. The property will be transferred to the settlor at the $75,400 tax cost recorded by the trust. This will
also be the value recorded by the settlor.

Election For No Rollover - If the fair market value election is made and the rollover does not apply, the
solution is as follows:

1. There is a loss of $13,400 ($75,400 - $62,000) on the transfer to the alter ego trust. However, the
settlor and the trust are affiliated persons [ITA 251.1(1)] and, as a consequence the loss is
disallowed.

2. While the transfer is made at the fair market value of $62,000, the settlor was an individual. Given
this, the disallowed loss will be added to this figure, resulting in a tax cost in the alter ego trust of
$75,400 ($62,000 + $13,400).

3. As the transfer is back to the settlor, it will be transferred at the $75,400 tax cost recorded by the
trust. This will also be the value recorded by the settlor.

Case B
1. Under the general ITA 70(6) rollover provision, the deemed proceeds to the decedent would be the
property’s cost of $32,600, resulting in no gain or loss on the transfer. As the deceased has net
capital loss carry forwards, a better alternative could be to elect out of ITA 70(6) and transfer the
property at its fair market value of $46,500. This will result in a taxable capital gain of $6,950[(1/2)
($46,500 - $32,600)]. This would reduce the net capital loss carry forward to $8,050 ($15,000 -
$6,950).

Note that in the year of death, net capital loss carry forwards can be deducted against any type of
income. If the decedent has other income against which the net capital loss carry forward can be
deducted, it may not be advantageous to elect out of the rollover. More information on the spouse’s

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current and future taxable income would be needed to optimize the use of the net capital loss carry
forward.

2. Under the general ITA 70(6) rollover provision, the trust would record the property at the
decedent’s cost of $32,600. If the fair market value election is made, the spousal trust will have
acquired the property at a deemed cost of $46,500. This higher value will serve to reduce any
future gain on the property when it is sold.

Case C
1. The settlor has deemed proceeds of disposition equal to the fair market value of $15,800. This will
result in the settlor recording a taxable capital gain of $1,200 [(1/2)($15,800 - $13,400)].

2. The deemed cost to the trust will also be the fair market value of $15,800.

3. The property will be transferred to the children at the trust’s tax cost. There will be no tax
consequences for the trust of the transfer. The children will be deemed to have acquired the
property for the trust’s tax cost of $15,800.

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Case D
1. The settlor has deemed proceeds of disposition of the fair market value of $9,400, and will record a
taxable capital gain of $700 [(1/2)($9,400 - $8,000)]. In addition, there will be recapture of CCA of
$1,750 ($8,000 - $6,250).

2. The trust acquires the property at a deemed capital cost of $9,400. However, for purposes of
calculating CCA and recapture, the ITA 13(7)(e) rules for non-arm’s length transactions apply and
the value will be $8,700 [$8,000 + (1/2)($9,400 - $8,000)].

Case E
1. Under the ITA 73(1) rollover provision, the deemed proceeds to the settlor would be the property’s
cost of $23,500, resulting in no gain or loss on the transfer.

2. Under the ITA 73(1) rollover provision, the trust would record the property at the settlor’s cost of
$23,500.

3. The transfer will be at the trust’s tax cost of $23,500. There will be no tax consequences for the
trust or the spouse. The deemed adjusted cost base to the spouse will be $23,500. Any income or
loss related to the asset or on the sale of the asset by the spouse will be attributed back to the settlor.

Case F
1. The settlor has deemed proceeds of disposition of the fair market value of $2,000, resulting in a
terminal loss of $2,200 (UCC of $4,200 minus the lesser of capital cost of $5,600 and proceeds of
disposition of $2,000). However, as the transfer is to an affiliated person, the loss will be
disallowed. Unlike the situation with disallowed capital losses, the terminal loss is not allocated to
the transferee. Rather, it will be retained in a separate class by the settlor. It will remain there until
the asset is sold to an unaffiliated person or its use is changed from income earning to non-income
earning.

2. The asset would be recorded in the trust records at a deemed capital cost of $5,600, the capital cost
of the transferor. There is deemed CCA of $3,600 ($5,600 less the fair market value at the time of
transfer of $2,000) which results in a UCC of $2,000.

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TIF Solution Nineteen - 7

A. It is an inter vivos trust. In less technical terms, it could also be described as a family trust in that
all of the beneficiaries are family members. In addition, it could be referred to as non-discretionary
in that the shares of beneficiaries are specified and annual distributions are required.

B. As the trust is an inter vivos trust, the year end will have to be December 31 of each year.

C. All of the income that is allocated to Ms. Dickson will be subject to the income attribution rules. As
a consequence, it will be included in the Net Income For Tax Purposes of Mr. Butler. This includes
interest, dividends, and capital gains earned by the trust.

As Barry is over the age of 17, the attribution rules will not apply to his share of the trust’s income.
This means that the income that is allocated to him will be included in his Net Income For Tax
Purposes.

As all of the trust’s income is either attributed back to Mr. Butler or allocated to a beneficiary, the
trust’s Net Income For Tax Purposes will be nil.

D. The answer here will depend on the terms of the loan to the trust as the rules for non-arm’s length
loans apply. If it is an interest free loan, the results will be the same as in Part C. That is, the
income allocated to Ms. Dickson will be attributed back to Mr. Butler, while the income allocated to
Barry will be included in his Net Income For Tax Purposes. This would also be the result if the
interest rate on the loan was less than the prescribed rate.

Alternatively, if the loan paid interest at the prescribed rate or higher, the income attribution rules
would not apply and the trust income allocated to Ms. Dickson would be taxed in her hands. Note
that the loan would have to have bona fide repayment terms and the interest would have to be paid
within 30 days of the end of each calendar year.

E. ITA 74.5(3) indicates that the income attribution rules do not apply to any income or loss from
property that relates to the period throughout which the individuals are living separate and apart
because of a breakdown of their marriage or common-law partnership.

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TIF Solution Nineteen - 8

A trust can be used to split income in these circumstances. However, there are complications. First, as
this is an inter vivos trust, any income that remains in the trust will be taxed at the maximum federal
rate. Since this is the same rate that is applicable to Genevieve, there is little point in transferring
property to the trust without distributing all of the income to lower income individuals.
There is no problem with allocating trust income to Genevieve’s daughter, Lisa, as she is over 17 years
old. As she has no other source of income, there would be significant tax savings, even if the entire
$40,000 was allocated to her. However, as Philip is under 18, any trust allocations made to him will be
attributed back to Genevieve. This means that there is no immediate tax advantage associated with
income allocated to Philip. Note, however, there is a long run advantage in that, when the attributed
earnings are reinvested, there is no attribution with respect to the compound earnings resulting from this
reinvestment.
These considerations make it clear that, if a trust is going to be used, all of the income should be paid, or
made payable, to Lisa, at least until Philip reaches 18 years of age. If the $40,000 exceeds the amount
that Genevieve wishes Lisa to receive, the amount of property transferred to the trust could be reduced.
With Lisa attending university in the U.S., it is likely that she will require at least the full $40,000 to
cover tuition, books, and living expenses. Given this, there would be excellent tax benefits associated
with allocating the full $40,000 of trust income to Lisa, at least for the period of time that she is in
university. The allocated income could be used to pay for her university costs, with the related tax
credits and her personal tax credits eliminating most, or all, of the taxation on the full $40,000. Since
Genevieve does not wish Lisa to receive cash from the trust, the trust could pay for her tuition and living
costs directly.
Given the fact that it is not currently tax efficient to allocate income to Philip, Genevieve may wish to
establish a discretionary trust. This would allow her to change the pattern of distributions once Philip
reaches 18 years of age. At that time, it might be possible to use the trust to support his university
education.
As the trust life is expected to extend beyond 21 years (until Philip turns 35), a deemed disposition of all
trust assets will occur in 21 years. If the trust continues to invest in term deposits or similar investments,
the deemed disposition will not be onerous. However, if the trust invests in securities that have
unrealized capital gains, this rule would require recognition of these gains.

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TIF Solution Nineteen - 9

Part A - Calculation Of Taxable Income
All amounts are allocated 30 percent to Mark, 40 percent to Steven, and 30 percent to the trust. The
Taxable Income of the two beneficiaries and the trust would be calculated as follows:

Mark (30%) Steven (40%) Trust (30%)

Interest On GICs ($96,450) $ 28,935 $ 38,580 $ 28,935

Non-Eligible Dividends Received

($326,940) 98,082 130,776 98,082

Gross Up Of 16 Percent ($52,310) 15,693 20,924 15,693

Taxable Capital Gain On Land

[(1/2)($625,000 - $375,000)] 37,500 50,000 37,500

Taxable Capital Gain On Building

[(1/2)($1,500,000 - $1,400,000)] 15,000 20,000 15,000

Net Rental Income (Note) 57,204 76,272 57,204

Net And Taxable Income $252,414 $336,552 $252,414

Note The net rental income, including the recapture of CCA, can be calculated as follows:

Revenues From Rental Property $131,000

Cash Expenses On Rental Property ( 87,320)

Recapture Of CCA:

Capital Cost Of The Building $1,400,000

UCC ( 1,253,000) 147,000

Net Rental Income, Including Recapture $190,680

Part B - Tax Payable For The Trust

The federal Tax Payable for the trust is as follows:

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Federal Tax Before Credits [(33%)($252,414)] $83,297

Federal Dividend Tax Credit [(8/11)($15,693)] ( 11,413)

Federal Tax Payable $71,884

As this trust is an inter vivos trust, all of its income is subject to federal tax at 33 percent [ITA 122(1)].

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TIF Solution Nineteen - 10

Part A - Amounts And Type Of Income To Be Distributed

Relative Tax Status

In attempting to minimize the Tax Payable to the GRE and the beneficiaries, the relative tax status of
these entities is relevant.

Mrs. Hyde As Mrs. Hyde has substantial amounts of other income, any income paid to her by
the GRE will be taxed at the maximum federal rate of 33 percent.

Ross Hyde As Ross has no other source of income during 2018, any income paid to him is
likely to be taxed at the minimum federal rate of 15 percent.

GRE As the Graduated Rate Estate (GRE) status is available for 2018, any income that is
retained in the GRE will be taxed at graduated personal tax rates, starting at the lowest federal
rate of 15 percent. We would note that the GRE status will end on December 31, 2020, even if
the estate assets have not been transferred to the trust that is specified in the will. When this
happens, any future income that is retained in the trust will be taxed at the maximum federal
rate of 33 percent.

Dividend Income
With respect to eligible dividend income, the gross up and tax credit mechanism provides significantly
reduced tax rates for all individuals. The relevant information for the GRE and the two beneficiaries is
as follows:

GRE As the trust has GRE status during 2018, it can receive up to $33,890 of eligible
dividends without paying any taxes.

Ross As Ross has a basic personal credit of $1,771 [(15%)($11,809)], the amount of tax free
eligible dividends that he can receive is increased to $57,321.

Mrs. Hyde As Mrs. Hyde already has income in excess of $250,000, any eligible dividends
that she receives will be taxed at a federal rate of 24.8 percent [(33%)(138%) - (6/11)(38%)].

Interest Income
While Ross could receive up to $11,809 of interest on a tax free basis, any additional amounts would be
taxed at 15 percent. This 15 percent rate would also be available to the GRE on income left in the GRE.
This is well below the 33 percent rate that would be applicable to interest that is paid to Mrs. Hyde from
the GRE.

