APPENDIX I

International Taxation in Canada

Solution 1 (Basic)
Andrew will be taxable on taxable income earned in Canada in 2010 because he will be deemed to have
been employed in Canada under subsection 115(2). Taxable income earned in Canada will be computed under
subsection 115(1) and taxable under Part I. He will need to file a Canadian income tax return to report the
signing bonus of $25,000. For 2011, Andrew will not be deemed a resident as he will not sojourn in Canada
183 days or more. His $35,000 salary will be included in taxable income under subsection 115(1) and taxable
under Part I. Both years he will be entitled to the personal tax credits for CPP and EI. He will not be entitled to
personal tax credits available to residents, such as the basic personal amount, since less than 90% of his world
income is from a Canadian source.
Employment income for Canadian tax purposes will consist of the $35,000 salary from the Toronto Metros
and the $25,000 signing bonus received under subsections 5(1) and 6(3), respectively. The $3,000 paid to the
agent is not deductible for Canadian tax purposes, as there is no provision for such a deduction in section 8 of the
Income Tax Act. The $100,000 earned in England will not be subject to any Canadian tax.
In addition to federal income taxes, he will also be liable for provincial taxes in Ontario.

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254
Solution 2 (Advanced)

(a) As Kresna is non-resident and has disposed of taxable Canadian property, she is required to file Form T2062
either before the proposed transaction is completed, or within 10 days of its completion unless the property is
excluded property. [Excluded property includes treaty-exempt property.] The CanadaKenya Tax Convention
should be referred to in order to determine whether the property is treaty exempt. Payment of a withholding tax,
computed at 25% of the difference between the sale price and the ACB of the property, must accompany the
T2062.
Proceeds
ACB
Gain
Withholding tax required (25%)

$100,000
35,000
$ 65,000
$ 16,250

Generally, the lawyer handling the transaction will pay the withholding tax from the proceeds she receives
in trust from the purchaser.
Under subsection 2(3), Kresna is taxable in Canada because she has disposed of taxable Canadian property.
She should file a Canadian non-resident return as soon as is practical after the end of the year. She will declare a
taxable capital gain on the sale of the property and claim a credit for the 25% withholding tax. Kresna will be
liable for additional federal tax of 48% of the federal tax in lieu of provincial/territorial tax.
Proceeds
ACB
Gain
Outlays and expenses

$100,000
35,000
$65,000
7,000

Capital gain
Taxable capital gain

$ 58,000
$ 29,000

Federal tax at 15%

Additional federal tax at 48% of $4,350
Less withholding tax
Refund due

(real estate and legal

fees)
(at 50%)
$4,350
2,088
6,438
(16,250)
$ 9,812

(b) In all probability, Kresnas agent has not been remitting the 25% non-resident withholding tax to the federal
taxation authorities. The withholding tax is required under subsection 212(1)(d). For example, assuming the
property was rented for $1,000 a month, the annual withholding tax is $3,000.
Kresna should be advised to pay the assessment, but then file tax returns for the current and the past two
years, reporting the net rental income. She is entitled to do this under subsection 216(1). The time limit to file is
two years from the end of the taxation year, so returns can be filed for all three years. Her actual tax liability will
in all likelihood be less than the withholding tax, and she is entitled to a refund of any excess tax paid.
Should the assessment be for more than three years, then any withholding tax for any other preceding years
cannot be recovered.

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255

Solution 3 (Advanced)
(A) Section 253 will deem USCO to be carrying on business in Canada in the year because it currently
solicits orders through an agent in Canada through the office.
The U.S. company solicits sales in Canada, has inventory in Canada, and has an office and employees in
Canada. Under common law, it is likely that USCO would be considered to be carrying on business in Canada
because the Toronto office would be considered to be a location of the operations from which profits arise.
Once USCO has three employees and an office in Canada it will still be considered to be carrying on
business in Canada. As a result, it will be required to file a tax return and be taxed on its taxable income earned
in Canada as calculated under subsection 115(1) and under 4(1)(b). This income will be subject to the general
federal corporate tax rate of 38% under subsection 123(1), which applies to all corporations. Furthermore, the
general deduction from tax of 10% will apply in 2010.
(B) The provincial abatement of 10% will apply if the corporation has taxable income earned in a province.
Regulation 402(3) indicates that where a corporation had a permanent establishment in a particular province and
no permanent establishment outside that province, the whole of its taxable income for the year is deemed to have
been earned therein. The definition of permanent establishment is in Regulation 400(2) and indicates that it
means a fixed place of business of the corporation including an office.
As USCO had a loss in the previous year of $4,000, the loss can be used to reduce the taxable income to
$256,000. All of the $256,000 of taxable income would be considered taxable income earned in a province. As a
result, the federal tax rate applicable to the income would be 18% and the provincial rate would be 13% for a
total rate of 31%. Therefore, the tax owing will be $81,920.
USCO will also be required to pay branch tax under subsection 219(1) of the Act. Per subsection 219(1), the
tax applies to every non-resident corporation. It will only result if the non-resident corporation earned taxable
income in Canada and only if the income less taxes is not reinvested back into Canada in the form of an
investment allowance as defined in Regulation 808.
Subsection 219(1) would calculate branch tax at $2,000 equal to:
25% of $8,000 * calculated as:
Corporations taxable income earned in Canada
Prior years investment allowance
Less:
Income taxes payable under Part I and provincial tax
Investment allowance for the year (see below)

$256,000
2,000
$ 81,920
168,080

$258,000

250,000
$8,000

Investment Allowance per Regulation 808

Cost amount of each depreciable property owned in Canada used to produce
income
Cost amount of each property that was described in the corporations inventory
Cost amount of each debt owing to it for a transaction by virtue of which an
amount has been included in computing its income for the year
Cost amount of allowable liquid assets
Less:
Amount owing to purchase depreciable assets/inventory
Amount owing for an outlay or expense made or incurred by the corporation to
the extent it was deducted in computing income for the year
Amount of tax payable under Part I and provincially

$200,000
400,000
150,000
50,000

800,000

$150,000
400,000
81,920

631,920
$168,080

The calculation represents the income earned by the corporation for the year that was not reinvested into the branch
operation.

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(C) USCO has an office in Canada. An office is a permanent establishment under paragraph 2, Article V of
the treaty if it is a fixed place of business under paragraph 1. Three conditions must be met:
1) There must be a place of business. The office is under the control of the U.S. company and it is at its
constant disposal.
2) The place of business must be fixed. The office appears to be permanent.
3) The business of the non-resident must be carried on through the fixed place of business. Employees
are carrying on the U.S. companys business through the office.
Impact on 2010 Canadian Return
There is no impact on the corporations Part I tax liability. The CanadaU.S. Tax Convention confirms
Canadas right to tax the income from carrying on business in Canada.
Article X, paragraph 6 of the CanadaU.S. Tax Convention indicates that nothing in the convention prevents
Canada from imposing a branch tax on earnings of a company attributable to a permanent establishment in
Canada provided that the tax does not exceed 5% of the amount of earnings not subject to branch tax in prior
years. Earnings would be calculated as:
Business profits attributable to permanent establishments in Canada in the year
and previous years
Less: Business losses attributable to such permanent establishments in the year or
previous years
Less:
Taxes imposed on such profits
Profits reinvested in Canada determined in accordance with the provisions of the
laws of Canada regarding the computation of the allowance in respect of
investment in property in Canada
Exemption

$260,000
(4,000)

256,000

$81,920

168,080
500,000

(750,000)
Nil

Therefore, USCO would not have a branch tax liability for 2010. The treaty exempts the first $500,000 of
earnings not reinvested in Canada from branch tax. A treaty disclosure note would be attached to the Canadian
tax return to recognize this fact (See Schedule 91 and 97 of the T2).

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Solution 4 (Advanced)
Sally Juarez appears to be a non-resident for Canadian tax purposes. Sallys Canadian income tax return
using 2010 figures and tax rates:
Business income (from partnership) (Note 1)
Business income from sale of raw land (Note 2)
Taxable capital gain on sale of real estate (Note 3)
Total income
Federal tax on first $40,970 at 15%
Federal tax on next $40,971 at 22%
Federal tax on last $59 at 26%
Personal tax credits (Note 4)
Additional federal tax (Note 5)
Provincial tax (Note 6)
Total income tax
Income tax withholdings
Balance of tax owing

$7,000
60,000
$67,000
15,000
$82,000
$6,146
9,014
15
$15,175

1,332
7,196
$23,703
$(7,500)
$16,203

(50%)

Other tax requirements

Withholding taxes (Note 7) at 25% (or tax treaty rate)
on:
Dividends
$5,000
Tax at 25%
$ 1,250

Notes:
1. Robinson, 98 DTC 6065 (F.C.A.), held that partners carry on the business of a partnership.
2. Per paragraph 253(c), a person who disposes of property (other than capital property) that is real
property situated in Canada is deemed to have been carrying on business in Canada in the year.
3. The gain of $15,000 on the Public Co Ltd. shares is not taxable in Canada as these are not taxable
Canadian property assuming she owns < 25% of the shares of any class of the corporation and more
than 50% of the value of the shares is not derived from real property situated in Canada (per March 4,
2010 federal Budget).
4. Sally is not entitled to any personal tax credits as her Canadian-source income is less than 90% of her
worldwide income and there is no indication that she otherwise qualifies for personal tax credits that
may be claimed by non-residents.
5. 48% of ($15,000/$82,000 $15,175).
6. 10% of $40,970 plus 12% of ($67,000 $40,970).
7. No withholding tax on interest or any other Canadian tax liability.

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Solution 5 (Advanced)
The following details the Canadian compliance and planning issues related to Cals move to Indonesia.
Child Support
Child support is not included in taxable income in Canada. There will be no withholding tax required from
this income, nor any other Canadian tax liability.
RRSP
If Cal deregisters the RRSP before leaving Canada, the $75,000 will be included as income in his final
(departure) income tax return. The income taxes on the $75,000 will be based on his marginal tax rate in that
return. There is no deemed disposition of the RRSP on emigration. If he deregisters the RRSP after leaving
Canada, there will be a 25% withholding tax on the $75,000, and that represents his complete tax obligation to
Canada on the RRSP. He would have an option to elect to file a Part I return [ssec. 217(2)] if beneficial.
[March 4, 2010 federal Budget] [Ssec. 116(1)]
GIC
The interest is not subject to withholding tax or any other Canadian tax liability.
Shares of CCPC
Any dividends that he receives from the shares while non-resident are subject to a 25% withholding tax.
Cal will be deemed to have disposed of the CCPC shares upon emigration for their fair market value of
$45,000, which will lead to a capital gain of $44,000 and a taxable capital gain of $22,000 that will be included
in his departure year tax return. However, Cal can elect to defer paying the tax that results from the deemed
disposition rule. The election must be made on or before the balance due date for the departure year. Since
security is not required for up to $100,000 of capital gains resulting from the deemed disposition rule, Cal will
not be required to post security with the CRA. If the election is made, the payment of the tax in respect of the
departure capital gain will be deferred without interest until the properties are actually sold. The adjusted cost
base of the shares will be increased to the deemed departure amount of $45,000, so any gain or loss on the actual
sale of the shares will be computed by reference to this new adjusted cost base for Canadian tax purposes. When
Cal sells the shares in the future, the shares will be taxable Canadian property if more than 50% of the value of
the shares is derived from real property situated in Canada. In such case, the gain will be taxed in Canada and
withholdings will apply unless the gain is exempt from tax in Canada under a Treaty.
Principal Residence
The real estate will not be subject to the deemed disposition rule upon emigration.
When he rents the property, there will be a deemed disposition at fair market value under subsection 45(1)
unless an election under subsection 45(2) is made. If he is a non-resident at the time, he will be required to file a
T2062 request [ssec. 116(1)] and remit a 25% withholding tax on the gain from $135,000 to the fair market value
at the time. This withholding tax is then used as a credit against any actual tax as calculated in the Canadian tax
return. He will be able to claim the principal residence exemption for the years prior to emigration. On the sale of
the property, he will be required to include any taxable capital gain or allowable capital loss on a Canadian return
under paragraph 115(1)(a) as the property is taxable Canadian property under paragraph 115(1)(d). The gain will
be calculated using an adjusted cost base equal to the fair market value at the time of the deemed disposition.
Section 116 will apply.
The ongoing rental income is taxable when paid/credited to him. There is a 25% withholding tax on the
gross rents. Alternatively, Cal can file a Canadian tax return pursuant to section 216, reporting the rental income
(net of expenses excluding CCA), and pay taxes at the marginal rate. This return is separate from any other tax
return he may be required to file and is due within two years of the relevant taxation year. The tax, as calculated
in that return, is likely to be substantially less than the 25% withholding tax (due to recognition of expenses). He
will receive a refund of the difference.
Another alternative is for Cal to file an undertaking to file a Canadian tax return within six months of the
relevant taxation year. If he does this, then his brother can remit the withholding tax based on 25% of the
amounts available (after expenses excluding CCA). If Cal does not file the required tax return, his brother is
liable for the full 25% withholding tax (i.e., on the gross rents), although he can legally recover that from Cal.
Provincial Tax
As there is no Canadian business or employment income, there is no provincial or territorial tax due on any
of the above noted income returns. Cal will pay additional federal taxes at the rate of 48% of federal tax instead
of provincial tax.

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259

Solution 6 (Advanced)
Transactions with SNI
Section 247 of the Act requires that transactions between non-arms length persons be made under arms
length terms and conditions. Information Circular 87-2R requires a taxpayer to choose a pricing methodology
that will reflect the arms length principle and provides a hierarchy of methodologies to be considered.
Comparable Uncontrolled Price (CUP) Method
The method that provides the highest degree of comparability is the comparable uncontrolled price (CUP)
method. This method is used when it is possible to find a sale of the same product by the taxpayer, or another
member of the group, in similar quantities and under similar terms to arms length parties in similar markets.
There are several possible CUPs in this circumstance:
1) The sale of drawer slides by SI to European distributors before the AOC;
2) The sale of drawer slides by SI to arms length distributors in Canada;
3) The sale of drawer slides by SUSI to arms length distributors in the U.S.;
4) An external comparable if one could be found; and/or
5) The sale of ergonomic products to SUSI by SI before the AOC of SUSI.
The following information would need to be verified to determine if any of these transaction streams could
be used as a CUP:
1) Are the sales in similar quantities and under similar terms as sales to SNI? Could reasonable adjustments
be made for differences?
2) Is SUSI selling a comparable product? Ergonomic products are unlikely to be similar enough to provide
a CUP.
3) Is a competitor selling the same product to distributors? Could information be obtained on prices
charged/paid by the competitor/distributor?
4) Does SNI purchase drawer slides arms length?
5) There appears to be a market level difference. Currently SI sells to Canadian distributors who likely sell
to end-users. In the non-arms length transaction, SI is selling to SNI who is selling to distributors who
sell to end-users. Therefore, it is unlikely that these transactions could be used as a CUP as it would be
difficult to make appropriate adjustments for market differences. It would be necessary to confirm
whether SIs distributors and SUSIs distributors sell to other distributors (this information may be
difficult to obtain).
It is unlikely that any of these transaction streams are suitable internal CUPs due to market level differences.
You should also check with the client to see if there is any information available on external CUPs. For example,
is a competitor selling to an arms length distributor in Europe that sells to other distributors. It would be very
unlikely that the client would have this information.
Note that in the future when SNI acts as a distributor of product to the end-user, the market level difference
will no longer be a factor. If the other attributes of the transactions are comparable, these streams may be an
appropriate CUP in future years.
Resale Price Method
The resale price method establishes a gross margin that a taxpayer may expect as a reward for the functions
performed, assets used, and risks assumed. Product differences are less important. The resale price method is
more appropriate if the least complex party is a distributor. A functional analysis would likely show that SNIs
distribution division is the least complex party in the transaction between SI and SNI as its activities are likely
restricted to selling activities, it does not own intangibles and risk is limited to collection risk. To determine an
appropriate gross margin for SNI, it would be necessary to find a margin earned by a member of the group or an
arms length enterprise in comparable uncontrolled transactions. The only apparent transaction stream in the SI
group per the facts above that would provide this margin would be the purchase and resale of curtain rods by
SNI. The following information would need to be verified to determine whether the gross margin percentage of
35% earned by SNI on this transaction stream would be appropriate to use for the purchase and sale of drawer
slides from SI:
1) Are curtain rods sufficiently similar to drawer slides to be able to justify the use of this transaction
stream as comparable?
2) Does SNI perform the same functions and assume the same risks for the distribution of the curtain rods?
If not, is it possible to make adjustments to the margin for this?
3) Are the quantities of curtain rods sold similar to drawer slides or is the curtain rod distribution business
just an insignificant side business?

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Federal Income Taxation: Fundamentals

Cost-Plus Method
The cost-plus method usually applies when the supplier of the product is the least complex party to the
transaction. As SI is a full-fledged manufacturer that performs development activities, it would not be considered
the least complex party suitable for the application of the cost plus methodology. It is likely that SI owns
valuable manufacturing intangibles.
Note that a genuine effort to apply either of the CUP or resale price methods would be preferred as
transactional profit methods are considered methods of last resort.
Profit-Split Methods
If, after further investigation, you are not satisfied that the uncontrolled transactions would provide
sufficient comparability to apply the CUP or resale price methods, it would be appropriate to consider the use of
a profit-split methodology. This method should be used where the operations of two or more non-arms length
parties are highly integrated making it difficult to evaluate their transactions on an individual basis and the
existence of valuable and unique intangibles in both parties makes it impossible to establish the proper level of
comparability with uncontrolled transactions to apply a one-sided method. As in this case, the operations of SI
and SNI are not highly integrated and SNI does not appear to own any valuable intangibles, the profit-split
method would not be applicable.
Transactional Net Margin Method (TNMM)
This method appears to be more appropriate than the profit-split method, as SNI does not own valuable
intangibles and a one-sided analysis could be performed. With TNMM, you are attempting to compare the net
profit margin of SNI to the net profit margin that would be realized by arms length parties from similar
transactions. If the curtain rod distribution transaction stream is determined to be an appropriate comparable, the
resale price method should be used over this method. If not, this method may be considered. Sales would be the
appropriate base for the measure of operating profit percentage as SNI would have few costs and assets due to
the nature of its operations.
The client should be asked if there is any industry data/information available on operating profit margins of
distributors in the furniture industry. If not, various worldwide databases are available to assist in finding
comparable data. Four steps would be followed in applying this method:
1) Database search of entities with similar industry classifications.
2) Screening of entities to determine if there are comparable transactions to the tested party. For example, if
any of the companies incur research and development expenses, these entities should be excluded.
3) Review detailed information (financial and textual) to determine if they have comparable transactions.
4) Make adjustments for material differences.
Recommendation: Use of the resale price method would be preferred. If the comparability of the
uncontrolled transactions is questionable, it may be prudent to also do a TNMM analysis in support.
Transactions with SUSI
SUSI does not appear to incur any uncontrolled comparable transactions to the distribution transactions of
ergonomic product for SI as it does not distribute product for any other entity.
The sales of ergonomic products by SI to Canadian distributors could provide a CUP. It would again be
necessary to obtain information on the quantities sold, comparability of the market etc. to support the use of this
CUP.
If SI is selling the ergonomic product to SUSI at the same prices and under the same terms as prior to the
acquisition of the company, these pre-acquisition transactions could provide a CUP as pre-acquisition, the
companies were arms length. It would be necessary to determine if any functions, risks etc. changed after the
acquisition of control to determine whether the pre-acquisition prices would be suitable CUPs at least in the short
term.
The resale price method could only be applied if information on gross margins of a distributor with similar
functions, assets used and risks assumed in the industry were available. The cost plus method is inapplicable as
SUSI is the least complex party and SI is the supplier of the product. The profit split method is not appropriate
per discussion above. The TNMM should be used if the potential comparable transactions noted above are not
appropriate. Information on profit margins earned by companies in the same industry would need to be obtained.

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261

Solution 7 (Advanced)
If the CRA was to audit Ergold Ltd., the following adjustments and tax liabilities would result:
Year Ended
December 31
2008
2009
2010

Adjusted
Taxable
Income
$150,000
$325,000
$475,000

Adjustment
$ 350,000
$ 725,000
$ 1,325,000
$2,400,000

Tax
Liability
$45,000
$97,500
$142,500
$285,000

10% of
Gross
Revenue
$300,000
$650,000
$950,000

Penalty
10% of
Adjustment
$35,000
$72,500
$32,500
$240,000

The 10% penalty will apply because the transfer pricing adjustment for each year is greater than the lesser of
10% of gross revenue and $5,000,000, per subsection 247(3). Furthermore, if Ergold Ltd. is not using transfer
prices that are based on the arms length principle and cannot support those prices through documentation, the
company is subjecting itself to potential audit and substantial tax ($285,000) and interest liabilities. [Note that the
tax could be offset if adjustments to reduce income in Sweden are accepted by the Swedish equivalent of the
CRA]. Furthermore, if there is a tax audit, the company could incur considerable professional expenses
defending itself, not to mention the time involved in going through the competent authority process.
Furthermore, it should be pointed out that the tax returns for Ergold would have required the company to file
T106 forms that would be used to determine if a tax audit should be performed. The companys losses along with
the T106 form indicating that all purchases are non-arms length would very likely trigger an audit. Anytime the
CRA audits a company that has non-arms length transactions, field auditors will request contemporaneous
documentation at the outset of the audit, per an October 2006 memorandum.
The Canadian company has effectively overpaid for goods it received. The overpayment will be considered
a subsection 15(1) benefit to the shareholder and would be deemed to be a dividend under paragraph 214(3)(a). It
will be subject to Part XIII tax unless the CRA agrees to waive the withholding tax. The CanadaSweden tax
treaty would reduce the withholding tax rate to 5% ($120,000 = 5% of $2,400,000). Per TPM-02 and IC 87-2R,
the CRA may waive the withholding tax when:

1) The taxpayer agrees in writing to the transfer pricing adjustment;

2) The transaction is not abusive (a transaction is considered abusive if the above penalty applies i.e.,
no contemporaneous documentation is available and/or GAAR or a recharacterization has
applied), and
3) The Swedish company repays the amount to the Canadian company immediately or agrees to do
so in writing (the repayment must be in the form of either a) an offset to an intercompany account
in the year of the adjustment, b) a creation of a shareholder loan account, or c) an offset to a
downward adjustment).
Therefore, without contemporaneous documentation, Ergold could not get a waiver for the tax. Interest
would apply to the Part XIII withholding tax. With contemporaneous documentation, a waiver may be possible if
intercompany balances exist or through the creation of a shareholder loan. If intercompany balances exist, any
interest deduction would need to be adjusted if a repatriation were made. If a shareholder loan were created,
subsections 15(2) and 15(9) would need to be considered.
Advantages of a Transfer Pricing Study
1) Minimize interest and penalties of prior years if a voluntary disclosure is made.
2) Minimize future tax liabilities by correcting transfer pricing problems now.
3) Increase the efficiency of a CRA audit.
4) If the CRA does adjust, a waiver of the Part XIII tax could be obtained.

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262
Solution 8 (Advanced)

The deduction for the interest expense of $458,808 on outstanding debts to specified non-residents will be
limited under subsection 18(4).
Subsection 18(4) applies where interest on the debt is otherwise deductible. As the loan is used to purchase
manufacturing equipment, the interest is deductible under paragraph 20(1)(c). The provision applies to interest
paid or payable on outstanding debts to specified non-residents (a debt payable to a specified non-resident
shareholder on which interest is deductible). The U.S. corporation is a specified non-resident shareholder as it
holds 25% or more of the shares of the Canadian company.
The formula to determine the non-deductible portion is as follows:
A (B 2 (C+D+E))
$458,808 ($5,886,962 2 ($1,260,548 + Nil + $341,667))/$5,886,962
= $209,067
B This is the average of all amounts for each calendar month ending in the year that is the greatest total
amount at any time in the month of the corporations outstanding debts to specified non-residents.
Jan
Feb
March
April
May
June
July
Aug
Sept
Oct
Nov
Dec
Average
of above

6,000,000
5,966,952
5,933,687
5,900,203
5,866,499
5,832,573
6,364,051
5,801,951
5,840,101
5,878,502
5,878,502
5,380,524

[ 600,000

5,764,051 ]

5,886,962

The July balance includes the additional loan of $600,000. The highest outstanding loan balance for the
month would have been just before the repayment of the $600,000 loan.
Note that the increase in outstanding debts to non-residents in July resulted in a higher average and a higher
non-deductible interest amount even though only a small amount of interest was paid on this short-term loan.
Note that the missed interest payments become part of the outstanding balance because interest is paid or
payable in respect of these balances (see Technical Interpretation Document Number 9315680, May 31, 1993).
C The retained earnings of the corporation at the beginning of the year.
E This is the average of all amounts for each calendar month ending in the year that is the corporations
paid-up capital (PUC) at the beginning of the calendar month that ends in the year. [300,000 x 11 + 800,000]/12
= 341,667.
Because of averaging, the PUC increase has little impact on the amount of deductible interest. A conversion
earlier in the year or a higher conversion would have been advisable. Note that a conversion on December 31
would have no impact on the calculation for 2009 as it is the PUC at the beginning of the month that is important.
Per subsection 84(1), the conversion of the debt to paid up capital will not result in a deemed dividend as the
paid up capital increased by the same amount as the increase in assets less the liabilities increase.

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263

Solution 9 (Advanced)
Receivable from Ronal Argentina Ltd.
As Ronal Argentina Ltd. is non-arms length with Ronal Inc., and is not a foreign affiliate of Ronal Canada
Ltd., it is connected with a shareholder for purposes of subsection 15(2).
Subsection 15(2) does not apply to a loan that is repaid within one year after the end of the taxation year of
the lender, per subsection 15(2.6). As Ronal Ltd. made the loan in its December 31, 2007 taxation year-end, to
meet the exception, the loan must have been repaid by December 31, 2008.
Ronal Canada Ltd. has a 2007 liability for the Part XIII tax that should have been withheld on the loan
because of paragraph 214(3)(a). The withholding liability would be 25% under subsection 212(2) of the Act.
Under the CanadaArgentina Tax Convention, the withholding tax on dividends would be reduced to 15%. Ronal
Ltd. has a liability for $615,000 for withholding tax that should have been remitted January 15, 2008. Interest
and a 10% penalty would apply to the failed withholdings.
Per subsection 227(6.1), where a loan has been subject to Part XIII tax under paragraph 214(3)(a) and the
non-resident repays the loan to the Canadian company, the withholding tax (but not the interest) on the
withholding tax will be refunded. [Note that if subsection 80.4(2) instead of subsection 15(2) had applied to the
loan, no refund of Part XIII tax would have been received on repayment of the loan.]
As the loan was repaid in 2011, section 17 must be considered. The 1% interest rate on the loan may be
considered to be less than a reasonable amount. As a result, Ronal Canada Ltd. would have an imputed interest
benefit each year the loan was outstanding computed at the prescribed rate (see Reg. 4301(c)) less the actual
interest received on the loan of 1% (October 1, 2007 to January 2011).
None of the exceptions in subsections 17(7), 17(8), or 17(9) apply. Ronal Argentina Ltd. is not a controlled
foreign affiliate (CFA) of Ronal Canada Ltd. per subsection 17(15) and it is a related to Ronal Canada Ltd.
Receivable from Ronal Germany Ltd.
Subsection 15(2) will not apply to this debt as it is likely to be repaid within one year of the end of the
taxation year-end in which it was incurred. Subsection 80.4(2) will not apply because of subsection 80.4(3). It
may be possible to argue that the loan was not received by virtue of shareholdings as required under
subsection 80.4(2).
Section 17 will not apply to this amount owing in the 2007 taxation year-end. The receivable is not likely to
be outstanding for 12 months.
Receivable from Ronal Switzerland Ltd.
Subsection 15(2) and subsection 80.4(2) would not apply to this receivable because, under
subsection 15(2.1) and subsection 80.4(8), a person connected to a shareholder does not include a foreign
affiliate of the corporation. Per subsection 95(1), Ronal Switzerland Ltd. would be considered a foreign affiliate
of Ronal Canada Ltd.
Ronal Canada Ltd. would be required to include an amount of imputed interest in income in its 2009, 2010,
and 2011 taxation year-end under subsection 17(1) because the amount was outstanding for more than
12 months. The interest inclusion would be calculated using the prescribed rates for the year. However, there is
an exception in subsection 17(8) of the Act which indicates that subsection 17(1) does not apply to a corporation
resident in Canada for an amount owing to the corporation by a non-resident person if the person is a CFA of the
corporation throughout the period in the year during which the amount is owing as long as:
(1) The amount owing arose as a loan or advance of money to the affiliate that the affiliate used throughout
the period that began when the loan was made to the end of the year (or repayment) for the purpose of
earning income from an active business, or
(2) The amount arose in the course of an active business carried on by the affiliate throughout the period
that began when the amount owing arose and ended at the end of the year.
Because the amount owing did not arise from a loan or advance of money (1) will not apply. However, it is likely
that (2) will apply as it appears that Ronal Switzerland Ltd. carried on an active business for the period the
amount owing was outstanding during the year and the payable arose in the course of that active business. Ronal
Switzerland is a CFA under subsection 17(15) and subsection 95(1).

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Investment in Ronal Luxembourg

Under subsection 17(2), Ronal Germany will be deemed to owe $5,000,000 to Ronal Canada Ltd. as of
January 15, 2009.
As Ronal Canada Ltd. would not have any interest included in income from the $5,000,000 investment or
any FAPI income on the amount, an imputed interest benefit would result in the 2009 and 2010 tax years since
the amount owing would be considered to be outstanding for more than a year.
Subsection 17(3) indicates that subsection 17(2) does not apply if the NR person receiving the loan and the
NR lender are both controlled foreign affiliates (CFAs) of Ronal Canada Ltd. If the share investment by Ronal
Canada Ltd. resulted in the company having de jure control over Ronal Luxembourg Ltd., the company would
meet the definition of a CFA in subsection 17(15). However, Ronal Germany Ltd. is not a CFA of Ronal Canada
Ltd. If it were possible to make both Ronal Germany Ltd. and Ronal Luxembourg Ltd. CFAs, the loan would not
be considered to be owing to Ronal Canada Ltd. for purposes of subsection 17(1) from that point forward.
Any investment in shares of the two companies should have a purpose other than to avoid the implications
of section 17, otherwise subsection 17(14) will apply and the share investment would be disregarded. For
example, it is likely that the issuance of a class of nominal value voting stock would be disregarded for purposes
of applying the exception in subsection 17(3).

Solutions to Appendix I Assignment Problems

265

Solution 10 (Advanced)
[ITA: 12(1)(k), 95(1), 95(4), 113(1), 113(1)(b), 113(1)(c), 126(1), 126(1.2); ITR: 5900(1), 5900(1)(d), 5901,
5907(1), 5907(11), 5907(11.2)(a)]
Part A
A foreign affiliate is a non-resident corporation in which the taxpayers equity percentage is not less than
1%, and the total of the equity percentages in the corporation of the taxpayer and each person related to the
taxpayer is not less than 10%. Equity percentage is the total of the persons direct equity percentage plus the
persons equity percentage in any corporation multiplied by the corporations direct equity percentage in the
corporation. Direct equity percentage is the percentage determined by looking at the percentage of issued shares
of each class owned by the person and taking the highest percentage.
U.S. Co. is a foreign affiliate of A Co. A Co. has an equity percentage in U.S. Co. of 6% (direct equity
percentage) plus 8% (100% 8%) (equity percentage direct equity percentage) = 14%. Therefore, A Co.s
equity percentage in U.S. Co. is not less than 1%. The total equity percentages in U.S. Co. of A Co. and related
taxpayer B Co. is 14% and, therefore, not less than 10%.
U.S. Co. is a foreign affiliate of B Co. B Co. has an equity percentage in U.S. Co. of 8% (direct equity
percentage). Therefore, B Co.s equity percentage in the company is not less than 1%. The total of B Co. and
A Co.s equity percentages in U.S. Co is 14% and, therefore, the equity percentage in U.S. Co. of B Co., and
each person related to B Co., is not less than 10%.
Taiwan Co. is a foreign affiliate of A Co. but not C Co. A Co. has an equity percentage in Taiwan Co. of not
less than 1% and 10%. Taiwan Co. is not a foreign affiliate of C Co. because although C Co. has an equity
percentage of not less than 1% in Taiwan Co.; in combination with related companies C Co. does not have not
less than 10% ownership in Taiwan Co.
Part B
Dividends from a share of a foreign affiliate of a Canadian corporation are included in Division B income.
Offsetting deductions in computing taxable income will be available to A Co. for dividends received from
U.S. Co. and Taiwan Co. Similarly, offsetting deductions will be available to B Co. for dividends received from
U.S. Co.
Taiwan Co. is not a foreign affiliate of C Co. Therefore, a Division C deduction will not be available. The
dividends will be included in income and a foreign tax credit for the withholding tax can be claimed.
Part C
Dividends from US Co.
Exempt surplus is computed as the exempt earnings less exempt losses of an affiliate for any of its taxation
years ending in the period starting with the first day of the taxation year in which it last became a foreign
affiliate. Exempt earnings include an affiliates net earnings for the year from an active business carried on in a
designated treaty country. A country is a designated treaty country where Canada and the country have entered
into a comprehensive agreement or convention for the elimination of double taxation or a comprehensive tax
information exchange agreement (TIEA). A company must be a resident of the designated treaty country under
both Canadian common-law principles (mind and management) and under the treaty. U.S. Co. appears to meet
both criteria and would be a resident of the U.S. Net earnings are defined as the earnings for the year from that
active business minus the portion of any income or profits tax paid in respect of those earnings.
As Canada has a treaty with the U.S., U.S. Co. has exempt earnings and its exempt surplus at the time the
dividend was received would have been $720,000 ($900,000 $180,000). (It would be necessary to ensure that
the earnings of the company meet the definition of earnings, i.e., computed in accordance with U.S. law, and
appropriate adjustments are made. Also note that surplus balances are maintained/accumulated in the foreign
currency. A Division C deduction is available to both A Co. and B Co. for the dividends received from U.S. Co.,
as 100% of the dividends would be considered to have been paid out of exempt surplus. (Note that if some of the
whole dividend had been paid from taxable surplus, the dividends received by A Co. and B Co. would have each
had an exempt surplus and taxable surplus portion.)
Dividend Income Inclusion
Division C Deduction
Impact on Taxable Income

A Co.
$36,000
(36,000)
Nil

B Co.
$48,000
(48,000)
Nil

ITA: 12(1)(k)
ITA: 113(1)(a)

The dividends received by each of A Co. and B Co. would have been subject to withholding tax at a rate of
15% under the CanadaU.S. Treaty, as neither company owned at least 10% of the voting stock of the company

Federal Income Taxation: Fundamentals

266

paying the dividends. A foreign tax credit for non-business foreign tax withheld on dividends from a foreign
affiliate paid to the taxpayer is not available where the taxpayer is a corporation.
Dividends from Taiwan Co.
As Taiwan does not have a treaty or TIEA with Canada, Taiwan Co. is not a resident of a designated treaty
country. As a result, the exempt surplus of the company will be nil. The taxable surplus of the affiliate consists of
its taxable earnings for any taxation year ending in the period beginning with the first day of the taxation year of
the affiliate in which it last became a foreign affiliate. Taxable earnings include an affiliates net earnings for the
year from an active business it carried on in a country. Net earnings are defined as earnings from the active
business less any income or profits tax paid in respect of those earnings. Therefore, Taiwan Co.s taxable surplus
when the January 31, 2011 dividends were paid would have been $400,000 ($500,000 $1 00,000) and the
associated underlying foreign tax would have been $100,000. The whole dividend of $222,000 would have been
paid out of taxable surplus, and the dividends received by A Co. would be entirely from taxable surplus.
The Division C deduction for A Co. for the underlying tax is the lesser of:
a) The underlying foreign tax applicable to the dividend of $24,629 [$222,000/$400,000 $100,000 =
$55,500 $35,520/$222,000 (1/.265 1)], and
b) The dividend out of taxable surplus of $35,520
The Division C deduction for the withholding tax is the lesser of:
a) The non-business income tax paid by the corporation applicable to the dividend of $4,021 [$35,520
3% 1/.265], and
b) The dividend out of taxable surplus less the deduction for the underlying tax per above of $9,249
[35,520 $26,271]
A Co. will have had the following income inclusion for 2010:
Dividends received
113(1)(b) Deduction
113(1)(c) Deduction
Taxable income
Federal tax at 26.5%

$35,520
(24,629)
( 4,021)
$ 6,870
$ 1,820

The income from which the dividends are paid is effectively taxed at the Canadian corporate tax rate when
distributed. Double tax is eliminated by providing a deduction for the underlying and withholding tax paid to
Taiwan. Rather than using a credit mechanism, the elimination of double tax is achieved through a deduction
from income for the underlying and withholding tax converted using the RTF.
The result is equivalent to what would have occurred under a credit system if A Co. was taxed on the pre-tax
income out of which the dividend were paid with credits for the underlying and withholding taxes as follows:
Pre-tax business earnings in Taiwan ($35,520/80%)
Federal tax at 26.5%
Less FTC underlying tax (20% of $44,400)
Less FTC withholding tax
Net Canadian tax

$44,400
11,766
( 8,880)
( 1,066)
$ 1,820

Note that if the foreign tax exceeds the Canadian federal tax, no excess deduction is allowed and no
carryforward or carryback is available. Similar to the credit system, the income is taxed at the higher of the
Canadian and foreign tax rates.
Because Taiwan Co. is not a foreign affiliate of B Co., no Division C deduction is available in relation to the
dividends received. As a result, the $19,980 of dividends will be included in income and subject to regular
corporate tax rates. A foreign tax credit would be provided for the withholding tax paid of $599. No foreign tax
credit is available for the underlying tax.
Part D
Dividends received from U.S. Co.
The Division C deduction available for dividends from a foreign affiliate paid out of exempt surplus reflects
an exemption method to eliminate double taxation. Jurisdiction to tax the dividend rests exclusively with the U.S.
The rationale for this method is that it presumes that countries that have a treaty with Canada have taxed the
income from which the dividend was paid at an equivalent rate of tax to the tax that would have been paid in
Canada had the income been earned in this country. Therefore, the system should do exactly what the credit
system would do, but it is an easier system to implement than trying to provide an indirect tax credit for the
underlying tax of the U.S. company. As some of Canadas treaty partners do not impose tax rates as high as

Solutions to Appendix I Assignment Problems

267

Canada, this can cause incentive to invest in lower tax countries. A credit system would prevent this possibility
but is more difficult to administer. Canada only allows an exemption method for dividend income arising from
active business income of a foreign affiliate in a treaty country or a country with which Canada has entered a
TEIA.
Dividends Received from Taiwan Co. by A Co.
The mechanism used in Part B above is partly a deduction method and partly a credit method of eliminating
double taxation. The deduction method allows a deduction for taxes paid to the foreign jurisdiction against
income earned by the corporation, whereas the credit method allows a credit for the tax paid to the foreign
jurisdiction against the Canadian tax liability on the income. The Division C deductions are equivalent to
providing a tax credit for the underlying tax and withholding tax related to the dividend received. This method
becomes very complex as it is necessary to determine the creditable portion of underlying tax for each dividend
that is paid.
Dividends Received from Taiwan Co. by B Co.
The mechanism used in Part B above is a credit method of eliminating double taxation. There is a credit
provided for the withholding tax but not for the underlying tax resulting in double tax.
Part E
A subsection 113(1) deduction is only available to a corporation. If individuals had received the dividends
from U.S. Co., there would have been a Division B income inclusion for the dividends and a foreign tax credit
for the withholding tax on the dividends. No credit for the underlying foreign tax would be available.

APPENDIX II

Short Questions and Discussion Notes

CHAPTER 2
Liability for Tax
Short Questions
(1) Will Canadian residents who earn investment income in another country be taxed in both countries on
the same amount of income?
(2) Mr. Smith went to Kuwait to work in the oil fields for an American company. He left his family (wife
and three minor children) in Canada, and was away for three years. During this period he would visit Canada for
vacations but would not stay more than four weeks during any one year. Is Mr. Smith a non-resident?
(3) Ms. Jones and her family have decided to move to Arizona in order for her to take up a lucrative oneyear contract. They have sold their house and possessions in Canada and are renting a house in the U.S. They
have also indicated to the bank, their clubs and their friends that they are becoming non-residents of Canada. At
the end of the one-year contract they plan to travel for six months before returning to Canada. Will they be nonresidents?
(4) If an individual were to leave Canada on September 30 of this year (breaking all ties with Canada) for a
five-year contract in the U.K., then would he or she still be considered to be a resident of Canada throughout this
year since he or she lived here for over 183 days in the year?
(5) If an individual were to leave Canada on September 30 of this year (breaking all ties with Canada) and
move to Buffalo, then would he or she be considered to be a non-resident even though he or she continued to
carry on his or her business in St. Catharines through a company incorporated in Ontario after he or she left?
(6) A client, who is resident in Canada, decides to set up a company in the U.S. to carry on business there.
In doing so she wants to maintain control over the operations and, therefore, she is the President and the sole
director and makes all important decisions. All other employees are resident in the U.S. Is this U.S. company
resident in Canada or the U.S.?
(7) If a person is considered to be resident in Canada by the Canadian authorities and in the U.S. by the
U.S. authorities, then will that person be subject to tax in both countries?

Discussion Notes for Short Questions

(1) Yes. They will pay tax in the foreign jurisdiction based on the investment income earned there and also
include the same amount in their Canadian income. However, they can obtain a foreign tax credit in Canada
[ssec. 126(1)] for the income tax paid in the foreign country.
(2) Probably not. It appears that Mr. Smith has not made a clean break from Canada. He has a
continuing state of relationship in Canada since his wife, children and family home are still here.
(3) Probably. Significant residential ties involving dwelling, spouse and dependants have been cut and so
have some secondary ties. If there is evidence that her return to Canada was foreseen at the time of her departure
(e.g., a contract for employment upon return to Canada), the CRA will presume that she did not sever all
residential ties on leaving Canada [IT-221R3. par. 11].
(4) No, he or she would be considered a part-year resident [sec. 114]. The sojourning rules [ssec. 250(1)]
only apply to persons who are non-residents and who sojourn in Canada for a period of 183 days or more in a
year.
(5) No. Since the business is being carried on in Canada by a corporation, the individual is not carrying on
business in Canada. Therefore, he or she will be subject to the part-time resident rules [sec. 114] and taxable on
his or her world income up to September 30. From October 1, he or she would only be taxed in Canada on his or
her income from employment, carrying on business and from the sale of taxable Canadian property [ssec. 2(3)].

269

Federal Income Taxation: Fundamentals

270

(6) Under the common law principles the central management and control would reside with the
directors and officers and, therefore, be in Canada. Reference to the CanadaU.S. tax treaty would be necessary
to avoid any double taxation.
(7) No. Paragraph 2 of Article IV of the CanadaU.S. tax treaty provides tie-breaking rules to follow when
a person is considered to be resident of both countries. This prevents double taxation.

CHAPTER 3
Employment Income
Short Questions
(1) When determining whether a person is employed or self-employed, one of the tests used is the
economic reality test. What does this test involve?
(2) A director of a corporation is considered to be an employee of the corporation for tax purposes and the
directors fees are income from employment. Comment.
(3) If an employer were to pay the premiums for an individual disability policy (i.e., for the president of the
company), then there would not be a taxable benefit as a result of subparagraph 6(1)(a)(i) and any disability
benefits received from the plan would not be taxable under paragraph 6(1)(f). Comment.
(4) Mr. Chow is the VP Marketing for Compusale Inc., a computer company. He and his wife are taking a
company-paid trip to a trade show in Hawaii at which he will be working. His wife is not an employee of the
company but she will be in charge of hospitality for Compusale Inc. at the show. She will spend the hours from
1:00 pm until 9:00 pm each day on this assignment getting things organized while her husband is in the company
booth. She will spend the mornings on the beach. Do you think that Mrs. Chows expenses will be a taxable
benefit to Mr. Chow?
(5) Mr. Benton, the President of Publicco Ltd., travels extensively on company business. It is the company
policy to pay him a meal allowance of $100 per day and $200 for hotel while he is on the road. The standard
salespersons allowances are $40 for meals and $100 for hotel. Comment on the reasonableness of the
Presidents allowances.
(6) XYZ Co. leases a car for its salesperson at a monthly lease cost that includes insurance. How should the
company deal with the insurance cost when calculating the taxable benefit for the salesperson?
(7) Mr. Tse is a stock broker working in downtown Toronto. He arrives at the office early in the morning to
read the papers and organize his day. Throughout the day he is on the telephone calling clients and prospective
clients. He occasionally takes clients out for lunch or dinner while he is downtown. He is required by his
employer to pay his own entertaining expenses. Can he deduct these entertainment expenses on his personal tax
return?
(8) Name and describe the two basic types of pension plans.
(9) Ms. Betty is a salesperson for XYZ Ltd. She is paid a travel allowance of $250 per month with a
reconciliation done at the end of the year to make sure that it is actually calculated based on the company policy
of $0.40 per km. How will this be treated for tax purposes?
(10) Ms. Jones is a salesperson for an office supply company. She has bought a computer for the client
management aspect of her business. It is a portable, so she can take it with her to the office and home. Assuming
she otherwise meets the conditions to claim expenses under paragraph 8(1)(f), can she deduct CCA on this
computer?

Discussion Notes for Short Questions

(1) The economic reality test examines several economic factors and draws from them an inference as to
the nature of the relationship. In particular, four dimensions have been advanced involving:
(a) control,
(b) ownership of the tools,
(c) chance of profit, and
(d) risk of loss.
In cases where the taxpayer supplies neither funds nor equipment, takes no financial risks, and has no
liability, an employer-employee relationship is implied.
(2) The definition of employee in subsection 248(1) includes an officer and the definition of officer
includes a corporate director. Paragraph 6(1)(c) includes directors fees in income under Subdivision a.

Appendix II: Short Questions and Discussion Notes

271

(3) The exclusion under paragraph 6(1)(a) provides for group sickness or accident insurance plans. A
plan taken out for one individual would not qualify for this exclusion of the premium paid by the employer.
However, any disability benefit the president receives under this plan would not be taxable since the
contributions are paid by the president through the fact that he or she paid tax on the taxable benefit [IT-428,
par. 20].
(4) Given that she has specific responsibilities to carry out and that she will be working a full day (8 hours)
performing her duties, it is unlikely that her travel costs will be a taxable benefit. IT-470R, paragraph 15,
indicates that there is no employment benefit to the employee if the spouse was, in fact, engaged primarily in the
business activities on behalf of the employer.
(5) The word reasonable is not defined in the Act and, therefore, must be applied to the particular facts of
the situation. It is not unreasonable that the President should receive a larger allowance while on the road than a
salesperson, since he is representing the company and must present a certain image. The difficulty is determining
when the reasonable amount is exceeded. If the allowance is in excess of what top-rate meals and hotel rooms
cost, then it would be considered unreasonable and the full allowance would be included in his income
[spar. 6(1)(b)(vii)]. He would then be able to claim his expenses [par. 8(1)(h)].
(6) The cost of the insurance should be excluded from the calculation of the standby charge [ssec. 6(2)].
However, the operating cost benefit [par. 6(1)(k)] would cover the insurance.
(7) In order to meet the conditions of paragraph 8(1)(f), he must ordinarily be required to carry on the
duties of his employment away from his employers place of business. In this case it does not appear that there
is such a requirement since he spends virtually all of his time in his office. Therefore, he would not be able to
deduct his expenses.
(8) Defined benefit plans guarantee a predetermined amount of retirement income based on a flat amount
per year of service or a percentage of the employees earnings over a defined period. These plans are funded by
actuarially determined contributions by the employee and/or the employer.
Money purchase plans provide whatever pension income the contributed funds in the plan can purchase
through the acquisition of an annuity. No predetermined amount of pension income is guaranteed under these
plans. Benefits will depend upon the actual contributions, the investment return of the plan and annuity rates at
the date of purchase.
(9) According to IT-522R, this method is acceptable and she will not have an income inclusion if:
(a) there is a beginning-of-the-year agreement stating that she will get a stated amount per kilometre for
business travel;
(b) there is a year-end accounting for the difference between the payments and the business travel times
$0.40; and
(c) the amounts paid are reasonable.
Generally, the per kilometre charges will be considered reasonable as long as they are within the rates set
out by the CRA, i.e., $0.52 for the first 5,000 km and $0.46 on the remaining.
(10) Paragraphs 8(1)(j) and (p) are the only provisions that will allow an employee to deduct CCA. These
paragraphs are restricted to automobiles, aircraft and musical instruments. It does not allow the deduction of
CCA on computers. Therefore, according to subsection 8(2), CCA on the computer will not be allowed.

CHAPTER 4
Income from Business: General Concepts and Rules
Short Questions
(1) In their manufacturing process, Canco uses specialized parts. These parts are identical, but each has its
own serial number. As they are received, they are put into storage compartments in front of the existing
inventory. As they are used, the ones closest to the front are taken first. When Canco calculates its year-end
inventory it uses the LIFO method in arriving at the inventory value. Canco uses the same for tax purposes and
feels that this is correct. Comment.
(2) ServiceCo is in the business of selling service contracts to customers and then providing the service as
needed over the term of the contract. The customers pay for the service contract at the beginning of the contract.
ServiceCo believes that it does not have to record these receipts as income when the cash is received but only
over the term of the contracts. Comment.
(3) A client is about to relocate to a new office tower. The new landlord is offering large incentives to
attract long-term tenants and has offered your client a cash payment of $100,000 in order to move in. The tenant

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Federal Income Taxation: Fundamentals

is then required to do his or her own leasehold improvements. Your client has heard from some friends that the
inducement will be treated as a tax-free receipt and that the courts have accepted this position. Comment.
(4) A client is in the business of developing and selling tax shelters. In order to market his products he has
joined the local golf club most frequently used by doctors and dentists. As a result of the contacts made there he
has been able to double his sales volume. Based on these results, he feels that his club dues are deductible as a
business expense. Comment.
(5) During the year a business client made donations to both charities and to political parties. Both types of
donations yielded additional business to the client. The clients accountant has advised it that all donations must
be added back to income to arrive at net income for tax purposes. Comment.
(6) In order to fund the buy-sell provisions of a shareholder agreement the company has taken out a life
insurance policy on the lives of each of the shareholders and is paying the premiums on a monthly basis. Since it
is a business expense the premiums are deductible. Comment.
(7) In order to support its bank loan, the company is required by the bank to provide life insurance as
collateral. Since the premiums are a business expense they are deductible. Comment.
(8) A client went to a convention that cost her $3,000 for three days. The cost was inclusive of all meals
and accommodation. Since nothing was separated in the convention fee for meals and accommodation, she can
deduct the full cost. Comment.
(9) A client had an employee who stole $30,000 of cash from it over a period of six months. Is this a
deductible expense to the business? Comment.
(10) Based on past experience, your client has found that 10% of its sales are returned for a refund within
60 days. At the end of each month an accounting reserve is set up for these returns. History has shown the
reserves to be accurate. Can these same reserves be claimed for tax purposes? Comment.
(11) Any reserve that is allowed as a deduction in one year must be taken into income in the next year.
Comment.
(12) If your client pays a fee to an accounting firm to help it prepare cash flow projections and a proposal to
successfully obtain bank financing for expansion, is the fee deductible? Comment.

Discussion Notes for Short Questions

(1) While the LIFO method is generally not acceptable as an assumption about inventory values for income
tax purposes, it is acceptable if this method actually best matches the flow of inventory through the business.
Alternatively, by using the specific identification method Canco could arrive at the same inventory value. Refer
to IT-473R.
(2) The cash receipts must be included in income in the year received [par. 12(1)(a)]. A reserve may then
be claimed for amounts that relate to services to be provided in a future period [par. 20(1)(m)].
(3) The amount will have to be included in income [par. 12(1)(x)], unless an election to reduce capital cost
[ssec. 13(7.4)] or cost [ssec. 53(2.1)] is available.
(4) Even though the club dues were incurred to earn income from his business, they are not deductible
since they are specifically disallowed [par. 18(1)(l)].
(5) The charitable donations are disallowed to the extent they were not incurred to earn income.
[par. 18(1)(a)] So, if they were incurred to earn income, then they will be deductible. The political donations, on
the other hand, are specifically disallowed [par. 18(1)(n)] and, therefore, are not deductible in computing income
for tax purposes, regardless of the fact that they were incurred to earn income. A limited tax credit is allowed for
federal political contributions.
(6) Since life insurance proceeds are not included in income on death, the premiums are not an expense
incurred to earn income and are, therefore, not deductible, [par. 18(1)(a)]
(7) Paragraph 20(1)(e.2) permits a deduction in respect of life insurance premiums where the policy is
assigned as collateral to a lender who is in the business of lending money. The deduction is based on the lesser of
the premiums paid and the net cost of pure insurance.
The deduction is calculated as the lesser of:
(a) the premiums paid under a life insurance policy in respect of the year where:
(i) the policy is assigned to the institution in the course of borrowing;
(ii) the interest on the loan would be deductible;
(iii) the assignment is required by the institution; and
(b) the net cost of pure insurance.

Appendix II: Short Questions and Discussion Notes

273

The deduction, further, must reasonably be considered to relate to the amount owing from time to time under the
borrowing.
(8) If meal costs are not specified, then subsection 67.1(3) deems the cost to be $50 per day for meals. This
is then subject to the 50% limitation [ssec. 67.1(1)].
(9) In IT-185R, the CRA allows employee thefts as expenses unless it is a senior employee who committed
the theft. However, in the court case, Cassidys Limited (formerly Packer Floor Coverings Ltd.) v. M.N.R.,
89 DTC 686 (T.C.C.), defalcation by a senior employee was allowed.
(10) Paragraph 18(1)(e) specifically disallows reserves of any kind unless they are specifically allowed
somewhere else in the Act. There are no reserves in section 20 which would allow a deduction for this reserve
since it is based on a contingency and not a known liability.
(11) Each reserve allowed under subsection 20(1) has a corresponding income inclusion under
subsection 12(1). In subsequent years a new reserve may be claimed depending on the provisions of the reserve
provision itself and the facts of the situation.
(12) Paragraph 20(1)(e) would not allow an immediate deduction. Instead, the fees would be deductible
evenly over a 5-year period including the year the expense was incurred.

CHAPTER 5
Depreciable Property and Eligible Capital Property
Short Questions
(1) Whenever an asset is sold the full amount of the proceeds is credited to the CCA class. Comment.
(2) If a CCA class is in a negative balance at any time in the year then this negative balance will have to be
brought into income. Comment.
(3) On December 1, Mr. Luigi buys his first rental property and immediately begins to rent it out. The CCA
that he is otherwise entitled to claim will be prorated for the fact that he only owned the building for 31 of the
365 days in the year. Comment.
(4) A construction corporation moved some heavy equipment into northern Ontario for a special project. At
the end of the project they abandoned the equipment at the site since the cost of removal exceeded the cost of
replacement. The equipment will forever remain in its class since it has not been disposed of. Comment.
(5) There can be no recapture or terminal loss on automobiles that cost over $30,000 plus HST. Comment.
(6) CCA is a discretionary deduction and, therefore, may be claimed or not claimed at the discretion of the
taxpayer. However, if it is claimed, then the full amount must be claimed. Comment.
(7) If a building is sold for less than its capital cost then a capital loss will be realized. Comment.
(8) A business made some leasehold improvements, costing $10,000, to their offices in year 3 of a fiveyear lease. There is one renewal period of five years. What is the maximum CCA that they can claim in year 3
based on these additions?
(9) A corporation bought a franchise on June 1, for $20,000. The franchise term is for 10 years. The yearend of the corporation is December 31. What class is this asset in and how much CCA can be claimed? (Ignore
the effects of leap years.)
(10) A corporation bought a franchise on June 1, for $20,000. The franchise is for an indefinite term. The
year-end of the corporation is December 31. What class is this asset in and how much CCA can be claimed?
(11) A client had a fire in their warehouse. They received insurance proceeds of $50,000 of which they used
$45,000 to repair the damage and the balance of $5,000 was taken into income. Their controller agreed that this
was the proper treatment. Comment.
(12) A personal tax client has come to you and told you that she cannot afford to buy a house based on her
own income. However, she has bought a duplex and is living in one half and renting out the other half. On the
sale of the duplex she thinks she will be able to claim it all as her principal residence. Comment.
(13) Fifteen years ago, Mr. Jones established his own unincorporated electronics business that manufactures
electronic controls. He has come to tell you that he has just sold one of his trademarks for $60,000 and that his
lawyer told him that the sale would be treated as a capital gain in the company. Comment.

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Discussion Notes for Short Questions

(1) The proceeds, up to a maximum of the original cost, are credited to the class. If proceeds exceed
original cost then there will be a capital gain.
(2) The negative balance will only have to be brought into income if the balance is still negative at the end
of the fiscal year. If a new asset is acquired at a cost high enough to bring the class into a positive balance then
CCA can be claimed in the year on this positive balance.
(3) As an individual earning property income, Mr. Luigi is considered to have the full calendar year as his
taxation year. Thus, there is no proration of CCA. However, he will be subject to the half-net-amount rule
[Reg. 1100(2)].
(4) In IT-460, the CRA takes the position that property that is abandoned is actually disposed of for
proceeds equal to nil. This becomes important when trying to claim a terminal loss on the disposal of the last
asset since, if all the assets of the class have not been disposed of, a terminal loss cannot be claimed.
(5) Subsections 13(2) and 20(16.1) provide that recapture and terminal loss rules do not apply to
automobiles costing over $30,000 plus HST. Each of these autos is in a separate class, Class 10.1 [Reg.
1101(1af)].
(6) The word may in paragraph 20(1)(a) makes it a discretionary deduction. However, in
Regulation 1100(1) the phrase not exceeding is used to allow any amount of CCA from nil to the maximum to
be claimed at the discretion of the taxpayer.
(7) Subparagraph 39(1)(b)(i) denies a capital loss on depreciable property. When the proceeds are less than
the capital cost they are credited to the CCA class.
(8) Regulation 1100(1)(b) and Schedule III provide for CCA on leasehold improvements as follows:
50% the lesser of:
(a)

/ 5 $10,000 = $2,000

(b) $10,000/(3 + 5) = $1,250

CCA = $625 (i.e., 50% of $1,250)
(9) Franchises with limited lives are in Class 14. CCA is claimed based on a proration of the cost over the
life, in days (ignoring leap years), of the franchise. Therefore, the CCA would be:

$20,000

(365 10)

214 = $1,173

Regulation 1100(2) excludes Class 14 from the half-net-amount rule. However, since the CCA is prorated
on a daily basis in Class 14, an acquisition during the year may not get the full CCA.
(10) Since the franchise is for an indefinite term, it is not a Class 14 asset. Instead, it is an eligible capital
expenditure and is subject to the rules in section 14. Three-quarters of the cost is added to the CEC pool and is
depreciated at 7% on the declining balance.
(11) The $45,000 should be treated as an offset to expenses or effectively as an income inclusion
[par. 12(1)(f)]. The extra $5,000 that was not spent should not be treated as income. Instead, it should be treated
as proceeds of disposition paragraph (f) of the definition of proceeds of disposition in subsection 13(21).
(12) She will be deemed to have disposed of the rental portion of the duplex for proceeds equal to the
proportion of use that was rental [par. 13(7)(d)]. This will give rise to potential recapture and capital gain that is
not eligible for the principal residence exemption.
(13) Trademarks are eligible capital property. Of the $60,000 of proceeds, only 75% is credited to the CEC
pool. If there is a negative balance then the total of 2/ 3 of the negative balance net of all previous CECA claims
plus all previous CECA claims, must be taken into income as business income in the year of sale [ssec. 14(1)].
Alternatively, he may elect under 14(1.01) to treat the gain as a capital gain to offset any capital losses. He
cannot claim the capital gains exemption on this gain, since the property sold does not qualify.

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275

CHAPTER 6
Income from Property
Short Questions
(1) The dividend gross-up and tax credit were introduced to provide an incentive to Canadian individuals to
invest in the stock market. Comment.
(2) Income from property includes capital gains since they arise from the sale of property. Comment.
(3) Individual taxpayers have three options for reporting interest income. They can report it on the cash
basis, the receivable method or the accrual method. Comment.
(4) Mr. Watson sold a piece of property to Mr. Holmes in an arms-length transaction at fair market value.
Mr. Watson took back a note with no interest being charged and is concerned that subsection 16(1) will apply to
deem part of the repayment to be interest income. Comment.
(5) Bill and Betty have been living together for 15 years and have three children together. They have never
married. Bill has loaned Betty $50,000 interest free from an inheritance he received so she can earn some
income. Comment.
(6) Ms. Jones owns all of the shares of Jones Co. She has had the company valued and 50% of the shares
are worth $100,000. Since her husband has inherited that amount she is going to sell him 50% of her shares for
$100,000 cash. She intends to report the gain on her tax return and have her husband pay tax on any dividends
paid by the company. Comment.
(7) A client has just come up with what he thinks is a clever plan for avoiding the attribution rules. He is
going to lend his mother, who lives in the U.K., $100,000 and she in turn will lend the money to his 12-year-old
son. His son will invest the money and earn interest income that will be taxed in his sons hands. Comment.
(8) Mrs. Campbell has heard that she can make the attribution rules work for her. She proposes to start up a
company and wants to own all the shares herself but she also wants to split income with her husband. She thinks
that she can buy 50% of the shares herself and have her husband buy the other 50% of the shares with his own
money. He would immediately give her the shares for no consideration. Once dividends are declared, 50% of her
dividends would be attributed to her husband under section 74.1. What do you think?
(9) Mom has been saving her child tax benefit cheques in a bank account for her daughter. Someone has
just told her that she does not need to report the interest earned on this account as income but that her daughter
could. She knew there were rules against this and wants your advice.
(10) Mr. Smith borrowed $300,000 at the bank to buy common shares in Smith Ltd., which in turn bought
30 acres of raw land for development at some time in future. Is the interest fully deductible to Mr. Smith?
(11) A tax client has just told you that she has sold a rental property that she has owned for a number of
years. Because of the large amount of recapture that she was faced with, she decided to buy another apartment to
bring the class back into a positive balance. Comment.

Discussion Notes for Short Questions

(1) The gross-up and tax credit mechanism was introduced to integrate corporate and personal income to
leave the individual indifferent as to whether he or she earned business or investment income through a
corporation or directly. See Chapter 12 of the text.
(2) Capital gains are specifically excluded from income from property [ssec. 9(3)]. Also, capital gains and
income from property are under two different subdivisions of the Act.
(3) For investment contracts, interest income must be reported on the accrual basis annually under
subsection 12(4).
(4) Since the transaction took place at fair market value and assuming that Mr. Watson and Mr. Holmes are
dealing at arms length, it is doubtful that the CRA would be successful in imputing an interest component under
subsection 16(1). If the purchase price were in excess of fair market value then the CRA would have a greater
chance of successfully converting some of the capital gain into interest income.
(5) Attribution will apply to this loan since Betty is Bills spouse or common-law partner
[ssecs. 74.1(1), 248(1)].
(6) In order to avoid the attribution rules, subsection 74.5(1) requires that she and her husband will not only
have to complete the transaction at fair market value but they will also have to complete a joint election under
subsection 73(1) not to have the rollover apply in order to avoid the attribution rules.

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Federal Income Taxation: Fundamentals

(7) On the surface, the attribution rules of subsection 74.1(2) will not apply since the grandmother is not
resident in Canada. However, subsection 74.5(6) provides an anti-avoidance rule that will catch this back-toback loan arrangement and have the interest income earned by his son taxed in your clients hands.
(8) On the surface, it works. But the artificial transaction rules in subsection 74.5(11) would apply to cause
the attribution rules to be ignored since one of the main reasons for this transaction is to reduce the amount of tax
that would be paid.
(9) Normally, the attribution rules would apply. However, subsection 74.1(2) provides that the income
attribution rules do not apply to a child tax benefit transferred or loaned to a child and allows the interest to be
taxed in the hands of the child.
(10) The ACE denies interest expense that can reasonably be considered as interest on borrowed money used
in respect of or for the acquisition of land, but the disallowed interest is added to the cost base of the shares
[par. 18(3)(b), 53(1)(d.3)].
(11) Regulation 1101(1ac) requires each rental building purchased after 1971 and costing $50,000 or more
be placed in a separate CCA class. Thus, if those two conditions are met, the new building she is buying will not
go into the same pool and the recapture will not be deferred.

CHAPTER 7
Capital Gains: Personal
Short Questions
(1) Mr. Trent retired a number of years ago and decided that he did not want to spend winters in Canada.
He sold his house in Waterloo and moved into an apartment for seven months of the year. For the other five
months he lived in a villa in Spain that he bought after he sold his house. He now wants to sell the villa and buy a
property in Arizona. He has come to you to see whether he can claim the principal residence exemption on the
villa. Comment.
(2) Mr. Platzer, who has been saving coins since he was a child, has now decided to sell a particularly
valuable set that he bought for $100 many years ago. There are five coins in the set and each is worth $800 for a
total selling price of $4,000. The coin dealer that he is selling them to suggested that he sell him each coin for
$800 instead of the set for $4,000, in order to avoid a capital gain. What do you think?
(3) Mrs. Amos likes to buy old books and furniture. She very rarely sells any of her pieces and is not
considered to be a trader. However, this year she has sold an antique stool for a loss of $2,000 and an old 1917
Income War Tax Act for a gain of $4,000. Her only previous transaction was the sale of another old book for a
loss of $3,000 six years ago. What will her capital gain be for the year from these transactions?
(4) Mr. Evans has been investing in the stock market for many years and has already used up his capital
gains exemption. It is now December and he is trying to minimize his tax liability for the year. In July he sold
some shares to realize a capital gain of $20,000. He does not want to pay tax on this gain so he wants to sell his
shares of PubCo. that are doing poorly and realize an offsetting loss. However, he is certain that the PubCo.
shares will increase in value again and wants to buy them back again in early January. Comment.
(5) How are stock dividends treated for tax purposes?
(6) Ms. Rose bought a summer cottage in 1996 and used it herself for the next 10 years. In the years 2006
to 2009 she travelled extensively and was unable to use her cottage at all. In fact, she rented it out to an unrelated
family for the entire four years. In 2010, she again began to use the cottage personally. Comment on the tax
issues involved.
(7) When her husband died suddenly, Mrs. Jones found that she needed extra income to support herself.
She proceeded to make a permanent apartment on the second floor of her house. She added a separate entrance, a
bathroom, a kitchen and had the utilities separately metered. The costs were considerable but she was confident
she would be able to make a profit very quickly. Comment on the tax issues.
(8) Mr. Carter has worked all his life to build up the value of his privately-owned company. Having started
from nothing, his shares are now worth $10 million. He would like to leave the country but does not feel that he
can because of the huge amount of tax that he would have to pay on the accrued gain on the shares. Discuss.
(9) Mr. King has been a non-resident of Canada and just last month moved to Canada to live. While
abroad, he bought some shares on the New York Stock Exchange at a cost of $10,000 and now wants to sell them
for $50,000. However, he is concerned about the amount of tax that he will have to pay on his $40,000 gain. He
has come to you for advice. Can you help him?

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277

(10) Mr. OMalley wants his wife to benefit from and pay tax on the future appreciation in the value of some
shares that he owns. These shares originally cost $5,000 and are now worth $12,000. He is going to sell them to
her in exchange for a note for $12,000 with interest at 8%. Discuss whether he can achieve his goal.
(11) Mrs. Reilly has sold shares that she owned to her husband. She elected under subsection 73(1) not to
have the rollover apply and he paid her cash for the shares. She originally paid $6,000 for the shares; they are
now worth $16,000 and he paid her $15,000 in cash. What are the tax consequences to Mr. and Mrs. Reilly?

Discussion Notes for Short Questions

(1) The definition of principal residence [sec. 54] does not restrict the location of a principal residence to
Canada. The claim of the principal residence exemption is restricted to Canadian residents [spar. 40(2)(b)(i)]. In
this case, Mr. Trent has not changed his resident status and therefore he would be able to claim the principal
residence exemption on the Spanish villa.
(2) Subsection 46(3) provides that, when the coins are all sold to the same person or related people, they will
be treated as being sold as a set and he will have a capital gain of $3,000 on the transaction. If he sold each coin to a
separate arms length dealer then he would have been able to use the $1,000 rule to eliminate the full gain.
(3) The antique stool is not listed personal property (LPP) according to the definition in section 54. However,
it is still PUP and, as such, the loss is disallowed [spar. 40(2)(g)(iii)]. The rare book, on the other hand, does meet
the definition of LPP and the gain is subject to tax. However, in determining Division B income, the current gain of
$4,000 is reduced by the previous loss of $3,000 and 1/ 2 of this net amount is considered to be the taxable net gain
from listed personal property [ssecs. 41(1) and (2)]. Losses on LPP can be carried back three years and forward
seven years to be applied against gains from LPP. It should be noted that these carryovers are applied within the
calculation of the capital gain in Division B and not under Division C as other loss carryovers are.
(4) If Mr. Evans buys the shares of PubCo. back within 30 days of selling them in December, then he will
have a superficial loss [sec. 54]. This loss will be denied [spar. 40(2)(g)(i)] and added to the cost base of the
replacement shares [par. 53(1)(f)].
(5) The stock dividend is treated in the same way as a cash dividend. The increase in paid-up capital is
considered to be a dividend [ssec. 82(1)] and the grossed-up amount is included in income. The cost base of the
shares received is equal to the increase in paid-up capital [ssec. 52(3)].
(6) When she began to rent out the cottage in 2006 she had a change in use [ssec. 45(1)] and the deemed
disposition and potential capital gain (unless the cottage was her principal residence) that go along with it. Then
in 2010 she had another change in use that would cause her to have another deemed disposition and potential
capital gain. However, she could have elected under subsection 45(2) not to have a change in use in 2006. This
would have left the property as personal-use property without the deemed disposition. As a result, when the
property was changed back to personal use in 2010, there would not have been a change in use at that time either.
In order to have the rules in subsection 45(2) apply she would have had to elect in 2006 when the first change in
use occurred (unless the cottage was her principal residence) and, under subsection 45(4) and
regulation 1102(1)(c), she could not have claimed any CCA on the cottage.
(7) Since she has made significant structural changes to the house, the CRA takes the position [IT-120R6,
par. 30], that she will have a partial change in use of the house and a disposition [par. 45(1)(c)] of that portion of
the house represented by the second floor. She will be able to claim CCA on the rental space. On the eventual
disposition of the entire property the principal residence exemption will only apply to the portion she lives in.
The second floor will be disposed of in the same manner as a rental property.
(8) The rules causing a deemed disposition on leaving the country do apply to an unlisted share of the stock
of a corporation resident in Canada [ssec. 128.1(4)].
(9) Mr. King is deemed to acquire the shares at their fair market value at the time he entered the country
[ssec. 128.1(1)]. This should give him a cost base of $50,000 and eliminate his accrued capital gain.
(10) In order to transfer property to his wife and avoid the attribution rules he must follow the attribution
rules [ssec. 74.5(1)] and have the sale take place at fair market value, have interest charged at the lesser of the
prescribed rate and the commercial rate, and elect [ssec. 73(1)] not to have the spousal rollover take
place. In this case the interest rate may be too low and no mention is made of the [ssec. 73(1)] election out of the
rollover. Therefore, the attribution rules are not avoided and income splitting is not achieved, unless it can be
established that the interest rate is at least equal to the lesser amount, above, and that the [ssec. 73(1)] election
was made not to have the automatic rollover apply.
(11) Since Mrs. Reilly elected out of the rollover in subsection 73(1) she will be taxed on the $10,000 capital
gain (subsection 69(1) applies to deem the proceeds to be equal to fair market value). However, since she did not
meet the condition of paragraph 74.5(1)(a), i.e., she did not receive fair market value consideration, the

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278

attribution rules will continue to apply. The cost base of the shares to Mr. Reilly will be the $15,000 that he paid
for the shares since section 69 does not adjust his cost base. Therefore, there will be double taxation on the
$1,000 difference between $16,000 and $15,000.

CHAPTER 8
Capital Gains: Business Related
Short Questions
(1) Opco, which has a December 31 year-end, sold the warehouse it used in its business this year and
started to use rented space. How long do they have to replace the warehouse in order to defer the tax on the one
that was sold?
(2) Opco has been operating in downtown Toronto for the past 25 years. It has decided to sell its land and
building and move its operations to London, Ontario where it is less expensive. They sold their land for
$2 million and the building for $500,000. These had a cost of $100,000 in total. The property they bought in
London cost $1 million for the land and $1.5 million for the building. It would appear that they will have a
significant capital gain on both the land and building with the only full deferral available on the building. Can
you suggest a method that will give them the full deferral on both the land and the building?
(3) Dealco originally bought its land and building for $500,000 each. The land has now gone up in value to
$1.3 million while the building has no value in its current location. No CCA has ever been claimed on the
building. A purchaser has now come along and has offered Dealco $1.3 million if they will demolish the building
and leave the land clear. Dealco thinks that this is a great idea since, of the $800,000 gain on the land, only
$400,000 is taxable and this will be offset by the $500,000 terminal loss on the building. What do you think?
(4) Your friend Ralph bought a rental property some years ago. He paid $50,000 for the land and $150,000
for the building. Unfortunately, the property values in the area have not gone up and, due to the recession, have
in fact gone down. He has to sell the property to meet other commitments and his proceeds will be $40,000 for
the land and $130,000 for the building. Since he has been operating at a loss he has not claimed any CCA yet. He
is upset that all he will get is a capital loss on the sale and he will not be able to use this loss to reduce his income
and help reduce his tax. Comment.
(5) Acme Co. has just bought a new piece of equipment in the U.S. for use in its Canadian plant. The
equipment cost $75,000, the shipping cost $10,000 and the installation cost $5,000. The controller wants to
capitalize the $75,000 and expense the balance of the costs for tax purposes. As the auditor on the engagement
you have been asked for your views on how the expenditures should be treated for tax purposes.
(6) Ms. Andrews has just sold her rental property for a capital gain of $200,000. However, in order to do so
she has had to take back a demand promissory note of $300,000 until the purchaser can get mortgage financing
which the purchaser expects to do early next year. Can Ms. Andrews do anything to defer her tax liability?
(7) Earlier in the year Mr. Barnes had sold the shares of his small business corporation to his son and had
taken back a term note for equal principal payments over 15 years. Mr. Barnes has already used up his capital
gains exemption and is glad that he took back the note since he can now defer tax on the gain over the next
15 years. Comment.
(8) Mrs. Blidge has sold her shares in her qualified small business corporation and realized a gain of
$300,000. In the process she took back a term note that is payable equally over five years. She does not know
whether to claim the capital gains exemption to eliminate the full amount of the gain now or to claim a reserve to
bring the gain into income over the next five years and use her exemption in each of the next five years. She has
come to you for your expert advice.
(9) Ms. Sleigh had taken advantage of the housing market in her city by putting $10,000 down on a new
house which was to be built in two years. By the time the house closed it had gone up in value by $60,000. She
and her family moved into the house for one month and then sold it and realized the gain. They then moved back
into their old house. When she came to have you prepare her personal tax return she said that she could claim the
principal residence exemption on the new house. Comment.

Discussion Notes for Short Questions

(1) They have to replace the warehouse before the later of 12 months after the initial year and the end of
the first taxation year after the initial year [par. 44(1)(d)]. If the sale closed this year, then they have until
December 31 of next year to replace the property. The initial year is the year that the amount has become
receivable as proceeds of disposition [ssec. 44(1)].

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279

(2) An election is allowed to reallocate proceeds from land to building [ssec. 44(6)]. In order to obtain a
full deferral, $1 million of proceeds could be reallocated from land to building to defer the full gain.
(3) The proceeds will be reallocated from the land to the building to the extent of the terminal loss (TL)
[ssec. 13(21.1)]. As a result, the proceeds on the building will be $500,000 and the proceeds on the land will be
$800,000. Under the proposal the effect on taxable income was ($100,000) ($400,000 TCG $500,000 TL)
whereas the effect is now $150,000 ($150,000 TCG nil TL).
(4) The Act does not allow a capital loss on the sale of depreciable property [spar. 39(1)(b)(i)]. Instead, he
will be able to claim a terminal loss of $20,000 on the sale of the building [ssec. 20(16)] and a capital loss of
$10,000 on the sale of the land. Even though there is a terminal loss on the building, there is no reallocation of
proceeds since there is not a capital gain on the land [ssec. 13(21.1)].
(5) Cost is not defined for tax purposes but it would normally include all of the costs necessary to obtain
the equipment, deliver it and install it in the plant. All of these costs relate to getting the equipment ready for use.
(6) She cannot claim a reserve [spar. 40(1)(a)(iii)] based on amounts that are payable to the taxpayer after
the end of the year, since the note payable on demand may become due to the taxpayer before the end of the year.
(7) Where shares of a small business corporation are transferred to a child, the reserve rules change so that
the 1/ 5 is changed to 1/ 10 to allow the gain to be brought into income over 10 years instead of five years
[ssec. 40(1.1), spar. 40(1)(a)(iii)].
(8) She can either claim the full exemption now or, if she claims the reserve, claim the exemption each year
as she brings the gain into income. However, there is usually no advantage to claiming the reserve if the full
amount of the gain will be exempt from tax. (One exception may be if she will be subject to alternative minimum
tax (discussed in Chapter 10) by bringing the full amount of the gain into income in the first year.)
(9) The CRA stated [IT-120R6, par. 5] that a taxpayer may designate any residence as his or her principal
residence as long as he or she lives in the home for a short period during the year and his or her intention is not to
make a profit on the residences disposition. In this case her intention seems to be to make a profit since she
moved in for such a short time and then moved back to her old house. The issue then becomes whether the gain
is an income or a capital gain. This transaction could well be considered an adventure in the nature of trade and
fully taxed.

CHAPTER 9
Other Sources of Income and Deductions in Computing Income
Short Questions
(1) Mr. Jones had been fired from his job as controller of a large manufacturing company for consistently
not performing his duties. Mr. Jones admitted that he had not performed his job up to the necessary standard but
he still took his former employer to court for wrongful dismissal. In court he won his case on a technicality and
was awarded $50,000 as damages with no award for back pay. Mr. Jones was delighted with the award since he
would not have to include damages in income, whereas he would have had to include an award for back pay in
his income. Comment.
(2) Andy and Sara agreed to a separation agreement that requires Andy to pay $1,500 per month to Sara as
an allowance for her maintenance and also to pay $500 per month directly to the financial institution that holds
the mortgage on her home. Comment on the deductibility of these payments.
(3) Sally received a loan from her employer to pay for her expenses while she returned to university. The
agreement was that if she returned to work for her employer when she graduated the loan would be forgiven. If
she did not return to work for her employer the loan would have to be repaid in full. How would this be treated
for tax purposes?
(4) Hugo was in an accident last year and has been receiving payments from Workers Compensation. He
is now trying to complete his tax return and is going to ignore these payments and not include them in his return
at all. Is this correct?
(5) Last year Wally, age 20, received a personal injury award settlement of $1,500,000 for a car accident he
was in two years earlier. He earned $150,000 of interest income on this award during the year and now he wants
to know how much tax he will have to pay on it.
(6) What are the major advantages of an RRSP?
(7) Joe can contribute up to $12,000 to his RRSP for the year. He does not have that much cash but he does
have stocks worth that much. He has heard that he can contribute these shares into his RRSP. Given that he

Federal Income Taxation: Fundamentals

280

wants to keep the same stocks and that these particular shares qualify, what are some of the tax consequences of
this transfer?
(8) Mrs. Littles employer was cutting staff, and as part of the process offered a generous retirement
package made up of a retiring allowance and pension benefits. Mrs. Little and her husband discussed the matter
and decided that after 30 pre-96 years with the company she wanted to do something else so she accepted the
offer. During the first year of her retirement her only income consisted of $30,000 as a retiring allowance and
$45,000 of pension income. How much of this can she contribute to an RRSP and receive a deduction for?
(9) For normal RRSP contributions, an individual has until 60 days after December 31 to make his or her
contribution and still have it deductible for the year. Why does the same 60-day extension not exist for the year
in which the individual turns 71?

Discussion Notes for Short Questions

(1) The definition of retiring allowance [ssec. 248(1)] includes an amount received in respect of a loss
of an office or employment of a taxpayer, whether or not received as, on account or in lieu of payment of,
damages or pursuant to an order or judgment of a competent tribunal. So, even though he received damages, the
amount must be included in income [spar. 56(1)(a)(ii)]. This amount is eligible for transfer to an RRSP within
the limits imposed by paragraph 60(j.1).
(2) Under this agreement, the monthly fees paid to the financial institution do not qualify as an allowance
since Sara does not have any discretion as to the use of the amount and the amount is in addition to the spousal
maintenance payment specified in the agreement.
(3) According to IT-340R, the loan would not be included in income when received. Instead, it would only
be included in employment income in the year that it is forgiven [ssec. 6(15)]. Presumably, Sally would be
assessed a deemed interest benefit [ssec. 80.4(1)] during the period of the loan. Then, if the principal amount of
the loan is included in her income, she could amend prior years returns to exclude the deemed interest benefit
from income [par. 80.4(3)(b)].
(4) Workers Compensation payments are included in net income [par. 56(1)(v)]. Therefore, the payments
should be included on his tax return. However, the same amount is deducted in arriving at taxable income
[par. 110(1)(f)]. Thus, there is no effect on taxable income. However, the income inclusion may reduce the
amount of the personal tax credit that a related person might try to claim.
(5) Income earned or capital gains realized on a personal injury award settlement is not taxable until the
year after the year in which the individual turned 21 years of age [par. 81(1)(g.1)].
(6) The two major advantages of an RRSP relate to tax deferral. One major advantage of an RRSP is that
the income earned on the funds within the plan can be accumulated tax free until the funds are withdrawn from
the plan. A second advantage is the deduction for the contribution of the funds to the plan. While this initial
deduction may be offset to some extent by the tax on the withdrawal of the funds from the plan, the tax is
deferred for what may be a long period of time.
(7) The following are some of the tax consequences of transferring shares to an RRSP:
(a)

the plan will need to be a self-administered plan in order to accept the assets being transferred,
and

(b)

the shares will be deemed to be disposed of at fair market value on the transfer to the RRSP. Any
capital gains will be recognized at the time of the transfer. Any capital losses will be denied
[spar. 40(2)(g)(iv)].

(8) Based on 30 pre-96 years of service, she should be able to contribute the full $30,000 to her RRSP as a
retiring allowance [par. 60(j.1)]. In addition, she could make a contribution to either her or her husbands RRSP
based on her earned income in the prior year adjusted for her pension adjustment. Neither the retiring allowance
nor the pension income could be categorized as earned income so no further contribution could be made on
this basis either in the current or the next year.
(9) By the end of the year in which an individual turns 71, he or she has to either cash in the plan, transfer it
to an RRIF or purchase a retirement annuity. As a result, as at December 31 of that year, the RRSP ceases to
exist and there is nothing to which a contribution can be made within the 60 days following the year.

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CHAPTER 10
Computation of Taxable Income and Taxes Payable for Individuals
Short Questions
(1) Ms. X earns $20,000 of employment income and has come to you to talk about her investment income.
She earns $1,000 of dividend income from a Canadian-resident public corporation in the year. She wants you to
tell her what her marginal tax rate is on this dividend income.
(2) Mr. Y earns $20,000 of employment income and has come to you to talk about his investment income.
He earns $1,000 of interest income in the year. He wants you to tell him what his marginal tax rate is on this
interest income.
(3) Ms. Z earns $20,000 of employment income and has come to you to talk about her investment income.
She realized $1,000 of capital gain in the year. She wants you to tell her what her marginal tax rate is on this
capital gain.
(4) Art Smith is an executive in the top tax bracket who collects antique cars. These antiques are capital
property, not inventory, to him. He is planning to donate one of these cars to a local charity to be used in one of
their fund-raising events. The value of the car is $20,000 and his cost of the car is $2,000. He knows there are
special rules for the donation of capital property, but he does not know if these rules will help him. He has
already made donations of $5,000. What is your advice?
(5) Ms. Lee found that when she did her personal tax return her personal credits far exceeded her federal
tax. Her federal tax was $900 and yet she had a basic personal credit of $1,557 as well as charitable donation
credits of $400. Is there anything she can do to maximize her potential benefits from this situation?

Discussion Notes for Short Questions

(1) Her marginal tax rate on dividend income would be:
Cash dividend ...............................................................................................................
Gross-up @ 44% ..........................................................................................................
Taxable dividend ..........................................................................................................
Federal and provincial tax @ 25%
Dividend tax credit ((18% + 12%) of $1,440) ..............................................................
Total tax........................................................................................................................
Marginal tax rate on dividends is nil/$1,000 = nil. The excess dividend tax credit of $72
(i.e., $432 $360) can be used to reduce income tax on other sources of income.

$ 1,000
440
$ 1,440
$
360
(432)
$
Nil

(2) His marginal tax rate on interest income would be:

Interest earned ..............................................................................................................
Federal and provincial tax @ 25% ...............................................................................
Marginal tax rate on interest is $250/$1,000 = 25%

$ 1,000
$
250

(3) Her marginal tax rate on capital gains would be:

Capital gain...................................................................................................................
Taxable capital gain (1/ 2 ) ..............................................................................................
Federal and provincial tax @ 25% ...............................................................................
Marginal tax rate on capital gain is $125/$1,000 = 12.5%.

$ 1,000
$
500
$
125

(4) Subsection 118.1(6) allows an individual to designate the proceeds of the capital property at anywhere
between the cost and the fair market value, in this case between $2,000 and $20,000. Looking at the alternatives:
(a) If he designates $2,000 he will report no net income on the disposition since his proceeds equal his cost.
However, he will receive a donation receipt for $2,000 which is worth an incremental federal credit of
$2,000 29% = $580.
(b) If he designated $20,000 as the proceeds, he would report a capital gain of $18,000 and include 1/ 2 or
$9,000 in income as a taxable capital gain. He would have additional federal tax of 29% x $12,000 =
$3,480. He will also receive a donation receipt for $20,000 which will generate a federal credit of
$20,000 29% = $5,800. On a net federal basis he would have a net federal credit from this alternative
of $2,320 (i.e., $5,800 $3,480).

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Federal Income Taxation: Fundamentals

On a net basis, he would be further ahead to designate the full $20,000 as the proceeds.
(5) Under the ordering rules for personal credits [sec. 118.92], the basic credit must be claimed before the
charitable donation credit. Since neither of these credits is refundable, Ms. Lee will be unable to receive a refund
for this year. However, she can carry her donations forward for five years so she should not claim any donations
this year, but carry them forward to see if she can claim them at a later time.

CHAPTER 11
Computation of Taxable Income and Tax After
General Reductions for Corporations
Short Questions
(1) In its current fiscal year, Smithco has had a business loss of $20,000 and a taxable capital gain of
$30,000. The corporation also has the following loss carryovers from the previous year: a non-capital loss of
$20,000 and an adjusted net capital loss of $20,000. The owner-manager has asked you to explain to him how he
has to apply the losses and what the companys loss carryforward will be.
(2) Mr. Smith has just bought the shares of a company that has a non-capital loss carryover. This carryover
includes a loss on a rental property. He is anxious to amalgamate the loss company with his company to use up
these losses. Comment on the plan.
(3) Mr. Elliott owned all the outstanding common shares of XYZ Co. until May 1 of this year, when he
sold 50% of these shares to Mr. Ng as part of his plan to retire. There are no other shares outstanding. Does
subsection 249(4) apply to deem a year-end at the time he sold the shares? Explain.
(4) Retail Co. has been having difficulty making money lately and the owner, Mr. Ed, has decided to sell
the company to a competitor. One of Mr. Eds problems is that his inventory has declined in value due to cheap
imports. However, the purchaser sees this as a benefit since Mr. Ed valued his inventory at cost for both
accounting and tax purposes. Once the purchase takes place, the purchaser will implement a tax plan to use these
accrued inventory losses as a deduction against the income of his profitable company. Comment on the tax
issues. Ignore any accounting issues.
(5) Pop Eye has the largest spinach store in the province. In order to assure himself of a constant supply of
the best spinach, he has bought a spinach processor that has been in financial difficulty in recent years and has
some non-capital losses that are about to expire. Pop plans to combine the two companies on a tax-free basis two
months after the acquisition in order to use the losses of the processor against his retail profits. Comment on the
plan.
(6) On December 31 of last year, all the shares of RustyCo were acquired and a deemed year-end took
place. RustyCo has non-capital losses of $50,000 being carried forward. During this year, the company realized
profits of $20,000 from the same business, a rental profit of $10,000 and a taxable capital gain of $15,000. How
much of the loss carryover balance can be applied this year? Explain why.
(7) Holdco had bought 25% of the shares of Opco five years ago for $500,000. Over the period of
ownership it has received dividends of $150,000, including $40,000 of capital dividends. Holdco has just sold
these shares for $300,000 and is using the $200,000 capital loss to offset a $300,000 capital gain on another sale.
Comment on the tax effects in the year the shares are sold.
(8) Hi Tech is a company that has recently gone to the public market for financing and its shares are now
trading over-the-counter in Toronto. The majority of the shares are still held by the founder who is a resident of
London, Ontario. The controller has just panicked when he realized that the company needs to be a CCPC in
order to get the SR&ED investment tax credits. He has asked you to determine whether it is still a CCPC. What
do you think?
(9) You are reviewing the working papers of one of your corporate clients that is in the electronics
business. You have just noticed that the corporation has expensed the cost of some scientific equipment. While it
is not material for financial statement purposes you are wondering whether these expenses should be capitalized
for tax purposes since paragraph 18(1)(b) specifically denies this type of deduction. Is there any way you can
justify the deduction?