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Conclusion
For both interest and dividends, the tax rate for Mrs. Hyde is much higher than that applicable to either
Ross or the GRE. Given this, if tax minimization is the objective, no distributions should be made to
Mrs. Hyde. As her other income is likely more than sufficient to meet her needs, this decision should
not cause a financial burden for her.
With respect to Ross and the GRE, either taxable entity could receive all of the dividends without paying
any taxes. However, because Ross has a basic personal credit available, he could receive, in addition to
the dividends, a larger amount of the interest while still not paying any taxes. This would suggest
distributing all of the dividends to Ross, along with sufficient interest to reduce his Tax Payable to nil.
Any remaining interest would be left in the GRE to be taxed at the minimum federal rate of 15 percent.
The after-tax funds in the GRE can be distributed tax free to either beneficiary.

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Part B - Tax Payable

Ross
If Ross receives all of the dividends, his federal dividend tax credit would be $6,011 [(6/11)(38%)
($29,000)]. When combined with his basic personal credit of $1,771, he would have total credits of
$7,782 ($6,011 + $1,771). For his Tax Payable before credits to be equal to this amount, his Taxable
Income would have to be $50,463. This value is represented by X in the following calculation:

$7,782 = $6,991 + [(20.5%)(X - $46,605)]

$7,782 = $6,991 + [(20.5%)(X)] - $9,554

$10,345 = [(20.5%)(X)]

X = $50,463

Subtracting the grossed up dividends of $40,020 [(138%)($29,000)] from this required Taxable Income
figure leaves $10,443 ($50,463 - $40,020) to be distributed to Ross as interest.
Ross’ Tax Payable would be nil as shown in the following calculation.

Tax On First $46,605 $ 6,991

Tax On Next $3,858 ($50,463 - $46,605)] At 20.5% 791

Tax Before Credits $7,782

Basic Personal Credit ( 1,771)

Dividend Tax Credit [(6/11)(38%)($29,000)] ( 6,011)

Tax Payable Nil

Note that the Tax Payable is exactly nil, with no unused credits remaining.

GRE
With all of the dividends and $10,443 of the interest distributed to Ross, this would leave $13,557
($24,000 - $10,443) of the interest to be taxed in the hands of the GRE. The tax on this amount would
be $2,034 [(15%)($13,557)].

Mrs. Hyde
As no distribution will be made to Mrs. Hyde, her 2018 Tax Payable will be unchanged by the existence
of the GRE.

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TIF Solution Nineteen - 11

Calculations
Taxable Income for the trust and for Mark would be calculated as follows:

Trust Mark

Interest Income Nil $18,500

Taxable Capital Gains:

[($43,000)(1/2)(20%)] $ 4,300

[($43,000)(1/2)(80%)] 17,200

Eligible Dividends Received:

[($32,000)(20%)] 6,400

[($32,000)(80%)] 25,600

Gross Up On Dividends:

[($32,000)(38%)(20%)] 2,432

[($32,000)(38%)(80%)] 9,728

Net Rental Income:

[($19,500)(20%)] 3,900

[($19,500)(80%)] 15,600

Taxable Income $17,032 $86,628

The Tax Payable for the trust would be calculated as follows:

Taxable Income $17,032

Federal Tax Rate (Inter Vivos Trust) 33%

Federal Tax Payable Before Dividend Tax Credit $ 5,621

Dividend Tax Credit [(6/11)($2,432)] ( 1,327)

Federal Tax Payable - Trust $ 4,294

The Tax Payable for Mark would be calculated as follows:

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Tax On First $46,605 $ 6,991

Tax On Next $40,023 ($86,628 - $46,605) At 20.5 Percent 8,205

Federal Tax Before Credits $15,196

Tax Credits:

Personal ($11,809)

Tuition ( 12,500)

($24,309)

Rate 15% ( 3,646)

Dividend Tax Credit [(6/11)($9,728)] ( 5,306)

Federal Tax Payable - Mark $ 6,244

Comment
The $17,032 of income that was retained in the trust was taxed at a federal rate of 33 percent, before
consideration of the dividend tax credit. If the income had been distributed to Mark, it would have been
taxed at 20.5 percent, before consideration of the dividend tax credit, resulting in a $2,129 [($17,032)
(33% - 20.5%)] reduction in federal Tax Payable. Based on tax considerations only, retention of the
income in the trust was not advantageous.

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TIF Solution Nineteen - 12

Part A - Increase In Net Income For Tax Purposes
As a consequence of her death, there would be a deemed disposition of her capital property, resulting in
the following increase in Net Income For Tax Purposes:

Capital Gain On Public Company Shares

($2,342,000 - $1,856,000) $486,000

Capital Gain On Government Of Canada Bonds Nil

Capital Gain On Land ($989,000 - $865,000) 124,000

Capital Gain On Building ($1,560,000 - $1,250,000) 310,000

Total Capital Gains $920,000

Inclusion Rate 1/2

Taxable Capital Gains $460,000

Recapture On Building ($1,250,000 - $932,000) 318,000

Increase In Net Income For Tax Purposes $ 778,000

Note The ITA 13(7)(e) provision which limits the capital cost of the asset for CCA purposes
to the transferor’s cost, plus one-half of any capital gain that results from the transfer, does not
apply to non-arm’s length transfers of depreciable property on death.

Part B - Taxable Income Of The GRE And Its Beneficiaries

The allocations required by the will are as follows:

Marilyn (35%) Murphy (45%) GRE (20%)

Eligible Dividends Received

($123,670) $ 43,284 $ 55,652 $24,734

Gross Up Of 38 Percent ($46,995) 16,448 21,148 9,399

Interest On Bonds ($22,490) 7,872 10,121 4,498

Net Rental Income ($100,910) 35,319 45,410 20,182

Net And Taxable Income $102,923 $132,331 $58,813

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Part C - Federal Tax Payable For The GRE

Income that remains in a GRE is taxed in the same general manner as would be applicable to an
individual. However, the GRE would not be able to use personal tax credits under ITA 118 to reduce
the amount of Tax Payable.
Federal Tax Payable for the GRE would be calculated as follows:

Federal Tax Payable On First $46,605 $6,991

Federal Tax Payable On Next $12,208

($58,813 - $46,605) At 20.5 Percent 2,503

Federal Tax Payable Before Credits $9,494

Federal Dividend Tax Credit [(6/11)($9,399)] ( 5,127)

Federal Tax Payable - GRE $4,367

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Chapter Twenty Test Item File Solutions

TIF Solution Twenty - 1

1. The required two items can be selected from the following:

 Prevention of double taxation.

 Provision of income tax certainty.

 Prevention of discrimination.

 Implementing a proper division of cross-border revenues.

 Provision of an information-sharing mechanism.

2. Non-residents are subject to Canadian Part I taxes on:

 employment income earned in Canada;

 income earned while carrying on a business in Canada; and

 gains resulting from dispositions of Taxable Canadian Property.

3. As described in the text, the exceptions are as follows:

$10,000 Rule Under this rule if, during a calendar year, a U.S. resident earns employment
income in Canada that is $10,000 or less in Canadian dollars, then the income is taxable only in
the U.S.

183 Day Rule This rule exempts Canadian source employment income from Canadian
taxation, provided it is earned by a U.S. resident who was physically present in Canada for no
more than 183 days during any twelve month period commencing or ending in the calendar
year. This exemption is conditional on employment income not being paid by an employer
with a permanent establishment in Canada who would be able to deduct the amount paid from
their Canadian Taxable Income. Stated alternatively, if the employment income exceeds
$10,000 and is deductible in Canada, it will be taxed in Canada, even if the employee is present
in Canada for less than 183 days during the year.

4. As described in the text, the situations are as follows:

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 An individual who acts on behalf of a non-resident enterprise and who is authorized to conclude
contracts in the name of that enterprise is considered a permanent establishment.

 An individual who acts on behalf of a business and meets both a physical presence test (183 days
or more in any 12 month period beginning or ending in the year) and a gross revenue test (that more
than 50% of the gross active business revenues of the U.S. business are from services performed by
that individual during the period the individual is in Canada), is considered a permanent
establishment.

5. The required two items can be selected from the following items that were covered in the text:

 interest income

 royalty income

 rental income

 dividend income

 pension benefits

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6. If she pays taxes under Part XIII, the taxes will generally be assessed at a 25 percent rate on her
gross rents. Alternatively, if she elects to be taxed under Part I, the tax will only be assessed on her
net rental income (gross rents, less expenses). Depending on her personal tax rate and the amount
of rental expenses involved, this may be a desirable alternative. Also note that, if she makes this
election, she cannot make deductions from Net Income For Tax Purposes in determining Taxable
Income, and she cannot deduct her personal tax credits in the determination of Tax Payable.

7. An individual immigrating to Canada may own capital property on which there are accrued capital
gains. If there was no deemed disposition/reacquisition at the time the individual enters Canada, a
subsequent sale of property could result in tax being assessed on gains that accrued prior to the
individual becoming a resident of Canada. This would not appear to be an equitable situation.

8. The most common reason for making this election would be a situation in which the individual has
capital losses. This could be either net capital losses from previous years carried forward, or current
year losses including those resulting from required deemed dispositions on departure. In this
situation, the taxpayer may wish to trigger a gain on real estate that can be used to absorb these
losses.

Alternatively, if the fair market value of the real estate is less than its cost, the individual could
make the election in order to use the capital loss on the required deemed disposition of other assets.

9. There would be a deemed disposition of his shares at the time of departure, resulting in his paying
taxes on a taxable capital gain of $100,000 [(1/2)($500,000 - $300,000)]. On his return, if no
election is made, the shares will have an adjusted cost base of $500,000.

While this information is not required by the question, there is an election available to reverse the
deemed disposition that resulted from his departure. If he makes this election, the taxable capital
gain would be reversed and any taxes paid would be refunded. However, the adjusted cost base
would revert to the original $300,000.

10. The full $20,000 in foreign source business income would be included in John’s Taxable Income,
with basic Canadian Tax Payable calculated on this amount. The $2,000 that was withheld can then
be used in the calculation of the foreign business tax credit available to be applied against the
Canadian Tax Payable.

11. Because Canadian corporations generally pay dividends out of income that has been subject to
Canadian taxation at the corporate level, dividends received by Canadian residents from taxable
Canadian corporations are given favourable tax treatment. This favourable tax treatment, based on
gross up and tax credit procedures, significantly reduces the effective tax rate on this type of
income.

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When dividends are received from non-resident corporations, this favourable treatment cannot be
justified. The reason for this is that the non-resident corporation that paid the dividends has not
paid Canadian taxes on the income that is the source of the dividends.

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12. Controlled Foreign Affiliates Whether the resident Canadian shareholder is an individual or a
corporation, Foreign Accrual Property Income (FAPI) that is earned by a Controlled Foreign
Affiliate must be included in income on an accrual basis as it is earned. When these amounts are
subsequently paid out as dividends they will be included in the income of the Canadian shareholder
but will be eligible for an offsetting deduction to recognize the fact that the amount was previously
taxed as FAPI. If the dividend is paid from non-FAPI sources of income, it will be included in
income, but, in the case of Canadian corporate shareholders, may be completely or partially offset
by the ITA 113(1) deduction from Taxable Income depending upon whether Canada has entered
into a tax treaty or Tax Exchange Information Agreement (TEIA) with the source country.
Canadian individual shareholders would obtain partial relief through the foreign tax credit system
only, since they are not entitled to the ITA 113(1) deduction. This generally encourages individuals
to hold shares in foreign corporations through a resident Canadian corporation.