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283

Discussion Notes for Short Questions

(1) Under Division B, the business loss is applied against the taxable capital gain to bring Division B income
down to $10,000. Then either the net capital losses or the non-capital losses can be applied against this net
income. The choice is based on which carryover is the more restrictive, given the circumstances and future
expectations of the company. If non-capital losses are the better choice, then the $20,000 of net capital losses
carried forward can be deducted against the $30,000 of net taxable capital gains in the year. Although this
procedure would have no effect on taxable income, the non-capital losses will be increased by the net capital loss
claimed, thereby reinstating $10,000 of the $20,000 business loss in the year. As a result, net capital losses would
be fully absorbed and non-capital losses available for carryforward would equal $30,000 (i.e., $20,000 +
$10,000).
(2) On the acquisition of control any loss from property expires since this loss is not a loss from a business
[par. 111(4)(a)]. His only hope is that the acquired company has some assets with accrued gains to which
paragraph 111(4)(e) could apply to create income to offset this property loss in the deemed year-end.
(3) A deemed year-end takes place when there has been an acquisition of control over the voting rights of
the corporation. In this case there has been a change in control since Mr. Elliott used to control the company and
now it is controlled by both Mr. Elliott and Mr. Ng. However, even though Mr. Ng has not acquired voting
control of the corporation, which is a requirement for subsection 249(4) to apply, the group of Mr. Elliott and
Mr. Ng has acquired control and, thus, the acquisition of control rules could apply.
(4) On the acquisition of control, a year-end is deemed to have occurred on the day immediately before the
acquisition of control. Since there is a deemed year-end the inventory has to be valued for tax purposes.
Inventory has to be valued at the lower of cost and market or in any other manner as allowed by regulation
[ssec. 10(1)]. Regulation 1801 allows inventory to be valued at market as long as all inventory is valued this way.
Since the value of the inventory has gone down in value Retail Co. will have to recognize the inventory loss in
the deemed year-end immediately before the acquisition of control. Unless Retail Co. can offset this loss through
a paragraph 111(4)(e) election, the loss will form part of the non-capital losses and can only be used against
income from the same business or from the sale of similar products.
(5) At the time Pop acquired control there was a deemed year-end of the processing company
[ssec. 249(4)]. This would cause one year of the non-capital loss carryover period to expire. Also, consideration
has to be given to whether the two companies sell similar products. IT-206R, paragraph 3, indicates that these
two businesses could be considered to be one business since they are vertically integrated businesses and,
therefore, the losses of the processor could be applied to the income of the retailer. Keep in mind that in cases of
significant dollar value, you may not want to rely totally on the Interpretation Bulletin to justify a similar
product or service. You will want to also build up a business case for this position.
(6) Pre-acquisition losses can only be applied against income from the same business or from the sale of
similar products [par. 111(5)(a)]. In this case, the only income from the same business is the $20,000. The rental
profits and the taxable capital gain are not income from a business and therefore cannot be offset.
(7) Although Holdco has held these shares for greater than 365 days (i.e., 5 years), Holdco owns more than
5% of the shares of Opco. Subsection 112(3) would apply to cause the capital loss on the sale to be reduced by
both the dividends deductible under subsection 112(1) and the capital dividends. In this case, the capital loss of
$200,000 would be reduced by $150,000 to $50,000. This reduced loss could then be applied to the $300,000
capital gain otherwise realized.
(8) In order to be a CCPC, the company has to be Canadian-controlled. In this case, Hi Tech qualifies,
since it is controlled by an Ontario resident. In addition, Hi Tech also has to be a private corporation which is
defined in paragraph 89(1)(f) where one of the criteria is that it is not a public corporation. A public corporation
is defined [par. 89(1)(g)] to include any company which has any class of shares trading on a designated stock
exchange in Canada. Section 262 provides for a list of these stock exchanges. However, in this case, Hi Tech is
not listed on a designated stock exchange since its shares are only trading over the counter. Therefore, Hi Tech
would not be considered to be a public corporation, unless it has elected to be one [par. 89(1)(g)], and would still
be considered to be a CCPC.
(9) If the equipment is to be used in scientific research and experimental development then
paragraph 37(1)(b) will allow the deduction of capital expenditures. Subsection 37(6) then deems the amount
deducted to have been claimed as CCA and the asset to be in a separate class. This will provide for the sale of the
asset to generate immediate recapture. A deduction for capital expenditures for buildings is specifically denied
[par. 37(7)(f)].

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284

CHAPTER 12
Integration for Business and Investment Income
of the Private Corporation
Short Questions
(1) Ms. Jones inherited $2 million from her mother and has transferred the capital to a company that she
has incorporated. Her intention is to spend 40 hours a week investing this money to earn interest income on first
and second mortgages. Given the high level of activity, will this income qualify for the small business deduction?
(2) Mr. X owns 100% of Holdco Ltd. which in turn owns 100% of three operating companies. Each of
these operating companies carries on an active business primarily in Canada. Holdco Ltd. employs Mr. X and
charges each of the operating companies $40,000 as management fees for Mr. Xs time. Mr. X gets paid from
Holdco Ltd. and is the president and chairman of each of the operating companies as well as Holdco Ltd. Discuss
how Holdco Ltd. will be taxed.
(3) Describe the three different types of control found in the association rules.
(4) Mr. Al owns 45% of the shares of Holdco which in turn owns all the shares of Opco. Discuss whether
Mr. Al owns any shares in Opco for purposes of the associated company rules.
(5) What is the relevance of the term specified class in section 256?
(6) When considering whether to incorporate, one should determine whether there will be any tax savings
or tax deferral. If someone is considering the incorporation of active business income, how can he or she achieve
tax deferral through the use of a company? What will be the amount of the deferral assuming he or she is in the
top tax bracket? Also assume a provincial rate of 10% for corporations.
(7) What tax rules prevent an individual from deferring a significant amount of tax on interest income by
flowing it through a corporation?
(8) Mr. Boss owns all the shares of Opco Ltd., a CCPC carrying on an active business in Canada. In recent
years Opco Ltd. has done very well and its income is well in excess of the business limit. Last year he
incorporated Rentco Ltd. to own land and building that is rented to Opco Ltd. The rent charged to Opco Ltd.
amounts to $80,000 per year. How will this rental income be taxed in Rentco Ltd.?
(9) Why did the government introduce the rules in subsection 129(6) to deem what would otherwise be
investment income to be active business income?
(10) Comment on the statement that no tax is payable on dividends received from connected corporations.
(11) A number of years ago a reorganization was undertaken and now Aco Ltd. owns voting preferred shares
in Bco Ltd. These preferred shares have 70% of the votes and are now only worth 7% of the value. The other
shares of Bco Ltd. are owned by an unrelated party. Are Aco Ltd. and Bco. Ltd. connected?
(12) A number of years ago a reorganization was undertaken and now Cco Ltd. owns voting preferred shares
in Dco Ltd. These preferred shares have 10% of the votes and are now worth 20% of the value. The other shares
of Dco Ltd. are owned by an unrelated party. Are Cco Ltd. and Dco Ltd. connected?

Discussion Notes for Short Questions

(1) Since the corporation is earning interest income and does not have more than five full-time employees
throughout the year it will be considered to be a specified investment business [par. 125(7)(e)]. Even though
she spends all of her time on this activity it will still not qualify for the small business deduction. However, the
income will qualify for the refundable tax treatment.
(2) Holdco Ltd. could be considered to be a personal services business since Mr. X performs the services
and is a specified shareholder of the corporation. However, there is an exception from this definition if Holdco
Ltd. is associated with each of the payer companies. In this case they are associated. Therefore, Holdco Ltd. is
not a personal services business and, since it is not a specified investment business, it will be eligible for the
small business deduction. Keep in mind that it will have to share the small business deduction with all of the
operating companies since they are associated.
(3) (a) Legal (de jure) control means the ownership of such a number of shares as carries with it the right
to a majority of the votes in the election of the Board of Directors. Legal control flows through a
corporation. For example, if Mr. X controls Holdco with 55% of the votes and Holdco in turn
controls Opco with 55% of the votes, then Mr. X controls Opco.

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(b) Actual (de facto) control extends the concept of control to situations where at any time the
controller has any direct or indirect influence that, if exercised, would result in control in fact of the
corporation [ssec. 256(5.1)].
(c) Deemed control extends the meaning of de jure and de facto control. Paragraph 256(1.2)(b)
extends the meaning of control to a group of persons even though one of the group may have de jure
control already. Paragraph 256(1.2)(c) also extends the meaning of control to a person who owns
more than 50% of the fair market value of all the outstanding shares of the corporation or more than
50% of the fair market value of the common shares of the corporation. Subsection 256(1.4) deems
both control and ownership where certain options and rights are in place to acquire shares or cause
the corporation to buy back shares of the corporation. Often these rights are found in the shareholder
agreement.
(4) Paragraph 256(1.2)(d) deems Mr. Al to own his proportionate share of the shares of Opco that he owns
through Holdco. In this case, Mr. Al would be deemed to own 45% of the shares of Opco. The proportions in
paragraph 256(1.2)(d) are based on the proportion that the fair market value of the shares that Mr. Al owns in
Holdco is of the total fair market value of all shares of Holdco.
(5) This term is defined in subsection 256(1.1) and is applicable to subsection 256(1) where this type
of share is excluded from consideration when determining ownership of shares. One might then be
concerned that subsection 256(1.2) could apply to deem control. However, subsection 256(1.6) deems the
specified class of shares to be ignored for purposes of subsections 256(1.2) and (1.4) and instead to be
considered as debt of the corporation. This, however, still leaves the question of whether control in fact
[ssec. 256(5.1)] applies.
(6) Tax deferral is what is achieved by having the income taxed in the company and leaving the after-tax
cash in the company rather than taking it out as dividends. In order to determine the amount of the deferral
you need to compare the tax paid in the company with the tax he or she would have paid if he or she had
earned the income directly. On income eligible for the small business deduction (using a theoretical provincial
tax rate of 10%) the corporation would have paid 21% tax. If one had earned this income personally and been
taxed at the top rates, the individual would have paid 46% (i.e., 29% + 17%)). Thus he or she will achieve a
tax deferral of 25% (46% 21%) by leaving the after-tax cash in the company instead of taking it out as a
dividend.
(7) By initially taxing interest income at the top corporate tax rates the Act minimizes the tax deferral
available. If, for example, the highest personal tax rate is 46% (see (6) above) and the highest corporate tax rate
hovers around 42% plus the 6 2/ 3 % ART, then there is no deferral available.
(8) Ordinarily the rental income would be taxed as investment income at the full rates (i.e., 38% + 62/ 3 %)
with part of this being classified as refundable Part I tax (i.e., 262/ 3 %) and added to the Refundable Dividend Tax
on Hand account resulting in a theoretical rate of 18% after a dividend refund of 262/ 3 %. However, since the two
companies are associated and the rent is being deducted against the active business income of Opco, an
associated corporation, subsection 129(6) will deem the rental income to be active business income and not
eligible for the refundable tax treatment. Opco and Rentco are associated since they are both controlled by
Mr. Boss [par. 256(1)(a)].
(9) The government is concerned that companies earning active business income in excess of the business
limit of $500,000 will convert active business income that would otherwise be taxed at the top corporate rates
into property income eligible for the refundable tax system through interest and rental charges.
(10) Dividends received from corporations resident in Canada are included in net income [ssec. 82(1)] and
are deducted [ssec. 112(1)] in arriving at taxable income. As a result, they are not taxable under Part I.
However, Part IV tax applies to dividends that are deducted [ssec. 112(1)], other than dividends from
connected corporations, unless the payer corporation received a dividend refund. If the payer corporation
received a dividend refund then the recipient corporation will pay Part IV tax equal to its proportion of the
dividend refund. Thus, the only time Part IV tax is payable on dividends from connected corporations is when
the payer received a dividend refund.
(11) Aco Ltd. and Bco Ltd. are connected [ssec. 186(4)]. While Aco Ltd. does not own more than 10% of
votes and value, Aco Ltd. does control Bco Ltd. [ssec. 186(2)], as a result of its having 70% of the votes.
(12) Cco Ltd. and Dco Ltd. are not connected [ssec. 186(4)]. Cco Ltd. does not own more than 10% of votes
and value and Cco Ltd. does not control Dco Ltd. [ssec. 186(2)].

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Federal Income Taxation: Fundamentals

CHAPTER 13
Planning the Use of a Corporation
and Shareholder-Manager Remuneration
Short Questions
(1) Mr. Big is the sole shareholder of a very successful private corporation. In order to prevent double tax
he has just declared a bonus from the company to himself in the amount of $800,000 which is in addition to his
salary of $72,000. Discuss the deductibility of this bonus.
(2) Discuss whether there are any benefits to having the ability to declare a bonus in one calendar year and
not pay it until the following calendar year.
(3) Ms. Leeper owns all the shares of Opco Ltd. and has declared and paid a large bonus to herself in each
of the past five years. She has taken the money and personally bought a building that she is renting back to the
company at an annual rent of $50,000. The company has a December 31 year-end. Is there any way that
Ms. Leeper can defer the reporting of the $50,000 per year of rental income while the company is deducting the
rent expense annually? Explain why or why not.
(4) Dad owns all the shares of both Opco Ltd. and Realco Ltd. Opco Ltd. is carrying on an active business
and Realco Ltd. owns the real estate and rents it to Opco Ltd. Is there any way that Realco Ltd. can defer the
reporting of the rental income while Opco Ltd. is deducting the rental expense annually? Explain why or why
not.
(5) On December 31 of last year, the fiscal year-end of the company, a bonus was declared payable to the
plant managers in the amount of $10,000 in total. This is considered to be a reasonable amount. However, since
the company did have some cash flow constraints the directors resolution stated that the bonus was only payable
if, as or when the cash was available in the corporation. On May 31 of this year, the cash became available and
the bonus was paid. Discuss the deductibility of the bonus accrual at the December 31 year-end of the previous
year.
(6) Mom and Dad did an estate freeze four years ago and all three of their adult children became common
shareholders along with a long-time employee. Two of the three children are active in the company and the third
lives in another province and has no interest in the company. The long-time employee has just retired and the
three children have bought her shares with the help of an interest-free loan from the company. Discuss the tax
implications of the loan to the children.
(7) On May 31, 2008, Opco Ltd. loaned its sole shareholder, Mr. Bolt, $100,000 to buy a boat. $50,000 of
this loan was repaid on May 31, 2009 and the balance was repaid on May 31, 2010. Opco Ltd. has an April 30
year-end. With hindsight, what are the tax implications of this transaction?
(8) Mr. Moyer, as president, decided to move his corporation from Dundas to London, Ontario in order to
improve his quality of life. As a result of the move he decided to borrow $100,000 from the corporation to buy a
house in Arva, just outside the city. The loan is to be repaid over 15 years with no interest being charged. None
of the other employees received such a loan. What are the tax implications to Mr. Moyer from this loan?
(9) Ms. Shaker borrowed $100,000 from her company on February 1 of last year to invest on the stock
market. She repaid the loan on December 1 of this year. The year-end of the company is December 31. What are
the tax implications to Ms. Shaker?
(10) Mr. Shantz, who owns a construction company, has used a slow period in the construction industry to
have some of his men build a boathouse at his cottage. Most of the materials were those left over from other
construction jobs and the men were otherwise not busy. Mr. Shantz did not reimburse the company for any of the
costs on the basis that it really did not cost the company anything extra. Comment.
(11) Mr. Scott, who is the President and sole shareholder of Scotts Tax Practice Inc., has taken a loan from
the company to buy a cottage for use by himself and his family during the summer months. He has had a note
drawn up to repay the loan over 20 years with no interest. All other employees of the corporation are eligible for
similar loans on similar terms. Comment.
(12) Ms. Kelly is the sole shareholder and President of her own company which has a December 31 yearend. She has borrowed money from the company over the past year for personal purposes and cannot afford to
repay the loan by the end of the fiscal year. She decides that she will take out a short-term loan at the bank, repay
the shareholder advances in December and then reborrow from the company in January to pay off the bank.
Comment.

Appendix II: Short Questions and Discussion Notes

287

(13) If a holding company is used to collect tax-free dividends from a connected small business corporation,
what impact might this have on the ability of the individual shareholders of Holdco to claim the $750,000 of
capital gains exemption?
(14) Big Bob started a company 20 years ago and built up the value of the family business which is a small
business corporation. On his death, he left all the shares to his daughter, Little Bobbi. After one year of
struggling she decided that she would like to start a different business, so she sold shares of the family business.
Will the shares she is selling be qualifying small business corporation shares?
(15) Mrs. Jones owns all the shares of an SBC, Opco Ltd. Five years ago her husband incorporated a
separate company, Rentco Ltd., that bought the land and building that is now used in the business. Rentco Ltd.
charges rent to Opco Ltd. for the use of the property. Rentco Ltd. and Opco Ltd. are not associated. Mr. Jones has
just received a generous offer for all the shares of Rentco Ltd. and he has come to you to see how much capital
gains exemption he is entitled to. Advise him.

Discussion Notes for Short Questions

(1) No expense is deductible unless it is reasonable in the circumstances [sec. 67]. In this case it may be
argued that the bonus is of such a magnitude that it is unreasonable compared to his normal salary. On the other
hand, you could argue that his normal salary is kept unreasonably low and his bonus is part of his regular
compensation. In addition, the CRA may not care since he will end up paying more tax on the bonus than the
corporation would have paid on the same income.
The deduction may also be challenged if there is no legal obligation to pay the bonus. The legal liability
might occur if the bonus is calculated based on a written company compensation system. The liability might also
be established if there was a directors resolution approving the bonus in the first place.
(2) The major benefit would be the ability to choose to have the bonus taxed in whichever year the personal
tax rate is lower. In addition, there may be a tax deferral advantage in that the corporation gets the benefit of the
deduction in the fiscal year it is accrued and the bonus is subject to tax in the return for the calendar year in
which it is paid. However, this advantage would be reduced by the fact that tax is required to be withheld at the
corporate level at the time the bonus is paid.
(3) The company may deduct the rent expense annually as long as the accrued liability is paid before the
end of the second taxation year after the end of the fiscal year in which it is accrued [ssec. 78(1)]. Alternatively,
the corporation and Ms. Leeper can file an election (by the due date of the tax return for the third taxation year)
to treat the accrued amount as income to Ms. Leeper on the first day of the third taxation year.
(4) Since the rental income is being earned by a corporation, the rental income has to be reported on the
accrual basis by Realco. Therefore, there is no way to defer the reporting of the rental income.
(5) As at December 31, there was no legal liability for the bonus since it was only payable if, as or when
the cash is available. Therefore, the accrual is not deductible. In order to be deductible, a liability must be
established and the liability cannot be contingent on some future event.
(6) Since the two children are shareholders, subsection 15(2) would apply to include the loans in their
income in the year the loans were made, unless they were repaid within one year from the end of the Opco Ltd.
year-end [ssec. 15(2.6)]. The exception in paragraph 15(2.4)(c) does not apply, since the shares were acquired
from a long-time employee and not issued by the corporation. In addition, that exception would not apply if the
children were acting in their capacity as shareholders, rather than as employees [par. 15(2.4)(e)].
(7) For 2008, Mr. Bolt will include $50,000 in income [ssec. 15(2)] through an amended return, since this
part of the loan was not repaid within one year of April 30, 2009 (the corporations year-end), as required by
subsection 15(2.6), and the loan did not meet one of the exceptions in subsection 15(2.4). In addition,
section 80.4 will apply to deem an interest benefit based on the $100,000 for the days outstanding in 2008. A
similar calculation would be required for 2009, based on the outstanding amount during the particular time
period (i.e., $100,000 and $50,000). However, when the amended return is filed for 2008 for the subsection 15(2)
inclusion of $50,000, the imputed interest thereon can be reversed out [ssec. 80.4(3)]. Mr. Bolt would get a
deduction in 2010 for the $50,000 repaid on May 31, 2010 [par. 20(1)(j)].
(8) Although the exception in paragraph 15(2.4)(b) is met and bona fide arrangements have been made for
repayment within a reasonable time and he is an employee, it appears that Mr. Moyer received the loan in his
capacity as a shareholder. Therefore, the loan must be included in income [par. 15(2.4)(e)].
(9) Even though the exceptions in paragraphs 15(2.4)(c) and (e) are not met, this loan will not have to be
taken into income since it was repaid on or before December 31 of the year following the year in which the loan
was made. However, section 80.4 will apply to deem an interest benefit in each of the two years. This deemed

288

Federal Income Taxation: Fundamentals

interest benefit will also be eligible for a deduction as interest expense since she borrowed to earn investment
income. This deduction is provided through section 80.5 and paragraph 20(1)(c).
(10) Mr. Shantz will likely have a benefit added to his income under subsection 15(1) equal to the value of
the work that was done and the materials that were used, since it is clear that he did receive a benefit from his
company. This will be income from property and not a dividend.
(11) Since Mr. Scott is a shareholder who received a loan, subsection 15(2) needs to be considered. Since he
owns all of the shares, he is a specified employee, he cannot use the exception in paragraph 15(2.4)(a). However,
paragraph 15(2.4)(b) provides an exception for loans to employees who borrow to acquire a dwelling for their
habitation. As President, Mr. Scott is an employee and the cottage does qualify as a dwelling for his habitation
under IT-119R4. Therefore, he will not have to include the principal amount of the loan in income, since he can
be considered to have received the loan because of his employment rather than his shareholdings, other
employees are eligible for similar loans, and bona fide arrangements were made at the time of the loan for
repayment within a reasonable period (i.e., 20 years). There will be a deemed interest benefit under section 80.4.
(12) These transactions will probably be considered to be a series of loans and repayments and if the loan
were effectively outstanding over two year-ends it would be included in her income under subsection 15(2).
Although the loan was paid off by the end of the fiscal year and did not show up on the financial statements, the
intention was that the loan remain outstanding. Subsection 15(2.6) contemplates a series of loans and repayments
and IT-119R4 comments on it.
(13) The accumulation of cash in a holding company without using that cash to invest in active business
assets or shares or debt of connected small business corporations may cause the holding company to no longer
qualify as a small business corporation since the corporation may not have all or substantially all of the fair
market value of its assets invested in qualified assets.
(14) The shares must meet the Holding Period Test in order to be QSBC shares. In this case they will qualify
since, even though she only held the shares for one year, a related person, her father, owned the shares for
20 years before that. See paragraph (b) of the QSBC share definition in subsection 110.6(1).
(15) The definition of small business corporation includes assets used in an active business carried on by a
corporation related to it [ssec. 248(1)]. In this case, even though Opco and Rentco are not associated, they are
related [par. 251(2)(b)]. Therefore, since he has held the shares for over two years and all the assets are used in
an active business of a related corporation for the past five years the shares should qualify as QSBCS.

CHAPTER 14
Rights and Obligations Under the Income Tax Act
Short Questions
(1) Mr. Lyons has come to you to prepare his personal tax return. After you have finished, he tells you that
he probably will not file the return by April 30 since he does not have the money to pay his tax liability. He does
not have any proprietorship business income. What advice do you have for him and why?
(2) Mr. Kuntz was required to make quarterly instalments for last year. However, due to poor cash flow he
was unable to make any payments until he filed his tax return in April of this year. What interest charges and
penalties will he be faced with?
(3) Four, five and six years ago, Mr. Cameron had a number of real estate transactions. He did not report
any of these since he could not bring himself to pay all the tax that was owing. He is now breathing a sigh of
relief since these transactions are now beyond the three-year reassessment period. What do you think?
(4) One of your dentist clients has overpaid her instalments for the year and has come to you in January of
the following year to see if she will be able to collect interest from the CRA on these overpaid instalments. What
do you think?
(5) On the Edge Inc. has lost money in past years and now some of the non-capital loss carryforwards are
about to expire. It has always been in the manufacturing business and its bad debts have been high. Is there
anything On the Edge Inc. can do to preserve some of those losses that are about to expire?
(6) Ms. Chai is in serious cash flow trouble in her company Red Inc. In order to prevent exceeding her
bank line of credit she is planning to defer payment of the employee payroll withholdings to the CRA. What
advice do you have for her?

Appendix II: Short Questions and Discussion Notes

289

Discussion Notes for Short Questions

(1) While he will be charged interest on the unpaid taxes [sec. 161], by filing the return he will be able to
avoid the late filing penalty of 5% of the unpaid taxes plus 1% per month for up to 12 months [ssec. 162(1)].
Therefore, he should file by April 30 to avoid these penalties. He can pay his tax liability later.
(2) Interest is imposed on deficient instalments from the day the instalment should have been made until
the earlier of the day it was actually made and April 30 of the following year [ssec. 161(2)]. In addition, a penalty
may be imposed equal to 50% of the amount by which the interest charged under section 161 exceeds the greater
of $1,000 and 25% of the interest that would have been charged under section 161 in respect of all instalments if
no instalments had been made for that year [sec. 163.1].
(3) the CRA is allowed to reassess at any time if there is any misrepresentation attributable to neglect,
carelessness or wilful default [par. 152(4)(a)]. In this case they would be able to reassess those years given that
he knew about the income and chose not to report it.
(4) Interest is levied at the prescribed rate plus an additional 2% on overpayments of tax by non-corporate
taxpayers [ssec. 164(3)] from the latest of:
(a) the day the overpayment arose,
(b) 30 days after the day on which the return was or would have been due (i.e., April 30th), and
(c) 30 days after the day the return was actually filed.
Therefore the recommendation to your client should be to file her tax return by April 30 in order to start the
clock.
(5) In order to reduce the loss carryovers it may be possible to go back to those prior years and amend the
returns to reduce the discretionary deductions such as CCA [par. 20(1)(a)] and the allowance for doubtful debts
[par. 20(1)(l)]. This action will take these accrued losses and allow them to be effectively carried forward
indefinitely within the CCA pools and the accounts receivable. However, the CRA will only allow these prior
year revisions to take place if there is no change to the taxes payable in those prior years. This policy is outlined
in IC 84-1.
(6) Any person who fails to remit the employee withholding is liable for a penalty of 10% of the tax that
should have been remitted together with interest [ssec. 227(9)]. If there is a second or further occurrence, then the
penalty increases to 20%. In addition, the directors may be personally liable for the unpaid withholding taxes
[sec. 227.1].

CHAPTER 1

Introduction
Solution 1 (Basic)
The following summary is discussed in more detail below:
Case
(A)
(B)
(C)
(D)
(E)
(F)
(G)

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

Part
XVII
I
XVII
I
I
I
I

Division

B
B
I
C

Subdivision

a
h

(H)

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

(I)
(J)

Definition of testamentary trust. ..............

Employee loan. ........................................
Disposition of non-depreciable capital
property ...................................................
RRSP administration fees........................

I
I

B
B

k
f

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

XVII
I

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

Limit on deductible expenses ..................

Taxable dividends received by Canadian
corporation ..............................................

section 67

subsection 112(1)

RRSP excess contributions......................

X.I

subsection 204.1(1)

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

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

Federal Income Taxation: Fundamentals

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

Solutions to Chapter 1 Assignment Problems

Solution 2 (Advanced)
Division B Sec. 3
Par. 3(a)
Subdivision a: Employment income
Sec. 5

Salary ...............................................................................

$ 12,000

Sec. 5

Gratuities ..........................................................................

12,100

Sec. 5

Bonus ...............................................................................

500

Par. 6(1)(a)
Less:

Board and lodging ............................................................

8,000

Par. 8(1)(i)

Union dues .......................................................................

$ 32,600
100
$ 32,500

Subdivision b: Business or property income

Par. 12(1)(c)

Interest on Canada Savings Bonds ...................................

Sec. 9

Rental revenue..................................................................

775
6,000

Less:

Par. 3(b)

Par. 3(c)

Sec. 9, par. 18(1)(a)

Maintenance on rental property ....................

$ 1,100

Sec. 9, par. 18(1)(a)

Property tax on rental property .....................

1,000

Par. 20(1)(a)

Capital cost allowance ..................................

1,200

Par. 20(1)(c)
Mortgage interest .........................................
Subdivision d: Miscellaneous sources

2,500

Par. 56(1)(a)

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

Par. 56(1)(a)

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

(5,800)
$

975

600
800

1,400
$ 34,875

Subdivision c: Net taxable capital gains

Par. 38(a)

Taxable capital gains ........................................................

Par. 38(b)

Allowable capital losses ...................................................

3,750
(4,500)

Nil
$ 34,875

Subdivision e: Miscellaneous deductions

Par. 60(o)

Expense of objection to tax assessment ............................

65

Sec. 62

Moving expense ...............................................................

1,700

Sec. 63

Child care expense ...........................................................

1,800

Losses from non-capital sources:

Sec. 9
Business: fitness instruction fees .................................
$ 2,000
Less:
Sec. 9,
Business: expenses of earning fitness
$ 900
par. 18(1)(a)
instruction fees ...................................
Par. 20(1)(a)
Capital cost allowance ..............................
1,300
Par. 20(1)(c)
Business: Interest on borrowed funds .......
75
2,275
Division B income .......................................................................................
Division C: Deductions Sec 111.1
Par. 111(1)(a)
Non-capital losses ..............................................................................
Taxable income .......................................................................................................................................
Division E: Basic federal tax Sec. 118.92
Tax before credits ............................................................................................................................
Sec. 118
Personal credits .........................................................................................................
Sec. 118.7 CPP contribution credit ............................................................................................
Sec. 118.7 EI premium credit ....................................................................................................
Ssec. 118(10) Canada Employment tax credit ................................................................................
Sec. 118.2 Medical expense credit .............................................................................................
Sec. 118.1 Charitable donations credit .......................................................................................

(3,565)
$ 31,310

Par. 3(d)

Basic federal tax ..............................................................................................................................

$ (275)
$ 31,035
(600)
$ 30,435
$ 4,565
(1,557)
(126)
(53)
(158)
(9)
(26)
$ 2,636

Federal Income Taxation: Fundamentals

4
Solution 3 (Basic)

Division A of Part I of the Act consists of section 2 of the Act. Section 2 consists of three subsections.
Subsection 2(1):

taxable income This is defined in subsection 2(2).

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

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

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

Solutions to Chapter 1 Assignment Problems

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

CHAPTER 2

Liability for Tax

Solution 1 (Basic)
(a) As Anthony has made a fresh start in Canada on March 1, 2010, he is considered a part-year resident.
Accordingly, he will be taxed on his worldwide income from March 1 to December 31. Prior to March 1, he
would only pay tax on income from Canadian sources.
(b) Lubie has a continuing state of relationship with Canada. In particular, all of her income is earned in Canada
and she crosses the border each day. She also carries on active trading in Canada as well. All of the facts
support that Lubie has a continuing state of relationship with Canada; therefore, she is a resident in Canada
for tax purposes. The 183-day sojourner rule would not apply because Lubie does not stay overnight. She
will also be taxed in the United States; therefore, she will have to apply for a foreign tax credit on her U.S.
return.
(c) Although Ephran spent over 183 days in Canada before severing all of his ties, he is still considered a partyear resident. This is because he made a clean break from Canada and does not plan to return. Accordingly,
he will be taxed on his worldwide income from January 1 to July 30, 2009. After July 30, he will only be
taxed on income from Canadian sources. (An argument could also be made that Ephran made a clean break
from Canada on May 1, 2010.)
(d) Julia has a strong continuing state of relationship with Canada even though she is a U.S. citizen.
Accordingly, she will be considered a resident of Canada and taxed on her worldwide income. Citizenship is
irrelevant to a persons resident status in Canada, but Julia will also be taxable in the United States.
Consequently, Julia will be taxed in both Canada and the United States and will need to apply for a foreign
tax credit.

Federal Income Taxation: Fundamentals

Solution 2 (Advanced)
[Reference: Glow v. The Queen, 92 DTC 6467 (F.C.T.D.)]
(A) Full-time resident: taxed in Canada on worldwide income for the whole year;
Criterion: continuing state of relationship with Canada; i.e., ties;
Evidence:
born, raised and educated in Canada,
agreed to short-term contract abroad,
contract provided for living expenses, indicating the temporary nature of the stay abroad,
fees under the contract were paid to the clients Canadian corporation,
he continued as a shareholder, director and officer of the Canadian corporation,
he maintained an interest in the activities of the Canadian corporation,
he maintained a Canadian bank account,
he owned a rental property in Canada,
he arranged a rental on a month-to-month basis to allow him to resume his habitation of the residence
on short notice,
he stored his major furnishings and winter clothing in Canada, indicating an intention to return,
he retained credit cards issued in Canada and his RRSP accounts,
he maintained his health coverage in Canada,
he did not extend his visa in Nigeria, indicating an intention to return,
he did not pay income tax in Nigeria, indicating a lack of permanence in his stay there,
his girlfriend returned to Canada, spending only a fall term and a summer in Nigeria with him,
indicating a lack of permanence in his stay,
he returned to Canada, leaving nothing in Nigeria.
(B) Deemed full-time resident of Canada: taxed in Canada on worldwide income for the whole year;
Criterion: sojourned in Canada for an aggregate of 183 days or more in the year [par. 250(1)(a)];
Evidence:
when he was in Canada until July 1976, he was not sojourning, despite being in Canada more than
183 days in that year,
therefore, deemed residence is not a possibility in this particular case for 1976.
(C) Part-year resident in 1976: taxed in Canada on worldwide income for the part of the year while resident;
Criterion: clean break, i.e., severed ties in July 1976;
Evidence:
the Canadian bank account was only to avoid foreign exchange difficulties and to maintain his rental
property,
no withholding of income tax on his fees,
he intended to establish an international consulting business abroad and to that end attempted to
promote such a business in Nigeria,
he intended to sell his rental property in Canada when market conditions were right and to this end he
arranged a rental on a month-to-month basis to facilitate a sale,
he moved his personal effects to Nigeria,
he sold his car,
he cancelled his auto insurance and a gasoline company credit card,
he was accompanied to Nigeria by his girlfriend who stayed with him when not in school,
he rented an apartment in Nigeria because more permanent accommodation was not available,
he obtained a Nigerian drivers licence,
he maintained two bank accounts and cars in Nigeria,
he joined clubs in Nigeria,
he had an office in Nigeria,

Solutions to Chapter 2 Assignment Problems

his business cards identified him as a consultant to the Nigerian government,

the credit cards he kept could be used internationally,
he maintained his health coverage in Canada only because it was a requirement of his contract.
(D) Non-resident: taxed in Canada on Canadian-source income;
Criterion: employed in Canada, i.e., performed services of employment in Canada;
Evidence:
after leaving in July 1976, he was not providing services of employment in Canada,
therefore, non-resident taxable in Canada is not a possibility in this case.
(E) Conclusion:
while the client stated an intention to establish residence abroad, he was not successful in doing so:
in fact, he returned immediately at the termination of a short-term contract,
he did not sever his major ties to Canada or establish strong ties abroad,
his ties to Nigeria were merely those necessary to sustain a lifestyle while there;
OR
on the other hand, it could be argued that
he made an effort to establish a consulting practice abroad and the lack of business was unforeseen
and beyond his control,
he attempted to integrate himself into Nigerian society by living there and joining clubs,
his lack of more permanent housing was due to market conditions beyond his control.

10

Federal Income Taxation: Fundamentals

Solution 3 (Advanced)
[Reference: Lee v. M.N.R., 90 DTC 1014 (T.C.C.)]
(A) Full-time resident of Canada after a fresh start: taxed in Canada on worldwide income for the whole year;
Criterion: a continuing state of relationship, i.e., continuing ties with Canada after a fresh start;
Evidence of residence:
although U.K. passport indicated residence in U.K., can be resident in more than one place,
room in parents house maintained for his use before his marriage, but not likely after that time,
married in Canada to a person who continued to reside in Canada,
supported his wife who was wholly dependent on him in Canada,
his wife bought a house in Canada with funds which he provided,
house mortgaged in Canada with a guarantee provided by the client,
he provided an affidavit with the mortgage in which he swore that he was not a non-resident,
he regularly returned to Canada
length of stay is not determining (see Thomson case),
the use of the term visitor by immigration officials does not mean that the term is applied with the
same meaning under the Act,
income from his employment was deposited to a Canadian bank account,
he never filed or paid income tax anywhere
it must be assumed that every person has at all times a residence (see Thomson case),
the mortgage on his first wifes house in Britain and the Caribbean bank account may have been simply
a foreign investment of a resident of Canada,
after the period in question, i.e., 1981 to 1983
he purchased a car,
he obtained a Canadian drivers licence,
he obtained a Canadian visa,
he became a landed immigrant.
(B) Deemed full-time resident of Canada for the years in question: taxed in Canada on worldwide income for the
whole year;
Criterion: sojourned in Canada for an aggregate of 183 days or more in a year [par. 250(1)(a)];
Evidence:
he may have been sojourning when he regularly returned to Canada,
but he was out of the country more than 183 days per year.
(C) Part-year resident in Canada after a fresh start and not resident before that time: taxed on worldwide
income for the part of the year after the fresh start;
Criterion: fresh start preceded by a period of non-residence;
Evidence of non-residence:
history in England,

U.K. passport held throughout the period in question

passport indicates residence in U.K.,
parents maintain a room in England available for his use at any time,
affidavit on which he swore that he was not a non-resident was not for income tax purposes but for
Ontario land transfer tax,
the concept of a non-resident for the transfer tax may differ from that for income tax,
on his entry to Canada, the length of his stay was limited by the setting of a date for his departure,
immigration officials considered him to be a visitor on stamping his passport,
he was employed on a full-time basis outside of Canada
he indicated that he did not want to work in Canada,

Solutions to Chapter 2 Assignment Problems

11

he was acquitted of failure to file a 1981 tax return in Canada, likely because he was not required to
file,
he was not allowed to work in Canada,
he could not join OHIP, pay El, maintain an RRSP or join a pension plan in Canada,
he held a mortgage in Britain on his first wifes house,
he had a bank account in the Caribbean,
the bank account in Canada may have been for convenience or an investment like any other that a nonresident might make in Canada.
(D) Non-resident throughout the period in question: taxed on Canadian-source income;
Criterion: employed or carried on business in Canada;
Evidence:
during the period in question he was neither employed nor carried on business in Canada.
(E) Conclusion:
he cannot be deemed a full-time resident, because he does not meet the criterion,
if he is held to be a non-resident throughout the period in question, he will not be taxable in Canada
because he has no Canadian-source income,
therefore, either he made a fresh start at some point in the period or he was a non-resident throughout
the period,
his ties to Canada appear to have begun with his marriage in June of 1981 and the subsequent
purchase of a matrimonial home to which he returned regularly,
at least, he could be considered to have become a resident in September of 1982 when he swore
that he was not a non-resident.
Note: A conclusion for non-resident is acceptable, if an argument for a weighing of the facts in that direction
is presented.

12

Federal Income Taxation: Fundamentals

Solution 4 (Advanced)
[Reference: Dale Boston v. The Queen, 98 DTC 1124 (T.C.C.)]
(A) Full-time resident of Canada: taxed in Canada on worldwide income for the whole year(s) in question;
Criterion: a continuing state of relationship, i.e., continuing ties with Canada
Evidence of residence:
during the entire period in question his wife and 3 children (including one minor child) remained in
Canada;
he had the family home in Edmonton available to him throughout the entire period in question as
his wife and youngest son continued to reside in this home;
he remained on the payroll of the Canadian subsidiary of Exxon;
his monthly pay was deposited into his Edmonton bank account;
he remained a member of the pension plan of the Canadian subsidiary of Exxon;
he did maintain some Canadian investments:
his 50% interest in the family home in Edmonton,
a 50% investment in rental property which his wife purchased after his move to Malaysia
because she thought it would be a good investment,
his RRSP,
his company savings plan, and
a few personal shares in Canadian public companies.
(B) Deemed full-time resident of Canada for the years in question: taxed in Canada on worldwide income for the
whole year(s) in question;
Criterion: sojourned in Canada for an aggregate of 183 days or more in a year [par. 250(1)(a)]
Evidence:
he may have been sojourning when he came to Canada for brief periods during 1990 and 1992;
but in neither of these years did he sojourn for a period in aggregate of 183 days; visits were 14
days in each of 1990 and 1992 and no days during 1989 and 1991, 1993 and 1994 and 1995 prior
to his return during the summer.
(C) Part-year resident in Canada in year of clean break or resident before the time: taxed on worldwide
income for the part of the year prior to the clean break.
Criterion: clean break, i.e., severed ties in September 1988
Evidence:
his employer obtained a work permit for him in Malaysia;
he sold his car in Canada;
he cancelled his Canadian provincial health plan;
his employer obtained private health insurance for him;
he closed all of his existing bank accounts at the Royal Bank;
he opened a savings account at the Bank of Nova Scotia because this bank had a branch in Kuala
Lumpur, the capital of Malaysia;
although he was paid by the Canadian subsidiary of Exxon, the cost of his pay was transferred
from the Canadian subsidiary to Exxon International;
no Canadian income taxes were withheld at source on his salary;
he allowed his membership in the Edmonton Petroleum Club to lapse;
he allowed his participation in the Model Guided Plane Association to lapse;
although his wife remained in Canada, their marriage was unstable throughout the period in
question and thus her presence in Canada cannot be considered a strong tie;
he was employed in Malaysia in a senior managerial capacity;
he hoped to stay on after the initial three years and in fact did remain for close to another
four years;

Solutions to Chapter 2 Assignment Problems

13

he maintained a dwelling in Malaysia in which he slept, took his meals, and kept his personal
effects;
he joined the local Malaysian yacht club;
he opened Malaysian bank accounts and obtained local Malaysian credit cards;
he purchased a car in Malaysia and obtained a Malaysian drivers licence;
he did not come back to Canada at all in 1989 or 1991 or for the period 1993 through the summer
of 1995; he returned only briefly during 1990 and 1992.
(D) Non-resident throughout the period in question: taxed on Canadian-source income;
Criterion: employed or carried on business in Canada
Evidence:
during the period in question, he was neither employed nor carried on business in Canada;
although his pay was from a Canadian subsidiary of Exxon, his employment was outside of
Canada.
(E) Conclusion:
he cannot be a deemed full-time resident, because he does not meet the 183-day criterion;
if he is held to be non-resident throughout the period in question, he will not be taxable in Canada
because he has no Canadian-source income;
therefore, either he made a clean break at some point or he was a full-time resident throughout
the period;
his ties to Canada quite clearly appear to have been severed in September 1988 when he moved to
Malaysia to commence his new position;
he may have re-established ties to Canada in the summer of 1995 when he retired from Exxon and
returned to Canada or in July 1997 when his employment in Thailand ended;
for the period from September 1988 through the summer of 1995 he appears to have been a nonresident of Canada.

14

Federal Income Taxation: Fundamentals

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

Solutions to Chapter 2 Assignment Problems

15

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

16

Federal Income Taxation: Fundamentals

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

Solutions to Chapter 2 Assignment Problems

17

Solution 8 (Advanced)
(A)

(B)

(C)

(D)

(E)

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

18

Federal Income Taxation: Fundamentals

Advisory Case
Case 1: Transfer to France
ADVISORY CASE DISCUSSION NOTES
This is a planning situation. The students are to recommend planning points that would support the desired
result of the family being non-resident.
There are two main issues in this case. The first is whether Sally and Harry will be able to support nonresident status given their circumstances. The second is, if they can argue non-resident status, what their date of
clean break is.
Non-Resident Status
In order for the members of this family to plan to become non-residents, they need to support their argument
that they have severed ties to Canada, and they need to establish that they have become residents of France.
To sever ties to Canada, Sally and Harry need to plan around the following main issues:
Length of stay in France: The family is going to be in France for at least two years, but that may be
extended. Clearly, the shorter the stay, the greater the risk that they will not be able to successfully defend nonresident status if challenged.
Golf club: Given that Sally and Harry do not want to give up their golf club membership, they will need to
see if the club has a non-resident membership status that would allow them to keep their membership, pay lower
annual fees, and clearly indicate to the CRA and others that they have left. However, a stronger case for nonresidency could be made if they gave up their membership altogether. It should be noted that the golf club nonresident classification probably also applies to those who have moved to, for example, another province.
Home: While it is clearly best for them to sell their home to establish a break in ties, they are reluctant to do
this. If they wish to keep it, they should rent the property to a third party. In Interpretation Bulletin IT-221R3, in
paragraph 6, the CRA states:
Where an individual who leaves Canada keeps a dwelling place in Canada (whether owned or leased),
available for his or her occupation, that dwelling place will be considered to be a significant residential tie
with Canada during the individual's stay abroad. However, if an individual leases a dwelling place located in
Canada to a third party on arm's length terms and conditions, the CCRA will take into account all of the
circumstances of the situation (including the relationship between the individual and the third party, the real
estate market at the time of the individual's departure from Canada, and the purpose of the stay abroad), and
may not consider the dwelling place to be a significant residential tie with Canada except when taken
together with other residential ties (see 17 for an example of this situation and see 9 for a discussion of the
significance of secondary residential ties).

If they do decide to keep the house, then this will increase their risk of being considered residents of Canada.
Harry is on leave, he did not resign: Harrys circumstances must be considered in this case. He is not
planning to resign from his teaching position; instead, he is taking an unpaid leave. This indicates a less
permanent move. It would be a stronger argument for non-resident status if he did resign.
Family ties: Sally and Harrys extended family ties are clearly still in Canada. There is nothing they can do
about this.
Visits back to Canada: They will need to be careful how often they come back to Canada on visits, and how
long they stay. The more frequent the trips, and the longer the stays, the weaker the non-resident argument.
Remember, the courts can view the next few years to determine whether the family severed their residential ties
this year.
Other issues: Sally and Harry should also do the following:
1. Advise those authorities who administer drivers licenses and medical coverage that they are now nonresidents.
2. Close out their Canadian bank accounts or tell the bank that they are non-residents so withholding tax
can be deducted from interest payments.
3. Move their investments to France and make sure their advisers are notified of their non-resident status.
4. Indicate on their tax returns the date of ceasing to be resident (see Date of clean break, below).

Solutions to Chapter 2 Assignment Problems

19

Establishing residency in France: For the family to be considered non-residents of Canada, they need to
have established residential ties somewhere elsein this case, in France. The CRA, in paragraph 14 of
Interpretation Bulletin IT-221R3, states:
Where an individual leaves Canada and purports to become a non-resident, but does not establish
significant residential ties outside Canada, the individual's remaining residential ties with Canada, if any, may
take on greater significance and the individual may continue to be resident in Canada. However, the fact that
an individual establishes significant residential ties abroad does not, in and by itself, mean that the individual
is no longer resident in Canada, as the Courts have held that it is possible for an individual to be resident in
more than one place at the same time for tax purposes.

Renting a furnished apartment may be appropriate for Sally when she first arrives, but she should find more
permanent accommodations when the family arrives.
Date of clean break
Assuming the family can successfully argue that they have become non-resident, you need to determine
what day they officially achieved this status. Sally is to be in France on May 15, so, if she leaves May 10, is that
the date? Alternatively, Harry and the children will leave, say, July 15, so is that the date?
The CRA, in Interpretation Bulletin IT-221R3, at paragraph 15, states:
It is a question of fact to be decided with regard to all of the circumstances of the case on what date a
Canadian resident individual leaving Canada becomes a non-resident for tax purposes. Generally, the CCRA
will consider the appropriate date to be the date on which the individual severs all of his or her residential ties
with Canada, which will usually coincide with the latest of the dates on which
(a) the individual leaves Canada,
(b) the individual's spouse or common law partner and/or dependants leave Canada (if
applicable), or
(c) the individual becomes a resident of the country to which he or she is immigrating.

The first two of the three dates set out above are easy to determine in this case. The third may be more
difficult and is discussed above.
This is not a particularly significant issue in that if you are arguing between May 10 and July 15it is only
about two months, and it only affects the tax return in the year of departure.
Conclusion
There is always a risk that the CRA and the courts will not agree with Sally and Harrys filing position that
they are non-resident. All the adviser can do is arrange the given facts in the best way to minimize the risk. In
this case, the risks of reassessment centre on the following issues:
1. Keeping the home
2. Length of stay in France
3. Establishing residential ties in France

20

Federal Income Taxation: Fundamentals

Case 2: Move to Chile

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

CHAPTER 3

Employment Income
Solution 1 (Advanced)
[Reference: Wiebe Door Services Ltd. v. M.N.R., 87 DTC 5025 (F.C.A.)]
In the court case on which these facts were based, the company had been treating the workers as selfemployed contractors. The CRA believed the workers to be employees and assessed the company for failure to
withhold employment source deductions. The Tax Court of Canada agreed with the CRA and the company
appealed.
The case was decided on the basis of the economic reality test. The Federal Court of Appeal held that the
economic reality test really encompasses the control test and the integration or organization test. As well,
ownership of tools and the chance of profit or risk of loss must be considered. It is not necessary that all tests be
independently satisfied. The economic reality test is decided on the basis of the overall scheme and the relative
importance of each of these factors.
(1) Economic Reality or Entrepreneur Test
(a) Control Test
Taken in isolation, the control test is indecisive on these facts. The workers had a fair degree of autonomy in
that they could accept or refuse specific assignments, could choose when and how to do the jobs they accepted,
within reason, and were not required to report to a specific workplace. This is indicative of self-employment. On
the other hand, the company assigned the jobs to the installers and had the right to require defective work to be
fixed by the workers and the workers were required to comply with this. This aspect of control is more indicative
of an employer relationship. As a result, the control test does not distinguish the case of employed versus selfemployed very well.
(b) Ownership of Tools
The ownership of tools test is indicative of self-employed status. Each worker supplied the majority of the
required tools, including the truck to transport the doors. Although the company would supply certain specialized
equipment on request, this was considered ancillary to the basic ownership responsibility. Interestingly, the Court
did not address the ownership of the doors and component parts, either under this or any of the other tests. The
rationale for this exclusion may be that the supply of such parts was unique to the companys business, while the
tools necessary to install or repair such parts could be used by the workers for any other assignments they
undertook.
(c) Chance of Profit, Risk of Loss
The chance of profit, risk of loss test would also indicate self-employed status. Although the fee provided
for each job was decided primarily by the company, the worker had some control over whether he or she would
make a profit or incur a loss. If the worker was efficient and accepted more jobs, his or her chance for profit
increased. Adversely, if the worker was careless and was required to redo much of his or her work, the risk of
loss increased.
(2) Integration or Organization Test
The lower court decision was based largely on the application of the integration or organization test. The
Tax Court of Canada decided that, without the workers, the company was unable to provide the services which
were, in essence, its business. Therefore, the workers were so integral to the business that they had to be
considered employees, according to this reasoning. The Federal Court of Appeal rejected this approach. The
appeal court ruled that the integration test must be applied from the workers perspective and not the companys
perspective. Although the workers may have been integral to the companys business, there was nothing to
suggest that the companys business was integral to the workers. That is, the facts did not indicate that the
workers could not carry on the business of installing and repairing doors or performing similar services in the
absence of the companys contracts. Taking this perspective on the test would suggest self-employed status on
the basis of the facts of this case.

21

22

Federal Income Taxation: Fundamentals

(3) Specific Result Test

This test was not considered by either court. Applying the test to these facts would seem to indicate selfemployed status. The workers were hired for a specific task to install or repair a specific door. Although the
worker may be hired for a number of installations, the worker was hired for a specific project, not for an
indeterminate period of time.
Conclusion
On the basis of the facts and the application of the combined tests, the Federal Court of Appeal ruled that the
economic reality of the relationship of the workers to the company was that of independent contractors.

Solutions to Chapter 3 Assignment Problems

23

Solution 2 (Basic)

The $132,000 gross salary will be included in income for tax purposes in the year of receipt [ssec. 5(1)].
The allowance of $25,000 for moving will be included in income for tax purposes in the year of receipt,
because there is no exclusion for such an allowance [par. 6(1)(b)].
The company contribution to the registered pension plan will not be included in income for tax
purposes [spar. 6(1)(a)(i)].
The company payment of the premiums for extended health care coverage and a dental plan is
specifically excepted as a benefit, since these are private health services plans [spar. 6(1)(a)(i)].
Tax return preparation is a taxable benefit under paragraph 6(1)(a), since it does not fit the exception in
subparagraph 6(1)(a)(iv) [IT-470R, par. 26].
The club membership fee in this particular case is likely to be a taxable benefit, because it is not likely
that the membership would be principally to the employers advantage. She will be the Director of
Taxation, a position that is not likely to require the membership for business purposes [IT-470R,
par. 34].
The housing loan benefit included in her employment income [par. 6(1)(d), ssec. 6(9), and sec. 80.4]
will be computed as follows according to the CRAs administrative practice.
61
6% (1) of $200,000
= $2,005
365
92
= 2,016
4% (1) of $200,000
365
92
= $3,025
6% (1) of $200,000
$ 7,046
365

245

Less: interest paid 3.5% of $200,000

....................................
365

$ 4,699

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

$ 2,347

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

Federal Income Taxation: Fundamentals

24
Solution 3 (Basic)
Employment Income

Section 5 Gross salary

Section 6 Provincial mandatory public health care (Note 1)
Standby charge (Note 2)
Operating benefits (Note 3)
Hawaii trip
Section 7 Stock option benefit (Note 4)
Section 8 Registered pension plan
Net income from employment

$59,000
0
6,960
2,376
6,000
7,000
( 3,000)
$78,336

Notes:
1. The CRA states at paragraph 41 of IT-470R that public health care premiums for a provincial hospital
insurance plan or a provincial medical care insurance plan that the employer is required to pay by law are
not a taxable benefit. A provincial employer health tax is not considered to be a taxable benefit either.
2.

Standby Charge = A/B (2% capital cost # of 30-day periods). Since the vehicle is not driven more than
50% of the time for business, the A/B element is equal to 1.
Standby Charge = $29,000 2% 12 = $6,960

3.

Operating benefit = 9,900 $0.24 = $2,376. No election is possible since the vehicle is driven less than 50%
of the time for business.

4.

Stock option benefit

FMV at exercise date
Employee cost
Taxable benefit

=
=

$19 1,000
$12 1,000

=
=

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

Since Erin exercised her option after March 4, 2010, she is not able to elect to defer the recognition of the
income until she disposes of the shares. Therefore, she must report the stock option benefit in 2010.
5.
6.
7.
8.
9.
10.

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

Solutions to Chapter 3 Assignment Problems

25

Solution 4 (Basic)
(a) A cash raise would increase the taxes payable of the senior executives by $2,250 or ($5,000 45%). It is a
good method of compensation if the executives are in need of cash flow. Net cash is $2,750.
(b) The bonus would increase their following year taxes by $2,475 or ($5,500 .45). This is assuming that their
tax rate remains constant over the next year. However, this is one-time, not ongoing, compensation.
This is a good method of compensation if the executives are not in need of immediate cash flows or if
their marginal tax rate will be lower in the following year. However, if the bonus is meant to be a
motivational tool, the incentive may lose its effectiveness if it is not paid out immediately. Net cash is
$3,025.
(c) Using the condo would create a taxable benefit of $3,000. This would increase the executives taxes payable
by $1,350 ($3,000 .45). It is a good method of compensation if the executives want to go to Hawaii, have
the money to buy plane tickets and can get the time off work. This alternative will depend on the executives
desire to have a luxury vacation over cash.
(d) A taxable benefit would have to be recognized in the year the executives exercise the options. If the option
is exercised in December 2010, the stock option benefit will be $1,500 (($5.00 $3.50) 1,000). They will
not be eligible for the 50% reduction of the benefit because the exercise price is less than the market price
on the date of grant. Therefore, this option will increase their current year taxes by $675 ($1,500 .45). If
they sell the shares in December 2011 at $6.50, theyll have a taxable capital gain of $750 ($6,500 $5,000
50%) and the tax will be $338 ($750 45%). Net cash is $1,987 ($3,000 $675 $338).
By exercising these stock options, the executives are exposing themselves to the risk of the stock prices
falling. However, management expects the share price to increase, which may result in increased
compensation for the executives. They also need to have cash of $3,500 for the purchase.
Although the executives believe that their performance can directly affect the share price, the
executives cannot directly influence the share price on a day-to-day basis.
Recommendation
As mentioned within each point above, there are many tax and non-tax implications when deciding on the
best compensation plan. If the executive is in immediate need of cash flow, the cash raise or interest-free loan
would be most desirable. If the executive is not in immediate need of cash flow, he/she would consider the
alternatives of the bonus, use of the company condominium, or the stock option arrangement. The condo would
be desirable if the executive was planning a trip to Hawaii only and was in need of accommodation. Otherwise, it
could be a wasted benefit. The stock options would be desirable if the share price increased as expected, but it is
a very risky form of compensation and will result in a taxable benefit in 2010. The bonus would likely be the best
alternative if immediate cash flow was not needed. This is because it is not risky; the executive will receive the
money and will not have to pay taxes on this money until 2012. However, the best choice may be the salary
increase, since the $5,000 would be paid each year into the future.

Federal Income Taxation: Fundamentals

26
Solution 5 (Basic)

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

2010 taxation year:

$100,000

(ii)

2011 taxation year:

$100,000

46 days
365 days
365 days
365 days

6%

$756

6%

$6,000

Solutions to Chapter 3 Assignment Problems

27

Solution 6 (Basic)
Mitch Employer-owned automobile:
Standby charge [par. 6(1)(e)](1)

20,004 km
(2% of $38,772 12) = ...............................................................................
20,004 km

9,305

11,705
1,200
10,505

3,239

Operating cost benefit [par. 6(1)(k)](2)

10,000 km $0.24 =
Total benefit ................................................................................................................................
Less: reimbursement ...................................................................................................................
Minimum net benefit ...................................................................................................................

2,400

Darly Employer-leased automobile:

Standby charge [par. 6(1)(e)]

9,000 km 2
($12,450 $1,650 ) = ...........................................................................
20,004 km 3
Operating cost benefit [par. 6(1)(k)](2)
Lesser of:
(a) 9,000 km $0.24 =

$2,160

(b) $3,239 =
$1,620
Total benefit ................................................................................................................................................
Less: reimbursement ...................................................................................................................................
Minimum net benefit...................................................................................................................................

1,620
$
$

4,859
630
4,229

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

Federal Income Taxation: Fundamentals

28
Solution 7 (Basic)

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

Solutions to Chapter 3 Assignment Problems

29

Solution 8 (Advanced)
(A) Employment income
Salary Gross ..........................................................................................
Disability payments Amount received ............................... $
1,600
Less amount paid (20072010) ...............................................
(350)
Preparation of 2009 income tax return(1) ...................................................
MBA tuition fees(1) ....................................................................................
Directors fee .............................................................................................
Christmas gift(2)..........................................................................................
Imputed interest(3) ......................................................................................
Gas allowance ($250 12) ........................................................................
Standby charge(4)........................................................................................
Car operating costs(4)..................................................................................
Bahamas condo Fair market value(1) ................................. $
500
Less amount paid ....................................................................
100
Frequent-flyer points ($800 + $104)(1) .......................................................

90,000
1,250
424
1,000
2,000
200
308
3,000
9,240
3,840

400
904
112,566

Sec. 5
Par. 6(1)(f)
Par. 6(1)(a)
Par. 6(1)(a)
Par. 6(1)(c)
Par. 6(1)(a)
Ssec. 6(9); 80.4
Par. 6(1)(b)
Par. 6(1)(e); 6(2)
Par. 6(1)(k)
Par. 6(1)(a)
Par. 6(1)(a)

(B) Omissions
(i) Income taxes are not deductible under section 8 [ssec. 8(2)].
(ii) CPP and El provide tax credits under Division E.
(iii) Group accident disability insurance premiums are not deductible under section 8 [ssec. 8(2)].
(iv) Employer-paid group accident disability insurance premiums are not a taxable benefit [par. 6(1)(a)].
(v) The employer-paid retirement planning advice is not a taxable benefit [clause 6(1)(a)(iv)(B)].
(vi) The employer-paid tuition for the two-day computer workshop is not a taxable benefit [IT-470R, par. 19].
(vii) A 30% employee discount which is available to all employees is not a taxable benefit, since the price is
not below cost [IT-470R, par. 27].
(C) If there was no company-owned car provided to Anita, there would be no standby charge ($9,240) or
operating cost benefit computed under paragraph 6(1)(k) ($2,400). Instead, paragraph 6(1)(l) would apply to
compute Anitas operating cost benefit as:

16,000 km
$2,920 = $1,869
25,000 km
NOTES TO SOLUTION
(1) These issues are discussed in Interpretation Bulletin IT-470R, paragraphs 10, 14, 18, 19, and 26.
(2) To meet the administrative exception, the gift cannot be cash or near cash. This was a cash gift.
(3) 7% $8,000 76/ 365 ........................................................................................................................ $ 117
6% $8,000 9l/ 365 ........................................................................................................................
8% $8,000 92/ 365 ........................................................................................................................
7% $8,000 92/ 365 ........................................................................................................................

Less: 3% $8,000 35l/ 365 ..............................................................................................................

120
161
141
$ 539
(231)
$ 308

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

20,004 km
[(2% 12) $38,500] = $9,240
20,004 km
Operating cost including HST benefit [par. 6(1)(k)]: 16,000 km $0.24 = $3,840
Anita is not eligible for either the standby charge reduction or the subparagraph 6(1)(k)(iv) election method
since she does not use the automobile more than 50% for business purposes, which is required for these
provisions.

30

Federal Income Taxation: Fundamentals

Solution 9 (Advanced)
[Reference: Mercier v. M.N.R., 92 DTC 2309 (T.C.C.)]
It should be noted that it was agreed that the $15,000 payment could not be for the purchase of the sales
territory, as Chrisa had always been a David employee and the sales territory had always belonged to David.
The taxpayer argued that the $15,000 payment was to reimburse her for expenditures (payments for the floor
space) made over the period of employment, which she had not deducted from income. Thus the payment was
non-taxable.
The Minister, on the other hand, argued that the $15,000 received by Chrisa was not paid as a
reimbursement of expenses, but must be deemed to be remuneration for services rendered by Chrisa in the course
of her employment. She received the $15,000 in consideration or partial consideration of a covenant with
reference to what Chrisa was, or was not, to do after the termination of her employment. Chrisa received the
$15,000 from David on account or in lieu of payment of an obligation arising out of an agreement made between
David and Chrisa during or immediately after a period that Chrisa was in the employment of David. Thus for the
purposes of section 5, the $15,000 should be deemed to be remuneration for services rendered by Chrisa during
her period of employment, in accordance with subsection 6(3).
The court found that the taxpayer produced no evidence which showed how much of the $15,000 receipt
represented compensation for expenses incurred by her. Part of this decision seemed to be based on the fact that
some portion of the payment was likely for the non-competition clause and the fact that the taxpayer was unable
to substantiate the actual non-deductible cash amounts that she paid over the years.
This would lead one to believe that if the payment had been clearly allocated between a reimbursement of
substantiated, deductible costs and a payment for the non-competition clause, the reimbursement portion might
have been held to be non-taxable.

Solutions to Chapter 3 Assignment Problems

31

Solution 10 (Advanced)
(A) Employment income
Salary gross .......................................................................
Group term life insurance .......................................................
Trip to Europe.........................................................................
Income protection payments ($12,000 - $2,300) ....................
Stock option benefit (1,000 ($4.50 $2.00)) .......................
Less: Registered pension plan................................................. $
Professional fees .............................................................
Employment income ...............................................................

$ 80,000
250
6,000
9,700
2,500
$ 98,450
5,500
800

(6,300)
$ 92,150

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

(B) (i) Private health plans such as those offered by Sun Life and Liberty Mutual are statutory exemptions
[par. 6(1)(a)]. In addition, Health Services tax levies, such as those in Manitoba, Ontario, and
Newfoundland, are not taxable benefits.
(ii) Membership fees paid by the employer for social clubs may not be included in the income of the
employee if the membership was principally for the employers advantage rather than employees [IT470R, par. 34].
(iii) There is no stock option benefit when the option is granted. The sale of shares in December results in a
capital gain of $0.50 per share (i.e., $5.00 - $4.50) which is not employment income.
(iv) Registered retirement savings plan Subdivision e, not Subdivision a deduction.
(v) Legal fees tax assessment Subdivision e, not Subdivision a deduction.
(vi) Income tax not deductible Subsection 8(2).
(vii) Charitable donation Division E tax credit,
(viii) CPP contributions and El premiums are tax credits deductible under Division E.
(C) GST rebate
13

/ 113 of professional fees (13/ 113 $800) ..............................................................................................

$92

Par. 6(8)(c) employment income inclusion in year of receipt of rebate ..................................................

$92

He would also be able to claim an HST rebate on the legal fees (13/ 113 $1,900 = $219) had this expense
been deducted in arriving at employment income. However, legal expenses incurred in appealing an income tax
assessment are deductible under paragraph 60(o) and not from employment income.

Federal Income Taxation: Fundamentals

32
Solution 11 (Basic)
Net Income from Employment
Gross salary
Commissions
Taxable Benefits
Christmas bonus (Note 1)
Life insurance
Conferencespouse (Note 2)
Interest benefit (Note 6)
Gross employment income
Less: Employment expenses
Meals and entertainment (Note 3)
CCA (Note 4)
Operating expenses (Note 5)
Promotional materials
Total deductions
Net income from employment

$ 4,000
18,000

ITA: 5(1)
ITA: 5(1)

300
400
800
491

IT-470R
ITA: 6(4)
IT-470R
$23,991

( 1,150)
( 2,000)
( 1,255)
( 1,500)

ITA: 8(1)(f)
ITA: 8(1)(j)
ITA: 8(1)(f)
ITA: 8(1)(f)
( 5,905)
$18,086

Notes:
1. Christmas bonus is a gift less than $500. However, as it was given in cash and not goods, e.g., a holiday
gourmet food basket, it is a taxable benefit and must be included in income.
2. Conference: spousal portion of trip is a taxable benefit.
3. Meals and entertainment: subsection 67.1(1), only 50% deductible.
4. Assumed the CCA was already prorated.
5. Gas and operating expenses and deemed interest expense: (7,500/12,500) ($1,600 + 491) = $1,255.
6. Interest benefit (subsection 6(9)): $21,000 7% (122 days/365 days) = $491.
7. EI, CPP, and charitable donations qualify for non-refundable tax credits that reduce federal taxes payable.

Solutions to Chapter 3 Assignment Problems

33

Solution 12 (Basic)
Net Income from Employment
Base salary
Gross commissions
Day care subsidy
Stock option benefit
Less: Employment expenses
Meals and entertainment
Hotel and travel
Airfare
Union dues
Total deductions
Net income from employment

$32,000
23,500
1,200
700

$57,400

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

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

( 5,010)
$52,390

Notes:
1. Stock option benefit = ($2.50 - $1.80) 1,000 = $700. (The individual cannot elect to defer taxable benefit
until the shares are sold since the stock option was exercised after March 4, 2010.)
2.

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

3.

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

4. EI and CPP qualify for a non-refundable tax credit against taxes payable.

Federal Income Taxation: Fundamentals

34
Solution 13 (Basic)
Sylvannas income from employment
Gross salary
Bonus based on sales
Standby charge (2% $36,000 12 30-day periods)

$48,000
40,000
8,640

Operating cost benefit ($0.24 9,900)

Taxable benefits ($350 + $150)
Total

2,376
500
$99,516

Sylvannas employment expenses

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

$14,250
5,300
$19,550
$ 4,000
(23,550)
$75,966

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

Solutions to Chapter 3 Assignment Problems

35

Solution 14 (Advanced)
(A) Employment income:
Inclusions:
Sec. 5
Sec. 5
Spar. 6(1)(b)(v)
Spar. 6(1)(b)(x)
Par. 6(1)(b)
Par. 6(1)(b)
Ssec. 7(1)

Salary (gross) ............................................................................................................. $ 84,800

Bonus based on sales/commission income .................................................................
24,000
Allowance for meals, accommodation and air travel (actual reasonable expense
$21,200 > allowance) ...........................................................................................
13,000
Allowance for car (not based solely on kilometres) ...................................................
6,300
Entertainment allowance ............................................................................................
2,000
Moving allowance (not an exception) ........................................................................
15,000
8,750
Stock option benefit (2,500 shares ($15 $11.50)) ................................................
$ 153,850

Deductions:
Par. 8(1)(f) (limited to $24,000 commission/bonus income)
Gas and oil ......................................... $ 3,900
Licences .............................................
100
Insurance ............................................
1,900
Maintenance .......................................
1,000
$ 6,900
38K km/ 45K km ..................
Meals (50% $7,000) [ssec. 67.1(1)] ..............................................
Accommodation ...............................................................................
Air travel ..........................................................................................
Home office expenses(1) [IT-352R2, par. 6]:
Insurance ($800 15%) ...........................................................
Property taxes ($4,500 15%) .................................................

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

Par. 8(1)(j)

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

120
675
$
24,322
Total par. 8(1)(f) limited to commission income(2)..................................................
Salary (includes amounts deductible under par. 8(1)(l.l)) .......................................
Home office expenses [IT-352R2, par. 5]:(3)
180
Fuel ($1,200 15%) ................................................................. $
105
Hydro ($700 15%) .................................................................
45
General maintenance ($300 15%) .........................................
Painting of office ......................................................................
100
Supplies ....................................................................................
700
Total spar. 8(1)(i)(iii)
CCA on car (($30,000 + $4,500 (HST))
(1/ 2 30%) 38K km/ 45K km .....................................................
Interest on car [sec. 67.2] lesser of:
(a) Amount paid = $3,600
(b) $300 290/30 = $2,900
Lesser amount $2,900 38K km/ 45K km ...............................................

(24,000)
(15,000)

(1,130)
(4,370)

(2,449)
$ 106,901

(B) Deductions:
Automobile expenses see (A) solution above ...........................................
Lease costs [sec. 67.3] lesser of:
(a) $800 1.15 290 = $ 8,893

$ 5,827

30

(b)

($1,100 10) ($30,000 1.15) = $ 9,706

85% of the greater of :

(i) l00/ 85 ($30,000 1.15) = $40,588

(ii) $46,000
Lesser amount $8,893 38K km/ 45K km .....................................................
Other employment deductions see (A) above ($24,322 $5,827) ...........

7,510
18,495
$ 31,832
Total par. 8(1)(f) limited to commission income of $24,000; therefore to avoid this
limitation deduct all expenses under pars. 8(1)(h) and (h.1) except the
insurance and property taxes ($31,832 - $120 - $675 = $31,037)(4)
Spars. 8(1)(i)(ii) and (iii) from (A) above ($15,000 + $1,130)
Total deductible expenses

$31,037
16,130
$47,167

36

Federal Income Taxation: Fundamentals

(C) Inclusions same amount as (A) above ($153,850):

Use spar. 6(1)(b)(vii) for meals and accommodation allowance.
Use spar. 6(1)(b)(vii.1) for car.
Deductions same as (A) or (B) above except:
No par. 8(1)(f) deduction or limit.
Use par. 8(1)(h) for meals, accommodation and air travel.
Use par. 8(1)(h.1) for car.
No home office expense deductions for insurance and property taxes since these expenses are
deductible only under par. 8(1)(f) salespersons expenses.
NOTES TO SOLUTION
(1) Fuel and hydro can be claimed under paragraph 8(1)(f) or subparagraph 8(1)(i)(iii). A deduction under
subparagraph 8(1)(i)(iii) is better, since it is not limited by commission income.
(2) If all meals are related to expenses incurred while travelling, then all of the expenses (except for
insurance of $120 and property tax of $675) could be deducted [pars. 8(1)(h) and (h.1)] with no limit. The limit
under paragraph 8(1)(f) denies only $322 of deductions; therefore, using paragraph 8(1)(f) is still better in this
situation.
(3) He cannot claim mortgage interest and he cannot use the fair market value rent if he owns the home
[IT-352R2].
(4) Since all of the meal expenses are likely consumed by Robby (and not others) while travelling away for
more than 12 hours, all of the expenses that could be deducted under paragraph 8(1)(f) (except for insurance of
$120 and property taxes of $675) are subject to the commission income limit. However, all the expenses, except
the property taxes and insurance, could be deductible under paragraphs 8(1)(h) and (h.1) with no limit.
Therefore, $31,037 would be deductible.

Solutions to Chapter 3 Assignment Problems

37

Solution 15 (Advanced)
(A) Employment income
Gross salary ..................................................................................................... $
Rent ($1,200 .75 12)..................................................................................
Bonus...............................................................................................................
Monthly allowance for incidentals ($150 12) ...............................................
Imputed interest [$8,000 .06 90/365](1) ....................................................
Group income protection benefits [$11,500 $2,880]] ...................................
Less:
RPP Current service(2) ......................................................
Union dues ............................................................................
Travel expenses .....................................................................
Car expenses(3) ......................................................................

5,000
800
1,200
9,837

$
$

115,000
10,800
12,500
1,800
118
8,620
$148,838

16,837
132,001

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

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

(B) Excluded items

(i) The 25% of the monthly rent on Anitas home in Toronto that she reimburses to the company does not
form part of the taxable benefit calculation as it is not paid by her employer.
(ii) Income tax withheld is not an allowable deduction under section 8 by virtue of subsection 8(2).
(iii) CPP and El premiums paid are not an allowable deduction under section 8 by virtue of subsection 8(2),
but these amounts will be allowed as tax credits under Division E.
(iv) Contributions to the company group RRSP are not deductible under section 8 by virtue of
subsection 8(2) but are deductible under section 60 of the Act subject to the applicable limits.
(v) Group accident income protection insurance premiums are not deductible under section 8 by virtue of
subsection 8(2).
(vi) The monthly rent reimbursed by Anita to the company is not deductible under section 8 by virtue of
subsection 8(2).
(vii) The company payment of the board and lodging costs when Anita is out of town is not a taxable benefit
as it meets the condition for exemption set out in subsection 6(6) because:
her duties at these locations are temporary;
she maintains a principal place of residence at another location (Toronto) that is available to her
throughout her period of stay at these out of town locations and her principal place of residence is
not rented to any other person during these periods;
due to the distances involved, she could not reasonably be expected to return to her principal place
of residence in Toronto from these out of town locations on a daily basis; and
she is never at an out of town location for less than 36 hours.
(viii) The provision of boots and company uniform is not a taxable benefit by virtue of IT-470R,
paragraph 29.
(ix) The company contribution to a registered pension plan is not a taxable benefit by virtue of
paragraph 6(1)(a)(i).
(x) The fitness club membership dues paid by the company would not be taxable by virtue of
paragraph 6(1)(a) if the membership is principally for the employers advantage than for Anitas
personal enjoyment [IT-470R, par. 34]. If the membership was determined to be principally for Anitas
personal enjoyment, the taxable benefit is $805.
(C) HST rebate
13

/ 113 of section 8 deductions excluding zero-rated and exempt items:

Car expenses deducted under pars. 8(1)(h) and (j) (see Note (3)).......................................................
Less:
Acquired car costs with no HST, and CCA:
Insurance (exempt) ...........................................
Licence (exempt) ..............................................
Interest
CCA (see below)

1,333
90
118
1,207
2,748

35,000 km
=
40,000 km

9,816

(2,405)

Federal Income Taxation: Fundamentals

38
Leased car costs with no HST:
Insurance (exempt) .............................................
Licence (exempt) ................................................

$
$

Add: CCA on car ...............................................................

667
30
697

1,207

18,000 km
=
20,000 km

35,000 km
=
40,000 km

(627)

HST rebate = 13/ 113 $7,840 ...............................................................................................

6,784

$
$

1,056
7,840
902

Employment income inclusion in year of receipt of rebate [par. 6(8)(c)]:

$6,784
$902 = $781
$7,840

Capital cost reduction in year of receipt of rebate [par. 6(8)(d)]:

$1,056
$902 = $121
$7,840
NOTES TO SOLUTION
(1) The imputed interest is based on total days the loan is outstanding for 2010 excluding the day that the
loan was actually repaid [31 + 28 + 31].
(2) Anitas contribution would be fully deductible if both her contributions and Car Parts Inc.s
contributions did not exceed the actuarially permitted amounts [par. 147.2(4)(a)].
(3) Car expenses:
Lease costs (see Note (a)) .................................................................
Gasoline and oil ................................................................................ $
Insurance...........................................................................................
Maintenance......................................................................................
Licence .............................................................................................
Interest (see Note (b)) .......................................................................
CCA ..................................................................................................
$

Acquired car
N/A
2,880
1,333
400
90
118
1,207
6,028

Leased car
2,668
1,440
667
240
30
N/A
N/A
$
5,045
$

Deductible car expenses [pars. 8(1)(h) and 8(1)(j)]

Acquired car
35,000 km
$6,028 =
40,000 km

5,275

Leased car
18,000 km
$5,045 =
20,000 km

Total car expenses

4,541

9,816

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

($800 1.13 122/30) $0

(b)

($920 4 months) $30,000 1.13

85% of the greater of :

=$

3,676

=$

2,668

(i) $30,000 1.13 100/85 = $39,882

(ii) $55,000

Note (b): The imputed amount of interest is deductible by virtue of section 80.5. The amount is subject to the
restriction under section 67.2 that is the lesser of $900 (i.e., $300 90/30) and the $118 deemed paid.
The lesser amount is $118.

Solutions to Chapter 3 Assignment Problems

39

Solution 16 (Advanced)
Part (A)
Reference
Employment inclusions:
Salary Gross ................................................................
Group term life insurance premiums paid by employer ...
B.C. provincial health care premiums paid by employer
Monthly allowance to cover travel and automobile
expenses(1) ................................................................
Travel expenses to Bermuda for Neds wife(2) .................
Outside financial counselling fees paid by
employer(3) ...............................................................
One-half of reimbursement on former residence
$15,000 .................................................................
Employer-paid rent ($1,200 3) (4) ..................................
Moving allowance ...........................................................
Mortgage interest reimbursement ....................................
Employment deductions:
Registered pension plan contributions made by Ned .......
Automobile expenses:
Lease cost(5) ......................................
10,200
Gasoline and oil ...............................
1,300
Insurance ..........................................
1,050
Maintenance .....................................
180
Licence .............................................
120
Subtotal ............................................ $
12,850
Employment use 22,500/36,000 .......
Travelling expenses:
Meals (50% $7,200) ......................
Accommodation ...............................
Total employment income ...............................

125,000
90
640

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

9,600
1,400

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

514

Par. 6(1)(a)

750
3,600
15,000
2,000
$

158,594

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

6,750

Par. 8(1)(m)

8,031

Par. 8(1)(h.1)

3,600
12,000

$
$

Par. 8(1)(h), 67.1

30,381 Par 8(1)(h)
128,213

Part (B)
(i) Income taxes paid are not deductible [ssec. 8(2)].
(ii) EI contributions and CPP contributions qualify for tax credits deductible under Division E.
(iii) Group income protection premiums and group term life premiums paid by the employee are not
specifically deductible under subsection 8(1) of the ITA and thus are prohibited [ssec. 8(2)]. Premiums
paid by an employee can be used to reduce the income inclusion required [par. 6(1)(f)].
(iv) Dental plan premiums are private health plan premiums and are exempted under the ITA [par. 6(1)(a)].
(v) Group income protection premiums paid by the employer are exempted under the ITA [par. 6(1)(a)].
(vi) Neds travelling expenses to Bermuda are not a taxable benefit to him because he was on employer
business.
(vii) The birthday gift is not included in income because it was less than $500 and it was not cash or near
cash, [administrative position].
(viii) The portion of the financial counselling fees that relates to retirement planning is not taxable
[spar. 6(1)(a)(iv)].
(ix) No benefit is taxable related to the use of the private swimming pool as recreational facilities provided
by the employer are not normally a taxable benefit [IT-470R, par. 33].
(x) The first $15,000 of reimbursement on loss of a former residence is not a taxable benefit. The balance
of the reimbursement in excess of $15,000 is one-half taxable [ssec. 6(20)].
(xi) The granting of the stock option does not result in a taxable benefit [ssec. 7(1)]. The exercise of
600 shares on September 15, 2010 does not result in any taxable benefit for Ned for 2010 because his
employer, Snoopy-Snacks Ltd., is a CCPC and there is no taxable benefit inclusion until Ned ultimately
sells the shares, [ssec. 7(1)]. The taxable benefit at the time Ned sells the shares will be 600
$(25 15) = $6,000. Ned may be eligible for a Division C deduction of 50% of the taxable benefit if he
does not sell the shares for at least 2 years after the exercise date [par. 110(1)(d.1)]. He cannot qualify
for a deduction under 1 because the exercise price was less than the fair market value of the shares at
the grant date.
(xii) The use of the company pool is not a taxable benefit according to paragraph 33 of IT-470R.
(xiii) Taxable benefits under par. 6(1)(a) or (e) which are not taxable supplies:
a)

Exempt supplies:

Federal Income Taxation: Fundamentals

40

b)

BC provincial health care premiums ........................................................................ $

640
Group term life insurance ........................................................................................
90
Rent..........................................................................................................................
4,800
The spouses travel expenses are outside the scope of the HST. They would not be subject to
GST if the spouse purchased the supplies directly. The supplies which include air travel to a
point outside Canada, accommodation and meals outside Canada and other miscellaneous items
consumed outside Canada, are not subject to HST.

Part (C)
The potential GST rebate and subsection 6(8) employment income inclusion:
Automobile operating expenses:
Deductible car expenses .......................................................................
Less:
prorated exempt supplies:.....................................................
Insurance ($1,050 22500/36000).......................................
Licence ($120 22500/36000) ............................................
Travelling expenses:
Meals....................................................................................................
Accommodation ...................................................................................
Rebate: 13/ 113 , therefore, and income inclusion in year of receipt ................

$
$

656
75

8,031

731

7,300

$
$

15,600
22,900
2,635

3,600
12,000

NOTES TO SOLUTION
(1) The monthly allowance to cover travel and automobile expenses must be reasonable [spar. 6(1)(b)(v)] in
order to be excluded from income. The $400 monthly travel allowance is unreasonably low as compared to the
actual travel costs of $19,200 and thus is taxable [spar. 6(1)(b)(v)]. The automobile allowance is not based solely
on km driven for employment purposes. The allowance is thus deemed not to be a reasonable amount
[spar. 6(1)(b)(x)]. Since both allowances are taxable, Ned is entitled to deduct both automobile and travel
expenditures per paragraphs 8(1)(h.1) and 8(1)(h) respectively.
(2) Neds wifes travelling expenses to Bermuda are a taxable benefit to Ned unless she was engaged
primarily in business activities on behalf of her husbands employer at the Bermuda site [IT-470R, par. 15].
(3) The ITA excludes counselling in respect of mental or physical health or re-employment or retirement
[spar. 6(1)(a)(iv)]. General financial counselling does not fall into these categories. This is confirmed in
IT-470R, par. 26.
(4) It is arguable that the temporary rent in Victoria is in the course of the move and is not a taxable
benefit.
(5) Deductible lease costs [sec. 67.3] lesser of:
(a)
= $ 11,958
$800 1.13 549
$4,585
30
(b)

(12 $850) $30,000 1.13

85% of the greater of :

(i) $30,000 1.13 100/85 = $39,882
(ii) $33,000

= $ 10,200

Solutions to Chapter 3 Assignment Problems

41

Advisory Cases
Case 1: Sandra Rae
ADVISORY CASE DISCUSSION NOTES
Issue
To determine whether Sandra is an employee of Global Investments or an independent contractor. If Sandra
is considered an employee for tax purposes she will be somewhat restricted in her ability to deduct expenses
incurred to earn income.
Analysis
The courts generally consider three tests:
1. Economic Reality or Entrepreneur Test
(a) Control Test
Based on this test, Sandra appears to be an employee because she is not allowed to work for anyone else,
and must obtain the VPs signature to close investment agreements.
Although she does have the ability to bill the company for services rendered, she appears to be
accountable to the VP.
(b) Ownership of Tools
She must use her own office, supplies, and equipment.
She must pay her own travel and entertainment expenses and have liability insurance. Global provides the
research and back room expertise.
(c) Chance of Profit, Risk of Loss
Who carries the business risk?
Although Sandra has access to supplies and promotional materials from Global, she is responsible for
carrying her own business insurance, locating her own sales clients, and using her own supplies and
equipment. She was also required to purchase a license to operate for $10,000.
It is evident that Sandra carries the business risk.
She doesnt get paid unless she sells investments.
2. Integration and Organization Test
This test attempts to identify whether Sandra is an integral part of the company.
It appears that she is not an integral part because her contract will not be renewed unless she meets the
sales quota.
The newspaper announcement advertising Sandra as a new sales associate points to her being part of the
organization.
All promotional materials have the companys letterhead.
3. Specific Results Test
Must have sales of $750,000 to continue employment.
Not contract oriented.
Sandra is paid at the completion of each sale.
Conclusion
Sandra is likely an independent contractor for the following reasons:
She carries the majority of business risk.
She purchased a license, which gives her the right to operate her own sales office.
As a self-employed person, Sandra will be able to claim expenses she wouldnt be entitled to as an
employee. These include her office in the home costs, CCA on her computer, printer and fax machine, and
amortization of her $10,000 licence cost.

42

Federal Income Taxation: Fundamentals

Case 2: Betina Harty

ADVISORY CASE DISCUSSION NOTES
Issue
To determine whether the courts would consider Betina Harty an independent contractor or an employee.
The courts will apply the following tests to determine if Betina was carrying on a business as an independent
contractor.
1. Economic Reality or Entrepreneur Test
(a) Control Test
Betina has broad limitations on what she uses to beautify the campus and the University retains the final
vote on what pieces Betina uses. However, she is not limited in how she goes about beautifying the campus, does
not have to report on a daily basis to a supervisor, and has a great deal of latitude in choosing the particular
pieces. Accordingly, this test does not definitively show whether Betina is an employee or an independent
contractor, but does lean towards an independent contractor finding.
(b) Ownership of Tools
She used her own tools to create art and she used her own resources to search out other art.
(c) Chance of Profit, Risk of Loss
Since Betina had to absorb the costs if the University did not like how she beautified the campus, she bears
economic risk. Accordingly, this test leads to the conclusion that Betina is an independent contractor.
2. Integration and Organization Test
Betina works out of her own studio and uses her own tools. These facts show that she can work in the
absence of the organization. However, she did not earn any income outside of the University. Nevertheless, this
test lends itself to the fact that Betina would be considered an independent contractor in the eyes of the court.
3. Specific Results Test
As Betina was engaged to beautify the campus, she was employed for a specific purpose. This tends to
establish an independent contractor relationship between the University and Betina.
Conclusion
The application of these leads to a conclusion for the independent contract status.
Based on the results of these tests, the courts would almost certainly conclude that Betina is an independent
contractor.

Solutions to Chapter 3 Assignment Problems

43

Case 3: Sherry Cane

ADVISORY CASE DISCUSSION NOTES
Issue
To determine whether Sherry should object to her notice of assessment that claims that she is a resident of
Canada for tax purposes. Is she an employee or an independent contractor? How should the fringe benefits be treated?
Residency
If Sherry were to go to court, the judge would consider the facts that would indicate that her continuing state
of relationship is with Canada. Facts to support residency:
stored furniture at mothers;
kept health care card, Visa, and bank account in Canada;
cheques deposited in Canadian bank account;
boyfriend visited her for six months and then returned; and
letters indicated that she wanted to come home.
Based on the above facts, it is obvious that Sherry did not sever all of her ties and, during her absence, her
intentions to return home were obvious.
Employer vs. Independent Contractor
Sherry was employed with TSE prior to going overseas and considered herself as part of the TSE team.
For example, she used TSE letterhead and business cards.
The Iraq government contracted with TSE, and not directly with Sherry.
Therefore, it would follow that Sherry conducted herself more like a TSE employee by not incurring any
financial risk. She also went to Iraq under the direction of TSE (Control and chance of profit/risk of loss tests).
Conclusion
Sherry is a full-time resident of Canada between the period of March 2008 and October 2009; therefore,
she must pay tax on her worldwide income.
Since Sherry is also considered a full-time employee of TSE, her income would include the $12,000
received from TSE, together with the value of fringe benefits. Some of the personal living expenses may
not be considered a taxable benefit, because Sherry is living in a remote location. However, the length of
stay may prevent her from being viewed as living in a remote location.
Sherry may be entitled to an overseas employment tax credit, which would essentially allow $80,000 of
employment income to be tax exempt if certain conditions are met. This credit is discussed further in
Chapter 10. Assuming that she was granted the overseas employment tax credit, it is recommended that a
notice of objection not be filed. This avoids professional legal fees and administration costs. Interest and
penalties will continue to accrue during the period of objection, unless the income tax is not outstanding.

44

Federal Income Taxation: Fundamentals

Case 4: Claire Jordan

ADVISORY CASE DISCUSSION NOTES
Claire was reassessed as being an employee resident in Canada for both 2007 and 2008. The two issues to be
considered are her residency status and whether she is an independent contractor or an employee.
Issue
Residency is described by case law as a question of fact rather than meaning. The CRA takes into
consideration the continuing state of the relationship the individual has with the country. For 2007, the courts
would look at factors such as:
Claire is Canadian and returned to Canada permanently.
She married upon her return to Canada and resumed employment with her previous employer.
She kept her furniture in Canada.
Her family ties remained in Canada.
Her contract was a temporary contract depending on demand and she had the intention to return to Canada
when it was terminated.
She was absent less than two years without completely severing all ties.
Claire did cancel her YWCA membership; however, it is not mentioned if all associations were cancelled,
nor is it mentioned whether she cancelled her health care.
Her intention to stay in Saudi Arabia is not supported. It is not stated if she tried to learn the language, if
she joined any clubs or if she tried to integrate into the society. (It is stated that she was happy to return
home.)
Claires employment ties remained in Canada.
The facts of the situation lead to the conclusion that Claire is a resident of Canada in 2007. The tax
consequences of this are that she would be taxed on her worldwide income in 2007. However, she could apply
for the overseas employment tax credit to allow her tax-exempt income.
Employee vs. Independent Contractor
Claire considers herself an independent self-employed dental hygienist. She is employed by the Canadian
Forces Dental Unit to work on a day-to-day basis. The Mobile Dental Unit contracts her in advance depending on
the regional need. The courts will apply various tests to determine if Claire is an independent contractor.
1. Economic Reality or Entrepreneur Test
(a) Control Test
This test tries to determine if Claire is free to organize her work independently. In this case, she decides how
she does her work based on special knowledge, skill, and judgment. However, she is responsible to the dentist
who is required by the Canadian Dental Association to supervise her work. The clinic organizes her clients and if
a workday is less than 60% booked, the clients are rescheduled to another day. The contract also specifies that
she be available four days a week and this prevents her from obtaining work elsewhere. Claire would likely not
pass the control test.
(b) Ownership of Tools
While Claire used her own car in Canada, she would not have a car in Saudi Arabia, and she would use the
equipment provided.
(c) Chance of Profit, Risk of Loss
This test is an attempt to determine if the individual incurs business risk, legal liability, and his/her own
expenses. In this case, Claire does not run the risk of financing the supplies, tools, and support staff. She is also
not responsible for seeking out clients. She has no control over the support staff that provides services to her.
Also, there is limited legal risk as the dentist is professionally responsible.
However, there is the risk that she may be without work because she is hired on a day-to-day basis
depending on demand and it is not unusual to be temporarily laid off. The dental unit appears to bear most of the
risk and Claire would probably not pass this test.
2. Integration and Organization Test
This test tries to determine if Claire is economically dependent on the Mobile Dental Unit and if Claires
work is an integral part of the business. Can the worker perform the same services in the absence of the
organization? In this case, the clinic supplies all the tools and supplies as well as the support staff. Claire works
substantially on the employers premises. Also, the work Claire performs is an integral part of the dental
treatment provided by the dental clinic. She is economically dependent on the organization and is unable to work

Solutions to Chapter 3 Assignment Problems

45

elsewhere because she has to be available to the clinic four days per week. Also, the Mobile Dental Unit
coordinates where she works and when. On the other hand, Claire does not receive any benefits. All facts
considered, Claire would probably not pass this test.
3. Specific Results Test
Claire is contracted on a day-to-day basis depending on demand for a period of time. She is not contracted to
achieve a specific result, but to supply her services as needed over the contracted period of time. Also, if she was
unable to supply her services, she is not in the position to substitute someone else in her place. Claire would not
pass this test either.
Conclusion
Claire failed all three tests and would be considered an employee of the Canadian Forces Dental Unit. Her
income would be included in employment income and her deductions would be limited. This applies for both
2007 and 2008.
In 2007, Claire would be taxed on her worldwide income. She would have to include all of the benefits
received or enjoyed in the year that she received as a result of her employment. The FMV of the free room and
board provided in Saudi Arabia would have to be included in her employment income under paragraph 6(1)(a).
Also, the deductions she could claim would be limited to those specified in subsection 8(1). Her deductions for
laundry, uniforms, shoes, and stockings would not be allowed. The travel expenses could be deducted if she
qualifies for the deduction under paragraph 8(1)(h) and (h.1). That is, if she is required by work to incur her own
expenses for employer-related travel or if she is required to carry on duties of employment away from the
employers place of business. Arguably, the travel expenses are not deductible as she does not perform her duties
away from her employers place of business. The fact that there is a change to the employers place of business is
irrelevant.
In 2008, Claires income would be classified as employment income. She would be limited to employment
expenses as mentioned for 2007, but again her entitlement is doubtful.