Non-Controlled Foreign Affiliates The income of Foreign Affiliates that are not controlled will
not be accrued as it is earned. Rather, it is included in income when dividends are received from the
Foreign Affiliate. If the dividend is paid from active business income earned in a country with
which Canada has a tax treaty or TEIA, it will be eliminated by the ITA 113(1) deduction in the
calculation of Taxable Income. In addition, dividends paid out of the non-taxable portion of some
types of capital gains, or the full amount of capital gains resulting from dispositions of property
used in an active business in a country with which Canada has a tax treaty or TEIA, are deductible
under ITA 113(1). When the ITA 113(1) deduction is available, no credit can be taken for any
foreign taxes paid.

Alternatively, if the dividend is paid out of passive income, or earned in a non-treaty/non-TEIA

country, it will be included in income and only be eligible for deductions under ITA 113 to the
extent income taxes or withholding taxes have been paid on the amounts distributed.

13. If the Canadian company undertakes to deliver the goods and provide the services required in the
contract, the total profit will be taxed at full Canadian rates. This reflects the fact that Canadian
corporations are taxed on their worldwide income. However, tax credits for any foreign taxes paid
on that income would be available to Clarkson Equipment Ltd.

If a separate subsidiary is established in the African country, the subsidiary can purchase the
required manufactured items from Clarkson and potentially resell them at a profit. Additional
profits could be engendered through the training operations. Any profits will be active business
income and will not be deemed Foreign Accrual Property Income (FAPI). This means that there
will be no Canadian taxation until such time as the earnings are repatriated into Canada and are paid
as dividends to individual shareholders. If the corporate tax rates in the African country are lower
than Canadian rates, forming the subsidiary may be advantageous.

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TIF Solution Twenty - 2

1. True.

2. False.

Regardless of the amount of Canadian income reported, some credits will be available to non-
residents filing a Canadian tax return. Examples include EI and CPP tax credits, and the
charitable donations tax credit.

3. True.

4. True.

5. False.

Non-residents are not required to file a Canadian tax return for income that is subject to Part
XIII tax.

6. False.

The Canada/U.S. tax treaty states that interest arising in a contracting state and beneficially
owned by a resident of the other contracting state may be taxed only in that other state.

7. False.

While there will be a deemed disposition of the assets in his brokerage accounts, as an
“excluded right”, RRSP assets are exempted from the deemed disposition rule.

8. True.

However, the Canada/U.S. tax treaty does provide two exceptions.

9. False.

In general, such income is taxable in Canada as mining is deemed to be carrying on a business

in Canada.

10. True.

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11. False.

Such facilities are not considered to be permanent establishments under the provisions of the
Canada/U.S. tax treaty.

12. False.

Only gains on dispositions of taxable Canadian property fall under ITA 2(3).

13. True.

14. False.

Only interest on participating debt and exempt interest paid to non-arms’ length non-residents
is subject to Part XIII tax.

15. True.

The rate applicable to U.S. residents is reduced to either 5 percent when the U.S. resident owns
10 percent or more of the voting shares, or to 15 percent in other situations.

16. True.

This rule prevents Canadian taxation of capital gains that accrued while the immigrant was not
a Canadian resident.

17. True.

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TIF Solution Twenty - 3

Part I Tax on Non-Residents

1. C. A multinational manufacturing business that has a factory in Canada.

2. B. $85,000 [$50,000 + $35,000]

3. B. $35,000 [$30,000 + $5,000]. The employment income is exempt from taxation in

Canada as it is less than $10,000.

4. D. Helen is employed by a Canadian resident company in a foreign country. The tax

treaty with the foreign country exempts her employment income from taxation.

5. D. Merivale is subject to Canadian tax on the income that is earned by the Calgary office.

6. B. Ku Jung owns a rental property in downtown Vancouver. Ku has owned the property
for 3 years and has never lived in it. The property is sold for a substantial gain.

7. B a storage facility

Taxation Of Non-Residents
8. D. $46,000 ($72,000 - $6,000 - $20,000); $72,000

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9. C. Mr. O’Shea will be subject to Canadian Part I tax.

10. C. Interest on Government of Canada bonds.

11. B. Interest on a GIC issued by a Canadian bank.

12. A. The gross rents are subject to withholding under Part XIII of the Income Tax Act.
However, the taxpayer can elect to file a Canadian tax return which will include the net rental
income.

13. D. Interest paid on a savings account at a Canadian bank branch located in Canada

14. D. Ying, a resident of a country that does not have a tax treaty with Canada, earns
$25,000 on a loan to Sun Enterprises Limited, a CCPC. Ying owns 40% of the shares in the
company. Note that U.S. residents are not liable for Part XIII tax on interest.

15. C. Interest paid to an arm’s length party

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Immigration And Emigration

16. D. Shares of a CCPC that primarily owns rental properties for resale.

17. A. Mr. Winsome will be deemed to have disposed of his mutual funds, sailboat, TNX
Co. shares, and Bell Canada shares on December 15, 2018.

18. C. There will be no tax consequences at the time of departure. However, any
withdrawals from the plan after his departure will be subject to Canadian Part XIII tax.

19. B. There would be an allowable capital loss of $20,000.

Taxation Of Foreign Source Income

20. B. $177,500 ($130,000 + $50,000 - $2,500)

21. D. All of the above.

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TIF Solution Twenty - 4

Exam Exercise Solution Twenty - 1 (Carrying On Business In Canada)
Case 1 Rawlings is not carrying on business in Canada and would not be subject to Canadian taxes.

Case 2 The tax treaty allows Canada to tax business income only if such income is attributable to a
permanent establishment in Canada. The warehouse constitutes a fixed place of business regardless of
whether it is owned or leased. However, since it appears to be used exclusively to maintain an inventory
for delivery, it would be an excluded activity and would therefore not be considered to be a permanent
establishment. A further consideration is the employee who sells the product. Since he is not allowed to
conclude contracts without approval, he would not be considered to be a permanent establishment.
Rawlings would not be taxable under ITA 2(3) on its Canadian profits.

Case 3 In this Case, because the employee has authority to conclude contracts on behalf of a non-
resident enterprise, the employee is deemed to be a permanent establishment. This means that Rawlings
is taxable in Canada under ITA 2(3) on its business profits attributable to the permanent establishment
(i.e., the employee).

Exam Exercise Solution Twenty - 2 (Non-Resident Liability For Tax)

She is not correct. Under ITA 2(3) she would be subject to Canadian taxes on employment income
earned in Canada. There would be an exception to this if:

 the amount was less than $10,000, or

 if she was in Canada for less than 183 days in any 12 month period beginning or ending in the
current year and the employer was not a Canadian resident in a position to deduct the payments.

As neither of these exceptions apply, Michelle would be subject to Canadian taxes on the Canadian
employment income.

Exam Exercise Solution Twenty - 3 (Non-Resident Employment In Canada)

Case 1 The employment income is taxable in Canada. The Canada/U.S. tax treaty allows Canada to tax
employment income earned in Canada unless either of the following two exceptions is applicable:

 The first exception is the $10,000 rule. This exception however does not apply since Mary earned
$13,300 Canadian in 2018 [($2,660)(5 months)].

 The second exception is the 183 day rule. Although Mary was in Canada for only 153 days
during 2018 and therefore met the first part of the test, she failed the remaining part of the test since
the employer was a Canadian resident and could deduct the payments.

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Case 2 The employment income is not taxable in Canada. The 183 day rule exempts the income from
Canadian taxation because the employer was not resident in Canada, nor had a permanent establishment
in Canada, and could not deduct the payments.

Case 3 The employment income is taxable in Canada. The Canada/U.S. tax treaty would exempt the
income from Canadian tax if the amount was less than $10,000 Canadian, or if Bill spent less than 183
days in Canada. As he earned $53,000 Canadian and spent 217 days at his job in Canada, neither of
these exceptions are applicable.

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Exam Exercise Solution Twenty - 4 (Non-Resident Employment In Canada)

Case 1 John would be taxable in Canada. In general, employment income of non-residents is taxable in
Canada under ITA 2(3). The Canada/U.S. tax treaty provides two exceptions to this general rule as
follows:

 The first exception is for individuals with employment income of less than $10,000. As John’s
salary is $72,000, this does not apply.

 The second exception is when the individual is in Canada for less than 183 days and the amounts
are paid by an employer who is not a Canadian resident and cannot deduct the salary payments for
Canadian tax purposes. While John is in Canada for less than 183 days, his employer is a Canadian
business that can deduct the payments.

Case 2 The employment income is not taxable in Canada. While his earnings exceed $10,000, he is
Canada for less than 183 days and his employment income is paid by a U.S. company that cannot deduct
the payments for Canadian tax purposes. This means that, under the Canada/U.S. tax treaty, he is
exempted from the general rule under ITA 2(3).

Case 3 In this case, the employment income would be taxable. As noted, the 183 day exception is only
available when the employment income is not paid by an enterprise that can deduct the amounts paid for
Canadian tax purposes. It would appear that the Montreal subsidiary will be able to deduct the payments
for Canadian tax purposes.

Exam Exercise Solution Twenty - 5

(Dispositions Of Taxable Canadian Property)
Case 1 Anne is taxable on the gain. The condo is taxable Canadian property since it is real property
(e.g. land and buildings) situated in Canada. The Canada/U.S. tax treaty gives Canada the right to tax
such gains. The property is not exempt from Canadian tax as a principal residence since Anne did not
acquire the condo for her own habitation.

Case 2 Anne would be taxable on the gain on the shares. Shares of an unlisted Canadian corporation
are taxable Canadian property. In addition, the Canada/U.S. tax treaty allows Canada to tax gains on the
disposition of shares if the value of the shares is derived principally from real property situated in
Canada.

Case 3 Anne would not be taxable on the gain on the shares. The shares are taxable Canadian property
because they represent shares of an unlisted non-resident corporation that, at some time in the 60 months
preceding the disposition, derived more than 50 percent of their value from taxable Canadian property.
However, the Canada/U.S. tax treaty does not list this as one of the items where Canada is allowed to
tax U.S. residents.

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Exam Exercise Solution Twenty - 6 (Interest Payments To Non-Residents)

The Canada/U.S. tax treaty states the following:

Article XI Interest arising in a Contracting State and beneficially owned by a resident of the
other Contracting State may be taxed only in that other State.

This means that, with respect to interest paid to U.S. residents, Canada does not have the right to
withhold taxes under Part XIII. As a result, there would be no Part XIII tax withheld in any of the three
Cases.

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Exam Exercise Solution Twenty - 7 (Rental Payments To Non-Residents)

Case 1 Carco appears to be carrying on business in Canada through a permanent establishment. As a
result, no Part XIII tax is payable. However, Carco would be subject to Part I tax on its income
attributable to the permanent establishment in New Brunswick.
Case 2 As the Canada/U.S. tax treaty does not reduce the rate for rentals of real property, Danielle
would be subject to Part XIII tax of $11,500 [(25%)($46,000)]. Alternatively, Danielle could elect
under ITA 216 to be taxed under Part I on the net rental income of $28,500 ($46,000 - $17,500). Based
on her net rental income, the Part XIII tax is at a rate of 40.4 percent ($11,500 ÷ $28,500). Unless she
has a significant amount of other income in Canada, the Part I alternative will result in her being taxed at
the lowest federal rate, making this the preferable choice.
Case 3 Danielle would be subject to Part XIII tax on the gross rents received for the all terrain vehicles
unless she would be considered to be carrying on a business. However, the Canada/U.S. tax treaty
reduces the withholding tax to 10 percent of the gross rents received, or $400. Note that Danielle would
not be eligible to elect under ITA 216 to be taxed under Part I on the all terrain vehicle rents, since this
election is generally restricted to real property.