CHAPTER 4

Income from Business: General Concepts and Rules

Solution 1 (Advanced)
Intention of the Taxpayer
(A) Primary intention: The corporation intended to construct an apartment building on the property, not to
purchase the property itself for resale at a profit. Unexpected circumstances resulted in the sale of the property.
These statements of intention must be substantiated by facts which can be observed objectively, as discussed
below.
(B) Secondary intention: The question of whether the corporation intended, at the time of purchase and as a
motivation for the purchase, to resell the property at a profit if the primary intention was frustrated must be
answered by reference to other factors discussed below.
Factors Used to Substantiate the Intention of the Taxpayer
(A) Relationship of the transaction to the corporations business: The corporation was not normally in the
business of buying and selling land. This was a relatively new corporation at the time of the transaction. In
addition to the land which it sold, it purchased another property which it has developed into a
commercial/industrial plaza and which it holds as a rental property. Furthermore, the principal shareholder of the
corporation owns and operates an electrical contracting business and, thus, cannot be said to be in the business of
buying and selling land.
(B) Nature of the activity surrounding the transaction: The transaction involving the sale of the property
should not be considered of a business nature or an adventure in the nature of trade. The sale was made only
after it was determined that the property location was not suitable for development into an apartment building. It
was listed for sale with the realtor only at that time and not immediately after purchase. It could be argued that
the minor improvements made were to make the property more marketable for resale purposes.
(C) Type of asset: The land was to be developed for an apartment building used for rental purposes and,
hence, would have been considered a capital asset rather than inventory. Plans were made for the development of
the property to the extent that surveys were made and that the land was stripped and excavated in preparation for
construction. The fact that no income was ever earned from the property as a capital asset could be used to
suggest it was held as inventory.
(D) Number and frequency of transactions: Since this is a new corporation and the transaction in question
was the first of its nature, there is no track-record on which to base an assessment of number and frequency
despite a short (i.e., six-month) holding period. As a result, this should not be a determining factor in this case.
(E) Articles of incorporation: There is nothing in the Articles of Incorporation to suggest that the
corporation can engage in the purchase and resale of land as a business activity. On the other hand, the articles
are very broad and might be interpreted to encompass this type of business activity.
(F) Other factors: IT-218R, paragraph 3 suggests other factors which might be considered in the evaluation
of real estate transactions, including:
(i) the feasibility of the taxpayers intention;
(ii) the geographical location and zoned use of real estate acquired;
(iii) the extent to which borrowed money was used and the terms of the financing;
(iv) the length of the holding period (relatively short, i.e., 6 months, in this case);
(v) factors which motivated the sale.
Conclusion
From the foregoing analysis of the facts, it is reasonable to conclude that the profit realized on the sale of the
property was a capital gain. The intention to develop the property as an income-producing capital asset, in the
same manner as the development of the other property, is substantiated by the nature of the transaction, the type
of asset and the Articles of Incorporation.

47

48

Federal Income Taxation: Fundamentals

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

Solutions to Chapter 4 Assignment Problems

49

Solution 2 (Basic)
(a) Both Dan and Mike are performing business services and, therefore, a value needs to be assigned to the
work they have done and the amount added to their business income. The value of the work exchanged
could be based on either Dan or Mikes normal rate. This is a verbal transaction unlikely to be added to
either tax return. The CRA would probably assign the higher rate for the work done if this were caught on an
audit.
(b) The $100,000 is an extraordinary item from business. Nevertheless, it would be taxed as business income as
it was earned in the course of carrying on business. This amount is usually shown separately on a companys
income statement with the tax effects also shown separately.
(c) The government grant of $5 per hour is taken into business income and the $10 per hour paid to Cornell is
an expense. The net result is that the company is only paying $5 per hour for Cornells services.
(d) Jessy will have a taxable benefit equal to the fair market value of the rent for the apartment
(paragraph 6(1)(a)). As Jessy uses one room as an office, she would be able to deduct that portion of
assigned rent and other household expenses relating to the home office from the taxable benefit for the
apartment as well as her supplies. If Jessy is considered an employee, she will not be allowed any CCA on
her equipment.

Federal Income Taxation: Fundamentals

50
Solution 3 (Advanced)

[Reference: Coupland v. The Queen, 88 DTC 6252 (F.C.T.D.)]

The following has been edited from the Courts decision (which preceded the Stewart decision, 2002 DTC
6969 (S.C.C.)).
The issue to be determined is purely one of the fact: did the [taxpayer] during the years in question incur
the expenses for the purpose of producing income from a business, that is, was he engaged in an activity with a
reasonable expectation of making a profit therefrom.
I could not conclude on the basis of the evidence in this case, that the expenses in question were incurred by
the taxpayer for the purpose of producing income from a business. I do not conclude that the activities in
which the [taxpayer] was engaged were carried on with a reasonable expectation of a profit.
My conclusion that the [taxpayers] activities were not carried on with a reasonable expectation of profit,
is based on the reasons which follow. The profit and loss record of the [taxpayers] business never showed a
profit from the first year of its operation, in 1975 to 1985.
With respect to the taxpayers training, I have no doubt that the [taxpayer] had adequate managerial and
the other abilities to develop the campground and run the operation had he chosen to do so as a serious
business venture, and, had he had the capital to do so. His past experience in various managerial functions,
albeit not in the private sector, and his obvious ability to deal well with people would have made him an ideal
candidate to operate such a business. And, in any event, the running of a campsite is not a high skill
occupation.
While I have no doubt that the [taxpayer] had the experience and ability to run a campground operation as
a business, he was not in fact doing so. He was not on the property much of the time. He had a full-time job in
Ottawa during the whole period and only returned to the Lanark property on weekends. There is no evidence
of a concerted effort to try to ensure a full occupancy rate of even the limited number of campsites which were
in existence. (By full occupancy I mean what would constitute average occupancy in the industry.)
There is no evidence of any concerted advertising of the campground property. There is no evidence of
any definite or specific plans for conversion of the house merely the [taxpayers] vague statement that this
was intended.
Mr. Binghams evidence was that the business was marginally viable in 1976 and that with the expansion
of the facilities, the business could become truly viable. I have no doubt that the operation of a campground
in the area might be a viable enterprise especially had the suggested improvements been made. But, the
issue is whether the business, as the [taxpayer] was operating it, was one which was being run with a
reasonable expectation of profit. I do not think it was.

Note that the case of Tonn et al. v. The Queen, 96 DTC 6001 (F.C.A.), has commented on the applicability
of the reasonable expectation of profit test. In that case, the Federal Court of Appeal indicated that where there is
no personal benefit element, that is, the venture is of a purely commercial nature, the application of the test may
not be appropriate. In the particular case at hand (i.e., the Coupland case), however, there was a personal element
to the fact situation, since the property was purchased as a holiday property for the taxpayer and his family and it
became their principal residence. Later, a house on the property was occupied by the taxpayers daughter at a
rent that was not sufficient to cover the mortgage costs of the property. Therefore, it would appear that under this
fact situation, application of the test is appropriate.
The Supreme Court of Canada, in the Stewart case, established a pursuit of profit source test, which
requires analysis, where there is some personal or hobby element to the activity in question. Since a personal
element was found to exist in this case, the question of whether the taxpayer intended to carry on a business for
profit must be addressed and it was, as is evident from the above excerpts from the decision.
One approach to addressing the issues of this case is to apply the checklist of factors in Exhibit 4-2 in
Chapter 4 of the text to the facts of this case, to the extent that they are known. The Exhibit is reproduced here
for that purpose. Recognize, however, that this list of factors was developed from U.S. jurisprudence which has
no legal precedent status in Canada.
Exhibit 4-2
Checklist of Factors Used to Determine the Existence of a Reasonable
Expectation of Profit or of Operating in a
Businesslike Manner
(1) Manner in which activity is operated:
(a) activity held out to community as a business
(b) activity operated in a businesslike manner
(c) operated in manner similar to comparable profitable businesses
(d) unsuccessful methods discontinued and new ones adopted
(e) formal books and records maintained
(f) separate bank account maintained

Solutions to Chapter 4 Assignment Problems

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

(10)

51

(g) record keeping system provides for the determination of segment profits and relevant costs
(h) detailed non-financial records maintained
(i) operating methods changed to improve profitability
(j) level of advertising or promotion undertaken
(k) development plan formulated and followed
(1) scale of operations sufficient to be profitable.
Elements of personal pleasure or recreation:
(a) taxpayer obtains personal pleasure from the activity
(b) facilities are utilitarian
(c) conduct of activity involves social or recreational functions (apart from the activity itself)
(d) long-time interest in activity as a hobby
(e) operating methods constrained by personal motives
(f) personal use separately accounted for.
Expertise of the taxpayer or his advisers:
(a) prior experience in the activity
(b) profit potential determined prior to entry
(c) pre-entry advice (or prior preparation) sought and followed
(d) post-entry advice sought and followed
(e) taxpayer belongs to business-related associations
(f) new or superior techniques developed.
History of income and loss:
(a) average ratio of receipts to disbursements
(b) percentage years receipts less than disbursements
(c) average magnitude of losses
(d) trend of losses declining
(e) number of years activity was operated
(f) losses due to circumstances beyond taxpayers control
(g) percentage of years with profits
(h) reasonable start-up period
(i) trend of gross revenues.
time and effort expended:
(a) competent and well-informed manager employed
(b) competent labour employed
(c) average time spent on activity by taxpayer
(d) taxpayer withdrew from another business to devote most of his/her time to the activity
(e) taxpayer did physical labour.
Financial status of taxpayer:
(a) taxpayers average income before activity loss
(b) extent of tax savings from net losses
(c) average ratio of activity losses to other income
(d) taxpayer maintains an extravagant standard of living
(e) majority of taxpayers other income is from investments
(f) extent of other net assets of taxpayer
(g) amount of capital invested in the operation.
Amount of occasional profits:
(a) ratio of average profit to average loss
(b) amount of largest profit earned
(c) ratio of net losses to net assets.
Sale or discontinuance of activity:
(a) activity sold or discontinued because no chance for profit
(b) activity sold or discontinued for any reason.
Success of taxpayer in other activities:
(a) extent of experience in similar successful business
(b) history of losses in a similar activity.
Expected appreciation of asset value:
(a) taxpayer expected property to appreciate in value as the major source of investment return.

Sources: Jane O. Burns and S. Michael Groomer, An Analysis of Tax Court Decisions That Assess the Profit Motive of
Farming-Oriented Operations, The Journal of the American Taxation Association, Fall 1983, pp. 23-39.
Jack Robison, Tax Court Classification of Activities Not Engaged in for Profit: Some Empirical Evidence, The Journal of the
American Taxation Association, Fall 1983, pp. 7-22.

Federal Income Taxation: Fundamentals

52
Solution 4 (Advanced)

Part A
In order to fully understand the income tax implications and thus the resulting adjustments that are needed in
computing income for tax purposes, the underlying accounting for the given transactions needs to be discussed.
The following solution will address the net impact on the income statement for accounting purposes of each of
the transactions and will then compare this to the required income tax treatment of each item. The comparison of
the accounting and tax treatment will indicate any necessary adjustments. The major discussion of the tax
treatment of each item is found in the notes.
Net impact on income
statement
Warranty reserve(1)
Accounts receivable(2)
TalkTech Inc.

(3)

PhonesNThings(4)

Net impact as per

Income Tax Act

Difference (resulting in T2
Schedule 1 Adjustment)

$(10,000)

$(17,500)

$ (7,500)

(6,000)

(6,000)

Nil

120,000

40,000

(80,000)

Notes:
(1) For accounting purposes, the increase of $10,000 in the balance sheet warranty reserve (a liability account)
will be recorded on the income statement as a warranty expense for the year. The $17,500 subtraction from
the balance sheet warranty reserve will simply reduce the cash balance as it represents the actual outlays
during the year to honour warranties that were recorded in the current or previous year(s).
For tax purposes, the $10,000 increase in the warranty reserve is not an allowable deduction because it
represents a contingent amount (not an amount which is paid or payable) which is specifically denied per
paragraph 18(1)(e). The amount does not qualify for deduction under paragraph 20(1)(m.l) since it is not an
agreement for an extended warranty nor is it insured by a third party insurer. For tax purposes, the $17,500
paid during the year to honour warranty claims is fully deductible because it represents a cost of doing
business under paragraph 18(1)(a).
(2) The bad debt expense for the year will be reflected as a single amount on the income statement. However,
this expense can often be made up of a number of additions and/or subtractions to this account. The income
tax analysis of the bad debt expense on the income statement requires that each individual component of this
amount be justified in terms of the relevant provision of the Income Tax Act. For example,
the addition to the allowance for doubtful accounts (and corresponding addition to the bad debt
expense) must meet the requirements set out in paragraph 20(1)(l),
the write-off of bad debts must meet the requirements of paragraph 20(1)(p), and
the recovery of previously written off bad debts is included in income under paragraph 12(1)(l). The
final net amount for both accounting and tax purposes should be the same.
TalkTech Inc.s $7,500 addition to the allowance as a result of the year-end aging is recorded as a bad
debt expense and thus will be a deduction on the income statement. The $5,000 written off from the
allowance during the year will be a balance sheet adjustment only as it represents amounts previously
included in the allowance and thus previously deducted for accounting purposes (as bad debt expense in the
previous year). The collection of $1,500 of previously written-off bad debts will be a credit adjustment to
the bad debt expense for the year. Thus, the net impact on the income statement is as follows:
Expense Bad debt expense..................................................................................................
Contra expense Collection of previously written-off bad debt ......................................
Net expense for the year ..........................................................................................................

$
$

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

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

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

Solutions to Chapter 4 Assignment Problems

53

(3) The sale to TalkTech Inc. will result in $120,000 of net income for accounting purposes ($300,000 of sales
and $180,000 of cost of goods sold). There is no accounting for reduced income due to the instalment
payment method being used.
For tax purposes, the net income for accounting purposes of $120,000 must be included in income due
to section 9 but an $80,000 reserve is allowable under paragraph 20(1)(n) to account for the amount not due.
Thus, a net profit of only $40,000 is recorded for the year ended October 31, 2010. The paragraph 20(1)(n)
reserve for amounts due later is calculated as that portion of the gross profit on the sale that relates to the
uncollected proceeds where at least some part of the proceeds are due more than two years after the date of
the original sale (April 1, 2010). The taxation year-end of TalkTech Inc. does not play a role in the
calculation of this reserve. $80,000 = $200,000/$300,000 ($300,000 $180,000)
(4) The deposit received from PhonesNThings is considered deferred revenue for accounting purposes and
will be recorded on the balance sheet only (as a liability).
For tax purposes, the $40,000 deposit received must be included in income per paragraph 12(1)(a),
although none of that amount has been earned since it is potentially refundable if the shipment of the
product does not take place. However, an offsetting reserve of $40,000 is available under
paragraph 20(1)(m) because none of the goods are going to be delivered until after the end of the taxation
year. Thus, the net impact on income for tax purposes is NIL for the year ended October 31, 2010. The
reserve recognizes the fact that none of the amount received and included in income has been earned. This
process requires all amounts received to be accounted for in income and that the full amount deducted as a
reserve be justified as unearned.
Part B
The $800 amount would not be part of the amount deductible per 20(1)(p) as there is still some hope of
collecting it. Therefore, the deductible amount under paragraph 20(1)(p) for the year will be $5,000 $800 =
$4,200. However, the method described in IT-442R, paragraph 24 would suggest that a reserve for 100% of debts
outstanding more than 180 days is reasonable. Thus, a closing reserve that includes this amount could be claimed
per paragraph 20(1)(l). Thus, the closing reserve for fiscal 2010 could be increased by $800 to $35,300.
The net impact on income for tax purposes for fiscal 2010 would be the same.
Add opening balance per 12(1)(d) ......................................................................................
Subtract amended closing balance per 20(1)(l)...................................................................
Subtract amended bad debt write-off per 20(1)(p) ..............................................................
Add bad debt recovery per 12(1)(i) ....................................................................................
Net impact for the year .......................................................................................................

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

However, in 2011, the $800 will have to be added to income per paragraph 12(1)(d) as it is part of the 2010
year-end allowance. This is a different result than in Part (A) because as a bad debt written-off in fiscal 2010, the
$800 would not otherwise be taken into 2011 income unless it was recovered in 2011.

Federal Income Taxation: Fundamentals

54
Solution 5 (Basic)
Net income from a business for tax purposes
Net income for accounting purposes
Add:
Golf dues (not allowed)
Amortization expense
Cycle Safety Program (personal)
Meals & entertainment (50%)
Cash register (capital)
Late instalment interest (not allowed)
Shelving & lighting (capital)
Sale of Disney rights (gain)
Business income for tax purposes

$11,000
3,000
8,000
1,200
2,000
1,200
3,000
3,200
8,200
$40,800

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

Solutions to Chapter 4 Assignment Problems

55

Solution 6 (Basic)
Net income before tax for accounting purposes
Add:
Unrecorded receivable (paragraph 12(1)(b))
Meals and entertainment ($10,400 50%) (subsection 67.1(1))
Charitable donations (paragraph 18(1)(a))
Club dues (paragraph 18(1)(l))
Interest penalty for late filing (paragraph 18(1)(t))
Amortization (paragraph 18(1)(b))
Less:
Sale of design contracts (Note 4)
CCA (paragraph 20(1)(a))
Net business income for tax purposes

$206,200
$14,500
5,200
2,200
1,800
8,100
8,000

(19,000)
( 8,900)

39,800
246,000

( 27,900)
$218,100

Notes:
1. The capital gain on the sale of real estate represents the sale of real estate that was purchased with the
intent of selling the homes for a profit after they had been redecorated. There is also no attempt to rent the
homes to a third party. Thus, the full amount will be included in business income.
2. Assume that the rental income and interest income are related to other transactions in carrying on this
business.
3. Since the reimbursement to employees for business use of their automobiles follows the prescribed
amounts in Regulation 7306 (paragraph 18(1)(r)), it is an allowable deduction for Source Renovations Ltd.
4. The sale of design contracts would be considered a capital gain and not business income.

Federal Income Taxation: Fundamentals

56
Solution 7 (Advanced)

ITA Reference
Net income per financial statements
Add (deduct):
Accounting fees
Legal
Personal expenses of shareholder
Advertising
Interest expense
Amortization
Meals
Exempt income
CCA
Bonus paid after 180 days after year end
Cumulative eligible capital
Lease termination payment
Lease termination payment (Note 1)
Financing costs
Financing costs (Note 2)
Net business income for tax purposes

$ 740,000
18(1)(b)
18(1)(e)
18(1)(a)
19.1(1)
19(1)(t)
18(1)(b)
67.1(1)
18(1)(c)
20(1)(a)
78(4)
20(1)(b)
18(1)(q)
20(1)(z)
18(1)(b)
20(1)(e)

10,000
15,000
30,000
10,000
5,000
80,000
20,000
50,000
(14,210)
80,000
(525)
100,000
(9,918)
30,000
(6,000)
$1,139,347

Notes:
1. Paragraph 20(1)(z) applies since the property is still owned at the end of the year. At the time the lease is
cancelled there are 1,825 days remaining in the lease term (five years 365 days, ignoring leap years). The
number of days remaining in the current year to June 30 is 181 days (from January 1 to June 30). The
calculation is as follows:
181/1,825 $100,000 = $9,918
2. $30,000 20% = $6,000. Paragraph 20(1)(e) limits the deduction for financing costs to 20% per year.

Solutions to Chapter 4 Assignment Problems

57

Solution 8 (Basic)
Business Income
Business loss (section 9)
Add:
Charitable donations (subsection 18(1))
Salary to proprietor
Accounts receivable accrue (subsection 12(1))
Meals & entertainment (section 67.1) (462 50%)
Club dues (paragraph 18(1)(l))

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

(1,580)
380
14,750
4,650
231
460
$18,891

Federal Income Taxation: Fundamentals

58
Solution 9 (Basic)

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

$64,300
4,000
2,500
1,000
8,000
1,700
(2,400)
$79,100

Solutions to Chapter 4 Assignment Problems

59

Solution 10 (Basic)
Traci does not prepare financial statements in accordance with GAAP, as her only need is to prepare
statements for tax.
Revenue for current year
Consulting fees
Reserve for doubtful accounts prior year (Note 1)
Tax deductible expenses
Materials (Note 2)
Association dues
Entertainment ($300 50%)
Computer World
CCA on equipment
Home office expenses (Note 3)
Telephone expenses
Reserve for doubtful accounts current year
Bad debt expense
Automobile expense (Note 4)
Net income from business

Notes:
1.
2.

3.

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

$35,500

(23,546)
$11,954

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

4.

$35,000
500

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

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

60

Federal Income Taxation: Fundamentals

Solution 11 (Advanced)
Note to instructors: Reference to Schedule 1 of the T2 corporate tax return may be helpful in completing
reconciliation problems.
Net income per financial statements ........................................................................
Add:
Provision for income taxes ....................................................................... $2,528,000
Charitable donations ................................................................................
57,000
Over contributions to company pension plan(1) ........................................
4,500
Loss on disposable of depreciable assets .................................................
35,900
Depreciation and amortization .................................................................
4,560,000
Club dues .................................................................................................
12,700
54,750
Meals and entertainment ($109,500 50%) ............................................
4,000
Hockey tickets ($8,000 50%) ................................................................
Non-deductible life insurance
Vice-president..............................
2,000
1,500
President ($300 5 months) ........
23,440
Legal and accounting expenses re issuance of shares (80% $29,300)...
Legal expenses re articles of incorporation ..............................................
2,300
36,880
Costs re bank loan (80% $46,100) ........................................................
Costs re equipment purchase....................................................................
38,700
4,080
Appraisal cost for bank (80% $5,100) ..................................................
Accrued early retirement payments(2) ......................................................
672,000
Total additions .........................................................................................
Subtotal ............................................................................................
Deduct:
Capital cost allowance .............................................................................
Income from business ..................................................................................

$ 3,784,000

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

8,037,750
$11,823,750
5,835,000
$ 5,988,750

Par. 18(1)(b)

Items Not Included in Computation:

1. The reserve for inventory obsolescence, although called a reserve, is deductible since the amount is
determined by identifying specific items that are obsolete and, therefore, is not a reserve or contingent liability
[par. 18(1)(e)].
2. Group term life insurance is deductible as part of the remuneration provided to employees and meets
the incurred to earn income test in paragraph 18(1)(a).
3. The life insurance premiums on the president are deductible after June 1, 2009 since the insurance was
held as collateral by the bank [par. 20(1)(e.2)].
4. The costs related to the wrongful dismissal charge are deductible as a cost of doing business
[par. 18(1)(a)].
5. The repairs to the outside of the building are deductible as a cost of doing business as long as they are
not enhancing the value of the building [pars. 18(1)(a), (b)] and the costs of landscaping are specifically allowed
[par. 20(1)(aa)].
6. The interest on the municipal taxes is a cost of doing business [par. 18(1)(a)].
7. The severance payments are deductible as a cost of doing business [par. 18(1)(a)].
8. Theft by an employee is an inherent risk for most businesses and as such the theft usually is a
deductible business expense [IT-185R, par. 2, and Cassidys Limited v. M.N.R., 89 DTC 686 (T.C.C.)].
9. Sponsoring of the local theatre company and sponsoring of the little league teams are deductible as a
cost of doing business [par. 18(1)(a)] as long as they are reasonable in the circumstances. [See No. 577 v. M.N.R.,
58 DTC 307 (T.A.B.), and No. 601 v. M.N.R., 55 DTC 128 (T.A.B.).]
10. The costs of the staff Christmas party and summer barbeque is exempt from the 50% limitation for meals
and entertainment [par. 67.1 (2)(e)], to the extent that these occasional events do not exceed six times in a year.
11. The interest earned on the cash on hand is considered business income if the income is incidental to the
business. The funds were only held for a short time and related to payments on contracts [sec. 9].
12. The interest and penalties on the income tax instalments is not a deductible expense [par. 18(1)(t)].
However, the expense has been recorded as part of income tax expense. Therefore, it has already been added
back to income as part of the income tax expense addback. No further adjustment is required.

Solutions to Chapter 4 Assignment Problems

61

NOTES TO SOLUTION
(1) RPP [par. 20(1)(q) and ssec. 147.2(1)]
President
Least of:
(a) Employer plus employee RPP contributions ........................
(b) Money-purchase limit for 2010 ............................................
(c) 18% of compensation ...........................................................
Least amount ..............................................................................
Less: employee and employer contributions ......................................
Amount to be added back (excess of actual over deductible)

26,500
22,450
45,000
22,450
26,950
4,500

Vice-President
$

20,500
22,450
27,000
20,500
20,500
Nil

Accountant
$

10,800
22,450
12,600
10,800
10,800
Nil

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

Federal Income Taxation: Fundamentals

62
Solution 12 (Advanced)
(A)

Coco Hardys sewing service would appear to generate business income and not employment income. The
characteristics noted below would suggest that she is not an employee.
The Economic Reality and Entrepreneur Test
(a) The Control Test
The facts suggest that Ms. Hardy is engaged to achieve a prescribed objective and is given all the freedom
she requires to attain the desired result.
The fact that she may perform the same services as an apprentice with her employer, does not mean that the
services performed on her own time cannot be independent.
(b) Ownership of Tools/Risk Tests
Ms. Hardy owns her own tools such as the sewing machine and provides the work space. She takes at least
some financial risk in doing the sewing by incurring the direct costs.
The Integration or Organization Test
The relationships between Ms. Hardys sewing service and the various clothing manufacturers are
relationships of mutual dependency. The organization test is properly viewed from the perspective of the
individual performing the service. From the perspective of Ms. Hardy, it is her business and not that of the
clothing manufacturers. She issues billings in her own name instead of being part of the payroll or benefits
programs of the clothing manufacturers. She performs the work on her own time instead of having fixed hours
determined for her. She is free to work for others and has many customers. She can decide what is required and
how to do the work.
The Specific Result Test
Ms. Hardy has agreed to perform a specific task for each particular clothing manufacturer instead of
agreeing to be at their disposal on an ongoing basis.
(B)
Income from business for one year, assuming a reasonable expectation of profit:
Billings ($600 per month 12).........................................................................................................
Direct expenses [$6,025 - (50% of $500)] ........................................................................................
Allocated costs (excluding home office) ..........................................................................................
Loss from business before home office costs ...................................................................................

$ 7,200
(5,775)
(1,975)
$ (550)

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

$ 12,000
2,100
400
$ 14,500
20%

$ 2,900

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

Solutions to Chapter 4 Assignment Problems

63

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

$ 7,200

5,590
$ 1,610

2,820
Nil

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

64

Federal Income Taxation: Fundamentals

Solution 13 (Advanced)
Please note that since Peter lives in Saskatchewan, the HST does not apply, but PST and GST do.
Notes on restriction of deductions as an employee:
Total deductible home office expenses cannot be used to create a loss from employment income
[ssec. 8(13)]. However, any excess can be carried forward against employment income, in effect,
indefinitely. This loss limitation rule will not have an effect in this particular case since total deductible
expenses do not exceed remuneration. However, one of the following conditions must be met:
(a) the home office must be the place where the individual principally performs the duties of the office
or employment, or
(b) the home office was used exclusively and on a regular and continuous basis for meeting customers
in the ordinary course of performing the duties.
Since Peter uses one room in his home exclusively as a home office, uses the office most days and
evenings, and visits his office at work only once a week, spending the rest of the time on the road, it
appears that condition (a) is met because his home office is the place where he principally performs
the duties of the office or employment. This assumes that his duties are considered to be performed
principally from his home office and not principally from either his office at work or on the road. If it
can be argued, based on the facts of the situation, that his duties are performed principally on the road,
then neither condition (a) nor (b) is met and no home office expenses are allowed.
Mortgage interest, capital cost allowance on computer and interest on loan to purchase computer are
outlays on account of capital which are not deductible in computing employment income
[spar. 8(1)(f)(v)]. Subparagraph 8(1)(f)(v) does not permit the deduction of outlays of a capital nature
except as described in paragraph 8(1)(j). The only amounts permitted under paragraph 8(1)(j) which are
applicable, in this case, are capital cost allowance and interest on a car.
Utilities and maintenance and repairs all qualify as supplies under paragraph 8(1)(i), but house
insurance and municipal taxes do not [IT-352R2, paragraph 5].
House insurance, municipal taxes, and the rental of the photocopies and fax machine are only
deductible under paragraph 8(1)(f).
Long distance telephone calls are deductible under subparagraph 8(1)(i)(iii) as supplies [IT-352R2,
par. 9(d)].
The monthly charge for the family internet connection is not deductible because it is a personal
expense. It is neither wholly nor partially applicable to the employment income source, in this case, and
does not meet the condition in the wording of the preamble to ssec. 8(1). A separate phone line would
be deductible under paragraph 8(1)(f).
Section 67.1 restricts the deduction for all meals and entertainment to 50% of the amount incurred. This
applies to the theatre tickets and all meals related to travelling and to entertaining clients.
Meals and entertainment (limited to 50%) and promotional gifts ($1,300) are deductible under
paragraph 8(1)(f) only. However, subsection 8(4) denies the deduction for meals unless the employee
incurs these expenses while performing his/her employment duties, for a period of not less than
12 hours, away from the municipality where his/her employers establishment is located and where
he/she ordinarily reports for work.
The country club membership ($3,200) is not deductible because paragraph 8(1)(f) does not allow the
deduction of expenses referred to in paragraph 18(1)(l).
Travelling expenses re car: because only 32,000km out of the 40,000 km driven are employmentrelated, only 80% of the car expenses are deductible with the exception of the cellular phone airtime
and parking expenditures which are 100% employment-related. These amounts are deductible under
paragraph 8(1)(h.1) or 8(1)(f), except for the cellular phone airtime which is deductible under
subparagraph 8(1)(i)(iii) as supplies per IT-352R2, paragraph 9(d).
The maximum CCA claim is restricted to the CCA on $30,000 (2009 acquisition) plus GST (6%) and
PST (10%). 80% of the CCA claim is deductible [spar. 8(1)(j)(ii)].
All of the travelling expenses are deductible under paragraph 8(1)(f), subject to the section 67.1
restriction of 50% for meals and entertainment. However, the deduction under paragraph 8(1)(h)
excludes the out-of-town entertainment.
Deductible expenses under paragraph 8(1)(f) total $18,162 but the maximum amount deductible
thereunder is limited to the $17,000 bonus based on sales. Note that Peter may still deduct amounts
under paragraphs 8(1)(i) (in respect of supplies) and 8(1)(j) (in respect of capital cost allowance and
interest) outside of this limit [IT-352R2, pars. 5 and 9]. His total claim is therefore $29,022.
The alternative is to deduct travel expenses under paragraph 8(1)(h) and car expenses under
paragraph 8(1)(h.1) which are not limited to his $17,000 bonus based on sales rather than a deduction
under paragraph 8(1)(f). Capital cost allowance under paragraph 8(1)(j) and expenses under

Solutions to Chapter 4 Assignment Problems

65

paragraph 8(1)(i) would be claimed as well. Since his total claim under this alternative is $23,814, Peter
is better off making a claim under paragraphs 8(1)(f), (i), and (j).
Notes on restriction of deductions as a proprietor:
The home office restrictions in subsection 18(12) are very similar to the rules in subsection 8(13).
Home office expenses cannot be used to create a loss but any excess can be carried forward, in effect,
indefinitely. Subsection 18(12) only allows the deduction of home office expenses in the computation
of business income if one of the conditions in subparagraphs 18(12)(a)(i) or (ii) are met. These
conditions are very similar to the conditions in subparagraph 8(13)(a)(i) and (ii) as outlined above for
an employee.
The home office expenses are not restricted to deductions in section 8 therefore the mortgage
interest, the CCA on the computer and the interest on the computer loan are allowed. Peter could deduct
capital cost allowance on office portion of the house (the amount is not given in the question), but it is
not advisable since it would disqualify that portion of the house from a principal residence exemption.
(See Chapter 7.)
Subsection 20(10) allows a deduction for up to two conventions in locations which are consistent with
the territorial scope of a business.
COMPARISON OF DEDUCTIONS
for Mr. Peter Rajagopal
Ordinary
employee
[s. 8(1)(h),
(h.1), (i), (j)]
Home office:
Utilities (10% $3,100)................................... $
Mortgage interest(2) (10% $12,000) ..............
House insurance(2) (10% $1,150) ..................
Municipal taxes(2) (10% $3,050) ...................
Maint. and repairs (10% $2,700) ..................
CCA on computer ($6,900 15%) ..................
Rental of photocopier .......................................
Rental of fax machine ......................................
Office supplies .................................................
Interest on computer loan .................................
Telephone:
Internet .............................................................
Long distance calls ...........................................
Promotional expenses:
Meals (with clients) (50% $2,100) ................
Theatre (50% $1,200) ...................................
Promotional gifts..............................................
Country club membership ................................
Automobile expenses:
Gas & oil (.8 $2,000) ....................................
Insurance (.8 $1,100) ....................................
Licence (.8 $90) ............................................
Repairs (.8 $800) ..........................................
Cellular phone airtime ......................................
Parking .............................................................
CCA on car(3) ...................................................
Interest on loan (.8 $800) [under limit of
$300/mo.] .........................................................
Other travel expenses:
Airfare ..............................................................
Accommodation ($4,960 $2,400)..................
Meals (50% $2,400)......................................
Convention (excl. meals) .................................
Meals and entertainment ($3,200 50%) ........
Total ......................................................................... $
Limit ........................................................................
Deduction(5).............................................................. $

310(1)

270

750

Salesperson/Negotiators

[s. 8(1)(f)]

[s. 8(1)(i), (j)]

$

115
305

1,200
200

310

Proprietor
$

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

270

750

1,000

1,000

1,000

1,050
600
1,300

1,050
600
1,300

1,600
880
72
640
700
320
8,280

1,600
880
72
640

320

700

8,280

1,600
880
72
640
700
320
7,920

640

640

640
4,520
2,560
1,200

23,742
none
23,742

4,520
2,560
1,200

1,600
18,162
$
17,000
$28,950

11,950
none

$
$

4,520
2,560
1,200
800(4)
1,600
33,107
none
33,107

66

Federal Income Taxation: Fundamentals

NOTES TO SOLUTION
(1) Deductible [spar. 8(1)(i)(iii)], as explained in IT-352R2, par. 5.
(2) Based on the case of Felton v. M.N.R., 89 DTC 233 (T.C.C.), and concurred with in The Queen v.
Thompson, 89 DTC 5439 (F.C.T.D.), mortgage interest, municipal taxes, and house insurance are not deductible
by an employee as office rent under subparagraph 8(1)(i)(ii). (See also IT-352R2, paragraph 6, which indicates
that taxes and insurance are deductible under paragraph 8(1)(f).)
(3) For an employee, the CCA would be $8,280 (32k/40k $30,000 1.15 30%). Peter would receive a
GST rebate in 2011 for all his deductible expenses except the car CCA and car insurance with an offsetting
income inclusion of 5/ 105 of the same amount. As a sole proprietor and a GST registrant, he would receive an ITC
for all his expenses except the CCA and car insurance. The CCA would be $7,920 (32k/40k $30,000 1.10
30%).
Capital cost allowance and interest on car, deductible under paragraph 8(1)(j), and certain office costs and
supplies deductible under paragraph 8(1)(i), (IT-352R2, pars. 5 and 9) are not restricted by the amount of
commission income. The restriction applies only to amounts deductible under paragraph 8(1)(f).
(4) Note that the provisions in sections 18, 19 and 20 pertain to expenditures including convention
expenses deductible from income from business. However, the deduction of such expenditures is far more
restricted in subsection 8(1) and, while convention expenses are allowed by subsection 20(10), convention
expenses would not be allowed by any of paragraphs 8(1)(f),(h),(h.1), or (i). Note that only 50% of the cost of
meals consumed at a convention is deductible, where the cost of meals is known; otherwise 50% of $50 or (i.e.,
$25) per day is deductible.
(5) Neither of the deduction limits in subsection 8(13) or subsection 18(12) applies in this case, because
there will not be an employment or a business loss.

Solutions to Chapter 4 Assignment Problems

67

Solution 14 (Basic)
Net loss before tax for accounting purposes
Add: disallowed deductions (Note 1):
Provision for returns (subparagraph 12(1)(a)(ii))
Non-deductible portion of travel meals (Note 2)
Non-deductible car expenses (paragraph 18(1)(a)) (Note 3)
Health club dues (paragraph 18(1)(l ))
Nanny expenses (paragraphs 18(1)(a),(h)) (Note 4)
Non-deductible portion of entertainment (Note 2)
Renovation costs (paragraph 18(1)(b)) (Note 5)
Straight-line amortization (paragraph 18(1)(b))
Home office expenses (paragraph 18(1)(b)) (Note 6)
Less: allowable deductions:
Bad debts expense (paragraph 20(1)(p))
Net business income

($11,500)
$1,200
750
470
2,200
12,000
900
21,200
3,800
1,400

43,920
( 380)
$32,040

Notes:
1. The private dental plan expenses are for the staff and hence, are deductible as compensation.
2. Subsection 67.1(1) only allows a deduction of 50% of meal and entertainment expenses.
3. Only business portion deductible: ((3,600/18,000) $2,350).
4. Wynns child care expenses are not deductible in the computation of business income for tax purposes. He
would, however, be entitled to take a child care expense deduction on his personal tax return in determining
his overall net income.
5. This is an outlay on account of capital, therefore, it is not deductible against current income. The amount is
added to the relevant CCA pool.
6. Wynn does not qualify for home office deductions due to the restrictions under subsection 18(12), because
it is not his principal place of business and he does not use it to continuously meet clients.

68

Federal Income Taxation: Fundamentals

Solution 15 (Advanced)
Net income for tax purposes before R&D ....................................
Add:
Amount booked for salaries .................................................
Amount booked for operating costs of lab ...........................
Investment tax credits on lab machinery and equipment(2) .......
Investment tax credits on salaries(3) .....................................
Investment tax credits on operating costs of lab(3) ...............
Deduct:
100% of cost of lab machinery and equipment(4) .................
100% of lab salaries .............................................................
100% of lab operating costs .................................................
Net income for tax purposes ........................................................

2010
615,000(1)

2011

Reference
(2)

65,000
26,000
157,500
35,000
14,000
(450,000)
(100,000)
(40,000)
$ 116,000

Pars. 37(1)(e); &

12(1)(v)
same as above
Par. 37(1)(b)
Par. 37(1)(a)
Par. 37(1)(a)

NOTES TO SOLUTION
(1) The amortization has already been added back in arriving at this number. CCA on the building would
have been deducted.
(2) We can only determine the impact of the year 2010 R&D expenditures on the year 2011 income, but we
do not know any further details of the income for tax purposes for the year 2011, as this is yet to be determined.
(3) In reality, a pool of R&D expenditures would be created in the year 2010 and include all of the amounts
deducted above. This pool will be reduced to Nil to the extent that all of the year 2010 eligible expenditures on
R&D are in fact claimed on the tax return. This pool will increase in 2011 by any R&D expenditures made in
that year and eligible for deduction under section 37. The balance in this pool will then be reduced in 2011 by the
investment tax credits (in total $206,500, i.e., 35% of ($450,000 + $100,000 + $40,000)) claimed in the
preceding year (2010) thus resulting in a smaller pool of available deduction in the year 2011.
(4) The building is not eligible for the 100% write-off due to the restriction in paragraph 37(8)(d).

Solutions to Chapter 4 Assignment Problems

69

Solution 16 (Advanced)
Note that the financial statements presented in the problem are unaudited and, hence, may not follow GAAP.
Net income after taxes per income statement
Add: Provision for income taxes ..........................................................
Payment to registered pension plan in excess of $5,820 (i.e.,
(18% of $74,000) $7,500) deductible in 2009 ($7,000
$5,820)(1) ..............................................................................
Warranty reserve on companys product(2)...................................
Depreciation expense ...................................................................
Cost of shareholder agreement (an expenditure of a capital
nature pertaining to the sale of shares by shareholders)(3) ....
Non-deductible issue expense (4/ 5 $12,700)(4) ..........................
Golf club membership fees ..........................................................
Donation to United Way (not deductible from business income).
Non-deductible portion of meals and entertainment (50% of
$4,000) .................................................................................
Appraisal fee (an expenditure of a capital nature)........................
Life insurance premium (does not earn income) ..........................
Unpaid management bonuses(5)....................................................
Amortization of bond discount(6)..................................................
SR&ED per financial statements..................................................

$ 111,300
$

52,000

Pars. 18(1)(e), (t)

Par. 20(1)(q)

1,180
16,000
30,000

Par. 18(1)(e)
Par. 18(1)(b)
Par. 18(1)(b)

8,500
10,160
2,200
3,000

Par. 20(1)(e)
Par. 18(1)(l)
Par. 18(1)(a)
Sec. 67.1

2,000
6,200
2,800
20,000
3,400
76,700

Interest and penalties....................................................................

1,250
Deduct: items not deducted in accounting statements but deductible
for tax purposes:
SR&ED Pool(7) .......................................................................................................
Net income from business and/or property for tax purposes ......................................