Exam Exercise Solution Twenty - 8 (Emigration)

There would be a deemed disposition on his departure, leaving him liable for the taxes on a $13,000
[(1/2)($56,000 - $30,000)] taxable capital gain.

Exam Exercise Solution Twenty - 9 (Emigration)

As real property is exempt from the deemed disposition provision contained in ITA 128.1(4)(b), there
would be no tax consequences with respect to the rental property at the time of Mrs. Rand’s departure.
However, real property is Taxable Canadian Property and, as a consequence, she would be liable for
Canadian taxes on both recapture and capital gains resulting from a subsequent sale of the property,
even after she becomes a non-resident.

Exam Exercise Solution Twenty - 10 (Emigration)

Maximum Net Income With respect to the shares of the Canadian private company, there would be a
required deemed disposition, resulting in a taxable capital gain of $62,500 [(1/2)($240,000 - $115,000)].
As the rental property is Taxable Canadian Property, there would be no deemed disposition on it at the
time of Mr. Koch’s departure.
Minimum Net Income While there would be no automatic deemed disposition on the rental property,
Mr. Koch could elect under ITA 128.1(4) to have a deemed disposition. The result would be a terminal
loss on the building of $43,000 [$121,000 - ($105,000 - $27,000)] and an allowable capital loss on the
land of $14,000 [(1/2)($55,000 - $27,000)]. These amounts can be used to eliminate all but $5,500
($62,500 - $43,000 - $14,000) of the taxable capital gain on the securities.

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Exam Exercise Solution Twenty - 11 (Short Term Residents)

In the absence of ITA 128.1(4)(b)(iv)], there would be a deemed disposition of both the Israeli shares
and the Canadian shares at the time of Dakota’s departure from Canada. However, as it appears that she
has been in Canada for less than 60 months in the last 10 years, there will be no deemed disposition of
the Israeli shares that she owned prior to her immigration to Canada. There will however, be a deemed
disposition of the Canadian shares acquired during her stay. This will result in a taxable capital gain of
$7,500 [(1/2)($70,000 - $55,000)]
There will be no deemed disposition of the Canadian land because real property is exempt from the
deemed disposition requirement of ITA 128.1(4)(b). Note, however, that vacant land is Taxable
Canadian Property. This means that any gain resulting from its disposition will be subject to Canadian
taxes, without regard to whether the vendor is a Canadian resident.

Exam Exercise Solution Twenty - 12 (Foreign Tax Credits)

The gross amount of the foreign business income will be subject to tax in Canada. Shelley’s tax liability
would be calculated as follows:

Gross Foreign Business Income $23,000

Rate 42%

Canadian Tax Payable Before Credit $ 9,660

Foreign Tax Credit (Given) ( 2,300)

Net Canadian Tax Payable $ 7,360

Foreign Tax Withheld 2,300

Total Taxes Payable $ 9,660

Based on these figures, her after tax retention and overall tax rate would be as follows:

After Tax Retention ($23,000 - $9,660) $13,340

Overall Tax Rate ($9,660 ÷ $23,000) 42%

Exam Exercise Solution Twenty - 13 (FAPI)

Subco is a controlled foreign affiliate of Parco. Given this, Parco is required to accrue its proportionate
share (100%) of Subco’s investment income. The required calculation is as follows:

FAPI [ITA 91(1)] $250,000

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Deduct Lesser Of:

 FAPI = $250,000

 ITA 91(4) Deduction [(4)(15%)($250,000)] ( 150,000)

Net Addition To Net Income For Tax Purposes $100,000

Exam Exercise Solution Twenty - 14

(Dividends From FAPI - Twenty-13 Continued)
The required calculation is as follows:

Foreign Source Dividend – ITA 90(1) $212,500

Deduct Lesser Of:

 Previous FAPI After ITA 91(4) Deduction = $100,000

 Dividend Received = $212,500 ( 100,000)

Net Addition To Net Income For Tax Purposes $112,500

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TIF Solution Twenty - 5A

The correct definitions for each of the listed key terms are as follows:

A. 4

B. 7

C. 6

D. 3

E. 2

F. 1

G. 10

H. 9

The two unused definitions are as follows:

International Tax Treaty = 5

Revenue Jurisdiction Approach = 8

Also not used is “None of the preceding definitions apply”

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TIF Solution Twenty - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.

The correct definitions for each of the listed key terms are as follows:

A. 4 (not 8)

B. 9 (not 7)

C. 6

D. 3

E. 2

F. 1

G. 12 (not 14)

H. 11 (not 13)

The two unused definitions are as follows:

International Tax Treaty = 5

Revenue Jurisdiction Approach = 10

Also not used is “None of the preceding definitions apply”

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TIF Solution Twenty - 6

A. Advertising in gun magazines would not result in a permanent establishment as there is no fixed
place of business in Canada.

B. Selling cabinets to Canadian distributors would not result in a permanent establishment, as there is
no fixed place of business in Canada. As well, the orders are filled from a U.S. warehouse and
customers pay for shipping from a U.S. port or border. This would be proof that no fixed place of
business exists in Canada.

C. Direct sales to wholesalers by non-exclusive agents would not result in a permanent establishment
as there is most likely no fixed place of business in Canada. The agents are independent, and do not
work exclusively for the U.S. gun cabinet manufacturer. More information is needed on where
orders are filled from and on where contracts are approved. If the orders are filled in the U.S., the
manufacturer would not be deemed to have a permanent establishment in Canada.

D. Direct sales to wholesalers by full-time salespeople would probably not result in a permanent
establishment because contracts are approved in the U.S. As well, orders are filled from a
warehouse in the U.S., again indicating that the business does not have a permanent establishment
in Canada. While there are no sales offices, the full-time salespeople could be considered to
provide permanence to the business arrangement. Questions to ask include:

 Do the full-time salespeople work from their homes and vehicles?

 Can a home or vehicle be considered a permanent establishment?

 Is the business listed in telephone directories in Canada?

A case could be made that there is a Canadian permanent establishment. However, the fact that
contracts have to be approved in the U.S. would likely override this conclusion.

E. Sales offices in each region lend permanence to the Canadian business. Also, filling of orders from
Canadian warehouses would also indicate that there is a permanent establishment in Canada. But,
as formal approval of contracts is controlled in the U.S. head office, a strong position could be taken
that there is no permanent establishment. Also, because the fixed place of business appears to be
used solely to either store or maintain goods for delivery, the Canada/U.S. treaty would likely deem
the fixed place of business not to be a permanent establishment. Questions should be asked about
where goods are manufactured or purchased, and where the business is administered. For example,
where are bank accounts located and books of account maintained? If virtually all business is
administered in Canada, a Canadian permanent establishment is assured.

F. Independent profit centres would likely be assessed as having a permanent establishment in Canada.
Further, management and control appears to be in Canada. Orders are filled from Canadian
warehouses, lending strong support to the Canadian permanent establishment position. Questions
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should be asked about where contracts are approved and where the business is administered (bank
accounts, collections, and books of account).

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TIF Solution Twenty - 7

Case 1
While the interest is being paid on participating debt, Bryan is a resident of the U.S. The Canada/U.S.
tax treaty exempts U.S. residents from Part XIII tax on all interest payments. Clark would not be subject
to Part XIII tax and no Canadian tax would be payable.

Case 2
Part XIII tax is applicable to interest only if the interest is paid on participating debt or is paid to a non-
arm’s length non-resident. The debt is not participating and Michael is at arms’ length with the
Canadian bank. Given this, Part XIII tax would not be applicable and no Canadian tax would be
payable.

Case 3
While the Canada/U.S. tax treaty reduces the Part XIII rate on dividends, Brigitte is a resident of a
country that does not have a tax treaty with Canada. Given this, the $4,800 in dividends would be taxed
at the full 25 percent Part XIII rate and the tax would equal $1,200 [(25%)($4,800)].

Case 4
As Richard is a resident of the U.S., the Canada/U.S. tax treaty would be applicable. Under this treaty,
the Part XIII rate on rents of assets other than real property is reduced to 10 percent. Given this, his Part
XIII tax would be $54,600 [(10%($546,000)]. Note that the election to be taxed under Part I is only
available when the asset being rented is real property. Therefore, the Part I election would not be
available to Saul and the Part XIII tax must be paid.

Case 5
As Frank is not a resident of a country with which Canada has a tax treaty, he would be subject to Part
XIII tax at a rate of 25 percent. This would require a payment of $5,750 [(25%)($23,000)].
Alternatively, he could elect to be taxed under Part I on his net income of $10,000 ($23,000 - $13,000).
As the Part XIII tax as a percent of his net rental income is 57.5 ($5,750  $10,000), a rate well above
any Canadian rate on individuals, the Part I election would clearly be a better alternative.

Case 6
Kristopher is a resident of a country that does not have a tax treaty with Canada. In addition, the interest
is paid on participating debt. Given these facts, the interest would be subject to Part XIII tax at the 25
percent rate and the tax would equal $86.75 [(25%)($347)].

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TIF Solution Twenty - 8

Part A
As Ms. Houston appears to have severed all residential ties with Canada and she and her employer do
not anticipate that she will return in the foreseeable future, it does not appear that she will be considered
a Canadian resident after her move to Australia.
An individual is considered to have ceased being a resident of Canada as of the latest of:

 the date they leave Canada,

 the date their spouse, common-law partner and/or other dependants leave Canada, and

 the date they become a resident of the country to which they are immigrating.

For Ms. Houston, the latest of these dates is September 1, 2018, the day that she established residence in
Sydney. This means that she will be considered to be a resident of Canada for the period January 1
through August 31, 2018.

Part B
Based on this analysis, the Net Income For Tax Purposes that would be shown in her 2018 Canadian tax
return would be as follows:

Income Under ITA 3(a):

Employment Income While Canadian Resident

[($12,000)(8 Months)] $96,000

Canadian Interest Income 3,500

Australian Interest Income While Canadian Resident

[($500)(1 Month)] 500 $100,000

Income Under ITA 3(b):

Taxable Capital Gains [(1/2)($27,300)] $13,650

Allowable Capital Losses [(1/2)($14,500 + $6,800)] ( 10,650) 3,000

Balance From ITA 3(a) And (b) $103,000

Subdivision e Deductions [($2,000)(8) + $8,800] ( 24,800)

Balance From ITA 3(c) $ 78,200

Deduction Under ITA 3(d):

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Business Loss ( 27,000)

Net Income For Tax Purposes $ 51,200

There would be no loss carry overs arising from the 2018 information.

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TIF Solution Twenty - 9

Part A
Assuming no election is made, Horace’s emigration would have the following tax consequences and/or
deferred income for each of the listed assets:

Savings Account There would be no tax consequences and no deferred income associated
with this asset.

Residence As the residence is Taxable Canadian Property, there would be no deemed

disposition on Horace’s departure from Canada. Given this, there would be no immediate tax
consequences. However, there would be a deferred gain calculated as follows:

Land Building

Fair Market Value $60,000 $180,000

Adjusted Cost Base ( 45,000) ( 85,000)

Capital Gain $15,000 $ 95,000

Inclusion Rate 1/2 1/2

Deferred Taxable Capital Gain $ 7,500 $ 47,500

As this real property is Taxable Canadian Property, a future disposition would be subject to
Part I Canadian tax even after Horace is no longer a Canadian resident.

Cottage As the cottage is Taxable Canadian Property, there would be no deemed disposition
on Horace’s departure from Canada. Given this, there would be no immediate tax
consequences. However, there would be a deferred loss calculated as follows:

Land Building

Fair Market Value $50,000 $250,000

Adjusted Cost Base ( 95,000) ( 250,000)

Capital Loss/Terminal Loss ($45,000) Nil

Inclusion Rate 1/2

Deferred Allowable Capital/Terminal Loss ($22,500) Nil

As this real property is Taxable Canadian Property, a future disposition would be subject to
Part I Canadian tax even after Horace is no longer a Canadian resident.

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If he continues to rent the cottage, a 25 percent Part XIII tax will apply to the gross rents
received once he becomes a non-resident. Horace can also elect to have the rental income
taxed under Part I of the Income Tax Act. This may be preferable in that he can deduct
expenses against the gross rents if he makes this election.

SUV As this SUV is personal use property, the loss arising from its deemed disposition would
not be deductible. There would be no tax consequences associated with this asset.

RRSP Unless Horace decides to collapse this plan prior to his departure, there will be no tax
consequences associated with his emigration. However, future withdrawals, subsequent to
terminating his Canadian residency, would be subject to Part XIII tax.

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Shares There would be a deemed disposition of the CCPC and public company shares
resulting in the following taxable capital gains:

CCPC Public Company

Fair Market Value $123,000 $135,000

Adjusted Cost Base ( 87,000) ( 120,000)

Capital Gain $ 36,000 $15,000

Inclusion Rate 1/2 1/2

Taxable Capital Gain $ 18,000 $ 7,500

Taxable Canadian Property includes a share of an unlisted corporation, if, at any time within
the preceding 60 months, more than 50 percent of the fair market value of the share or interest
was derived from certain properties including Canadian real property. It appears the CCPC
shares are Taxable Canadian Property. As a result, any additional gain on the disposition of
these shares would be subject to Canadian taxation even though Horace is no longer a Canadian
resident.

The total inclusion in Net Income For Tax Purposes that results from Horace’s emigration can be
calculated as follows:

CCPC Shares $18,000

Public Company Shares 7,500

Total Net Income For Tax Purposes Inclusion $25,500

Horace can pay the related tax when he files his tax return for the year of departure. However, he is not
obliged to pay the tax until he actually disposes of the shares [note that this deferral requires an election
under ITA 220(4.5)]. Further, he is not required to post security for the estimated Tax Payable as the
total taxable capital gains of $25,500 are within the $50,000 exemption.

Part B
The ITA 128.1(4)(d) election could be used to trigger a deemed disposition on the principal residence
and/or the cottage. Horace should elect to have a deemed disposition on both properties.
With respect to the residence, the gain resulting from such a deemed disposition could be completely
eliminated by designating it as his principal residence.
With respect to the cottage, the loss resulting from the deemed disposition could be used to offset the
gains on the CCPC and public company shares. The result would be as follows:

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Income Inclusion Before Election $25,500

Allowable Capital Loss On Cottage ( 22,500)

Total Net Income For Tax Purposes Inclusion $ 3,000

The use of the election has decreased his Net Income For Tax Purposes by $22,500.
With respect to future years, both the residence and the cottage are Taxable Canadian Property and,
when they are sold, any gains would be subject to Part I tax in Canada. The deemed dispositions have
resulted in an increase (principal residence) and reduction (cottage) in the adjusted cost base of the
properties. The revised adjusted cost base would be used to determine the capital gain or loss on the
actual dispositions.

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TIF Solution Twenty - 10

A. Foreign investment reporting is required for the shares held outside of the RRSP. The cost of one-
half of the shares is greater than $100,000 [(1/2)($317,000) = $158,500]. The current fair market
price is not relevant. Specified foreign property held in an RRSP is excluded from form T1135
reporting requirements.

B. Foreign investment reporting is required. The condo is primarily a rental property and its cost is
greater than $100,000.

C. Foreign investment reporting is not required since the yacht is not real property. In addition, it is
personal use property.

D. Foreign investment reporting is not required. Since the cottage is personal use property, the fact
that the total cost of the Cape Hatteras cottage is greater than $100,000 is not relevant.

E. No foreign investment reporting is required when assets are used in an active business.

F. Foreign investment reporting is not required. The total of the amount owing on the mortgage for
the current year ($55,000) and the highest balance in the U.S. bank account for the year ($10,000)
total less than $100,000.

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TIF Solution Twenty - 11

As a Canadian resident, Ms. Borody would be taxed on her worldwide income. This would include all
of the German investment income. The amounts to be included in her Net Income For Tax Purposes
would be as follows:

Dividends Since 15 percent was withheld from the dividends, the gross dividend income totals
€6,000 (€5,100 ÷ 85%). Converted to Canadian dollars, the amount to be included in Ms.
Borody’s Net Income For Tax Purposes would be $8,700 [($1.45)(€6,000)]. The German
dividends will not be grossed up as would be eligible dividends received from public Canadian
corporations. They would also not give rise to a dividend tax credit. The foreign taxes
withheld would generate a credit against Tax Payable of $1,305 [($1.45)(€6,000 - €5,100)].

Since the withholding is not more than 15 percent, all of the withholding can be used in the
foreign tax credit calculation. The problem does not provide Ms. Borody’s Division B Income
or her Tax Payable, so the full calculation for the foreign tax credit cannot be done.

Interest The interest income would be converted to Canadian dollars and the amount included
in Ms. Borody’s Net Income For Tax Purposes would be $2,900 [($1.45)(€2,000)]. The fact
that it has not been removed from the German bank account is irrelevant as she is taxed on her
worldwide income.

Rental Income The amount to be included in Ms. Borody’s Net Income For Tax Purposes
would be based on the net rental income of €18,000 (€30,000 - €12,000). Converted to
Canadian dollars, this amount would be $26,100 [($1.45)(€18,000)]. As no German taxes were
withheld, no tax credit is available on this amount.

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TIF Solution Twenty - 12

The SP Ltd. withholding equals 25 percent ($4,250  $17,000) of the dividend paid. The FR Ltd. tax
withholding equals 10 percent ($800  $8,000) of the dividend paid.
As the foreign non-business tax credit is limited to 15 percent, the additional 10 percent ($1,700)
withheld by Foreign Country 1 will have to be deducted in the determination of Mark’s Net Income For
Tax Purposes.

Net Employment Income $ 67,500

Taxable Capital Gains 4,500

Eligible Canadian Dividends 12,000

Gross Up [(38%)($12,000)] 4,560

SP Ltd. Dividends (No Gross Up) 17,000

FR Ltd. Dividends (No Gross Up) 8,000

Excess Withholding [(25% - 15%)($17,000)] ( 1,700)

Net Income For Tax Purposes $111,860

Net Capital Loss Carry Forward* ( 4,500)

Business Loss Carry Forward ( 6,200)

Taxable Income $101,160

* The net capital loss carry forward is limited to the taxable capital gains.

Using this result, Mark’s Taxable Income would be calculated as follows:

Tax On First $93,208 $16,544

Tax On Next $7,952 ($101,160 - $93,208 At 26%) 2,068

Tax Payable Before Credits $18,612

Basic Personal Credit ($11,809)

EI ( 858)

CPP ( 2,594)

Canada Employment ( 1,195)

Total Credit Amount ($16,456)

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Applicable Rate 15% ( 2,468)

Tax Otherwise Payable $16,144

Dividend Tax Credit [(6/11)($4,560)] ( 2,487)

Foreign Tax Credits (See Note)

SP Ltd. ( 2,550)

FR Ltd. ( 800)

Federal Tax Payable $10,307

Note The foreign non-business tax credits are calculated on a country by country basis (see
Chapter 11).

For use in the following formula, Adjusted Division B Income would be equal to $107,360
($111,860 - $4,500). Note that the business loss carry forward is not deducted in this
calculation. As shown in the preceding table, Tax Otherwise Payable would be before the
deduction of the dividend tax credit.

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The tax credit on the SP Ltd. shares would be the lesser of:

 Amount Withheld (Limited To 15%) = [(15%)($17,000)] = $2,550

 [(Foreign Non-Business Income

÷ Adjusted Division B Income)(Tax Otherwise Payable)]

= ($17,000 ÷ $107,360)($16,144) = $2,556

The tax credit on the FR Ltd shares would be the lesser of:

 Amount Withheld (Less Than 15%) = $800

 [(Foreign Non-Business Income

÷ Adjusted Division B Income)(Tax Otherwise Payable)]

= ($8,000 ÷ $107,360)($16,144) = $1,203

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Chapter Twenty-One Test Item File Solutions

TIF Solution Twenty-One - 1

1. The main advantages can be described as follows:

 An HST system is less complex. With an HST system, the staff of the business only has to
understand and deal with one set of rules. In contrast, under a GST/PST system, two separate
sets of rules must be dealt with.

 An HST system has lower compliance costs. GST/PST systems require the filing of two
separate tax returns, as opposed to the one return that is required with an HST system.

 With an HST system, business organizations receive input tax credits for the taxes paid on their
purchases. They receive input tax credits for only the GST portion under a GST/PST system.

2. The required two factors can be selected from the following:

 Simplicity Transaction taxes are easy to administer and collect. No forms are required from
individuals paying the tax and, if the individual wishes to acquire a particular good or service, it
is difficult to evade payment.

 Incentives To Work An often cited disadvantage of income taxes is that they can discourage
individual initiative to work and invest. Transaction taxes do not have this characteristic.

 Consistency Transaction taxes avoid the fluctuating income and family unit problems that are
associated with progressive income tax systems.

 Keeping The Tax Revenues In Canada While some types of income can be moved out of
Canada, resulting in the related taxes being paid in a different jurisdiction, taxes on Canadian
transactions remain in Canadian hands.

3. The problem is that there is pyramiding of taxes. When the tax is applied at each level using normal
markups, there is a tax on taxes that have been previously paid. This can result in a very high
overall rate being charged in the process of getting the product to the ultimate consumer.

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4. An accounts-based value added tax system applies a specified rate to the value added at each stage
in the production/distribution process. Such systems require an accounting based measurement of
the amount of value added.

An invoice-credit value added tax applies a specified rate to the revenue generated at each stage in
the production/distribution process. The remittance of this amount is offset by claiming input tax
credits for the tax that has been paid on all current purchases and on the full amount of capital
expenditures used in producing these revenues. Its application involves no matching of costs and
revenues, and no allocation of costs to periods other than the period in which the asset was acquired.

5. The GST/HST consequences are as follows:

Fully Taxable Goods And Services The vendor would charge GST/HST on all such sales.
The vendor would be eligible for input tax credits for GST/HST paid on the costs associated
with such sales.

Zero-Rated Goods And Services The vendor would not charge GST/HST on such sales. The
vendor would be eligible for input tax credits for GST/HST paid on the costs associated with
such sales.

Exempt Goods And Services The vendor would not charge GST/HST on such sales. The
vendor would not be eligible for input tax credits for GST/HST paid on the costs associated
with such sales.

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6. With respect to tangible goods, GST/HST will be collected using the rules of the province where the
goods are delivered.

With respect to services, GST/HST will be collected using the rules of the province where the
recipient of the services is located.

7. HST will only be levied on the net cost of the new car. The 13 percent rate will be applied to the
cost of the new car, less the trade-in allowance provided.

8. While several examples could be cited here, unincorporated businesses (proprietorships and
partnerships) and not-for-profit organizations are most commonly mentioned in the text.

9. In general, non-residents are not required to register for GST/HST. However, if a non-resident is
carrying on business in Canada, registration would be required. In addition, a non-resident could
voluntarily register.