235,390

(190,000)
$ 156,690

Par. 18(1)(b)
Par. 18(1)(a)
Ssec. 78(4)
Par. 18(1)(b)
Pars. 37(1)(e),
12(1)(v)
Par. 18(1)(t)

Par. 37(1)(b)

Items not included in computation above:

Landscaping costs deductible [par. 20(1)(aa)].
Interest on loan to buy shares deductible [par. 20(1)(c)].
Interest on property taxes deductible as incurred to earn income [par. 18(1)(a)].
Insurance proceeds to compensate for profits included [sec. 9].
Investment tax credit on SR&ED claimed in 2010 to be included in income in 2011.
Dividends received are included in income from property [par. 12(1)(j)].
Volume rebates and purchase discounts reduce the cost of goods sold as a part of normal business
operations.
NOTES TO SOLUTION
(1) The excess contribution would not be in violation of RPP registration requirements, since it was
contributed in the first 120 days of 2011 and will likely be deductible in respect of 2011.
(2) Paragraph 20(1)(m.1) permits a manufacturer to deduct prepaid insurance premiums paid to insure
against risk under extended warranties sold to customers. The reserve must be in respect of goods to be delivered
or services to be rendered under the warranty and cannot exceed the prepaid portion of the premium that was
payable to an insurer that carried on an insurance business in Canada. The reserve in this case does not qualify.
(3) The potential subsection 15(1) benefit to the shareholder is not considered in this problem.
(4) One-fifth of legal and accounting fees deductible [par. 20(1)(e)].
(5) The amount of a bonus unpaid 180 days after the end of the employers fiscal period can only be
deducted when it is paid and not when it was incurred.
(6) A deduction for a bond discount is available within the limits of paragraph 20(1)(f) only at the earlier of
redemption or maturity of the bonds when the amount is paid. Since no amount is paid, as required by
paragraphs 18(1)(f) and 20(1)(f), the amortization is like a reserve which is denied [par. 18(1)(e)] or is considered
to be on account of capital and denied [par. 18(1)(b)].
(7) SR&ED adjustments
The research and development expenditures on the financial statements are made up of the following:
Current SR&ED expenditures
Amortization of capital expenditures net of ITC
[($90,000 35% of $90,000)/5]
ITC for current expenditures
Net accounting deduction added back for tax

$100,000
11,700
(35,000)
$ 76,700

Federal Income Taxation: Fundamentals

70
In 2010, the SR&ED Pool is made up of the following:
Current SR&ED
Capital SR&ED
Total before deduction
Deducted
Balance carried forward

$100,000
90,000
190,000
(190,000)
Nil

In 2011, the total ITC claimed in 2010 would be added to income:

Current (35% of $100,000)
Capital (35% of $90,000)
Total additional income

$ 35,000
31,500
$ 66,500

Over the two-year period, the net cost of $123,500 (65% of $190,000) will have been deducted for tax:
Current ($100,000 $35,000)
Capital ($90,000 $31,500)
Total deducted for tax

$ 65,000
58,500
$123,500

Solutions to Chapter 4 Assignment Problems

71

Solution 17 (Advanced)
(A) Since the corporation is carrying on business, it is engaged in a commercial activity. [ETA: ssec. 123(1)]
Therefore, the corporation is required to register and collect HST on its supplies, i.e., sales of goods, which are
taxable supplies. As a registrant, the corporation is entitled to a full input tax credit (ITC) in respect of HST
paid or payable on goods and services that it purchases for use in its commercial activity. [ETA: ssec. 169(1)] If
HST collected or collectible on its sales exceeds its ITCs, the corporation must remit the difference. On the other
hand, if ITCs exceed HST collected or collectible, a refund of the excess is available.
Since the corporations annual revenue is less than $6 million but greater than $500,000, it will be required
to file HST returns on a quarterly basis. It may, however, elect to file HST returns on a monthly basis.
(B)(1) The following items listed in the additional information notes represent costs incurred for taxable supplies,
eligible for an ITC:
(a) landscaping costs incurred for goods and services
(b) costs of arranging a shareholder agreement, which may include, for example, legal fees which are
subject to HST
(c) legal and accounting fees related to the issue of shares
(d) costs of meals and entertainment deducted (i.e., only 50% of the HST paid gives rise to an ITC)
[ETA: sec. 236]
(e) appraisal fees incurred for service
(f) current SR&ED expenditures incurred that would likely be for goods and services
(2) The following items listed in the additional information notes represent costs incurred for exempt supplies,
not eligible for an ITC, since no HST was paid:
(a) employer contributions to a registered pension plan
(b) interest on a bank loan that results from a financial service which is an exempt supply [ETA: ssec. 123(1)]
(c) interest paid on late municipal taxes that results from a financial service
(d) donations involve a transfer of money without consideration [ETA: ssec. 123(1)]
(e) insurance premiums are for an exempt supply of a financial service
(f) a bond discount, which is a cost incurred in respect of a financial service and is an exempt supply
(g) interest and penalties charged by governments
(C) Appropriate HST treatment of other items:
Net income according to financial accounting statements is comprised of revenues and costs (expenses).
HST would have been charged on the revenue items and HST would have been paid on the expenses.
HST charged net of ITCs from HST paid or payable must be remitted.
There are no HST implications for the provision for income taxes.
A charge to customers for a warranty would be subject to HST, which must be remitted by the
corporation collecting it. Expenses incurred under the warranty may be subject to HST, which will
provide the corporation with an ITC. Increasing the reserve, by itself, will have no HST consequences.
HST paid on the purchase of depreciable property provides an ITC, as discussed in Chapter 5. When the
cost of the asset is subsequently written off through depreciation or capital cost allowance, there are no
further HST implications.
The capitalization of SR&ED expenses would not have any HST consequences.
As the issue of shares is a financial service, an ITC would not normally be available to the corporation.
However, where HST has been paid on services, relief is available [ETA: sec. 185], since the financial
service is related to the commercial activities of the corporation. This provision would allow the payer
corporation to claim an ITC.
Golf membership fees do not give rise to an ITC, because HST paid on golf membership is not
deductible as an expense [ETA: par. 170(1)(a)].
Amounts paid to employees as remuneration are not supplies, since these amounts are excluded from the
definition of services in subsection 123(1) of the ETA. As a result, remuneration is not subject to HST.
Items included in financial accounting statements:
i) Insurance premiums are paid in respect of a financial service which is an exempt supply. An amount
received from an insurance company under a policy also involves an exempt supply of a financial service.
ii) Dividends received involve an exempt supply of a financial service on which no HST is collected.
iii) Cash discounts reduce the cost of goods on which HST is paid only where the customer is invoiced
for the net amount. However, if the invoice is for the full amount and a cash discount is
subsequently taken, the cost of goods on which HST is paid is not reduced. Thus, the payer may
claim a full ITC. [ETA: sec. 161] Adjustments made to reflect changes in the consideration payable
for a supply arising from volume rebates will allow the supplier to refund the excess HST charged,
provided a credit note is issued. Thus, the payers ITC will be reduced. [ETA: sec. 232]

Federal Income Taxation: Fundamentals

72
Solution 18 (Advanced)
(A)
Employee Benefit
Salary

Employee Tax Impact

Taxable to employee

Employer Tax Impact

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

Bonus

Taxable to employee

Deductible as compensation expense

if paid within 179 days of year-end

Interest-free loan

No impact for employer

Moving cost reimbursement

Group life insurance plan premiums

Imputed interest taxable benefit

partially offset by deduction
Not taxable to employee
Taxable benefit to employee
Not taxable to employee

Deductible as compensation expense

4
5

Private health, dental, and drug plan

premiums
Spouse's travel expenses
Automobile standby charge

Taxable benefit to employee

$6,800 taxable benefit to employee

6
7

Automobile operating benefit

Fitness club access
Physical health counseling services

$3,360 taxable benefit to employee

Not taxable to employee
Not taxable to employee

May not be deductible by employer

Lease cost deductible as business
expense to a specified limit
Deductible as business expense
Not deductible for employer
Deductible as compensation expense

DPSP contributions

Not taxable to employee

Yacht access

Taxable benefit to employee

Note #
1

Deductible as business expense

Deductible as compensation expense

Specified amount deductible by

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

NOTES TO SOLUTION (A)

1. The full amount of Valeries salary, wages, and other remuneration, including bonuses, received in the
calendar year are included in the computation of her income from an office or employment under
subsection 5(1) for that particular calendar year. A bonus tied to performance in respect of one calendar year,
but paid in the following calendar year, is taxed only in the year it is received.
Salaries, wages, and other remuneration paid to Valerie by Key are considered expenses incurred to earn
profit from the business under subsection 9(1) and not denied under paragraph 18(1)(a) as not incurred for
the purpose of gaining or producing income from the business. Therefore, it is deductible. These amounts,
including the bonus, must be paid to Valerie within 179 days after the firms taxation year to be deductible by
Key or they become deductible in the taxation year in which they are actually paid [subsection 78(4)].
2. Interest-Free Loan
This creates a taxable benefit annually equal to the amount by which the prescribed interest on the loan
exceeds the actual amount of interest paid on the loan in respect of the year up to 30 days after the end of the
year [ssec. 6(9), 80.4(1)]. Because the loan is interest-free, the benefit is equal to the prescribed interest.
Since the loan will be used by Valerie to buy a home, the prescribed rate used to calculate the taxable benefit,
for five years, will not exceed the prescribed rate in effect at the time the loan is made [ssec. 80.4(4)].
Subsection 80.4(6) deems the loan to be renewed every five years at the prescribed rate in effect on that fiveyear anniversary date.
Since Valerie will have an eligible relocation, the loan qualifies as a home relocation loan and, thus, Valerie
will be entitled to a deduction in computing her taxable income for the first five years of the loan effectively
equal to the prescribed rate applied to a $25,000 loan [par. 110(1)(j)].
The loan to Valerie will be a home relocation loan [ssec. 248(1)], because:
Valerie will commence work at a new work location in Canada;
she will move from a former residence to a new one;
the move will bring her at least 40 kilometres closer to her new work location (measured as the
difference between the distances travelled from the new work location to each of the old and new
homes);
the loan will be received in her capacity as an employee;
the loan proceeds will be used to buy a home to be occupied by her;
the loan will be designated by her as a home relocation loan; and

Solutions to Chapter 4 Assignment Problems

73

there will be no other home relocation loans in connection with the move or outstanding at the
time.

The home relocation loan deduction for Valerie is calculated under paragraph 110(1)(j) as the least of:
the imputed interest benefit on the home relocation loan
$25,000 x the prescribed rate
the imputed interest benefit on all loans from her employer
The deduction is available for the first five years of the loan, or for the period to the date the loan is
extinguished, if shorter.
The home loan results in no tax implications to the employer, since it neither paid nor received interest on the
loan. If the company had to borrow to fund the loan then the interest expense would be deductible as a
compensation-related expense.
Reimbursement of Moving Costs
This is not considered to be a taxable benefit by administrative policy [IT-470R]. Typically, a reimbursement
allows an employee who paid an expense to recover an amount that is the business expense of the employer.
The reimbursement would reduce the amount the employee can claim as a moving expense under section 62.
3. Employer-paid premiums to group term life insurance and health services plans (including health, dental, and
drug plans) are specifically exempted from inclusion as a fringe benefit in calculating income from an office
or employment under subparagraph 6(1)(a)(i). However, this exemption is overruled for group term life
insurance premiums by subsection 6(4), which states that the full amount of these specific premiums paid on
an employees behalf is to be included in the income calculation as a taxable benefit.
Key will be able to deduct the full amount of premiums paid as compensation expense.
4. Amounts paid in respect of Matts travel are considered a taxable benefit to Valerie under the general rule
that benefits of any kind are taxable as employment income, unless otherwise exempted [par. 6(1)(a)].
Expenses relating to Matts travel may not be deductible by Key, as they may not be considered to have been
incurred for the purpose of gaining or producing income from the business [par. 18(1)(a)] or they may be
considered to be personal or living expenses [par. 18(1)(h)]. However, it may also be argued that this is part
of the normal compensation package and therefore deductible by the employer.
5. Valerie will receive both a taxable operating cost and standby charge benefits with respect to the automobile.
The standby charge (capital benefit) is taxable under paragraph 6(1)(e) and is calculated using the formula in
subsection 6(2). Since the automobile is not used primarily (more than 50%) in the performance of
employment duties, the operating benefit is calculated using the kilometre method presented in
subparagraph 6(1)(k)(v). The calculation of the income inclusions is as follows:
ITA 6(1)(k) Operating benefit 14,000 km x 24
$ 3,360
ITA 6(1)(e) Standby charge:
ITA 6(2)
2/3 x $850 x 12 months
6,800
$10,160
All operating expenses paid during the year in respect of the car are deductible as a compensation expense by
Key. The cost of leasing the BMW will be deductible by Key as well up to the limit allowed by the
calculations outlined in section 67.3, which is $800 plus HST on the $800.
6. By administrative policy (IT-470R), the benefit derived by an employee, through use of employer-provided
recreational facilities, is not normally taxable.
Recreation club expenses or dues are specifically excluded from being deducted by Key under
paragraph 18(1)(l).
7. The value of any benefit received by Valerie relating to counselling services in respect to her physical health
is specifically exempted from being a taxable benefit under clause (6)(1)(a)(iv)(A).
The expenses incurred by Key in respect of physical health counselling will be deductible as compensation
expenses.
8. By exception to the general rule on benefits, DPSP contributions are not taxable when they are contributed to
the plan (spar. 6(1)(a)(i)). Both the contributions and the investment returns on the contributions remain nontaxable until the year which they are paid out to Valerie.

74

Federal Income Taxation: Fundamentals

The payments to the DPSP by Key are deductible under paragraph 18(1)(j) to the extent that they are paid to
a trustee within 120 days after the end of the taxation year and do not exceed an amount equal to the lesser
of:
a) One-half of the money purchase limit for the year as defined in subsection 147.1(1), and
b) 18% of the employees compensation as defined in subsection147.1(1).

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

Solutions to Chapter 4 Assignment Problems

75

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

Federal Income Taxation: Fundamentals

76
Case 2: Greater Prospects Ltd.
ADVISORY CASE DISCUSSION NOTES
To: Samara
c.c.: Greater Prospects
From: Adviser

This memo is to inform you of the tax consequences of the items brought out by the CRA reassessment.
The reassessment has raised the following issues:
(1) Is the bonus declared in 2009 deductible for tax purposes?
(2) How is the interest on the interest-free loan accounted for?
(3) Is your relationship with Greater Prospects that of an employee or that of an independent
contractor?
(4) Are the expenses relating to the fishing lodge deductible?
I will assume that Greater Prospects year end is December 31.
The bonuses paid to Samara and the senior VP were not paid out within 180 days of the end of the year
and therefore, according to subsection 78(4), they are not deductible in 2009, although they are deductible in
2010 when paid.
There will be an imputed interest benefit on the loans as a taxable benefit to the employees, pursuant to
subsection 6(9). Greater Prospects will be able to deduct the $20,000 interest paid on its loan as an
employment expense. The employees may be able to deduct their taxable benefit as interest expense against
investment income, but this has nothing to do with the company.
Samaras status as an independent contractor through Sole Trust is being challenged by the CRA. The
issue is whether Samara is really an employee. If she is, Greater Prospects was required to make the
appropriate deductions for tax, EI, and CPP. The issue would be decided on the tests of employee versus
independent contractor. Based on the limited information in the question, it would appear Samara and Sole
Trust would fail all four tests control, integration and organization, economic reality (risk borne), and
specific results. Samara is an employee of Greater Prospects. Thus, the company is liable for any assessment
for failure to deduct tax, EI, and CPP.
The fishing lodge rental is denied under paragraph 18(1)(l). This is an explicit prohibition and could not
be successfully challenged. Some corporations carry out corporate retreats in hotels and convention centres
and the related expenses are successfully deducted. The meals and entertainment costs for clients are being
restricted by the CRA under an explicit rule in section 67.1.

Solutions to Chapter 4 Assignment Problems

77

Case 3: London City Electronics Inc.

ADVISORY CASE DISCUSSION NOTES
Allowance for doubtful accounts

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

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

Exchange of goods for accounts receivable

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

Warranty claims

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

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

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

Set up a reserve for potential law suits

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

Federal Income Taxation: Fundamentals

78
Case 4: Kitchener Medical Inc.
ADVISORY CASE DISCUSSION NOTES
This case deals with:

the start-up of a business, and

the form of ownership.
1. Opening party
Are the deductible costs limited to 50% [sec. 67.1]?
Who attended the party? If it was mainly for suppliers and customers, then it does not meet the
exception in subsection 67.1(2).
2. When did the business start? [See IT-364: Commencement of business operations]
This determines when the expenses start to be deductible.
IT-364 states that a business commences whenever some significant activity is undertaken that is a
regular part of the income-earning process in that type of business or is an essential preliminary to
normal operations.
Market research is an essential preliminary.
3. Trip to California
This will not be deductible since there was no business being carried on at the time.
They were just searching for a business.
4. Expenses incurred before incorporation [See IT-454: Business transactions prior to incorporation]
The Canada Business Corporations Act and some provincial jurisdictions allow the company, within
a reasonable time after it came into existence, to adopt any contracts made in its name or on its behalf
before it came into existence.
If the jurisdiction of incorporation does not allow for this, then the CRA will allow the deduction by
the corporation of pre-incorporation transactions if five conditions are met.
(a) The facts clearly indicate that it is the intention of those persons who authorize the transactions in
the situations described above that the business will be carried on by a corporation. This will
usually be so where application for incorporation is made before or at the time the business is
commenced or purchased.
(b) The period of time between the commencement or purchase date and the incorporation date is
relatively short or, if not, the delay is not due to any action taken or not taken by the parties
involved.
(c) There is no dispute between the persons authorizing the transactions and the newly formed
corporation as to who will account for the transactions.
(d) The effect on the combined tax liabilities of the parties involved is negligible.
(e) The corporation adopts any written contract made in its name or on its behalf before it came into
existence in respect of the pre-incorporation transactions it is accounting for.
eleven months may be too long a period to accumulate pre-incorporation transactions
5. Partnership alternative
Joe and Bill could carry on business as a partnership and deduct the start-up losses against any
personal income they might have.
Once the business becomes profitable, they could transfer the business to the corporation
[ssec. 85(1)] to defer tax through the small business deduction.
6. Ownership of share capital or partnership interest
Bill is going to manage the business and Joe is providing the capital.
How will they share the ownership if they want a 50/50 interest?
Joe could take preference shares for his capital and receive dividends on these shares. They could
then each have 50 common shares.
Joe could loan the capital to the corporation with or without interest being charged. This way, he
could get security on his loan.
7. Incorporation costs
These are eligible capital expenditures; 75% of them are added to the pool and depreciated at 7% per
year.
8. Financing costs
Deductible at 20% straight line over five years [par. 20(1)(e)].

Solutions to Chapter 4 Assignment Problems

79

9. Leasehold improvements
Amortize over the term of the lease plus one renewal period [Class 13].
Half-year rule applies [Reg. 1100(2)(a)(iii)].
Keep the initial term and renewal period less than 5 years in total to maximize the deduction.
10. Travel and entertainment expenses
Entertainment expenses limited to 50% [sec. 67.1].
11. Purchase of assets
Inventorydeducted in the year it is sold.
Customer listeligible capital expenditure.
Accounts receivablethe section 22 election should be made to allow the purchaser to deduct any
losses on the collection of the accounts receivable as a business loss and not a capital loss.
o Need to acquire at least 90% of the active business assets in order for the election to be available.
Equipment will be added to the CCA class to which it belongs.
12. Compensation
Bill is providing the labour and Joe is providing the capital.
How will they each be compensated?
Joe could receive dividends or interest on his capital as suggested above while Bill would receive a
salary.
o Joe would have difficulty receiving a bonus since he is not active.
Consideration should be given to paying Joe a guarantee fee for providing his guarantees.
Once the salary, interest and guarantee fees are paid they could share the extra profits as dividends.
If a partnership is used then the sharing of profits is much easier, all they have to do is agree between
themselves.
13. Legal agreements
Either a shareholder or a partnership agreement is necessary.

CHAPTER 5

Depreciable Property and Eligible Capital Property

Solution 1 (Basic)
Silvias decision to sell her van and replace it with a leased van has a number of income tax implications.
First, CCA class 10 is credited for the lower of cost or proceeds, or $10,300. The balance of $3,980 becomes a
terminal loss (subsection 20(16)) in the year of disposition.
UCC on van
Disposition
Lesser of cost or proceeds
Terminal loss

$14,280
10,300
$ 3,980

Second, the lease payments are deductible in the current year, assuming an operating lease.

81

Federal Income Taxation: Fundamentals

82
Solution 2 (Advanced)
Cl. 1-MB:
10%
$
Post-Mar. 2009 Purchases:(1)
Manufacturing
equipment ...............
Tools .........................
Dies and moulds .......
Computer equipment/software(2) ......
Photocopier ...............
Office furnishings .....
Delivery van .............
TV commercial video
tape.........................
Chairs and tables .......
Cutlery and dishes.....
Table linens ..............
Automobile(3) ............
Licence to
manufacture(4).........
Leasehold
improvements(6) ......
Dec. 31, 2009 UCC before
adjustment ................
1
/ 2 net-amount(5) ........
UCC before CCA
CCA prorated 306/ 365
days ........................
1
/ 2 net-amount ...........
Jan. 1, 2010 UCC ..........
Purchases:
Brick building(7)......
Office furniture ......
Disposals:
Photocopier ............
Automobile(8)..........
Office furnishings ...
TV commercial video
tape ......................
Small tools .............
Dec. 31, 2010 UCC before
adjustment ................
1
/ 2 net-amount ...........
UCC before CCA ......
CCA .........................
Recapture ..................
Terminal loss ............
1
/ 2 net-amount ...........
Jan. 1, 2011 UCC ..........

Cl. 8:
20%
(Sep.)
$

Cl. 8:
20%

Cl. 10:
30%

Cl. 10.1:
30%

Cl. 12:
100%

Cl. 13:
S.L.

Cl. 14:
S.L.

Cl. 29:
50%

Cl. 52:
100%

20,000
16,000
8,000
12,000
6,000
15,000
28,000
22,000
2,500
2,000
1,200
30,000
30,000
9,000
6,000
(3,000)
3,000

17,500
(8,750)
8,750

28,000
(14,000)
14,000

30,000
(15,000)
15,000

49,200
(15,000)
34,200

9,000

30,000

20,000
(10,000)
10,000

12,000

9,000

30,000

(503)
3,000
5,497

(1,467)
8,750
16,033

(3,521)
14,000
24,479

(3,773)
15,000
26,227

(28,672)
15,000
20,528

(629)

(8,384)

(10,060)

21,616

(4,192)
10,000
15,808

8,371

12,000

1,940

90,000

(4,000)
(23,000)

(18,000)
(5,000)
90,000
(45,000)
45,000
(4,500)

1,497

16,033

24,479

(3,277)

(2,472)

8,371

21,616

15,808

1,940

1,497

16,033
(3,207)

24,479
(7,344)

Nil
(3,934)

(2,472)

8,371
(1,500)

21,616
(10,000)

15,808
(10,000)

1,940
(1,940)

6,871

11,616

5,808

Nil

2,472
(1,497)
45,000
85,500

Nil

12,826

17,135

Nil

Nil

NOTES TO SOLUTION
(1) The customer lists purchased for $4,000, which are expected to be usable indefinitely, are eligible capital
property.
(2) She should elect [Reg. 1101(5p)] to include the photocopier in a separate Class 8 from the office
furnishings.
(3) The maximum cost for Class 10.1 is $30,000 (for 2009) plus HST [Reg. 7307(1)(b)]. HST would be
refundable. There is no recapture or terminal loss on the disposition of a Class 10.1 vehicle [ssecs. 13(2) and
20(16.1)].
(4) The $30,000 licence to manufacture, based on patented information, Tax is a Microcosm of Life on
CD expiring February 28, 2012 can be treated as:
(a) a Class 44 asset with CCA claimed on a declining-balance basis at the rate of 25%, or
(b) a Class 14 asset with CCA claimed on a straight-line basis over the remaining 1,095-day (3-year) life of
the licence, since Regulation 1103(2h) allows a taxpayer to elect that the property not be included in
Class 44.
Because Class 14 treatment allows for a faster write-off of the cost of the licence, she should elect that the
property not be included in Class 44. Class 14 CCA for 2009 is $30,000 306/1095 days = $8,384. Class 14
CCA for 2010 is $30,000 365/1095 = $10,000.

Solutions to Chapter 5 Assignment Problems

83

(5) Some Class 12 items, such as the tools, cutlery and linen in this case, are not affected by the half-year
rule.
(6) Lesser of: (a) 1/ 5 capital cost ($9,000) = $1,800
(b)

capital cost
$9,000
=
= $1,500
3+3
remaining lease term plus first renewal option

The CCA for 2009 is $1,500 1/ 2 306/365 = $629.

The CCA for 2010 is $1,500.
(7) Since the building represents 45% of the total cost of the $200,000, the cost of the building is $90,000.
(8) Cl. 10.1: $26,227 .30 1/ 2 CCA = $3,934 in year of disposition [Reg. 1100(2.5)].

Federal Income Taxation: Fundamentals

84
Solution 3 (Advanced)
2009

2010
2011

Acquisition of depreciable capital property on January 20, 2009:

Lesser of [par. 13(7)(b)]:
(i) FMV of the property at January 20, 2009 ................................................................................
(ii) the total of:
(A) original cost at the time of change in use ..................................................... $ 280,000
(B) FMV of the property at January 20, 2009 .............................. $ 320,000
Less the original cost at the time of change in use ...............
280,000
Excess, if any ....................................................................... $ 40,000
of the above excess, if any......................................................................
20,000
Lesser amount = UCC at January 20, 2009 ..................................................................................
CCA claimed ( $300,000 .04) [no short-year proration]......................................................
UCC at January 1, 2010 ................................................................................................................
CCA claimed ($294,000 .04) .....................................................................................................
UCC at January 1, 2011 ................................................................................................................
Disposition of undepreciated capital property on June 1, 2011:
Lesser of:
FMV of the property at June 1, 2011 [par. 13(7)(a)] .................................... $ 305,000
capital cost.................................................................................................... $ 300,000
lesser amount ..........................................................................................................................
Recapture included in income.......................................................................................................

320,000

$
$

300,000
300,000
(6,000)

$ 294,000
$ (11,760)
$ 282,240

(300,000)
$ (17,760)

Comments:
(1) The purpose of this problem is to illustrate the application of the change-in-use rules on the calculation
of capital cost allowance. It does not address the treatment of deductions for capital cost allowance in respect of
rental property, nor does it address the principal residence exemption.
(2) The impact of the change-in-use rules on the calculation of a capital gain or loss is as follows:
January 20, 2009 disposition:
Proceeds of disposition..........................................................................
Adjusted cost base .................................................................................
Capital gain ...........................................................................................
June 1, 2011 disposition:
Proceeds of disposition..........................................................................
Adjusted cost base (January 20, 2009 proceeds) ...................................
Decline in value (not deductible)...........................................................
Adjusted cost base subsequent to the change in use ..............................

320,000
(280,000)
$
40,000
$

305,000
(320,000)
$
15,000
$ 305,000

Solutions to Chapter 5 Assignment Problems

85

Solution 4 (Basic)
CEC a/c
........................................................................................................................ $ 11,492
3,750
Purchase of licence (3/ 4 $5,000)...................................................................
CEC balance ................................................................................................... $ 15,242
CECA @ 7% ................................................................................................... (1,067)
January 1,
2007 CEC balance ................................................................................................... $ 14,175
2007 Sale of licence (3/ 4 $6,000) .......................................................................... (4,500)
December 31, 2007 CEC balance ................................................................................................... $ 9,675
CECA @ 7% ...................................................................................................
(677)
January 1,
2008 CEC balance ................................................................................................... $ 8,998
2008 No transactions ...............................................................................................

December 31, 2008 CEC balance ................................................................................................... $ 8,998

CECA @ 7% ...................................................................................................
(630)
December 31, 2009 CEC balance ................................................................................................... $ 8,368
CECA @ 7% ...................................................................................................
(586)
January 1,
2010 CEC balance ................................................................................................... $ 7,782
2010 Sale of band name (3/ 4 $20,000) .................................................................. (15,000)
December 31, 2010 CEC balance ................................................................................................... $ (7,218)
Business income1 ................................................................................................................
6,125
1,093
7,218
Non-taxable balance 1/ 3 of gain [1/ 3 ($7,218 3,939)] ................................................
January 1,

2006
2006
December 31, 2006

January 1, 2011 CEC balance .............................................................................................

1

Nil

Business income for 2010 is the total of:

a) the lesser of:
i) $7,218 and
ii) $979 + 1,067 + 677 + 630 + 586 = $3,939..................................................................
plus
b) 2/ 3 ($7,218 3,939) .........................................................................................................

3,939

Proceeds ($6,000 + $20,000)......................................................................................................

Cost ($500 + $16,128 + $5,000) .................................................................................................
Gain ............................................................................................................................................
1
/ 2 ...............................................................................................................................................

$ 26,000
(21,628)
$ 4,372
$ 2,186

2,186 2
6,125

Federal Income Taxation: Fundamentals

86
Solution 5 (Advanced)

CEC balance at January 1, 2003

Purchase of goodwill (3/ 4 $68,000) .............................................................................................
Purchase of liquor licence of second restaurant (3/ 4 $21,133) .....................................................
Subtotal
CECA balance @ 7% .....................................................................................................................
CEC balance at January 1, 2004 .....................................................................................................
CECA balance @ 7% .....................................................................................................................
CEC balance at January 1, 2005 .....................................................................................................
Purchase of franchise (3/ 4 $103,000) ...........................................................................................
Subtotal
CECA balance @ 7% .....................................................................................................................
CEC balance at January 1, 2006 .....................................................................................................
CECA balance @ 7% .....................................................................................................................
CEC balance at January 1, 2007 .....................................................................................................
Disposal of franchise (3/ 4 $110,000)............................................................................................
Subtotal
CECA balance @ 7% .....................................................................................................................
CEC balance at January 1, 2008 .....................................................................................................
CECA balance @ 7% .....................................................................................................................
CEC balance at January 1, 2009 .....................................................................................................
Disposals: Goodwill (3/ 4 $80,000)...............................................................................................
Liquor licence (3/ 4 $60,000) ........................................................................................................
Subtotal
Business income inclusion(1) ...........................................................................................................
Non-taxed 1/ 2 of gain [1/ 3 (i.e., 1/ 2 2/ 3 ) ($61,816 $50,666)] ...............................................
CEC balance at January 1, 2010 .....................................................................................................
Disposal of goodwill (3/ 4 $250,000) ............................................................................................
Subtotal
Business income inclusion(2) ...........................................................................................................
Non-taxed 1/ 2 of gain [1/ 3 (i.e., 1/ 2 2/ 3 ) ($187,500 $0)] ......................................................
CEC balance at January 1, 2011 .....................................................................................................

2003

2004

2005
2006
2007

2008
2009

2010

20,865
51,000
15,850
$ 87,715
(6,140)
$ 81,575
(5,710)
$ 75,865
77,250
$ 153,115
(10,718)
$ 142,397
(9,968)
$ 132,429
(82,500)
$ 49,929
(3,495)
$ 46,434
(3,250)
$ 43,184
(60,000)
(45,000)
($ 61,816)
58,099
3,717
$
Nil
(187,500)
(187,500)
125,000
62,500
$
Nil

NOTES TO SOLUTION
(1) The business income in 2009 is calculated as:
The total of:
(a)

the lesser of:

(i) the negative amount ...............................................................................
and
(ii) the total of:
all cumulative eligible capital deductions ..............................................
less: all recaptured deductions in prior years .........................................

61,816

50,666
(0)
50,666

$
The lesser is ....................................................................................................
and
(b)

50,666

/ 3 of negative amount less recaptured deductions above [2/ 3 ($61,816

$50,666)] ........................................................................................................
Business income ............................................................................................................
2

7,433*
$ 58,099

(2) The business income in 2010 is calculated as:

The total of:
(a)

the lesser of:

(i) the negative amount ...............................................................................
and
(ii) the total of:
all cumulative eligible capital deductions...............................................
less: all recaptured deductions in prior years ..........................................
The lesser is ....................................................................................................

and
(b)

187,500

50,666
(50,666)
$
Nil
$

Nil

/ 3 of negative amount less recaptured deductions above

[2/ 3 ($187,500 $0)] ...................................................................................

125,000*

Solutions to Chapter 5 Assignment Problems

Business income ............................................................................................................
This income number can be reconciled using the concept of a taxable capital gain as follows:
Proceeds ($110,000 + $80,000 + $60,000 + $250,000)
Cost ($43,000 + $68,000 + $21,133 + $103,000)
Gain
1
/2
Initial gain recognized
Second gain recognized
Total

87
$ 125,000
$ 500,000
(235,133)
$ 264,867
$ 132,434
$ 7,433
125,000
$ 132,433

The costs incurred in 2008 with respect to the presentation to the liquor licensing board would be considered
costs of representation and, therefore, fully deductible [par. 20(1)(cc)].

Federal Income Taxation: Fundamentals

88
Solution 6 (Basic)

(a) Janice has a terminal loss of $300 on selling her car, but she cannot claim this as subsection 20(16) does
not apply to employees.
(b) The building is a Class 1 asset and the CCA rate is 4%. Applying the half-year rule, Rameshs
maximum CCA is 4% of $37,500, or $1,500. As rent is property income and not business income, there is no
proration for number of days, because the taxation year for the owner who is an individual is the full calendar
year.
(c) As each building cost in excess of $50,000, each is a separate class. Consequently, William will have a
recapture on one but will be allowed CCA on the other:
Class 1
Building 1
Disposition
CCA/Recapture
UCC

UCC
$45,000

(1,800)
$43,200

UCC
$45,000
(60,000)
15,000
NIL

(lesser of cost/proceeds)

(d) Land is not a depreciable property. Colin is not allowed any CCA.
(e) The buildings gross proceeds were $75,000 but Randi also paid legal fees of $2,000 on the sale of the
property. The legal fees should be allocated between the land and building based on the selling price ratio. The
buildings proceeds are $73,500 ($75,000 less $1,500 legal fees).

Solutions to Chapter 5 Assignment Problems

89

Solution 7 (Advanced)
Cl. 1-MB:
10%
UCC, Jan. 1/10 ..........................................
Additions:
Building ............................................
Steel fence .........................................
Office equipment ..............................
Radio equipment ...............................
Disposals:
Office equipment ..............................
Building ............................................
UCC, Dec. 31/10 before adjustment .........
net-amount ............................................
UCC before CCA .....................................
CCA or recapture for 2010........................
net-amount ............................................
UCC for Jan. 1/2011 .................................

Cl. 3:
5%
$153,000

Cl. 6:
10%

Cl. 8:
20%
$ 39,000

Cl. 10:
30%
$ 170,000

$1,300,000
$ 65,000
47,000
60,000
(1,950)
(390,000)(1)
$ (237,000) $ 65,000

(32,500)
$(237,000) $ 32,500
237,000(1)
(3,250)

32,500
Nil
$ 61,750

$1,300,000
(650,000)
$650,000
(65,000)
650,000
$1,235,000

UCC, Jan. 1/10 .................................................................

Additions:
Parking lot ................................................................
Leasehold improvement ...........................................
Manufacturing equipment ........................................
Licence .....................................................................
UCC, Dec. 31/10 before adjustment ................................
net-amount ...................................................................
UCC before CCA ............................................................
CCA for 2010 ..................................................................
net-amount ...................................................................
UCC for Jan. 1/2011 ........................................................
CEC a/c
Opening balance .......................................

3
/ 4 ECE (legal fees)(5)............................. $ 25,875
Balance ..................................................... $ 25,875
CECA @ 7% .............................................
(1,811)
Balance ..................................................... $ 24,064

Cl. 13:
SL
$ 165,000

Cl. 14:
SL
$ 87,393

$ 144,050
(52,525)(2)
$ 91,525
(18,305)
2,525(2)
$ 125,745

$ 170,000
(Nil)
$ 170,000
(51,000)
Nil
$ 119,000

Cl. 17:
8%

Cl. 29:
50% SL

$97,000
51,000
$ 255,000
$
$

216,000

216,000
(28,700)(3)

187,300

240,000
$ 327,393
N/A
$ 327,393
(62,341)(4)
N/A
$ 265,052

$97,000
(48,500)
$48,500
(3,880)
48,500
$
93,120

$ 255,000
(127,500)
$ 127,500
(63,750)
127,500
$ 191,250

NOTES TO SOLUTION
(1) Capital gain on building of $178,000 (i.e., $568,000 - $390,000); recapture of $237,000.
(2) ($47,000 + $60,000 $1,950)
(3) 2008: lesser of

(a)
(b)

2009: lesser of

(a)
(b)

2010: lesser of

$81,600
= $16,320
5
$81,600
= $13,600
5 +1
$100,000
= $20,000
5
$100,000
= $10,000
6+4

$51,000
= $10,200
5
(b) $51,000 = $12,750
3 +1
(a)

........................................................................... $13,600

........................................................................... $10,000

in first year ...........................................

$5,100

Total CCA ......................................................................................................................................

$ 28,700

Federal Income Taxation: Fundamentals

90

(4) Licences .................... $110,500 365 days ................................................................................

$ 22,100

$240,000
306 * * * ..................................................................................
(5 365)

40,241

Total .......................................................................................................................................................

$ 62,341

(5 365) * *

Licence ......................

** Remaining days from April 22, 2007 (excluding leap year effects) of 5-year licences.
*** Class 14 is not affected by the half-net-amount rule [Reg. 1100(2)(a)].

(5) Legal fees pertaining to the capital structure of the firm would be treated like incorporation costs as
eligible capital expenditures.

Solutions to Chapter 5 Assignment Problems

91

Solution 8 (Advanced)
Notes to Instructors:
(1) The Required does not (on purpose) ask for closing UCC balances (because most problems of these
type do not), so the solution does not do them in this case.
(2) Most of the CCA calculations have been put in the reconciliation rather than the notes to simulate the
calculations that students should do in this type of problem. The alternate tabular calculation is also presented.
Net income after income taxes .........................................................................................
Add:
Provision for income taxes .......................................................................................
Amortization ............................................................................................................
Reserve for future decline in the value of inventory ................................................
Increase in the reserve for warranty expenses ..........................................................
Donations to registered charities ..............................................................................
Golf club membership dues for the Vice-President of Sales ....................................
Meals and entertainment at golf club (50% $2,000) .............................................
Accrued bonus not paid until June 30, 2011 ............................................................
Financing fees (4/ 5 $8,000) ...................................................................................
Legal fees in connection with purchase of shares ....................................................
Accounting software update for payroll tax information .........................................
Class 12: Recapture ($300 (software) $500 (small tools)) ....................................
Bond discount amortization .....................................................................................

$ 440,000

Deduct:
Gain on disposal of property, plant and equipment ..................................................
Capital cost allowance, etc.:
Class 1-NRB (6%): CCA = $700,000 1/ 2 6% ....................................................
Class 3 (5%): terminal loss = $200,000 $180,000
Class 8 (20%): CCA = 20% of ($60,000 + 1/ 2 ($25,000 $4,000))......................
Class 10 (30%): CCA = $80,000 30% ..................................................................
Class 13 (SL): (see Schedule 1) ...............................................................................
Class 17 (8%): CCA = $20,000 1/ 2 8% ..............................................................
Class 6 (10%): CCA = $30,000 1/ 2 10% ............................................................
Class 44 (25%): (see Schedule 2).............................................................................
CEC: 7% of ($5,000 + 3/ 4 $100,000) ....................................................................

ITA Reference
9

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

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

(40,000)

18(1)(b)

(21,000)
(20,000)*
(14,100)
(24,000)
(7,000)
(800)
(1,500)
(2,500)
(5,600)
$ 852,900

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

Alternate Tabular Calculation of CCA/CECA

UCC 1/1/10 ...
Purchases ......

Cl. 1-NRB
6%

$ 700,000

Cl. 3
5%
$ 200,000

Cl. 6
Cl. 8
Cl. 10
Cl. 12
10%
20%
30%
100%

$ 60,000 $ 80,000

$ 30,000
25,000

$
300

Cl. 13
SL
$ 37,500
28,000

Cl. 17
8%

$ 20,000

Cl. 44
25%

$ 20,000

CEC
7%
$ 5,000
75,000

Disposals ......
UCC 12/31/10
1
/ 2 N-A .........
UCC..............
Recapture ......
CCA/CECA ..
Terminal loss

$ 700,000
(350,000)
$ 350,000

(21,000)

(180,000)

(4,000)

(500)
$ 20,000
$ 30,000 $ 81,000 $ 80,000 $
(200)

(15,000)
(10,500)

$ 20,000
$ 15,000 $ 70,500 $ 80,000 $
(200)

200

(1,500)
(14,100)
(24,000)

(20,000)*

$ 65,500

$ 65,500

(7,000)

$ 20,000
(10,000)
$ 10,000

(800)

$ 20,000
(10,000)
$ 10,000

(2,500)

$ 80,000

$ 80,000

(5,600)

(3/ 4 )

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

Schedule 1: Class 13
2008 Improvements:
Lesser of:

(a)

/ 5 capital cost: $45,000 = $9,000

(b)

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

The lesser amount is $5,000.

Federal Income Taxation: Fundamentals

92
2010 Improvements:
Lesser of:

(a)

/ 5 capital cost: $28,000 = $5,600

(b)

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

The lesser amount is $4,000.

The CCA for 2010 is $4,000 1/ 2 = $2,000
The total CCA for the 2008 and 2010 improvements is $5,000 + $2,000 = $7,000.
Schedule 2: Class 44
The $20,000 licence to use patented information which expires June 30, 2020 can be treated as a Class 44 or
Class 14 asset on an elective basis. The 2010 CCA in class 44 is $20,000 25% 1/ 2 = $2,500.
Class 44 treatment allows for a faster write-off and is automatic. Class 14 treatment, which is possible if a
taxpayer elects [Reg. 1103(2h)] not to have Class 44 apply, allows for CCA claim computed on a straight-line
basis over the 3,650-day life of the licences.
The 2010 Class 14 claim would only be $20,000 184/3,650 = $1,008. The Class 44 CCA is, therefore,
better.
Class 44 treatment is therefore recommended.
Items not Adjusted for in the Reconciliation:
$9,000 loss from a theft by warehouse employee is deductible according to IT-185R, par. 2 and
Cassidys Limited v. M.N.R., 89 DTC 686 (T.C.C.).
$62,000 paid to employees on May 31, 2010 is paid before the 179-day deadline(1) in subsection 78(4)
and is deductible providing there is a legal obligation to pay it.
A $15,000 year-end party for all employees is exempted from the 50% rule [par. 67.1(2)(e)].
$18,000 of interest on bonds issued to buy shares in another company is deductible [par. 20(1)(c)].
$50,000 of interest on the mortgage on the new plant is deductible [par. 20(1)(c)].
NOTE TO SOLUTION
(1) IT-109R2 paragraph 10 permits payment to be made on the 180th day without invoking
subsection 78(4).

Solutions to Chapter 5 Assignment Problems

93

Solution 9 (Basic)
The list of property acquired in the year that is not subject to the half-year rule is found in the Income Tax
Regulations, ITR 1100(2). Refer to ITR 1100(2)(a)(iii) and note the reference to other than followed by a
listing of the properties that are exempt from the half-year rule. Specifically it refers paragraphs (a) to (c), (e) to
(i), (k), (l), (p), (q), and (s) of Class 12.
Now, if you go to Regulation Schedule II, Class 12, you will note that cutlery is mentioned in paragraph (b).
Thus, cutlery is exempt from the half-year rule. Word processing (application) software is mentioned in
paragraph (o). Paragraph (o), however, is not in the list of exceptions given in Reg. 1100(2)(iii). Hence, the halfyear rule applies to application software.

Federal Income Taxation: Fundamentals

94
Solution 10 (Basic)

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

2009

2010
2009

UCC at January 1, 2009 ..............................................................................................................

Disposal(1)
lesser of: (a) capital cost ................................................ $ 406,000
(b) proceeds .................................................... $ 362,500
UCC at December 31, 2009 ........................................................................................................
Recapture ....................................................................................................................................
UCC at January 1, 2010 ..............................................................................................................
File an amended return for 2009 [ssec. 13(4)] as follows:
UCC at January 1, 2009 ..............................................................................................................
Deemed disposal [par. 13(4)(c)]
lesser of: (a) capital cost ................................................ $ 406,000
(b) proceeds .................................................... $ 362,500 $ 362,500
reduced by lesser of:
(a) normal recapture
($362,500 $188,500).................... $ 174,000
(174,000)
$ 1,276,000
(b) replacement cost

Building
Class 3: 5%
$
188,500

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

188,500

(188,500)

UCC December 31, 2009 ............................................................................................................

Nil
(2)

Building
Class 1: 4%
2010

2009

Add:

capital cost of new building...................................................................... $ 1,276,000

reduced as above [par. 13(4)(c)] ...............................................................
(174,000)
UCC December 31, 2010 ............................................................................................................
CCA claimed for 2010 @ 4% of [$1,102,000 1/ 2 $1,102,000)] ............................................
UCC January 1, 2011..................................................................................................................

$ 1,102,000
$ 1,102,000
(22,040)
$ 1,079,960

UCC January 1, 2009..................................................................................................................

Less: disposal (proceeds not in excess of cost) ...........................................................................

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

UCC December 31, 2009 ............................................................................................................

Terminal loss ..............................................................................................................................
2010

UCC January 1, 2010..................................................................................................................

Add: capital cost of new appliances and fixtures ........................................................................
UCC December 31, 2010 ............................................................................................................
CCA claimed for 2010 @ 20% of [$46,400 (1/ 2 $46,400)] ..................................................
UCC January 1, 2011..................................................................................................................

$
$

4,650
(4,650)
Nil
46,400
46,400
(4,640)
$ 41,760

NOTES TO SOLUTION
(1) IT-259R4, paragraph 3 appears to require that even if a replacement property is purchased in the
subsequent taxation year before the tax return is due for the year of disposition (i.e., before April 30, 2009 in this
case), the recapture must be reported for the year of disposition. Then an amended return can be filed to
implement subsection 13(4) when the replacement is purchased within the allowable time limit.
(2) Note how the rules [ssec. 13(4)] allow for a replacement with an asset of another class.
(3) Even if the equipment had been considered part of the involuntary disposition there would not have been
any recapture to defer.

Solutions to Chapter 5 Assignment Problems

95

Advisory Cases
Case 1: RBL Proprietorship
ADVISORY CASE DISCUSSION NOTES
Impact on taxable income for the current year:
Insurance receipts business interruption
Moving costs
Lease cancellation penalty
Impact on taxable income

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

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

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

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

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

Federal Income Taxation: Fundamentals

96
Case 2: Dundas Printing Inc.

ADVISORY CASE DISCUSSION NOTES

The main tax issues in this case relate to the acquisition of fixed assets, including goodwill.
1. Capital versus expense

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

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

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

Printing presses are included in Class 8 20%

For accounting purposes, the presses will be written off over their useful life, i.e., five years for the
used press they bought

Subject to the half-year rule [Reg. 1100(2)]

4. Luxury automobiles

Special rules apply for luxury automobiles costing over $30,000 [par. 13(7)(g)]
o Class 10.130%
o CCA limited to $30,000 on the new car
o Limitation on interest [sec. 67.2] and leasing cost [sec. 67.3]

No recapture [ssec. 13(2)] or terminal loss [ssec. 20(16.1)], but one-half of normal CCA
[Reg. 1100(2.5)], since conditions met

Standby charge taxable benefit on full cost of car including HST, not just the $30,000
5. Goodwill

Deduction for goodwill as eligible capital property [sec. 14, par. 20(1)(b)]

Solutions to Chapter 5 Assignment Problems

97

Case 3: Kingston Carpets Inc.