10. Under this test, an entity qualifies as a small supplier in the current quarter and the month following
the current quarter if, during the calendar four quarters preceding the current quarter, the entity and
its associated entities did not have cumulative taxable supplies exceeding $30,000.

11. The basic questions that should be asked are as follows:

 Do you have large amounts of fully taxable costs that would generate input tax credits?

 Do you expect to exceed $30,000 in annual taxable sales in the near future?

 Would adding GST/HST to your sale price reduce your ability to compete?

12. For capital expenditures on real property, the GST/HST paid is eligible for an input tax credit at the
time of purchase. However, if the property is not used exclusively for commercial activity, only a
portion of the GST/HST is eligible for the credit. The portion is based on the extent to which the
property is used for commercial activity. This is subject to a minimum rule (there is no input tax
credit if the property is used 10 percent or less for commercial activity) and a maximum rule (100
percent of the GST/HST paid is eligible for the credit if the property is used 90 percent or more for
commercial activity).

For most capital expenditures other than real property (capital personal property), the GST/HST
paid is eligible for an input tax credit at the time of purchase. However, if the property is used 50
percent or less for commercial activity, no credit is available. Alternatively, if the property is used
more than 50 percent for commercial activity, 100 percent of the GST/HST paid is eligible for an
input tax credit.

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13. Input tax credits on current expenditures are available at the time the expenditure is made, without
regard to matching with related revenues. If all, or substantially all (generally understood to mean
90 percent or more), of a current expenditure is related to commercial activity, then all of the GST/
HST that was paid can be claimed as an input tax credit. In contrast, if 10 percent or less of an
expenditure is related to commercial activity, no input tax credit can be claimed. If the percentage
of the current expenditure used for commercial activity is between 10 and 90 percent, the input tax
credit available is calculated by multiplying the total GST/HST paid by the percentage of
commercial activity usage.

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14. The required two examples can be selected from the following:

Passenger Vehicles No input tax credits are available for GST/HST paid on the portion of the
cost or lease payment of a passenger vehicle that is in excess of the prescribed limits (see
Chapter 6 for details on these limits).

Club Memberships No input tax credit is allowed for GST/HST paid on membership fees or
dues in any club whose main purpose is to provide dining, recreational, or sporting facilities.

Provision Of Recreational Facilities No input tax credits are available for the GST/HST costs
of providing certain types of recreational facilities to employees, owners, or related parties.

Business Meals And Entertainment The recovery of GST/HST on meals and entertainment
expenses is limited to 50 percent of the amounts paid.

Personal Or Living Expenses Input tax credits cannot be claimed on costs associated with the
personal or living expenses of any employee, owner, or related individual.

Reasonableness Both the nature and value of a purchase must be reasonable in relation to the
commercial activities of the registrant before an input tax credit can be claimed.

15. With respect to the GST that is received with revenues, these amounts will have to be remitted to
the government and should not be included in reported revenues.

With respect to the GST included in expenses, its treatment in the financial statements of an
enterprise will depend on whether or not it will be refunded as an input tax credit. If it is eligible
for input tax credit treatment, it should be excluded from the expenses reported. Alternatively, if
the amounts will not be refunded, they should be included in the expenses reported.

With respect to GST assets (refunds) or liabilities (payments), they should be reported in full in the
Balance Sheet of the enterprise.

16. The major advantages of using the Quick Method can be described as follows:

 As the remittance rate is charged on GST/HST inclusive sales, there is no need for separate
tracking of GST/HST collections.

 There is no requirement to separately track purchases, other than those for capital expenditures,
in order to determine the amount of input tax credits.

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 While this is not always the case, the Quick Method may reduce the amount of GST/HST that
would be paid by the registrant if he were to use the regular accounting method for determining
his GST/HST liability. Note, however, the use of this method may also increase the amount to
be paid.

17. Under the streamlined method of accounting for input tax credits, detailed records are not kept of
the GST/HST that is paid on all purchases other than real property. The total GST/HST and non-
refundable PST inclusive amount of fully taxable costs incurred, including eligible costs incurred
for capital assets other than real property, is multiplied by a factor to arrive at the figure that will be
used for input tax credits in the GST/HST return of the registrant.

The factor used will depend on the GST/HST rate in the province (e.g., 5/105 in Alberta, 15/115 in
New Brunswick). As with the regular method of calculation, separate attention is given to the GST/
HST paid on real property. This means that this amount will have to be pro rated based on the
extent to which it is used in commercial activity.

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18. This would happen if the entity had input tax credits in excess of GST/HST collections on a regular,
ongoing basis. This type of situation would entitle the entity to regular payments from the
government. An example of this would be a business selling goods for export.

19. The required two could be selected from the following:

 Determining whether they qualify for the small supplier’s exemption,

 Determining whether they are eligible for the Quick Method of accounting,

 Determining whether they are eligible for the streamlined method of calculating input tax
credits,

 Determining the required filing frequency of their returns (i.e., monthly, quarterly or annually).

20. Employees and individual partners are not GST/HST registrants and, in the absence of a special
provision, would not be eligible to claim input tax credits for their employment or business related
expenditures. The Employee and Partner GST/HST Rebate allows employees and partners to
recover the GST/HST paid on their employment or partnership related expenditures in a way that is
similar to the input tax credits that they would have received if they were GST/HST registrants.

21. For homes that cost $350,000 or less, the rebate is equal to 36 percent of the GST that is paid on the
purchase. This provides a maximum rebate of $6,300 [(36%)(5%)($350,000)]. For homes that cost
more than $450,000, no rebate is available. For homes costing between $350,000 and $450,000, the
total rebate is reduced using the following formula:

[A][($450,000 - B) ÷ $100,000]

Where:

A = The lesser of 36 percent of the GST paid and $6,300; and

B = The greater of $350,000 and the cost of the home.

22. The major condition is that 90 percent or more of the assets needed to carry on the business must be
transferred. In addition, the election is only available if both the purchaser and vendor are
GST/HST registrants, if both the purchaser and vendor are non-registrants, or if the purchaser is a
registrant and the vendor is a non-registrant. It cannot be used if the vendor is a registrant and the
purchaser is a non-registrant.

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TIF Solution Twenty-One - 2

1. True.

2. False.

A multi-stage tax allows for a quicker accrual of revenues.

3. True.

4. True.

5. False.

While they do not charge GST/HST on sales, they are still eligible to claim input tax credits.

6. True.

7. False.

Zero-rated supplies are taxed at a zero rate, thereby allowing the supplier to claim input tax
credits.

8. False.

GST is charged on the net amount of the purchase price, less the trade-in value.

9. True.

10. False.

Input tax credits on real property are based on a pro rata amount determined by the percentage
of usage for the production of taxable supplies.

11. True.

12. True.

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13. False.

The GST rebate is equal to 5/105 of the deductible expenses.

14. True.

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TIF Solution Twenty-One - 3

General GST/HST
1. A. All persons engaged in a business must register with the CRA for GST purposes.

Transaction Tax Concepts

2. C. The tax charged for spending a day in Banff National Park.

3. C. Income taxes are less regressive than transaction taxes.

4. D. By providing a refundable GST tax credit that is available to low income individuals.

Liability For GST/HST

5. C. The sale of a life insurance policy by an insurance agency which is an exempt supply.

Supply Categories
6. B. The purchase of milk at the grocery store.

7. A. Fully taxable supplies are taxed at the HST rate and zero-rated supplies are taxed at
0.0 percent. Expenditures related to both types of supplies are eligible for input tax credits.

8. C. Zero-rated supplies are taxable at 0.0 percent, while exempt supplies are not taxable.
Expenditures related to zero-rated supplies are eligible for input tax credits and those related to
exempt supplies are not.

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Applying The GST/HST Rate

9. B. $2,300 [(5%)($82,000 - $36,000)

10. D. An Ontario registrant ships a product to a recipient in Alberta.

Collection And Remittance Of GST/HST

11. A. $322.12 [(13%)($2,800 ÷ 1.13)]

4.

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GST/HST Registration
12. C. August 1, 2018.

13. B. August 1.

Input Tax Credits

14. D [13%][$150,000 - ($96,000 + $83,000 + $17,000)] = ($5,980)

15. D. All capital expenditures made during the period and goods purchased for resale during
the period.

16. C. [($7,000 + $400 + $500)(5%)] = $395. An input tax credit is not permitted for the
club fee as the fee is not deductible for income tax purposes.

17. C. $3,445.

Revenues $30,000

Office supplies ( 500)

Rent ( 3,000)

Total $26,500

Rate 13%

HST Payable $ 3,445

18. C. $16,705.

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Revenues $300,000

Purchase of bicycles ( 150,000)

Purchase of tires and other parts ( 18,500)

Premises rental ( 3,000)

Total $128,500

Rate 13%

HST Payable $ 16,705

19. B. $39,325.

Revenues $325,000

Stationery and supplies ( 5,000)

Utilities ( 2,500)

Rent ( 15,000)

Total $302,500

Rate 13%

HST Payable $ 39,325

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Relief For Small Business

20. C. A business involved in legal, accounting and financial consulting services, cannot use
the quick method.

21. B. Capital expenditures are not tracked separately for purposes of determining input tax
credits. Real property purchases are tracked separately.

22. C. $8,810 [(5/105)($180,000 + $5,000)]

GST/HST Procedures and Administration

23. A. A Ltd. sells 100% fully taxable supplies, and B Ltd. sells 100% zero rated supplies.
They would like to claim the full input tax credit on the purchase of a building for A Ltd.

Employee And Partner GST/HST Rebate

24. E. All eligible expenses for fully taxable supplies deducted in the calculation of net
employment income, including capital cost allowances.

25. B. $ 1,273 [(13/113)($1,100 + $4,176 + $5,791)]

Residential Property And New Housing GST Rebate

26. A. Nil. [$6,300][($450,000 - $625,000)  $100,000]

Sale of a Business
27. D. The vendor is selling substantially all of the assets of his business. Neither the vendor
nor the purchaser are GST/HST registrants.

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Specific Applications
28. B. The charity will not have to collect any GST on their clothing sales. (There is a
$50,000 small supplier exemption for charities.)

Partnerships and GST/HST

29. B. The partnership is required to collect the GST/HST on taxable supplies and is eligible
for input tax credits.

Trusts and GST/HST

30. A. A distribution of taxable supplies by the trust to the beneficiaries.

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TIF Solution Twenty-One - 4

Exam Exercise Solution Twenty-One - 1 (Alternative VAT Approaches)
The amount of tax to be paid under the two systems would be calculated as follows:

Accounts Invoice

Based System Credit System

Value Added ($476,000 - $302,000)] $174,000 N/A

Taxable Revenues N/A $476,000

Base For Credits N/A ( 371,000)

Subtotal $174,000 $105,000

Rate 5% 5%

Total $ 8,700 $ 5,250

The fact that the tax is less under the invoice-credit system reflects the fact that the purchases of goods
exceeded the cost of goods sold.

Exam Exercise Solution Twenty-One - 2 (Alternative VAT Approaches)

The amount of tax to be paid under the two systems would be calculated as follows:

Accounts Invoice

Based System Credit System

Value Added ($825,000 - $562,000)] $263,000 N/A

Taxable Revenues N/A $825,000

Base For Credits ($562,000 + $150,000) N/A ( 712,000)

Subtotal $263,000 $113,000

Rate 8% 8%

Total $ 21,040 $ 9,040

The fact that the tax is less under the invoice-credit system reflects the fact that the purchases of goods
exceeded the cost of goods sold.

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Exam Exercise Solution Twenty-One - 3 (Requirement To Register)

As his sales exceed $30,000 in the third quarter, he will be required to begin collecting GST on the first
sale in that quarter that exceeds the $30,000 threshold. This means he will have to begin collecting GST
sometime between July 1 and September 30. He will be required to register within 29 days of that date.

Exam Exercise Solution Twenty-One - 4 (Requirement To Register)

Ms. Hammer’s sales exceed $30,000 in the second quarter. This means that she will be required to
begin collecting GST on the first sale in that quarter that exceeds the $30,000 threshold. This will be
sometime between April 1 and June 30. Registration will be required within 29 days of that date.

Exam Exercise Solution Twenty-One - 5 (Requirement To Register)

As Ms. Holt’s sales accumulate to more than $30,000 by the end of the third quarter, she will have to
begin collecting GST on November 1, one month after the end of the quarter. (The fourth quarter sales
are not relevant.) She will be required to register by December 26, within 29 days of the November 27
sale.

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Exam Exercise Solution Twenty-One - 6 (Requirement To Register)

Mr. Gardens’ sales accumulate to $32,000 ($18,000 + $14,000) by the end of the April/June quarter.
This means that he will begin collecting GST on August 1, one month after the end of the quarter. He
will be required to register by October 26, within 29 days of the September 27 sale.

Exam Exercise Solution Twenty-One - 7 (ITCs - Capital Expenditures)

As the building is real property, an input tax credit would be available on a pro rata basis. This means
that the credit would be $25,375 [($1,450,000)(5%)(35%)]. No input tax credit would be available on
the equipment as it is used less than 50 percent in the provision of taxable supplies.

Exam Exercise Solution Twenty-One - 8 ( (ITCs - Capital Expenditures)

The available input tax credits would be calculated as follows:

Building [(13%)(100%)($2,825,000 ÷ 1.13)] $325,000

Equipment [(13%)(100%)($904,000 ÷ 1.13)] 104,000

Total Available Input Tax Credits $429,000

While there is a pro rata calculation on real property, the building is used 100 percent for taxable (fully
and zero-rated) supplies. With respect to the equipment, it is used 60 percent (35% + 25%) for taxable
supplies. This allows Logan to claim the input tax credit on 100 percent of the cost of the asset.

Exam Exercise Solution Twenty-One - 9 (GST Calculation)

The GST payable would be calculated as follows:

GST On Sales [(5%)($286,650 ÷ 1.05)] $13,650

Input Tax Credits:

Rent [(5%)($18,000)] ( 900)

Salaries Nil

Interest Nil

Purchases Of Supplies [(5%)($4,500)] ( 225)

Capital Expenditure [(5%)($32,000)] ( 1,600)

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GST Payable For The Year $10,925

Exam Exercise Solution Twenty-One - 10 (GST Calculation)

The GST payable would be calculated as follows:

GST On Sales [(5%)($326,000)] $16,300

Input Tax Credits:

Rent [(5%)($36,000)] ( 1,800)

Salaries Nil

Interest Nil

Purchases Of Supplies [(5%)($23,000 + $4,000)] ( 1,350)

CCA Nil

Capital Expenditure [(5%)($18,000)] ( 900)

GST Payable For The Year $12,250

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Exam Exercise Solution Twenty-One - 11 (HST Calculation)

The HST payable would be calculated as follows:

HST On Sales [(13%)($136,000)] $17,680

Input Tax Credits:

Rent [(13%)($29,450)] ( 3,829)

Assistant’s Salary Nil

Capital Expenditures [(13%)($43,700 + $18,000)] ( 8,021)

HST Payable For The Year $ 5,830

Exam Exercise Solution Twenty-One - 12 (HST Calculation)

As the vehicle is owned by an individual and used more than 90 percent for business purposes, the input
tax credit is based on 100 percent of the cost for GST purposes. However, in calculating the input tax
credit, the cost of the car is limited to the Class 10.1 maximum of $30,000.

HST On Sales [(15%)($517,500 ÷ 1.15)] $67,500

Input Tax Credits:

Rent [(15%)($48,000)] ( 7,200)

Salaries To Employees Nil

Interest On Business Loan Nil

Office Supplies [(15%)($14,000 - $3,000)] ( 1,650)

CCA Nil

Vehicle [(15%)(100%)($30,000)] ( 4,500)

HST Payable For The Year $54,150

Exam Exercise Solution Twenty-One - 13 (Quick Method)

The HST refund under the regular method would be calculated as follows:

HST On Sales [(15%)($42,300)] $ 6,345

Input Tax Credits:

Current Expenses [(15%)($37,800)] ( 5,670)

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Capital Expenditures [(15%)($72,000)] ( 10,800)

HST Payable (Refund) - Regular Method ($10,125)

Alternatively, under the Quick Method, the calculation would be as follows:

Basic Tax [(5%)(115%)($42,300)] $ 2,432

Credit On First $30,000 [(1%)($30,000)] ( 300)

Subtotal $ 2,132

Input Tax Credit On Capital Expenditures [(15%)($72,000)] ( 10,800)

HST Payable (Refund) - Quick Method ($ 8,668)

As the Regular Method produces a larger refund, it would be the preferable method. Note that input tax
credits on capital expenditures are available, even when the Quick Method is used.

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Exam Exercise Solution Twenty-One - 14 (Quick Method)

Since the security system is being amortized it is reasonable to assume it is a capital expenditure. If the
Quick Method is not used, the GST payable (refund) would be calculated as follows:

GST On Sales [(5%)($63,400)] $3,170

Input Tax Credits:

Current Costs [(5%)($26,275)] ( 1,314)

Capital Expenditures [(5%)($44,900)] ( 2,245)

GST Payable (Refund) - Regular Method ($ 389)

Alternatively, under the Quick Method, the calculation would be as follows:

Basic Tax [(1.8%)(105%)($63,400)] $1,198

Credit On First $30,000 [(1%)($30,000)] ( 300)

Subtotal $ 898

Input Tax Credit On Capital Expenditures [(5%)($44,900)] ( 2,245)

GST Payable (Refund) - Quick Method ($1,347)

As the Quick Method produces a larger refund, it would be the preferable method. Note that input tax
credits on capital expenditures are available, even when the Quick Method is used.

Exam Exercise Solution Twenty-One - 15 (Streamlined Input Tax Credit Method)

Using the streamlined method of accounting for input tax credits, the GST payable (refund) would be
calculated as follows:

GST On Sales [(5%)($472,500 ÷ 1.05)] $22,500

Input Tax Credits On Purchases And Capital Personal Property

{[5/105][($320,000)(105%) + ($23,000)(105%)]} ( 17,150)

Input Tax Credits On Real Property [(5%)($85,000)] ( 4,250)

GST Payable (Refund) For The Year $ 1,100

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Exam Exercise Solution Twenty-One - 16 (Streamlined Input Tax Credit Method)

Using the streamlined method of accounting for input tax credits, the HST payable (refund) would be
calculated as follows:

HST On Sales [(13%)($395,500 ÷ 1.13)] $45,500

Input Tax Credits On Purchases And Capital Personal Property

[(13/113)($254,250 + $56,500)] ( 35,750)

Input Tax Credits On Real Property [(13%)($113,000 ÷ 1.13)] ( 13,000)

HST Payable (Refund) For The Year ($ 3,250)

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TIF Solution Twenty-One - 5A

The correct definitions for each of the listed key terms are as follows:

A. 4

B. 7

C. 3

D. 5

E. 2

F. 8

G. 10

H. 6

The two unused definitions are as follows:

Exempt Goods And Services = 9

Registrant = 1

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TIF Solution Twenty-One - 5B

For some terms there is both a 100 percent correct answer and an answer that is close. We have
indicated the “close answer” in brackets.

The correct definitions for each of the listed key terms are as follows:

A. 4

B. 8

C. 3 (not 9)

D. 5 (not 14)

E. 2 (not 6)

F. 10

G. 13

H. 7 (not 12)

The two unused definitions are as follows:

Exempt Goods And Services = 11

Registrant = 1

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TIF Solution Twenty-One - 6

Single Stage Consumer Tax
The ultimate price to the consumer would be calculated as follows:

Selling

Vendor Cost Price

Raw Materials Supplier $ 500.00

Manufacturer $ 500.00 750.00

Wholesaler 750.00 1,125.00

Distributor 1,125.00 1,687.50

Retailer 1,687.50 2,531.25

Applying the tax rate of 7 percent to the $2,531.25 selling price results in a tax of $177.19.

Turnover Tax Calculation

The turnover tax would be applied on each transfer of the product. Given this, the tax rate that would
result in a total tax of $177.19 would be calculated as follows:

[($500)(X%)] + [($750)(X%)] + [($1,125)(X%)] + [($1,687.50)(X%)] + [($2,531.25)(X%)]

=$177.19

[($500 + $750 + $1,125 + $1,687.50 + $2,531.25)(X%)] =$177.19

[($6,593.75)(X%)] =$177.19

X% = $177.19 ÷ $6,593.75

X% = 2.69%

As would be anticipated, because this tax is applied at each stage in the production/sale process, the
required rate is lower than the 7 percent that would be applied at only the consumer level.

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TIF Solution Twenty-One - 7

A. By the end of the April to June quarter, cumulative sales in the first two calendar quarters
accumulate to $32,000, $2,000 in excess of the $30,000 threshold that is used in the “last four
calendar quarters” test. As a result, Jewel’s Jewels will have to begin collecting GST on the first
sale in the second month following the end of the quarter in which the $30,000 threshold was
exceeded. This means that she will have to collect GST on her first sale in August, 2018.
Registration is required within 29 days of her first sale in August, the day GST collection is
required to begin.

B. Both the GST return and the payment are due one month after the end of the applicable quarter.
The quarterly remittances for 2018 would be calculated as follows:

GST Taxable

Quarter Quarterly Sales GST At 5% Due Date

January To March Nil N/A

April To June Nil N/A

July To September $13,000 $ 650 Oct. 31, 2018

October To December 23,000 1,150 Jan. 31, 2019

C. The annual remittance for 2018 would be the $1,800 total of the quarterly remittances calculated in
Part B. Since Jewel Hyder is an annual filer who is an individual with business income and a
December 31 fiscal year end, her GST return is due on June 15, 2019, and her payment due date is
April 30, 2019.

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TIF Solution Twenty-One - 8

As sales of commercial property are taxable, HST of $650,000 [(13%)($5,000,000)] will be payable on
the purchase. An input tax credit can be claimed as Total Health Inc. is a registrant and commercial use
of the building exceeds 10 percent.
The input tax credit will be based on the expected use of 40 percent for zero-rated supplies (the
pharmacy), resulting in an input tax credit of $260,000 [(13%)(40%)($5,000,000)]. Medical and dental
services are exempt supplies. As a result, no input tax credit is available for 60 percent of the HST paid
on the building.

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TIF Solution Twenty-One - 9

Mrs. Archer’s input tax credits would be calculated as follows:

Meals With Clients [(50%)($208)] $ 104

Country Club Membership Nil

Laptop (100%) 325

Automobile [(13%)($30,000)] 3,900

Total Of Input Tax Credits $4,329

The deductibility of certain types of business costs are restricted for income tax purposes. For many of
these items, there is a corresponding restriction on the ability of the business to claim input tax credits
for HST purposes. In this problem, the applicable restrictions are as follows:

 The recovery of HST on meals and entertainment expenses is limited to 50 percent.