ADVISORY CASE DISCUSSION NOTES
The main tax issues in this case are:

expenses that might result in T2 Schedule 1 adjustments, and

taxable benefits.

1. Golf club memberships

Used extensively and successfully for business entertainment;

however, they are non-deductible under paragraph 18(1)(l) even if they are used extensively to
earn income.

2. Entertainment expenses

The entertainment expenses at the golf club are 50% deductible [sec. 67.1].
The seasonal holiday party is not subject to that limitation since it is available to all employees
[ssec. 67.1(2)].

3. Land and Building

Discuss whether the repairs made to the building should be capitalized or expensed.

4. Cars

Limitation on the deductibility of the interest [sec. 67.2], lease costs [sec. 67.3], and CCA
[par. 13(7)(g)].
Taxable benefits for the standby charge and related HST benefit and the operating benefit which
includes the HST benefit [ssecs. 6(1)(e), 6(1)(k), 6(2)].

5. Boat and cottage

These entertainment expenses are deductible if they are incurred to earn income [par. 18(1)(a)] and
can be supported by receipts and records of who was entertained and when.
The entertainment expenses are still subject to the 50% limitation [sec. 67.1]

6. Employees

No taxable benefits for the group plans [par. 6(1)(a)] except for life insurance which is a taxable
benefit [ssec. 6(4)]
Taxable benefit for company payment of the premium on the individual life insurance policies
where Andy or Sue are beneficiary
Company payment of the premium on the individual disability policy for Andy and Sue will be a
taxable benefit, but any payments received under the plan will not be taxable to Andy and Sue
[IT-428, par 20]
Deduction for all or part of the life insurance used as collateral for the bank [par. 20(1)(e.1)]

7. Donations

Political donations are specifically disallowed [par. 18(1)(n)]

Charitable donations are disallowed [par. 18(1)(a)] if they were not incurred to earn income.
o however, if some donations were made in order to gain future business then this limitation
may not apply [par.18(1)(a)]

8. Interest-free loan to employee

there will be a deemed interest benefit [ssec. 80.4(1)] with an adjustment [ssec. 80.4(4)] for the
housing loan rules
the interest expense incurred by the company to loan this money interest-free should be fully
deductible on the basis that it is part of funds borrowed to earn income from business
[par. 18(1)(a)].
o Administrative practice (and a proposed amendment) under paragraph 20(1)(c) would allow
the full deduction

CHAPTER 6

Income from Property

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

99

100

Federal Income Taxation: Fundamentals

Solution 2 (Basic)
(A) Dividend Fund:
Dividend Income (6% of $2,000)..........................................................................................
Add: gross-up of 44% of dividend ........................................................................................
Grossed-up dividend subject to tax .......................................................................................
Federal and provincial tax on grossed-up dividend @ 46% ..................................................
Less: dividend tax credit .......................................................................................................
Net tax payable .....................................................................................................................
After-tax dividend ($120.00 $26.69)..................................................................................
Income Fund:
Interest income (8% of $2,000) .............................................................................................
Federal and provincial tax payable @ 46% ...........................................................................
After-tax interest ($160.00 $73.60) ....................................................................................

$ 120.00
52.80
$ 172.80
$ 79.49
(52.80)
$ 26.69
$ 93.31
$ 160.00
$ 73.60
$ 86.40

The difference between the two is $93.31 $86.40 = $6.91. As a percentage of the $2,000 principal
invested, this difference is marginal (less than 1% of the principal invested), so non-tax factors may affect the
decision.
(B) Putting the investment in the name of the daughter would be of no advantage in the holding period
envisaged:
this would be considered as a transfer of the property subject to the income attribution rules
[ssec. 74.1(2)];
the effect would be to require that the investment income be included in the income of the father until
the daughter reaches the age of 18 years;
since the holding period is expected to be until 2013, the daughter who is presently 8 years old will
not reach 18 in the holding period.
(C) Subsection 74.5(2) would except this loan with interest at the prescribed rate from attribution in
subsection 74.1(1):
the wife must pay interest which will be income to him and will reduce or eliminate any income
splitting benefit on a fixed-income security;
would be a good strategy if substantial capital gains were expected.

Solutions to Chapter 6 Assignment Problems

101

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

Federal Income Taxation: Fundamentals

102
Solution 4 (Advanced)

Income or loss from rental property:

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

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

Schedule 1
509 Brunswick(1)
Class 1: 4%
UCC, December 31, 2009 ....................................................... $383,500
Disposition in 2010 (lesser of cost and proceeds) ...................
(393,750)(2)
Balance....................................................................................
$(10,250)
Recaptured CCA in 2010 ........................................................
10,250
Nil
CCA for 2010 at 4% (limited) .................................................
Nil
UCC, December 31, 2010 .......................................................
Nil

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

$400,000

$400,000
(15,250)(3)
$384,750

Total

$10,250
$15,250

NOTES TO SOLUTION
(1) Regulation 1101(1ac) requires that rental buildings with a cost over $50,000 be placed into separate
CCA classes.
(2) Sale of 509 Brunswick Ave.:
Building
Proceeds of disposition (75% of ($550,000 $5,000)) .................................................................
Cost base (75% of $525,000) ........................................................................................................

$ 408,750
$ 393,750

(3) The inclusion of recaptured CCA in income from property allows for more CCA to be deducted without
creating a loss on rental property. In most circumstances, a loss on rental property cannot be created or increased
by claiming CCA [ITR 1110(11)]. In this situation, the full $16,000 (4% $400,000) of CCA was restricted to
$15,250 so as not to create a loss.

Solutions to Chapter 6 Assignment Problems

103

Solution 5 (Advanced)
The 2010 year can be broken into three different time periods: pre-construction (January to February 14,
45 days); construction (February 15 to October 30, 258 days); post construction (October 31 to December 31,
62 days).
The following amounts must be capitalized to the building [ssec. 18(3.1)]:(1)
Cost .....................................................................................................................................................
Architectural fees ................................................................................................................................
Engineering fees..................................................................................................................................
Building insurance during construction (61/ 2 mos. $450) ................................................................
Property taxes during construction (81/ 2 mos. $770) .......................................................................
Soil testing ..........................................................................................................................................
Utilities service connections ...............................................................................................................
Mortgage insurance during construction (8 mos. $325) ...................................................................
Interest accrued on mortgage during construction (258/ 365 days 8% of $875,000)............................
Total cost ............................................................................................................................................
The following amounts are deductible in computing BDCs income for 2010:
CCA on building @ 6% of $1,424,474 1/ 2 .......................................................................................
Building insurance after construction (2 mos. $450) .......................................................................
Property taxes after construction (2 mos. $770)...............................................................................
Mortgage insurance after construction (2 mos. $325) ......................................................................
Relocation expenses ............................................................................................................................
Maintenance from October 31, 2010...................................................................................................
Utilities from October 31, 2010 ..........................................................................................................
Landscaping [par. 20(1)(aa)] ..............................................................................................................
Interest accrued on mortgage one month before and two months after construction
(93/ 365 days 8% of $875,000) ....................................................................................................
Issue costs [par. 20(1)(e)] (1/ 5 ($18,450 + $58,300))(2) ....................................................................
CECA on articles of amendment (3/ 4 $1,800 7%) ........................................................................
Total deductible costs..........................................................................................................................

$ 1,348,000
7,200
2,100
2,925
6,545
1,825
3,800
2,600
49,479
$ 1,424,474
$

42,734
900
1,540
650
34,100
2,500
6,300
15,500
17,836
15,350
95
137,505

NOTES TO SOLUTION
(1) Subsection 20(29) does not apply to allow the deduction of all or some part of the soft costs in this
case because the building is not being rented to tenants.
(2) The issue costs are considered to be long-term financing costs that are not attributable to the period of
construction.

104

Federal Income Taxation: Fundamentals

Solution 6 (Advanced)
To the extent that property and services are purchased for use in commercial activities, input tax credits in
respect of the HST paid on those purchases may be claimed. The expenditures are given the following HST
treatment.
Expenditure
Land ......................................................................
Building ................................................................
Architect and engineer fees ...................................
Building insurance ................................................

GST treatment
taxable
taxable
taxable
exempt: financial service
[ETA: ssec. 123(1)]
Landscaping costs ................................................. taxable
Maintenance.......................................................... taxable (unless salaries or wages)
Utilities ................................................................. taxable
Mortgage insurance premium ............................... exempt: financial service
[ETA: ssec. 123(1)]
Relocation expenses .............................................. taxable
Property taxes ....................................................... exempt [Sched. V, Part VI, 21]
Soil testing ............................................................ taxable
Utilities service connections ................................. taxable
Interest on mortgage ............................................. exempt: financial service
[Sched. V, Part VII]
Dividends on preferred shares............................... exempt: financial service
[ETA: ssec. 123(1)]
Discount on bonds ................................................ exempt: financial service
[ETA: ssec. 123(1)]
Legal and accounting fees ..................................... taxable
Commissions......................................................... exempt: financial service
[ETA: ssec. 123(1)]
Articles of amendment .......................................... exempt: financial service
[ETA: ssec. 123(1)]
Total ITC ........................................................................................................................

Amount
$ 405,000
1,348,000
9,300

ITC @ 13%
$
52,650
175,240
1,209

15,500
2,500
6,300

2,015
325
819

34,100

1,825
3,800

4,433

237
494

18,450

2,399

$ 1,844,775 $

239,821

Note that the ITC in respect of capital expenditures can be claimed for the period in which the tax is paid or
becomes payable. As a result, there is no requirement for amortization. Since an ITC represents a recovery of the
cost of HST, the amount of HST paid, if any, does not become part of the capital cost of a capital asset such as
the building in this case. Similarly, the HST paid is not deductible as an expense because it is recovered through
an ITC.

Solutions to Chapter 6 Assignment Problems

105

Solution 7 (Basic)
Net Income for Tax Purposes
Employment income:
Salary
Deemed interest benefit (Note 1)
Income from Employment
Property Income:
Rental revenues
Maintenance expense
Utilities expense
Interest expense (Note 2)
CCA (Note 3)
Net rental income
Foreign dividends received
Add: Withholding tax
Gross foreign dividends
Interest income
Taxable dividend received
Add: Gross up at 45%
Taxable amount of dividend
Net income from property
Net income for tax purposes

$92,000
8,000
$100,000
$26,000
( 5,500)
( 8,200)
(12,800)
(
0)
$ (500)
$18,000
2,000
20,000
10,000
$30,000
13,500
43,500
73,000
$173,000

Notes:
1. Subsection 80.4(1) deems an interest benefit of ($160,000) (8% 3%).
2.

Section 80.5 and paragraph 20(1)(c) allows interest expense of the actual paid amount at 3% ($4,800) and
the deemed interest benefit included in employment income ($8,000).

3.

CCA allowed = zero (cannot create/increase a loss with CCA on the rental property).

Federal Income Taxation: Fundamentals

106
Solution 8 (Basic)
(a)
Net income from employment, team salary
Net income from proprietorship business
Net income from endorsements (business income)
Net income from property:
Dividends from Canadian corporation
Add 44% gross-up
Taxable amount
Dividends from foreign corporation
Interest from Canadian bank
One-year anniversary interest accrual on GIC
(attributed to Trent)
Expenses: SDBox
Interest on loan
Net income from property
Net income

50
4,000

$150,000
35,000
30,000
$ 7,200
3,168
$10,368
7,500
3,000
600
$21,468
( 4,050)
17,418
$232,418

(b) Basic Tax Planning

Consider using a deferred-income fund, such as an RRSP, for the GICs.

Investigate whether the investment in the foreign corporation might not be better invested in a Canadian
corporation because of the dividend tax credit.
Pay higher, yet reasonable, compensation to Mary.
Mary has a salary in her own right; consider investing it rather than spending it on family personal needs.
This will result in the investment income being taxed in her hands.
Consider incorporating the sporting goods store.
Consider setting up a tax-free savings account.

Solutions to Chapter 6 Assignment Problems

107

Solution 9 (Basic)
(a) Mr. Lee must include the dividend in his income, since the attribution rules will apply. The amount to be
included in Mr. Lees income is $7,200 ($5,000 44% gross-up). He will also be eligible for the dividend
tax credit.
(b) As Carey turned 18 in the year, subsection 74.1(2) will not apply to attribute any of the income back to
Ellen.

Federal Income Taxation: Fundamentals

108
Solution 10 (Advanced)

Joint bank account (his portion)(1) ...............................................................................................

Interest on broker account ...........................................................................................................
Interest on income tax assessment ...............................................................................................
Interest on short-term investments(2)............................................................................................
Interest on GIC(3) .........................................................................................................................
Interest of Government of Canada T-Bills(4)................................................................................
Dividends from common shares of taxable Canadian corporations ($24,000 1.44)(5) ..............
Dividends from common shares in U.S. corporation (gross amount)(6) .......................................
Rental loss(7) ................................................................................................................................
Interest on bank line of credit(8) ...................................................................................................
Income from property ..................................................................................................................

1,000
800
450
Nil
16,000
991
34,560
20,000
(1,200)
(50,000)
$ 22,601

NOTES TO SOLUTION
(1) If both John and his spouse contribute capital equally to the bank account, the attribution rules do not
apply [sec. 74.1].
(2) Interest is not taxable for 2010 on the term deposit because there is no anniversary date in 2010. The
interest will all be taxable when paid in 2011 [ssecs. 12(4), 12(11)].
(3) Interest on an investment contract (the GIC) must be accrued on the anniversary day, which is defined as
the day that is one year after the day before the date of issue. The date of issue was November 1, 2009. The day
before that day is October 31, 2009. Therefore, the first anniversary day is October 31, 2010 [ssec. 12(11)].
(4) The difference between the face amount and the amount paid ($10,000 $9,009) is deemed to be interest
[ssec. 16(1)].
(5) A dividend tax credit [par. 12(1)(j); ssec. 82(1)] (as discussed in Chapter 10) will be available in the
calculation of tax.
(6) A foreign tax credit (as discussed in Chapter 10) will be available in the calculation of tax.
(7) The calculation of the rental loss is based on the aggregate of the two properties:
Gross rental revenue ........................................................................................
Utilities ............................................................................................................
Property taxes ..................................................................................................
Repairs .............................................................................................................
Mortgage interest .............................................................................................
Income/(Loss) before CCA ..............................................................................
Less: CCA property 1 ($368,209 * .04 = $14,728) ...................................
CCA property 2 ($520,225 * .04 = $20,809) ...................................
Net income/(loss) .............................................................................................

Property 1
$
30,000
(5,000)
(2,400)
(1,500)
(20,000)
1,100
Nil
Nil
$
1,100

Property 2
$
46,000
(8,000)
(3,500)
(4,800)
(32,000)
(2,300)
Nil
Nil
$ (2,300)

The aggregate rental loss before CCA is $1,100 - 2,300 = ($1,200). Since there is an aggregate loss from all
rental sources, there is no CCA claim allowed for fiscal 2010.
(8) This interest is paid in respect of common shares and thus is incurred for the purpose of earning income.
The interest paid on the loan to acquire the automobile is for the purchase of personal use property and thus does
not meet the requirements in paragraph 20(1)(c). The interest on the vacant land is not deductible by virtue of
subsection 18(2).

Solutions to Chapter 6 Assignment Problems

109

Solution 11 (Basic)
(a) Under paragraph 20(1)(c) of the Act, interest expense can be deducted on debt incurred to earn income. In
this instance, Ashley has sold her investments to pay down her mortgage. She then remortgaged the house
and reacquired her investments. While the CRA might challenge this under GAAR, it appears Ashley has
met the conditions required for the interest deduction.
Placing 50% of the investments in her spouses name is an ineffective way of splitting income with her
husband. Subsections 74.1(1) and 74.2(1) will attribute any income, loss, or capital gain on the split
properties back to Ashley.
(b) The accrued interest amount of $262.50 Ashley paid on acquiring the bond will be deductible in the current
taxation year [ssec. 20(14)]. This is because Ashley, as the registered bondholder, will receive all the interest
due on the bond from the bond issuer. Only the difference represents her real investment income.
(c) Under subsection 18(2) of the Act, Ashley is only eligible to deduct interest expenses and property taxes up
to the amount of income received from that vacant land. In this case, she will only be able to deduct $17,500
(seven months $2,500/month). As this is vacant land used to earn income and not a personal-use property,
she will add the non-deductible carrying charges to the adjusted cost base of her capital property, resulting
in an adjusted cost base for the land of $478,000 ($450,000 + $45,500 $17,500).

110

Federal Income Taxation: Fundamentals

Solution 12 (Basic)
(a) The interest is not deductible [par. 20(1)(c)], unless the gains or losses are treated as business or
property income or losses, because of the requirement that funds be borrowed to produce income from
business or property. Capital gains are not income from business or property [ssec. 9(3)].
(b) Paragraph 18(11)(b) prohibits a deduction of interest on funds borrowed to invest in an RRSP.
(c) Interest on funds borrowed to invest in a fixed-income security may be limited to the income from that
security since subparagraph 20(1)(c)(i) requires that funds be borrowed for the purpose of earning
income. Interest expended in excess of 8% will result in no net income in some years. However,
administrative practice may be more generous in its interpretation, based on the Ludco case. If all or
part of the outstanding loan is repaid over time such that total interest paid is less than total interest
earned over the total holding period, then paragraph 20(1)(c) should permit the deduction of interest.
Refer to IT-533, paragraph 31.
(d) Interest is deductible even if no dividends are being paid, because there is theoretically always the
expectation of a dividend on common shares, even if that dividend is a liquidating dividend on the
winding-up of the corporation. Refer to IT-533, paragraph 31.
(e) Interest expense would be limited to the amount of the grossed-up dividend on preferred shares, i.e.,
145% of 7% or 10.15%. If all or part of the outstanding loan is repaid over time such that total interest
paid is less than the total grossed-up dividend earned at some time in the holding period, then it may be
arguable that the deduction of interest should be permitted. Refer to IT-533, paragraph 31.
(f) Interest expense may be limited to 9%, because there is no gross-up on foreign-source dividends and a
preferred-share dividend is not expected to grow. If all or part of the outstanding loan is repaid over
time such that total interest paid is less than the total dividend earned in the total holding period, then it
may be arguable that the deduction of interest should be permitted. Refer to IT-533, paragraph 31.
(g) Since more funds were withdrawn (i.e., $18,000) than the borrowed funds generated in business income
(i.e., $9,750), the CRA could argue that $8,250 (i.e., $18,000 $9,750) of the $100,000 in borrowings
funded the drawings (i.e., were withdrawn from the business) and, therefore, were not used in the
business to produce income, thereby denying the deduction of interest on the $8,250 drawings from the
borrowed funds.
(h) Interest on funds borrowed to buy lottery tickets is not deductible, because the lottery winnings are not
taxable and, hence, the borrowed funds did not produce income from business or property. However,
according to IT-533, paragraphs 17 and 18, if the borrowed funds can be traced from a non-eligible use
(buy lottery tickets) to an eligible use (securities) then the interest will be deductible, since it is the
current use that determines the deductibility.
(i) Interest on the funds borrowed to buy the common shares is deductible until the shares are sold.
Thereafter, the funds are not used to earn income from business or property and, hence, the interest is
not deductible.

CHAPTER 7

Capital Gains: Personal

Solution 1 (Basic)
All residences qualify as principal residences according to the definition in section 54 because they are
housing units that are ordinarily inhabited by Mr. Hart, a Canadian resident, at any time during the year. The fact
that the Florida condominium is outside Canada does not affect its status as a principal residence.
Since all residences were bought after 1981, only paragraph 40(2)(b) applies.
The minimum amount of taxable capital gains that Mr. Hart will have to report in 2010 is $26,000 ($10,000
+ $16,000 + nil). The calculation of this amount is set out below.
Toronto home
P of D .....................................
$240,000
ACB .......................................
(160,000)
Gain .......................................
$ 80,000
Years of ownership ................
8 (2003 - 2010)
Gain per year..........................
$ 10,000
Optimal allocation of years
(see analysis below) .........
5 (2003 - 2007)
Principal residence
5 +1
$80K = $60K
exemption (PRE)..............
8
Capital gain (Gain - PRE) ...... $80K - $60K = $20K
Taxable capital gain (1/ 2
capital gain) .....................
$ 10,000

Farm in Quebec
$ 148,000
(100,000)
$ 48,000
6 (2005 - 2010)
$ 8,000

Condominium in Florida
$ 186,000
(150,000)
$ 36,000
3 (2008 - 2010)
$ 12,000

1 (2008)

2 (2009, 2010)

1+1
$48K = $16K
6

2 +1
$36K = $36K
3

$48K - $16K = $32K

$ 36K - $36K = Nil

$ 16,000

Nil

Analysis
Because of the one-plus rule, the maximum number of years that needs to be designated to totally exempt a
gain is always one less than the number of years of ownership.
The years of the residence with the highest gain per year are designated first. The condominium in Florida
has the highest gain per year ($12,000 gain per year) and two out of three years are designated in respect of it.
(The actual years chosen could be any two of 2008, 2009, and 2010.)
The next residence to look at is the Toronto home, which has been owned since 2003 (eight years), with a
gain per year of $10,000, rather than the Quebec farm, which has been owned since 2005 (six years), with a gain
per year of $8,000. Initially, it seems to make sense to allocate all of the six remaining years to the Toronto home
because it has the higher gain per year. However, because of the one-plus rule, designating one year for the
Quebec farm gets you two, that is, it shelters two years of gain. The year 2008 is chosen for the Quebec farm.
(The year designated, could have been one of any of the years of ownership that were left over from the
condominium: 2005 to 2008.) The remaining five years (2003 to 2007 shown in the calculation above) are
designated in respect of the Toronto home.

111

Federal Income Taxation: Fundamentals

112
Solution 2 (Advanced)

Part (A) Subsection 45(2) election

When Ms. Andrews moves out of the Waterloo home and begins to rent it out, there is a deemed disposition
on the change in use. However, if she makes an election under subsection 45(2), then the result is that there is no
change in use and the property remains a personal-use property. In addition, paragraph (d) of the definition of a
principal residence in section 54 provides that it is possible for this property to be designated as her principal
residence for up to four additional years even though she is not living there. This would allow her to designate
the property as her principal residence for the years 20002003 and 20092010 based on the years she lived there
and for the years 20042007 based on the four additional years, for a total designation of 10 years. The only year
missing is 2008 and it is protected with the 1+ rule.
Gain ($284,000 $86,000) ...................................................................................................................
Exemption(1) .........................................................................................................................................
Capital gain...........................................................................................................................................

$ 198,000
(198,000)
Nil

Part (B) No subsection 45(2) election

In 2003, when Ms. Andrews moves out of her Waterloo home and begins to rent it to earn income, there is a
deemed disposition on the change in use . Since she has been living in the house since she bought it in 2000, she
can claim the principal residence exemption on the gain that results from the deemed disposition. By designating
the years 2000 to 2002 she can eliminate the full gain as shown below.
P of D, deemed 2003 ............................................................................................................................
ACB ......................................................................................................................................................
Gain ......................................................................................................................................................
Exemption(2) .........................................................................................................................................
Capital gain...........................................................................................................................................

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

In 2009, when she returns to Waterloo and moves back into the house, there is another change in use and a
resulting deemed disposition. In this case the principal residence exemption can be claimed for the two years
2003 and 2009, since the house was her principal residence at some point during each of those years.
P of D, deemed (2009) ..........................................................................................................................
ACB, deemed .......................................................................................................................................
Gain ......................................................................................................................................................
Exemption(3) .........................................................................................................................................
Capital gain (2009) ...............................................................................................................................
P of D, actual (2010).............................................................................................................................
ACB ......................................................................................................................................................
Capital loss (2010) not allowed on PUP ...............................................................................................

$ 294,000
(230,000)
$ 64,000
(27,429)
$ 36,571
$ 284,000
(294,000)
Nil

Comparison:
Subsection 45(2) election .....................................................................................................................
No subsection 45(2) election ................................................................................................................

Nil
$ 36,571

Conclusion
In summary, by making no elections, she will report a capital gain of $36,571 in 2009 along with any
recaptured CCA that also has to be reported.
If she had made the 45(3) election in 2009 when the house was changed from income producing to personaluse property, then the capital gain could be deferred and would not have to be reported until the actual
disposition in 2010.
Since nothing had to be filed with the 2003 tax return to reflect the change in use, the above decisions can be
made before filing the 2009 tax return.
NOTES TO SOLUTION
(1)

10 + 1
$198,000 = $198,000; designate 20002003, 2009, and 2010; and 20042007 inclusive
11

(2)

3 +1
$144,000 = $144,000; designate 2000 to 2002, inclusive.
4

(3)

2 +1
$64,000 = $27,429; designate 2003 and 2009.
7

Solutions to Chapter 7 Assignment Problems

113

Solution 3 (Advanced)
June 6, 2005:
Proceeds of disposition (500 shares @ $2.75) ........................................................................................
ACB (500 shares @ $4.00(1)) .............................................................................................. $ 2,000
Commission ........................................................................................................................
50
Capital loss (superficial loss(2) = $675) ...................................................................................................
November 5, 2010:
Proceeds of disposition (10,000 shares @ $7.50) ...................................................................................
ACB (10,000 shares @ $2.444(3)) ....................................................................................... $ 24,440
Commission ........................................................................................................................
650
Capital gain .............................................................................................................................................
Taxable capital gain 1/ 2 ...........................................................................................................................

1,375
(2,050)
Nil

$ 75,000
(25,090)
$ 49,910
$ 24,955

NOTES TO SOLUTION
(1)

(2)
(3)

1,000 shares @ $5.00 ............................................................................

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

5,000
7,000
$ 12,000

3,000

= $ 4.00

$10,000
675
8,000
225
Nil
12,000
1,190
$ 32,000

13,090

= $ 2.444

Federal Income Taxation: Fundamentals

114
Solution 4 (Advanced)
Schvantz Ltd.

August 27, 1999

P of D (900 @ $24.50) .................................................................................................
ACB (900 @ $28.75)(1) ................................................................................................
Selling cost ...................................................................................................................
Loss ..............................................................................................................................
Superficial loss denied (600/900 $4,585) ..................................................................
Capital loss ...................................................................................................................
Allowable capital loss (3/ 4 $1,528) ...........................................................................

$ 22,050
$ 25,875
760

(26,635)
$ (4,585)
3,057
$ (1,528)
$ (1,146)

A superficial loss results due to the fact that 600 shares were reacquired 30 days after the
disposition. The superficial loss will be 600/900 $4,585 = $3,057 and the capital loss will be the
balance of $1,528.
June 9, 2001
P of D (250 @ $32) ......................................................................................................
ACB (250 @ $27.44)(2) ................................................................................................
Selling cost ...................................................................................................................
Capital gain ..................................................................................................................
Taxable capital gain (3/ 4 $865) .................................................................................
December 28, 2010
Transaction does not settle until 2011. Therefore, no disposition until 2011.
January 4, 2011
P of D (350 shares @ $29) ...........................................................................................
ACB (350 shares @ $26.76)(3) .....................................................................................
Selling cost ...................................................................................................................
Capital gain ..................................................................................................................
Taxable capital gain (1/ 2 $429) .................................................................................

8,000

$
$

(7,135)
865
649

6,860
275

$ 10,150
$

9,366
355
$
$

(9,721)
429
215

6,400

Shtupp Metals Ltd.

October 31, 1999
P of D (200 $32) .......................................................................................................
ACB (200 $36.20)(4)..................................................................................................
Selling cost ...................................................................................................................
Capital loss...................................................................................................................
Allowable capital loss (3/ 4 $1,060) ...........................................................................
June 30, 2005
P of D (150 $36.50) ..................................................................................................
ACB (150 $34.73).....................................................................................................
Selling cost ...................................................................................................................
Capital gain ..................................................................................................................
Taxable capital gain (1/ 2 $100) .................................................................................

7,240
220

(6,802)
$ (1,060)
$ (795)
$

5,475

$
$

5,375
100
50

5,210
165

NOTES TO SOLUTION
(1)

(2)

(3)

(4)
(5)

1996 (800 shares @ $25) + $690 ..........................................................................

1987 (1,100 shares @ $30) + $940 .......................................................................
ACB = $54,630/1,900 shares .....................................................................................
1,000 shares @ $28.75 ...............................................................................................
Superficial loss ..........................................................................................................
1997 (600 shares @ $19.50) + $400 .....................................................................
ACB = $43,907/1,600 ................................................................................................
2001 1,350 shares @ $27.44 .................................................................................
2007 135 shares @ $20.00 ....................................................................................
ACB = $39,744/1,485 ................................................................................................
1997 (500 shares @ $35) + $600 ...........................................................................
ACB = $18,100/500 ...................................................................................................
300 shares $36.20 ...................................................................................................
2007 Stock dividend (30 shares $20) .................................................................
ACB = $11,460/330 ...................................................................................................

$ 20,690
33,940
$ 54,630
$ 28.75
$ 28,750
3,057
12,100
$ 43,907
$ 27.44
$ 37,044
2,700
$ 39,744
$ 26.76
$ 18,100
$ 36.20
$ 10,860
600
$ 11,460
$ 34.73

per share

per share

per share
per share

per share

Solutions to Chapter 7 Assignment Problems

115

Solution 5 (Advanced)
A summary of the specific income implications of the above transactions is set out below. Any transfer of
the shares received under the stock option, whether in the form of a gift, a sale for cash or a sale in exchange for
a note, is a disposition of the shares for tax purposes. Thus, by virtue of subsections 7(1) and 7(1.1), Madame
Martel must include the employment income in 2010, the year of sale, because the employer is a CCPC, the
difference between the exercise/option price and the fair market value at the date the option is exercised.
However, she will have an offsetting deduction under Division C [par. 110(1)(d)] in 2010 because the fair market
value of the shares was equal to the exercise price at the grant date.
Employment Income ($35 $20) 6,000 shares.................................................
Division C deduction (1/ 2 $90,000)...................................................................
ACB of shares to Madame Martel ($35 6,000) .................................................

$ 90,000
$ 45,000
$ 210,000

The net effect of the above is the inclusion in 2010 of an amount equivalent to the one-half taxable portion
of a capital gain.
Because the word transfer in sections 74.1, 74.2, and 69 includes either a gift or a sale, these sections
apply to all three proposed transactions.
1. Gift

Implications to Madame Martel

Proceeds(a) ......................................
ACB ................................................
Capital Gain ....................................
ACB to recipient(b) ..................................
Attribution ..............................................
Dividends ........................................
Capital gains....................................
Double Tax Potential ..............................

2.

Transferee
15-year-old
Spouse
child
ssec. 73(1)

Spouseno
ssec. 73(1)

$ 84,000
(70,000)
$ 14,000
$ 84,000

$ 84,000
(70,000)
$ 14,000
$ 84,000

$ 70,000
(70,000)
$
0
$ 70,000

$ 84,000
(70,000)
$ 14,000
$ 84,000

No(j)
No(e)
No

Yes(c)
Yes(f)
No

No
No(e)
No

Yes(c),(d)
Yes(f),(d)
No

Sale for cash of $20 per share

Implications to Madame Martel

Proceeds(g) .......................................
ACB ................................................
Capital Gain ....................................
ACB to recipient(h) ..................................
Attribution ..............................................
Dividends ........................................
Capital gains....................................
Double Tax Potential ..............................

3.

21-year-old
child

21-year-old
child

Transferee
15-year-old
Spouse
child
ssec. 73(1)

Spouseno
ssec. 73(1)

$ 84,000
(70,000)
$ 14,000
$ 40,000

$ 84,000
(70,000)
$ 14,000
$ 40,000

$ 70,000
(70,000)
$
0
$ 70,000

$ 84,000
(70,000)
$ 14,000
$ 40,000

No
No(e)
Yes

No(j)
No(e)
Yes

Yes(c)
Yes(f)
No

Yes(c),(d)
Yes(f),(d)
Yes

Sale for note receivable of $42 per share with no interest (present value is $25 per share)

Implications to Madame Martel

Proceeds(g) .......................................
ACB ................................................
Capital Gain ....................................
ACB to recipient(h) ..................................
Attribution ..............................................
Dividends ........................................
Capital gains....................................
Double Tax Potential ..............................

21-year-old
child

Transferee
15-year-old
Spouse
child
ssec. 73(1)

Spouseno
ssec. 73(1)

$ 84,000
(70,000)
$ 14,000
$ 50,000

$ 84,000
(70,000)
$ 14,000
$ 50,000

$ 70,000
(70,000)
$
0
$ 70,000

$ 84,000
(70,000)
$ 14,000
$ 50,000

Yes(i)
No(c)
Yes

No(j)
No(e)
Yes

Yes(c)
Yes(f)
No

Yes(c),(d)
Yes(f),(d)
Yes

116

Federal Income Taxation: Fundamentals

NOTES TO SOLUTION
(a) The proceeds of disposition to the children are deemed to equal fair market value [par. 69(1)(c)]. In the
absence of any election filed by Madame Martel, the proceeds of disposition on the gift to the spouse
equal Madame Martels ACB [ssec. 73(1)]. If Madame Martel elects for subsection 73(1) not to apply
to the transfer then the proceeds of disposition to the spouse are fair market value [par. 69(1)(c)].
(b) The ACB of a gift is fair market value [par. 69(1)(c)] for the children or the spouse if Madame Martel
elects for section 73 not to apply. The ACB of a gift to the spouse is equal to Madame Martels ACB
[ssec. 73(1)] in the absence of any election to ignore subsection 73(1).
(c) Attribution will occur on the transfer to the spouse since the acquisition price is less than the fair market
value [par. 74.5(1)(a)]. Where spouses are living apart by reason of a breakdown of their marriage,
there is an exemption from section 74.1 [par. 74.5(3)(a)]. Income earned on income previously
attributed back (e.g. second generation income) is not subject to the attribution rules because the
income previously attributed is not included in the definition of substituted property in subsection
248(5).
(d) If Madame Martel elects not to have subsection 73(1) apply, the attribution rule will still apply since the
fair market value of the consideration (gift Nil; cash sale of $20; note payable for $42 per share
without interest) is less than the fair market value of the transferred shares ($42) [par. 74.5(1)(a)].
(e) There is no capital gain attribution in respect of children (except where farming property was
transferred under 75.1).
(f ) When her spouse disposes of the shares, the resulting gain or loss would be attributed back to Madame
Martel if she is still married to her spouse and they are living together [sec. 74.2]. However, where the
spouses are living apart by reason of a breakdown of their marriage, an exemption from section 74.2 is
provided if a joint election is filed with the tax return of the transferor spouse in the first year in which
the above conditions apply [par. 74.5(3)(b)].
(g) The proceeds to the children are deemed to equal fair market value [spar. 69(1)(b)(i)]. In the absence of
any election filed by Madame Martel, the proceeds of disposition on a sale for cash or a note equal
Madame Martels ACB [ssec. 73(1)]. If Madame Martel elects for subsection 73(1) not to apply to the
sale then the proceeds of disposition are fair market value [spar. 69(1)(b)(i)].
(h) The ACB of a sale at less than fair market value ($20 cash or $42 note with no interest $42) is not
affected by section 69. Section 69 provides only for an adjustment to the transferors proceeds of
disposition on a transfer at less than the fair market value not to the transferees cost. Thus the ACB
is the amount paid $20 per share/$25 present value of the note (for the children or the spouse if
Madame Martel elects for section 73 not to apply). If section 73 applies to the sale to the spouse then
the ACB to the spouse is equal to Madame Martels ACB.
(i) Since this transaction involves indebtedness between related parties, ssec. 56(4.1) applies to cause
attribution of income from property (dividend income in this case) for the 21-year-old child. Note that
par. 56(4.1)(b) requires that one of the main reasons for the transfer of the shares to the 21-year-old
was to reduce or avoid tax by effectively transferring taxation of the income from the shares to the
21-year-old. This test is met in this particular situation.
(j) The dividends received by the 15-year-old child are subject to the income-splitting tax, and therefore,
will not be subject to the attribution rules. The income splitting tax stops at age 18. The effect of the
income splitting tax is, in essence, the same as the attribution rules where the transferor is in the top
federal tax bracket.

Solutions to Chapter 7 Assignment Problems

117

Solution 6 (Advanced)
As Roxanne acquired the property in a non-arms length transaction, her cost for CCA purposes is reduced
by the amount specified in paragraph 13(7)(e).
Brothers cost
Brothers proceeds
Brothers cost

Roxannes cost for CCA purposes

350,000

125,000
475,000

$ 600,000
350,000
$ 250,000
50%

The condominium is a Class 1 asset (building acquired after 1987). Since the capital cost of the property is
greater than $50,000, it must be put into its own separate CCA class. The maximum CCA that Roxanne may
claim in her first year is:
Class 1-4%
Capital cost of additions
Less CCA ($475,000 4%) (see Notes)
UCC at end of year

$ 475,000
2,250
$ 472,750

Notes:
The half-year rule does not apply [Reg. 1100(2.2)] since she acquired the property from a non-arms length
person.
CCA at 4% = $19,000, but Roxanne cannot create or increase a rental loss by claiming CCA on her rental
property. As her rental income for the year is 1/ 4 $9,000 = $2,250, this is the maximum CCA available. As this
is income from property and not income from a business, the CCA is not prorated by the number of days she
owned/operated the property.

Federal Income Taxation: Fundamentals

118
Solution 7 (Advanced)
Par. 3(a)

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

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

Par. 3(b)
Net taxable capital gains (see Note (3)) ......................................................................
Par. 3(d)
ABIL (see Schedule 10) ..............................................................................................
Income under Division B ......................................................................................................................

$ 73,518
30,792
$ 104,310
46,161
(24,000)
$ 126,471

Note (1)
Employment Income
Sec. 5
Spar. 6(1)(b)(x)
Spar. 6(1)(b)(v)
Ssecs. 7(1), (1.1)
Ssec. 80.4(1)

Salary gross ..........................................................................................

Car allowance ($650 12) ........................................................................
Travelling allowance ($550 12) .............................................................
Stock option (see Schedule 1) ...................................................................
Interest-free loan benefit (see Schedule 2) ................................................

$ 72,000
7,800
6,600
4,725
463
$ 91,588

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

Par. 8(1)(h)

RPP current service ........................................................

Professional fees..................................................................
Travelling expenses:
Meals ($3,500 50%) .................................................
Accommodation...........................................................
Car expenses (see Schedule 3) ............................................

$ 3,700
500
1,750
4,500
7,586

18,036
$ 73,552

Comments:
(a) Income taxes are not deductible [ssec. 8(2)].
(b) CPP contributions and EI premiums are tax credits deductible under Division E.
(c) The deduction for meals is restricted to 50% of the lesser of the amount paid or payable and a
reasonable amount [ssec. 67.1(1)].
(d) Since Mr. Richmond negotiates contracts for his employer, an allowance is not a taxable benefit if it is
considered to be reasonable [spar. 6(1)(b)(v)]. In this situation, it appears that the amount for travelling
expenses is not reasonable, since the actual expenses for meals and accommodation exceed the
allowance ($8,000 versus $6,600). Therefore, the allowance is taxable, but the expenses are deductible
[par. 8(1)(h)] since Mr. Richmond was required to carry on his duties away from his employers place
of business and his contract required him to pay his travelling expenses.
Note (2)
Income from Property
(A) Dividends
Dividends from Wealth Inc. ($800 1.25)..................................................... $ 1,000
Dividends from Foreign Corp. ($500 + $88)..................................................
588
Taxable amount of dividends from Dumark Mutual Fund .............................
500
(B) Attribution
Interest income Children ($1,050 2)....................................................... $ 2,100
Interest income Wife .................................................................................
600
(C) Rental properties (see Schedule 4) ................................................................................................
(D) Accrued interest (ssec. 20(14)) on Government of Canada Bond (see Schedule 9) ......................
Total income from property ..........................................................................................................
Less: Interest expense re: Wealth Co. shares (see Schedule 2) .....................................................

2,088

2,700
21,140
5,327
$ 31,255
(463)
$ 30,792

Comments:
(a) Dividends from Canadian-controlled private corporations resident in Canada are to be included in income
[par. 12(1)(j)]. The amount to be included in income is the actual amount of dividends (from income taxed at
the low corporate rate) received plus 1/ 4 of the dividends received [ssec. 82(1)]. Dividends allocated by a
mutual fund from dividends that it receives from Canadian-resident public corporations are included in
income with a 44% gross-up, as reported on the T3 slip. A dividend tax credit [sec. 121] reduces the tax on
dividends received by an individual.
(b) Dividends from non-resident corporations are to be included in income [par. 12(1)(k)]. The amount to
be included in income is set out in section 90. Under section 126, a foreign tax credit reduces tax paid
on such dividends.

Solutions to Chapter 7 Assignment Problems

119

(c) Attribution of income from property occurs due to the fact that Mr. Richmond gifted monies (property)
to his spouse [ssec. 74.1(1)].
(d) Attribution of income from property occurs due to the fact that Mr. Richmond gifted monies (property)
to his children, i.e., non-arms length minors [ssec. 74.1(2)].
(e) Subsection 74.1 does not apply to loans to non-arms length persons who are 18 years of age or older, i.e.,
Mr. Richmond and his brother. Anti-avoidance rules [ssec. 56(4.1)] prevent the avoidance of tax on loans
between non-arms length persons. In order for subsection 56(4.1) to apply, one of the main reasons for the
loan must be to reduce or avoid tax on income from property. Since Mr. Richmonds brother paid his tuition
fee with the loaned money, there will be no income from property to attribute to Mr. Richmond.
(f) Section 80.5 provides that where a benefit is included in income under section 80.4, the amount of the benefit
will be regarded as interest paid which might be deductible under paragraph 20(1)(c). Mr. Richmond
borrowed funds from his employer to invest in securities. Therefore, a deduction [par. 20(1)(c)] can be taken
because the interest expense was incurred for the purpose of earning income from property.
Note (3)
Taxable Capital Gain (Allowable Capital Loss)
(A) Listed personal property (see Schedule 5)
Painting ...................................................................................................................................
Stamp collection ($1,000 $1,000) ........................................................................................

$
$

Less: LPP carryforward (limited to gain) ................................................................................

(B) Personal-use property (see Schedule 5)
Antique foot stool....................................................................................................................
Car (see Schedule 6)................................................................................................................
(C) Stock options (see Schedule 1)
($9,600 ) ............................................................................................................................
(D) Rental property (see Schedule 7)
($36,600 ) ..........................................................................................................................
(E) Mutual funds
Dumark Mutual Fund ( $1,200) ........................................................................................
Sale of Dumark units (see Schedule 8)....................................................................................
Paget Mutual Fund ( $280) ...............................................................................................
(F) Government of Canada bonds (see Schedule 9)
($12,000 ) ..........................................................................................................................
(G) Loan to brother-in-laws company (see Schedule 10) .....................................................................
(H) Principal residences (see Schedule 11)
($92,000 ) ..........................................................................................................................

500
Nil
500
(500)

Nil
Nil
$

4,800
18,300
600
321
140

6,000
(30,000)
46,000
$ 46,161

Schedule 1 Stock Options

Employment income:
1st lot 450 shares ($10.50 $8) =...................................................................................................
2nd lot 600 shares ($21 $15) = .....................................................................................................

$
$

The $100,000 deferral is not available on either lot because the shares are shares in a CCPC.
Capital gain:
1st lot 450 shares ($26.50 $10.50) = ...........................................................................................
2nd lot 600 shares ($25 $21) =......................................................................................................

$
$

1,125
3,600
4,725

7,200
2,400
9,600

The 1st lot sold by Mr. Richmond will be eligible for a deduction [par. 110(1)(d.1)] equal to $1,125 = $563.
The deduction, however, is permitted under Division C, not under Division B.
Schedule 2 Interest-free Loan Benefit
$9,000 (7% 268/365) = $463
Schedule 3 Car Expense Deduction
Car expenses:
Gas and oil ......................................................................................................................................
Insurance .........................................................................................................................................
Maintenance ....................................................................................................................................
Licence ............................................................................................................................................
CCA old (see note (a) below) ..................................................................................................
new .................................................................................................................................

2,100
800
500
130
1,500
5,085
$ 10,115

Federal Income Taxation: Fundamentals

120
Deductible, $10,115

18,750
= ............................................................................................................
25,000

7,586

Note (a)
CCA calculation Class 10.1: old car
Jan. 1, 2010 UCC ..................................................................................................................
2010 CCA 1/ 2 30% $10,000); reg. 1100(2.5).......................................................
Proceeds of disposition .....................................................................................
Recapture denied under ssec. 13(2) ...................................................................
CCA calculation Class 10.1: new car
2010 Purchase ($33,900* 1/ 2 ) .................................................................................
CCA (30% $16,950) ......................................................................................
Add: 1/ 2 of purchase ..........................................................................................
Jan. 1, 2011 UCC ..................................................................................................................

$ 10,000
(1,500)
(12,500)
Nil
$ 16,950
(5,085)
16,950
$ 28,815

* The capital cost used as basis for capital cost allowance with respect to the new car is limited to $30,000 plus HST of
13% (i.e., $30,000 1.13 = $33,900).