 No input tax credit is allowed for HST paid on membership fees or dues in any club whose main
purpose is to provide dining, recreational, or sporting facilities.

 No input tax credits are available for HST paid on the portion of the cost or lease payment of a
passenger vehicle that is in excess of the deduction limits. For vehicles purchased by a taxpayer,
the limit is $30,000.

As a further note, since the laptop is used more than 50 percent for commercial activity, 100 percent of
the input tax credit can be claimed. The fact that it was invoiced in December means that the input tax
credit can be claimed despite the fact it was not paid for until the following quarter.

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TIF Solution Twenty-One - 10

The sales are fully taxable. GST paid on the cost of balloons purchased and Operating Costs can be
claimed as an input tax credit. All other items are GST exempt.
The net GST remittance for the year is calculated as follows:

GST On Sales [(5%)($69,000)] $3,450

Input Tax Credits:

Balloons Purchased [(5%)($12,000 - $3,000 + $4,000)] ( 650)

Salaries And Wages Nil

Operating Costs [(5%)($14,500)] ( 725)

Interest On Demand Loan Nil

Interest On Mortgage Nil

Amortization Expense Nil

Income Taxes Nil

Net GST Remittance $2,075

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TIF Solution Twenty-One - 11

The HST refund for Montagne Inc. for the year would be calculated as follows:

HST Collected [(13%)($823,000 - $120,000 - $116,000)]$76,310

Input Tax Credits:

Purchases [(13%)($478,000 - $74,000)] ( 52,520)

Amortization Expense Nil

Salaries And Wages Nil

Interest Expense Nil

Other Operating Expenses [(13%)(100%)($32,000)] ( 4,160)

Building [(13%)(85%)($800,000)] ( 88,400)

Other Capital Expenditures [(13%)(100%)($400,000)] ( 52,000)

HST Payable (Refund) ($120,770)

Notes:

 The fact that HST is paid on all purchases is not unreasonable, despite the fact that the Company
provides both zero-rated and exempt supplies to its customers. Some zero-rated supplies, for
example exports, involve selling items on which HST is paid. Exempt supplies could include the
provision of certain types of services for which no purchases are required.

 Amortization expense does not affect the HST calculation.

 No HST is paid on salaries and wages, or interest. As a result no input tax credits are available.

 Input tax credits on real property are available based on a pro rata portion of their usage in
providing taxable supplies.

 Full input tax credits are available on capital expenditures other than real property if more than 50
percent of their usage is to provide fully taxable and zero-rated supplies.

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TIF Solution Twenty-One - 12

The following recommendations are based solely on the minimization of the HST payment. No
consideration is given to the reduction in accounting costs available through the use of the Quick
Method.

Billy Bob - Guided Fishing Services (Service Business)

The Regular Method would be preferable in this case.

Regular Method

[13%][($90,400 - $24,860) ÷ 1.13] $7,540

Quick Method

Basic Tax [(8.8%)($90,400)] $7,955

Credit On First $30,000 [(1%)($30,000)] ( 300)

Net HST $7,655

Bubba - Fishing Equipment Sales (Retailer)

The Regular Method would be preferable in this case.

Regular Method

[13%][($197,750 - $135,600) ÷ 1.13] $7,150

Quick Method

Basic Tax [(4.4%)($197,750)] $8,701

Credit On First $30,000 [(1%)($30,000)] ( 300)

Net HST $8,401

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Nancy Sue - Cooking Equipment Sales (Retailer)

The Regular Method results for Nancy Sue are as follows:

Regular Method

[13%][($158,200 - $45,200) ÷ 1.13] $13,000

While Nancy Sue is in a retail business, her costs for the current year are well below the 40 percent that
is required for use of the favourable quick method rates that are applicable to retail operations. However,
this test is based on sales and purchases in the previous year, information that is not available in this
problem. If we assume that this 40 percent test was met in the previous year, the quick method gives a
more favourable result as follows:

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Quick Method - Rate For Retailers

Basic Tax [(4.4%)($158,200)] $6,961

Credit On First $30,000 [(1%)($30,000)] ( 300)

Net HST $6,661

Alternatively, if the 40 percent test is not met, the quick method results are less favourable than the
results under the Regular Method.

Quick Method - Rate For Service Providers

Basic Tax [(8.8%)($158,200)] $13,922

Credit On First $30,000 [(1%)($30,000)] ( 300)

Net HST $13,622

Sally Ann - Individualized Cooking Courses (Service Business)

The Regular Method would be preferable in this case.

Regular Method

[13%][($107,350- $67,800) ÷ 1.13] $4,550

Quick Method

Basic Tax [(8.8%)($107,350)] $9,447

Credit On First $30,000 [(1%)($30,000)] ( 300)

Net HST $9,147

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TIF Solution Twenty-One - 13

Part A
As Dorknell’s GST included taxable sales of $226,800 [(105%)($216,000)] are less than $400,000 and it
is not engaged in an ineligible business such as accounting, Dorknell can use the Quick Method.
In order to determine the Quick Method remittance rate, the following amounts from the preceding year
are required:

2017 GST Inclusive Purchases Of Goods For Resale [($110,000)(105%)] $115,500

2017 GST Inclusive Sales Of Taxable Supplies [($302,000)(105%)] $317,100

Since $115,500 ÷ $317,100 equals 36 percent and this is less than 40 percent, Dorknell Ltd. cannot use
the reseller’s remittance rate of 1.8 percent and must use the 3.6 percent rate.
Although this would not be a common situation, it could occur if a large quantity of the inventory that
was sold was purchased in a prior year.

Part B
Using the regular calculations, the GST payable for Dorknell Ltd. for the current year would be
calculated as follows:

GST Collected [(5%)($216,000)] $10,800

Input Tax Credits On Current Expenditures:

Purchases [(5%)($123,000 - $8,000)] ( 5,750)

Amortization Expense Nil

Salaries And Wages Nil

Rent [(5%)($42,000)] ( 2,100)

Interest Expense Nil

Other Operating Expenses [(5%)($27,000)] ( 1,350)

Input Tax Credits On Capital Expenditures

[(5%)(100%)($62,160 ÷ 1.11)] ( 2,800)

GST Payable (Refund) ($ 1,200)

Notes:

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 Amortization expense does not affect the GST calculation.

 No GST is paid on salaries and wages, or interest. As a result, no input tax credits are available.

 Full input tax credits are available on capital expenditures other than real property if more than 50
percent of their usage is to provide fully taxable supplies.

Part C
The Quick Method calculations would be as follows:

Basic Tax [(3.6%)(105%)($216,000)] $8,165

Credit On First $30,000 [(1%)($30,000)] ( 300)

Total Before Capital Expenditures $7,865

Input Tax Credit On Capital Expenditures

[(5%)(100%)($62,160 ÷ 1.11)] ( 2,800)

GST Payable (Refund) $5,065

In this case, the regular GST calculation is preferable as it produces a refund rather than requiring a
remittance. This would be the case even if the Quick Method remittance rate had been 1.8 percent rather
than 3.6 percent.

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TIF Solution Twenty-One - 14

The car cost $29,000 before HST. Since this is less than the limit for Class 10, the total amount paid,
including HST, is included in Class 10. The maximum CCA that Martin can claim for the year is as
follows:

Opening UCC ($32,770 - $4,916) $27,854

HST Rebate Claimed On Car CCA In Preceding Year ( 566)

Adjusted UCC $27,288

Class 10 Rate 30%

Maximum CCA $ 8,186

The employee HST rebate for Martin would be calculated as follows:

Total Expenses Other Than CCA $27,330

HST Exempt Purchases:

Interest ( 2,200)

Insurance ( 1,400)

Eligible Expenses Other Than CCA $23,730

Rate 13/113 $2,730

Eligible CCA $8,186

Rate 13/113 942

Employee HST Rebate $3,672

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TIF Solution Twenty-One - 15

The total input tax credit that can be claimed is calculated as follows:

Total Expenditures $34,060

Ineligible Items

Salaries ($4,000)

Interest ( 1,000) ( 5,000)

$29,060

Input Tax Credit Factor 5/105

Input Tax Credit To Be Claimed $ 1,384

Note that the $1,384 input tax credit is greater than the GST paid of $1,300. The reason for the $84
($1,384 - $1,300) discrepancy is due to the inclusion of the non-refundable provincial sales tax of
$1,760 in the tax base for purposes of calculating the input tax credit [($1,760)(5/105) = $84].
This difference benefits registrants who use the streamlined input tax credit method.
The GST refund is $184 ($1,200 - $1,384).

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TIF Solution Twenty-One - 16

Part A
Using the regular calculations, the HST payable for Nikkee Sports for the current year would be
calculated as follows:

HST Collected [(13%)($265,000)] $34,450

Input Tax Credits On Current Expenditures:

Purchases [(13%)($140,000 + $13,000)] ($19,890)

Amortization Expense Nil

Salaries And Wages Nil

Rent (Paid To Non-Registrant) Nil

Interest Expense Nil

Other Operating Expenses [(13%)($21,000)] ( 2,730) ( 22,620)

Input Tax Credits On Capital Expenditures

[(13%)(100%)($62,150 ÷ 1.13)] ( 7,150)

HST Payable $ 4,680

Notes:

 Amortization expense does not affect the HST calculation.

 No HST is paid on salaries and wages, or interest. As a result, no input tax credits are available.

 Full input tax credits are available on capital expenditures other than real property if more than 50
percent of their usage is to provide fully taxable supplies.

Part B
The Streamlined Input Tax Credit Method calculations would be as follows:

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HST Collected [(13%)($265,000)] $34,450

Input Tax Credit Items:

Purchases [(113%)($140,000 + $13,000)] ($172,890)

Other Operating Expenses [(113%)($21,000)] ( 23,730)

Subtotal ($196,620)

Streamlined ITC Method Factor 13/113

Input Tax Credit On Taxable Current Expenditures ($ 22,620)

Input Tax Credits On Capital Expenditures

[(13%)(100%)($62,150 ÷ 1.13)] ( 7,150) ( 29,770)

HST Payable $ 4,680

The HST Payable is the same under both methods. This is because all of Nikkee Sports’ transactions
took place in Ontario.

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TIF Solution Twenty-One - 17

The GST and total cost of each purchase would be calculated as follows.

Property A
As this property is a used residential unit, no GST will be payable. This means that no GST will be
required and the total cost will be $346,000.

Property B
GST will be paid on the purchase price of $314,000, plus all of the improvements. However, the new
housing rebate is only available on the $12,000 cost of the improvements done by the builder in addition
to the purchase price. It is not available on the additional $22,000 of costs incurred by Misty.

GST Payable [($314,000 + $12,000 + $22,000)(5%)] $ 17,400

Less: New Housing Rebate

[($314,000 + $12,000)(5%)(36%)] ( 5,868)

Net GST Payable $ 11,532

Purchase Price ($314,000 + $12,000 + $22,000) 348,000

Total Cost $359,532

Property C
As the renovations involve more than 90 percent of the interior, they will be considered substantial.
Since the renovations would be done by the vendor prior to the sale, the purchase would be deemed to
be that of a “new” home. As a result, the total purchase price would be subject to GST and a new
housing rebate could be claimed on the total, as follows:

GST Payable [($390,000)(5%)] $ 19,500

Less: New Housing Rebate

[$6,300][($450,000 - $390,000)  $100,000] ( 3,780)

Net GST Payable $ 15,720

Purchase Price 390,000

Total Cost $405,720

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695 Canadian Tax Principles 2018/19 Edition – Test Item File Solutions