Schedule 4 Rental Properties

Wealthier St.
$ 18,000

$ 18,000
Less: Total expenses ....................................................................
10,000
CCA (see below) ................................................................
1,560
Income (loss) ................................................................................
$ 6,440
CCA and recapture calculation:
UCC beginning of year ..................................................
$ 39,000
Disposition ..........................................................................

$ 39,000
CCA 4%.........................................................................
1,560
Recapture ............................................................................

UCC end of year ......................................................................

$ 37,440
Rental revenue ..............................................................................
Recapture (see below) ..................................................................

Richmount St.
$
7,600
15,000
$ 22,600
7,900

$ 14,700

= $ 21,140

65,000
80,000
$ (15,000)

15,000

Schedule 5 Personal-Use Property and Listed Personal Property

Proceeds of disposition ....................................................
ACB .................................................................................
Capital gain......................................................................

Painting
(LPP)
$ 1,500
(1,000)
$ 500

Antique foot stool

(PUP)
$ 1,000
(1,100)
Nil*

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

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

Schedule 6 Car Disposition

Proceeds of disposition .......................................................................................................................
Capital cost (limit in 2010) .................................................................................................................
Loss denied [spar. 40(2)(g)(iii) and spar. 39(1)(b)(i)] ........................................................................

12,500
(30,000)
Nil

Schedule 7 Rental Property Sale

Proceeds of disposition for land and building .............................................................
Capital cost of land and building ($100,000 + $80,000)............................................. $ 180,000
Selling cost .................................................................................................................
9,000
Gain ....................................................................................................................................................
Less reserve lesser of:
(a)

$ 250,000

189,000
61,000
(24,400)

$100,000
$61,000 = $24,400
250,000

(b) (1/ 5 $61,000) (4 - 0) = $48,800

$

36,600

Schedule 8 Sale of Dumark units

P of D (1,000 units) ............................................................................................................................
ACB (1,000 units @ $12.240*) ..........................................................................................................
Capital gain.........................................................................................................................................
TCG (1/ 2 $641) ................................................................................................................................
* Adjusted cost base of units:

12,881
(12,240)
$
641
$
321

Solutions to Chapter 7 Assignment Problems

1,640.824
3.845
119.358
1,764.027

121

units .................................................................................................................
units @ $12.044 ...............................................................................................
units @ $12.944 ...............................................................................................

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

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

Schedule 9 Government of Canada Bonds [ssec. 20(14)]

Amount received ................................................................................................................................
Accrued interest received ...................................................................................................................
Proceeds of disposition .......................................................................................................................
ACB ....................................................................................................................................................
Capital gain.........................................................................................................................................

115,327
(5,327)
$ 110,000
(98,000)
$
12,000

Schedule 10 Loan to brother-in-laws company

Since the brother-in-laws company qualifies as a small business corporation, the loss is a business
investment loss [par. 39(1)(c)]. However, since Mr. Richmond claimed a $60,000 capital gains exemption in
prior years, $60,000 of the business investment loss is disallowed and treated as a capital loss. Since the question
does not indicate that Mr. Richmond had any previously disallowed business investment losses, the full $60,000
reduction under subsection 39(9) is applied to the business investment loss realized in 2010.
Proceeds of disposition
ACB
Business investment loss before disallowed portion
Less: business investment loss disallowed [ssec. 39(9)]
Business investment loss
Allowable business investment loss (1/ 2 )
Capital loss (equal to disallowed business investment loss)
Allowable capital loss (1/ 2 )

$
$
$
$
$
$

12,000
(120,000)
108,000
(60,000)
48,000
24,000
60,000
30,000

Schedule 11 Principal Residence

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

$
$

95,000
21,000

Cottage

350,000

$
$

(116,000)
$ 234,000
= $ 23,400

15,500
12,000

$234,000
$172,500
10 years
15 years
Therefore, Mr. Richmond should assign the maximum designation to the City Home first.
Maximum capital gain:
City Home
Par. 40(2)(b):
Gain ................................................................................................................. $ 234,000
Exemption ....................................................................................................... (234,000)(1)
Nil

NOTES TO SOLUTION
(1) Designate 20022010

1 + 9 years
$234,000 = $234,000
10 years

(2) Designate 19962001

1 + 6 years
$172,500 = $80,500
15 years

200,000

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

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

Federal Income Taxation: Fundamentals

122
Solution 8 (Advanced)

Part A
In the absence of any elections, Marys minimum income/taxable capital gains are calculated as follows:
Asset
Toronto rental land(1) ..............................................
Toronto rental building(1) ........................................
Stratford rental land(2) .............................................
Stratford rental building(3).......................................
CBV shares(4) ..........................................................
View Canada shares(5) ............................................
Totals ......................................................................

Recapture
n/a

n/a
$ 23,000
n/a
n/a
$ 23,000

Taxable capital gain

$ 10,000
14,000

(15,000)
$ 9,000

NOTES TO SOLUTION
(1) The Toronto rental building transfers to Marys spouse per spar. 70(6)(d)(i) at the lesser of:
(i) capital cost........................................................ $ 55,000
and
(ii) UCC ................................................................. $ 15,000
The lesser is ............................................................. $ 15,000
Proceeds...................................................................
Capital cost ..............................................................
Capital gain/loss ......................................................
Opening UCC ..................................................................................................
Less:
lesser of (i) capital cost .......................................................
$55,000
(ii) proceeds ..........................................................
$15,000
Recapture .........................................................................................................

15,000
(55,000)
$
0
$ 15,000

(15,000)
0

The Toronto rental land transfers to Marys spouse at its ACB [spar. 70(6)(d)(ii)]. Therefore, there is no
capital gain/loss on the transfer of the Toronto rental land.
(2) The Stratford rental land transfers to Margaret at its fair market value [par. 70(5)(a)]. This results in the
following capital gain:
Proceeds....................
Adjusted cost base ....
Capital gain ..............
Taxable capital gain

$ 45,000
(25,000)
$ 20,000
$ 10,000

(1/ 2 )

(3) The Stratford rental building transfers to Margaret at its fair market value [par. 70(5)(a)]. This results in
the following capital gain and recapture:
Proceeds.................... $ 93,000
Capital cost ............... (65,000)
Capital gain ............... $ 28,000
Taxable capital gain
$ 14,000
(1/ 2 )
Opening UCC ..................................................
Less:
lesser of (i) capital cost ........ $ 65,000
(ii) proceeds ........... $ 93,000
Recapture .........................................................

$ 42,000

(65,000)
$ 23,000

(4) The CBS shares transfer to Marys spouse at ACB [spar. 70(6)(d)(ii)]. Therefore, no gain or loss is
recognized.
(5) The Bell Canada shares transfer to Margaret at fair market value [par. 70(5)(a)]. Marys adjusted cost
base in these shares is equal to the fair market value as of the date she inherited the shares from her
father $180,000 per paragraph 70(5)(a). This results in a capital loss calculated as follows:
Proceeds........................................
Adjusted cost base ........................
Capital loss ...................................
Allowable capital loss ...................

$ 150,000
(180,000)
$ (30,000)
$ (15,000)

(1/ 2 )

Solutions to Chapter 7 Assignment Problems

123

Part B
The cost amounts of the inherited assets to the respective beneficiaries are set out below.
Marys Spouse
Asset
Toronto rental land(1)................................................................................
Toronto rental building(2) Class 3 ........................................................
CBS Shares(3) ...........................................................................................
Margaret
Asset
Stratford rental land(4) ..............................................................................
Stratford rental building(5) Class 1 ......................................................
Bell Canada shares(4) ................................................................................

Capital Cost/ACB
$ 40,000
55,000
500,000

UCC
n/a
$ 15,000
n/a

Capital Cost/ACB
$ 45,000
93,000
150,000

UCC
n/a
$ 93,000
n/a

NOTES TO SOLUTION
(1) Beneficiary spouse acquires non-depreciable capital property at adjusted cost base [spar. 70(6)(d)(ii)].
(2) Beneficiary spouse acquires depreciable property at a cost amount equal to the proceeds to the deceased
taxpayer [spar. 70(6)(d)(i)]. The capital cost of depreciable property acquired by a spouse is equal to the capital
cost to the deceased taxpayer [par. 70(6)(e), spar. 70(5)(c)(i)]. Note that Marys spouse is not subject to the halfyear rule in computing CCA on the Toronto rental building for 2009 [Reg. 1100(2)(h)]. Note also that the
Toronto rental building is deemed to be a Class 3 asset to Marys spouse [Reg. 1102(14)(d)].
(3) These shares had an adjusted cost base to Mary of $500,000 [spar. 70(5)(a)]. On transfer to Marys
spouse, these shares are acquired by the spouse at this adjusted cost base [spar. 70(6)(d)(ii)].
(4) Any beneficiary other than a spouse (or spousal trust) acquires non-depreciable capital property at fair
market value [par. 70(5)(b)].
(5) Any beneficiary other than a spouse (or spousal trust) acquires depreciable property at its fair market
value [par. 70(5)(b)]. Note that paragraph 13(7)(e) contains an exception for transfers as a result of the death of
the transferor and thus the UCC for Marys daughter will be the full $93,000. Note that Marys daughter is not
subject to the half-year rule in computing CCA on the Stratford rental building for 2010 [Reg. 1100(2)(h)].

Federal Income Taxation: Fundamentals

124
Solution 9 (Basic)
Par. 3(a)

Par. 3(b)

Par. 3(d)

2008
Income from non-capital sources (non-negative):
Subdivision b
Business..................................................................... $ 60,000
Property .....................................................................
2,000
$ 62,000
Net taxable capital gains (non-negative):
Subdivision c
LPP(1) .........................................................................
Nil
PUP ...........................................................................
Nil
Other.......................................................................... $(2,000)
Nil(2)
$ 62,000
Losses from non-capital sources:
Property ......................................................................................
Nil
ABIL ..........................................................................................
(2,000)(3)
$ 60,000

2009

2010

$ 65,000
3,000
$ 68,000

$ 70,000

$ 70,000

Nil
$ 2,500
3,000
$ 5,500
$ 73,500

Nil
Nil
$ 73,500

(1,000)
Nil
$ 69,000

500
2,000
(18,000)
Nil(2)
$ 70,000

NOTES TO SOLUTION
(1) Listed personal property:
2008 $5,000 of 2009 capital loss applied to 2008 resulting in nil.
2010 $2,000 of 2009 capital loss applied to 2010 leaving a $500 net taxable capital gain (($3,000

$2,000) ).
(2) Paragraph 3(b) does not permit a negative figure; therefore, the 2008 allowable capital loss of $2,000 (
($8,000 $4,000 BIL)) is available as a carryover under Division C. Similarly, $5,500 (i.e., ($16,000
$500 $2,000) of 2010 loss is available as a carryover under Division C.
(3) 2008 allowable business investment loss of $2,000 ( $4,000 BIL).

Solutions to Chapter 7 Assignment Problems

125

Solution 10 (Basic)
Classification of Properties and Taxable Capital Gains (Losses)

Household furniture
Skis, etc.
Rights to season tickets
Paintings
Chevrolet
Fishing lodge
ABC shares
Total capital gain
Taxable capital gain
Business loan

Property
Type
PUP
PUP
PUP
LPP
PUP
PUP
ordinary

BIL

Proceeds
$20,000
1,000
4,000
2,400
3,600
45,000
46,000

ACB
Disposal
$35,000
1,200
3,500
1,900
12,000
31,000
20,000

$ 8,000

Disposition
Costs
$ 800
0
0
120
350
4,500
200

$0

Gain (Loss)
$

0
0
500
380
0
9,500
25,800
$36,180
$18,090
$ (8,000)

Notes:

1.
2.
3.
4.

Gain on personal residence is exempt as principal residence.

Losses from the disposition of personal-use property are not deductible.
We assume that the fishing lodge cannot be designated as Billys principal residence.
The BIL will qualify as an ABIL and can be deducted against any other source of income.

Computation of Net Income

Paragraph 3(a)
Paragraph 3(b)
Paragraph 3(d)
Net income for tax purposes

Employment income
Taxable capital gains
ABIL

$48,000
18,090
(4,000)
$62,090

Federal Income Taxation: Fundamentals

126
Advisory Case
Case 1: Theresa Vert

ADVISORY CASE DISCUSSION NOTES

Theresa should be advised that, upon becoming a non-resident, she is deemed to have disposed of each
property that she owned, except for the following:
real property situated in Canada, Canadian resource properties, and timber resource properties;
capital property used in, and eligible capital property in respect of, a business that she carried on
through a permanent establishment in Canada, and the inventory of the business;
excluded rights and interests (defined in subsection 128.1(10));
if she was resident in Canada for 60 months or less out of the last 120 months, property that she owned
when she last moved to Canada, or property inherited during the period of residency; and
property in respect of which she, upon subsequently returning to reside in Canada, makes an election to
unwind the deemed disposition.
Treatment of Real Property
In light of the above, Theresa should reconsider her decision to dispose of her real property. Unless she
actually disposes of it, she will not incur any tax liability in regard to it upon emigrating. Obviously, if she has to
liquidate some of her real property assets, making use of the principal residence exemption should be considered.
If she disposes of her real property, the tax consequences will be as follows.
Years owned
Capital gain:
Downtown townhouse (1988)
Cottage (1989)

13
12

Gain/year
$320,000 130,000 = $190,000
$270,000 55,000 = $215,000

$14,615
$17,917

A married couple can have only one principal residence. For the years during which both properties were
owned, it would be possible to designate the cottage as the principal residence since it has the highest gain per
year. However, one year should be moved from the cottage to the townhouse to take advantage of the 1+ rule.
Rental Property
Since the gain on the sale of land and building must be reported separately, the legal and disposition costs
should be prorated between the land and the building accordingly. The legal expenses incurred at the time of
purchase would be prorated based on cost and the disposition costs would be prorated based on proceeds.
Land proceeds
ACB (includes 25/105 of $3,000 legal expenses)
Disposition expenses ($20,000 150/250)
Capital gain
Taxable capital gain

$150,000
(25,714)
(12,000)
$112,286
$ 56,143

Since the building has appreciated, there will be recaptured depreciation. The capital cost of the building is
$105,000 25,000 + (3,000 (80/150)) = $82,286.
Building proceeds
ACB (includes 85/105 of $3,000 legal expenses)
Disposition costs ($20,000 100/250)
Capital gain
Taxable capital gain
Recaptured depreciation ($82,286 30,000)

$100,000
(82,286)
(8,000)
9,714
$ 4,857
$ 52,286

Treatment of Stocks and Bonds and Other Assets

These assets are not exempted; accordingly, there will be a deemed capital gain as follows:

Publicly traded shares $50,000

Province of Alberta bond $10,000

Piano $2,000
Total capital gain: $62,000; total taxable capital gain: $31,000.
Posting Security
Where an individual has a deemed capital gain upon emigrating, he or she has the option of posting adequate
security with the CRA and deferring the payment of the tax (without interest) until the property is actually sold.
Security is not required for the first $100,000 of capital gains resulting from the deemed disposition rule.
Accordingly, if Theresa were to retain her real property assets, she could emigrate without immediate tax
liability.

Solutions to Chapter 7 Assignment Problems

127

Case 2: Belleville Furniture Inc.

ADVISORY CASE DISCUSSION NOTES
The main tax issues in this case relate to:
inventory valuation,
liability for U.S. tax,
the refinancing of the business, and
foreign exchange.
1. Inventory valuation
Lower of cost or market or all at market are acceptable methods of valuing inventory for tax purposes
[ssec. 10(1); reg. 1800].
Reserves for decline in the value of inventory are not allowed as a deduction for tax purposes [par. 18(1)(e)].
A deduction is allowed if the decline is real and measurable as at year end.
2. Sales in the U.S.
It needs to be determined whether the company has a permanent establishment in the U.S.
o If they do, then this will result in it having to file a U.S. tax return and pay tax in the U.S. on the
profits of that permanent establishment.
A business foreign tax credit would be available for any tax paid in the U.S. [ssec. 126(2)].
The 10% federal abatement is not available for profits earned by a Canadian company carrying on business
in the U.S.
3. Refinancing Issues
(a) Personal guarantees
Tax treatment of losses resulting from contributions made to the company as a result of a personal
guarantee being called [IT-239R2].
o These losses may be BILs if the company is a small business corporation and if the money was
loaned to earn income from business or property [par. 39(1)(c)].
Interest expense deductible if borrowing to meet obligation under personal guarantee [IT-445].
Guarantee fees could be charged to show that the guarantees were made to earn income.
(b) Professional fees for the financing
Legal fees for collateral mortgage, accounting fees for cash flows and the appraisers fees for the real estate
appraisal can be deducted straight-line over five years [par. 20(1)(e)].
(c) Sale of shares
Since the suppliers company is probably a SBC, the ABIL is available, since he deals at arm's length with
the supplier [sec. 251, par. 39(1)(c); IT-219].
(d) Interest expense
After the sale of the shares, interest on the full $50,000 loan will be deductible [ssec. 20.1(1)].
He should secure the loan that he makes to the company.
4. U.S. dollar bank account
Foreign exchange gains and losses on the money in this account would probably be income in nature, given
that the bank account is for the collection of accounts receivable [IT-95R].

CHAPTER 8

Capital Gains: Business Related

Solution 1 (Advanced)
[Reference: Joseph Schillaci v. M.N.R., 92 DTC 1648 (T.C.C.)]
Intention of the Taxpayer
(A) Primary intention
The stated intention of the partners, including Jean-Luc, was to develop and own an income-producing
capital asset. The CRA will argue that the plaza was held as inventory developed for resale at a profit. This
intention must be substantiated by observation of the whole course of conduct of the taxpayer in this situation.
(B) Secondary intention
The CRA will argue that even if Jean-Luc intended his participation in the partnership to be an investment in
a capital investment at the time of the purchase, he had the secondary intention of reselling the commercial
enterprise if circumstances made that desirable. The courts have held that to give a transaction which involves
the acquisition of capital the double character of also being at the same time an adventure in the nature of trade,
the purchaser must have in mind, at the moment of the purchase, the possibility of selling as an operating
motivation for the acquisition. That is, he must have had in mind that upon a certain type of circumstance arising
he had hopes of being able to resell it at a profit instead of using the thing purchased for purposes of capital. A
decision that such a motivation exists will have to be based on inferences flowing from the circumstances
surrounding the transaction rather on direct evidence of what the purchaser had in mind.
Behavioural Factors and Circumstances used to Substantiate Intention of the Taxpayer
(A) Relationship of the transaction to the taxpayers business
Jean-Luc was experienced in real estate and, at the time, he was a licensed real estate broker and owned a
brokerage firm. It can be argued that he had the special expertise to know that the asset could be resold at a
profit, if the primary intention of holding a capital asset failed. However, on this project he was in partnership
with Jorge who was a developer of real estate properties which were held as income-producing rental assets.
(B) Nature of the activity or organization associated with trade
The evidence does not suggest that the purchase and subsequent sale transactions were organized in the
manner of an inventory purchase and sale. Although the sale followed the purchase in a fairly short period of
time, the property was purchased and developed into an income-producing rental property. The sale arose only as
a result of the financial difficulties of the principal partner. Given the development and financing effort and the
full rental of the property on a net-net lease basis, the evidence does not suggest that the sale was a strong,
operating motivation for the purchase in existence at the time of the purchase.
(C) Type of asset
While owned by the partnership, the property was actually used as an income-producing asset with rents
being collected. The evidence does not suggest that the development effort was directed to enhancing the value
of an inventory asset for resale. At the time of the purchase, it appeared fairly certain that the development of an
income-producing asset was feasible, given the agreements with anchor tenants and the likelihood of financing.
On the other hand, it might be argued that the relatively short holding period after completion of the project
suggests an inventory asset.
(D) Number and frequency of transactions
This appears to be Jean-Lucs first venture as an owner. His previous transactions in real estate appear to be,
to a large extent, as an employee, first of the fast-food chain and, then, of Jorge. Little is known about his real
estate transactions as a broker firm owner. In the case at hand, Jean-Luc had very little control over the sale
transaction, since the principal partner owned such a large share that he would not have needed Jean-Lucs
approval of the sale.

129

130

Federal Income Taxation: Fundamentals

(E) The length of the period of ownership of the asset

Two years is a relatively short period to hold an income-producing property, suggesting a speculative intent,
in the CRAs view.
(F) Any supplemental work on or in connection with the property
The building was completed to the point where the tenants took possession and the tenants were in operation
and paying rent. This would indicate an intention to hold a capital asset as an investment, although the CRA
would argue that the project was completed and rented to make it more saleable as a package.
(G) Stated objectives of the organization
The asset in question was not held by a corporate entity, so there are no articles of association. The evidence
suggests that the partnership agreement would probably provide for the holding of the property for rental
purposes, but would also likely provide for the sale of the property under certain conditions. This agreement is
not likely to be conclusive in distinguishing this transaction between income or capital.
(H) Other factors
In IT-218R, paragraph 3, the CRA suggests other factors which might be considered in the evaluation of real
estate transactions, including:
(i) the feasibility of the taxpayers stated intention of using the property as a capital asset in this case, it
was in fact used as a capital asset;
(ii) the geographic location and zoned use of the real estate acquired in this case, location was attractive
to the tenants and zoning was appropriate for a viable plaza;
(iii) the extent to which borrowed money was used and the terms of financing in this case, the financing
was mostly by borrowings and it was temporary, implying a speculative interest in the property, in the
CRAs view; and
(iv) factors which motivated the sale in this case, the property was sold as a result of unforeseen financial
difficulties of the principal partner which were beyond the control of Jean-Luc.
Conclusion
At the time of the purchase, there did not appear to be the prospect of a quick sale as an operating
motivation for that purchase. The development of the project into a viable income-producing property, at that
time, could be foreseen, given the pre-development activity and the prospects of full financing. The evidence can
substantiate the partners stated intention to hold the property for investment purposes and not with a view to
resale.
There are sufficient arguments in Jean-Lucs favour to pursue the case further in a meeting with the CRA.

Solutions to Chapter 8 Assignment Problems

131

Solution 2 (Basic)
Capital Property
A reserve is available [spar. 40(1)(a)(iii)] for that proportion of the gain that is attributable to proceeds not
due in the year. This reserve is restricted to a five-year period and on a cumulative basis at least 20% of the gain
must be brought into income each year.
2010
Proceeds of disposition ...........................................................................................................
Adjusted cost base ...................................................................................................................
Gain .........................................................................................................................................
Reserve lesser of:
(a) $156,000 $120,000/$160,000 = $117,000
(b) (1/ 5 $156,000) (4 - 0) = $124,800 ........................................................................
Capital gain .............................................................................................................................
Taxable capital gain (1/ 2 ) ........................................................................................................
2011
Prior years reserve .................................................................................................................
Reserve lesser of:
(a) $156,000 $100,000/$160,000 = $97,500
(b) (1/ 5 $156,000) (4 - 1) = $93,600 ..........................................................................
Capital gain .............................................................................................................................
Taxable capital gain (1/ 2 ) ........................................................................................................
2012
Prior years reserve .................................................................................................................
Reserve lesser of:
(a) $156,000 $80,000/$160,000 = $78,000
(b) (1/ 5 $156,000) (4 - 2) = $62,400 ..........................................................................
Capital gain .............................................................................................................................
Taxable capital gain (1/ 2 ) ........................................................................................................
2013
Prior years reserve .................................................................................................................
Reserve lesser of
(a) $156,000 $60,000/$160,000 = $58,500
(b) (1/ 5 $156,000) (4 - 3) = $31,200 ..........................................................................
Capital gain .............................................................................................................................
Taxable capital gain (1/ 2 ) ........................................................................................................
2014
Prior years reserve .................................................................................................................
Reserve lesser of
(a) $156,000 $40,000/$160,000 = $39,000
(b) (1/ 5 $156,000) (4 - 4) = 0 .....................................................................................
Capital gain .............................................................................................................................
Taxable capital gain (1/ 2 ) ........................................................................................................

$ 160,000
(4,0000)
$ 156,000

(117,000)
$ 39,000
$ 19,500
$ 117,000

$
$

(93,600)
23,400
11,700

93,600

$
$

(62,400)
31,200
15,600

62,400

$
$

(31,200)
31,200
15,600

31,200

$
$

(0)
31,200
15,600

Note how the capital gain of $156,000 is effectively spread over the five years 2010 to 2014, inclusive [i.e.,
$39,000 + $23,400 + (31,200 3)].
Income Property (Inventory)
A reserve is available [par. 20(1)(n)] for that proportion of the profit on the sale of land that is attributable to
proceeds due after the year.
2010
Sale proceeds...........................................................................................................................
Cost .........................................................................................................................................
Profit .......................................................................................................................................
Reserve: $156,000 $120,000/$160,000 =.............................................................................
Income ....................................................................................................................................
2011
Prior years reserve .................................................................................................................
Reserve: $156,000 $100,000/$160,000 =.............................................................................
Income ....................................................................................................................................

$ 160,000
(4,000)
$ 156,000
(117,000)
$ 39,000
$ 117,000
(97,500)
$ 19,500

Federal Income Taxation: Fundamentals

132

2012
Prior years reserve .................................................................................................................
Reserve: $156,000 $80,000/$160,000 =...............................................................................
Income ....................................................................................................................................
2013
Prior years reserve .................................................................................................................
Reserve: limited by ssec. 20(8) ...............................................................................................
Income ....................................................................................................................................

97,500
(78,000)
$ 19,500
$
$

78,000
(0)
78,000

Note how the profit of $156,000 is effectively spread over the four years 2010 to 2013, inclusive [i.e.,
$39,000 + ($19,500 2) + $78,000].
Summary of Cash Flows
Year
2010
2011
2012
2013
2014
2015
2016

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

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

20,000

20,000
($ 39,000)
$ 121,000

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

20,000

20,000

20,000
$ (78,000)
$ 82,000

Solutions to Chapter 8 Assignment Problems

133

Solution 3 (Basic)
This situation involves a voluntary disposition of a former business property in respect of the land and
building. As a result, Power Boat Corporation Ltd. must replace the land and building within the later of
12 months and one taxation year from the end of the December 31, 2010 taxation year (i.e., the taxation year of
the disposition), in order to obtain the benefits of the rollover. This is illustrated by the following time line:
Dec. 31

2010

2011

Dec. 31

Feb.
Replacement
Disposition
replacement period limit

(A) (i) No subsection 44(6) election

Capital gain section 44 election (file an amended return for 2010):
The lesser of:
(a) Proceeds of disposition................................................................................
Adjusted cost base .......................................................................................
Gain .............................................................................................................
(b) Proceeds of disposition................................................................................
Replacement cost.........................................................................................
Excess, if any ..............................................................................................
Capital gain (lesser amount)........................................................................................
Adjusted cost base of replacement property [par. 44(1)(f)]:
Replacement cost ........................................................................................................
Less: excess of (a) over (b) deferred capital gain ...................................................
ACB ............................................................................................................................

Land

Building

$ 300,000
(50,000)
$ 250,000
$ 300,000
(75,000)
$ 225,000
$ 225,000

$ 200,000
(100,000)
$ 100,000
$ 200,000
(350,000)
0
0

$ 75,000
25,000
$ 50,000

$ 350,000
100,000
$ 250,000

Note, from part (b) of the capital gain calculation for the building, that up to $150,000 (i.e., $350,000
$200,000) could be added to the proceeds of the building before there is an excess over replacement cost. This
determines the room for a reallocation under subsection 44(6).
UCC subsection 13(4) election (file amended return for 2010):
UCC just prior to the sale..........................................................................................................
Par. 13(4)(c) lesser of:
(a) cost, $100,000
(b) P of D, $200,000 ........................................................................................... $ 100,000
Less: the lesser of:
(a) recapture, $100,000 $55,000 = $45,000
(b) replacement cost, $350,000 ...........................................................................
45,000
UCC, December 31, 2010 ..............................................................................................................

Addition to 2011 [par. 13(4)(d)]

Replacement cost ................................................................................................ $ 350,000
Less: deferred capital gain [par. 44(1)(f)] ........................................................... 100,000
Deemed capital cost ............................................................................................ $ 250,000
Less: deferred recapture [par. 13(4)(c)] ..............................................................
45,000
UCC ...............................................................................................................................................
CCA, 2011 ($205,000 6% 1/ 2 ) .................................................................................................
UCC, January 1, 2012 ....................................................................................................................

Class 1: 4%
$ 55,000

55,000
0
Class 1-NRB:
6%

$ 205,000
(6,150)
$ 198,850

(ii) Using a subsection 44(6) election

Using an election under subsection 44(6) to allocate $150,000 of the proceeds of disposition on the land to
the building, the following results:
Capital gain section 44 election (file an amended return for 2010):
The lesser of:
(a) Proceeds of disposition .....................................................................

Land

Building

$ 300,000

$ 200,000

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Federal Income Taxation: Fundamentals

Ssec. 44(6) adjustment......................................................................
Deemed proceeds of disposition .......................................................
Adjusted cost base ............................................................................
Gain ..................................................................................................
(b) Deemed proceeds of disposition (above) ..........................................
Replacement cost..............................................................................
Excess, if any....................................................................................
Capital gain (lesser amount) .............................................................................
Adjusted cost base of replacement property [par. 44(1)(()]:
Replacement cost .............................................................................................
Less: excess of (a) over (b) deferred capital gain ........................................
ACB .................................................................................................................
UCC subsection 13(4) election (file amended return for 2010):

(150,000)
$ 150,000
(50,000)
$ 100,000
$ 150,000
(75,000)
$ 75,000
$ 75,000

150,000
$ 350,000
(100,000)
$ 250,000
$ 350,000
(350,000)
0
0

$ 75,000
25,000
$ 50,000

$ 350,000
250,000
$ 100,000

UCC just prior to the sale .................................................................................................

Par. 13(4)(c) lesser of:
(a) cost, $100,000
(b) P of D, $200,000 (not adjusted by ssec. 44(6))................................. $ 100,000
Less: the lesser of:
(a) recapture, $100,000 $55,000 = $45,000
(b) replacement cost, $350,000 ..............................................................
45,000
UCC, December 31, 2010 .....................................................................................................

Addition to 2011 [par. 13(4)(d)]

Replacement cost...................................................................................... $ 350,000
Less: reduction for deferred capital gain [par. 44(1)(f)] ...........................
250,000
Deemed capital cost ................................................................................. $ 100,000
Less: reduction for deferred recapture [par. 13(4)(d)] ..............................
45,000
UCC ......................................................................................................................................
CCA, 2011 ($55,000 6% 1/ 2 ) ..........................................................................................
UCC, January 1, 2012 ...........................................................................................................

Class1: 4%
$ 55,000

55,000
0
Class 1NRB: 6%

$ 55,000
(1,650)
$ 53,350

The effect of the subsection 44(6) election can be compared as follows:

Capital gains recognized:
Land ..........................................................................................
Building.....................................................................................
ACB of replacement property:
Land ..........................................................................................
Building.....................................................................................
UCC (before CCA) of replacement building ....................................

Without
ssec. 44(6)

With
ssec.44(6)

Difference

$ 225,000
0

$ 75,000
0

$ 150,000
0

50,000
250,000
205,000

50,000
100,000
55,000

0
150,000
150,000

The taxpayer corporation has deferred an additional $150,000 of capital gain in the land, but the UCC base
for CCA on the Class 1-NRB has been reduced by $150,000. A present value comparison can be made to
evaluate this trade-off.
(B) (i) Since the apartment building does not fit the definition of a former business property, no rollover of the
accrued capital gains and recapture would be possible in a voluntary disposition of the property.
(ii) On an involuntary disposition, like an expropriation, the rollover of the accrued capital gains and
recapture would be allowed as long as the property is replaced within two years from the end of the year in which
the expropriation proceeds become receivable, as outlined in subsection 44(2).
In both cases, the new Class 1 apartment building would be amortized at the 4% CCA rate.

Solutions to Chapter 8 Assignment Problems

135

Solution 4 (Advanced)
This situation involves a voluntary disposition of a former business property in respect of land and building,
as well as a disposition of property not eligible for a rollover. Raymond must replace the land and building
within one taxation year of the end of the December 31, 2010 year (i.e., the taxation year of the disposition), in
order to obtain the benefits of the rollover.
2010
Mar. 1

Dec. 31

2011
Feb.

Disposition

Dec. 31
Nov.
Replacement

replacement period limit

(A)
2010 income Subdivision b
Par. 12(1)(d)
Sec. 22
Sec. 23
Sec. 13

Sec. 14

Last years reserve ..................................................................................................

$6,000 $10,000.....................................................................................................
$5,200 $7,000 ......................................................................................................
Recapture Class 3 ($62,000 $28,000) .............................................................
Class 8 ($1,200 $300) ....................................................................
Class 10 ($4,000 $800) ..................................................................
2
/ 3 3/ 4 $52,000...................................................................................................

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

Taxable capital gain Subdivision c

Land
Building
Equipment

($120,000 $65,000) $55,000 1/ 2 ..............................................................

($170,000 $62,000) $108,000 1/ 2 ............................................................
Class 8 (($3,000 $1,200) 1/ 2 .........................................................................
Class 10 ..............................................................................................................

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

(B) 2010 amended tax return

Section 44 election on capital gains
TCG on land:
Lesser of:
(a) $55,000 CG (above)
(b) ($120,000 $105,000) = $15,000 - $15,000 1/ 2 ........................................... $ 7,500
ACB [par. 44(1)(f)] = $105,000 ($55,000 $15,000) = $65,000
TCG on building:
Lesser of:
(a) $108,000 CG (above)
(b) $170,000 $220,000 = Nil..............................................................................
Nil
ACB = $220,000 ($108,000 Nil) = $112,000
Note from the capital gain calculation for the building that up to $50,000 (i.e., $220,000 $170,000) could
be added to the proceeds of the building before there is an excess over replacement cost. This determines the
room for a reallocation under subsection 44(6).
Subsection 13(4) election on recapture
Cl. 1: 4%
Building:
UCC January 1, 2010 ....................................................................................................................
Less: lesser of [par. 13(4)(c)]:
P of D ............................................................................. $ 170,000
Capital cost .....................................................................
62,000
$ 62,000
Less: reduction [par. 13(4)(d)] which is the lesser of:
(a) recapture ................................................................... $ 34,000
(b) replacement cost .......................................................
220,000
34,000
UCC, December 31, 2010 ..............................................................................

$ 28,000

28,000
Nil

136

Federal Income Taxation: Fundamentals

Cl. 1-NRB:
6%

Capital cost of replacement property in 2011:

Actual cost .............................................................................................................
Less: reduction [par. 44(1)(f)] ................................................................................

$220,000
108,000
$112,000
Less: reduction [par. 13(4)(d)] ...............................................................................
34,000
UCC, December 31, 2011 .............................................................................................................
CCA 2011 (6% 1/ 2 of $78,000) ..................................................................................................
UCC, January 1, 2012 ...................................................................................................................

$ 78,000
$ 78,000
2,340
$ 75,660

(C) Using a subsection 44(6) election:

Allocate $15,000 of proceeds of disposition on the land to the building.
Capital gain Section 44 election (file an amended return for 2010):
The lesser of:
(a) P of D ......................................................................................................
Ssec. 44(6) adjustment ............................................................................
Deemed P of D ........................................................................................
ACB ........................................................................................................
Gain .........................................................................................................
(b) Deemed P of D (above) ...........................................................................
Replacement cost.....................................................................................
Excess, if any ..........................................................................................
Capital gain (lesser amount)....................................................................................
Adjusted cost base of replacement property [par. 44(1)(f)]:
Replacement cost ....................................................................................................
Less: deferred capital gain ((a) (b) above)............................................................
ACB ........................................................................................................................
UCC Subsection 13(4) election (file amended return for 2010):

Land

Building

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

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

$ 105,000
40,000
$ 65,000

$ 220,000
123,000
$ 97,000

UCC just prior to sale ...............................................................................................................

Reduction [par. 13(4)(c)]: lesser of:
(a) cost ($62,000).......................................................................................... $ 62,000
(b) P of D ($170,000) (not adjusted by ssec. 44(6))
Less: the lesser of:
(a) recapture ($62,000 $28,000 = $34,000)................................................
34,000
(b) replacement cost ($220,000)
UCC, December 31, 2010 .............................................................................................................
Addition for purchase in 2011:
Replacement cost ............................................................................................ $ 220,000
Less: reduction for deferred capital gain [par. 44(1)(f)] ..................................
123,000
Deemed capital cost ........................................................................................ $ 97,000
Less: reduction for deferred recapture [par. 13(4)(d)] .....................................
34,000
UCC ..............................................................................................................................................
CCA, 2011 ($63,000 6% 1/ 2 ) ..................................................................................................
UCC, January 1, 2012 ...................................................................................................................

Class 1: 4%
$ 28,000

28,000
Nil
Cl. 1-NRB:
6%

$ 63,000
(1,890)
$ 61,110

Comparison of Part (B) without and Part (C) with subsection 44(6) election:
Without ssec. 44(6)
Capital gain Land ......................................................... $ 15,000
Building....................................................
Nil
ACB of replacement property Land ..........................
65,000
Building .................... 112,000
UCC (before CCA for the year) of replacement building
78,000

With ssec. 44(6)

Nil
Nil
$ 65,000
97,000
63,000

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

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

Solutions to Chapter 8 Assignment Problems

137

Solution 5 (Basic)
Pidgeon Dock Ltd. has sold the building for less than its cost amount, with a concurrent capital gain on the
land. When this occurs, subsection 13(21.1) reallocates the proceeds of disposition between the land and the
building. Any loss on the building is reduced by the amount of the gain on the land.
Deemed proceeds of the building is equal to the lesser of:
(a) Total FMV of land and building
Deduct the lesser of:
i) FMV of land
ii) Cost of land
amount (a)
(b) The greater of:
i) FMV of building
ii) the lesser of:
a) UCC of building
b) Capital cost
amount (b)
Deemed proceeds building (lesser of (a) and (b))
Deemed proceeds land ($475,000 350,000)
The tax implications are:
Capital gain on land: Proceeds
Cost
Capital gain
Taxable capital gain (50% inclusion rate)
Building: UCC at beginning of year
Deduct the lesser of:
Capital cost
Proceeds
UCC at end of year

$ 475,000
$175,000
$100,000

100,000
$ 375,000

$300,000
$350,000
$400,000

$350,000
$ 350,000
$350,000
$125,000
$125,000
(100,000)
$ 25,000
$ 12,500
$350,000
$400,000
$350,000
$

350,000
0

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

Federal Income Taxation: Fundamentals

138
Solution 6 (Advanced)

Given that High Towers intention is to demolish the building, its fair market value to High Towers is nil.
High Towers is effectively paying $1 million to acquire the land on which the building sits. In the absence of a
specific provision, Johnny Wong would have a capital gain of $920,000 (i.e., $1,000,000 $80,000) on the land
and a terminal loss on the building of $103,000 (i.e., $140,000 $37,000). The capital gain is only 1/ 2 taxable
and the terminal loss could be used to shelter a portion of the taxable capital gain. Therefore, in the absence of a
specific provision to prevent such an offset, Johnnys tax implications would be as follows:
Land:
P of D ........................................................................................................................................
ACB ..........................................................................................................................................
Capital gain ...............................................................................................................................
Taxable capital gain (1/ 2 ) ..........................................................................................................
Building:
P of D ........................................................................................................................................
UCC ..........................................................................................................................................
Terminal loss.............................................................................................................................
Combined:
Taxable capital gain land......................................................................................................
Terminal loss building..........................................................................................................
Net income ................................................................................................................................

$ 1,000,000
(80,000)
$ 920,000
$ 460,000
Nil
$ (103,000)
$ 103,000
$

460,000
(103,000)
$ 357,000

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

$ 1,000,000

80,000
920,000

103,000

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

$ 1,000,000

103,000
897,000

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

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

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

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

Solutions to Chapter 8 Assignment Problems

139

Solution 7 (Advanced)
(A) Net income before taxes ......................................................................................................................
Add:
Sec. 3
Book loss on sale of securities ...................................... $ 20,000
Sec. 3
Book loss on sale of trademark .....................................
10,000
Ssec. 14(1)
E.C.A. (Schedule 1) ......................................................
4,239
Sec. 39
Taxable capital gain on land: 1/ 2 of
($150,000 $120,000).............................................
15,000
Taxable capital gain on sale of building 1/ 2 of
($120,000 $100,000).............................................
10,000
Par. 18(1)(b)
Depreciation ..................................................................
80,000
Par. 18(1)(t)
Assessment interest .......................................................
1,500
Par. 18(1)(a)
Donations ......................................................................
10,000

$ 900,000

150,739
$1,050,739

Less:
Sec. 3
Sec. 3
Sec. 39

Book gain on sale of land .............................................. $ 50,000

Book gain on sale of building........................................
95,000
Allowable capital loss on securities:
1
/ 2 of ($50,000 $30,000) .......................................
10,000(1)
Sec. 50
Allowable capital loss on bad capital debt:
2,500
(1/ 2 $5,000) ...........................................................
Par. 20(1)(a)
Capital cost allowance ...................................................
100,000
257,500
Net income for income tax purposes ...................................................................................................... $ 793,239
Schedule 1 Cumulative Eligible Capital
2007 eligible capital expenditure ($80,000 3/ 4 )........................................................................
Cumulative eligible capital amount 2007 @ 7% .........................................................
2008 @ 7% .........................................................
2009 @ 7% .........................................................
2010 sale ($70,000 3/4) ............................................................................................................
Income [ssec. 14(1)] since less than previous CECA claims.......................................................

60,000
(4,200)
(3,906)
(3,633)
(52,500)
$ (4,239)

(B) HST treatment:

Overview:
Since the corporation is carrying on business, it is engaged in a commercial activity [ETA: ssec. 123(1)].
Therefore, the corporation is required to register for and collect HST on its supplies, i.e., sale of goods or other
property which are taxable supplies. As a registrant, the corporation is entitled to a full input tax credit (ITC) in
respect of HST paid or payable on goods and services that it purchases exclusively for use in its commercial
activities [ETA: ssec. 169(1)]. If HST collected or collectible on the companys sales exceeds its ITCs, the
corporation must remit the difference. On the other hand, if ITCs exceed HST collected or collectible, a refund of
the excess is available.
Specific Items Presented:
Land and building Real property that is capital property [ETA: ssec. 123(1)] of a registrant is referred to
as capital real property. Acquisitions of capital real property generate proportional ITCs based on the extent of
use in a commercial activity. The capital real property at issue was acquired after 1990, likely, for at least 90%
use in a commercial activity. An ITC of 100% of the HST paid or payable on acquisition was available. If capital
real property were used for residential purposes, no ITC would have been available. On the sale of capital real
property used in a commercial activity, HST must be charged by the vendor.
Securities Securities are financial instruments, the supply of which is considered to be a financial service
[ETA: ssec. 123(1)]. A supply of a financial service is exempt from HST.
Trademark A trademark is intangible personal property. On its purchase, the corporation would have paid
HST and claimed an ITC. On the sale, the corporation must charge HST on the sale price of $70,000 if the
trademark may be used in Canada and the purchaser is resident in Canada or a registrant. (The purchaser, if a
registrant, would be eligible for a full ITC in the year that the HST is incurred with no amortization requirement.)
Depreciation Equipment is considered capital personal property. A full ITC is available where capital
personal property is purchased after 1990 for use primarily (i.e., more than 50%) in commercial activities. On the
sale of such property, the vendor must charge HST. Since ITCs on capital property are not matched with revenue

140

Federal Income Taxation: Fundamentals

over time, there are no HST consequences to either depreciation for accounting purposes or CCA for income tax
purposes.
Interest on unpaid income taxes Interest on unpaid income taxes is a cost incurred in respect of a
financial instrument which is an exempt supply. No HST is paid and, hence, no ITC is available.
Donations Donations involve a transfer of money without consideration. No HST is charged on the
donation and, hence, no ITC is available.
Employee dinner-dance(2) ITCs in respect of HST-paid expenses on food, beverages and entertainment
are allowed in full in the reporting period in which they are incurred. If the expenses had been subject to the 50%
limit in section 67.1 of the Income Tax Act, there would be a recapture of 50% of the total ITCs at the end of the
registrants fiscal year. The amount recaptured would be included in the registrants HST return for the first
reporting period in the next fiscal year [ETA: sec. 236].
Bad debt HST relief is available in respect of bad debts [ETA: sec. 231]. Where HST is remitted but not
collected on a debt that is subsequently written off, a registrant is permitted to deduct an amount equal to 13/113
of the amount written off. The $5,000 bad debt must be in respect of a supply made to an arms length party. If
the debt is subsequently repaid, 13/113 of the recovered amount must be added to net tax by the registrant.
NOTES TO SOLUTION
(1) The aggregate of taxable capital gains reported in 2010 is in excess of the 2010 allowable capital losses.
Thus, all the 2009 capital losses can be claimed in 2010.
(2) The $14,000 spent on the annual employee dinner-dance is not restricted by the 50% limitation under
section 67.1, since the party was for all employees at a particular location.

Solutions to Chapter 8 Assignment Problems

141

Advisory Cases
Case 1: Sudbury Processing Inc.
ADVISORY CASE DISCUSSION NOTES
The following are the issues that arise from the transactions in this case:
insurance proceeds
replacement property rules
equipment lease with option to purchase
business interruption insurance
sale of land with warranty
option to acquire land
1. Insurance proceeds for repairs
Any insurance proceeds used for repairs are included in income [par. 12(1)(f)] to offset the repair expense.
The balance of the insurance proceeds is considered proceeds of disposition [ssec. 13(21)] for the
equipment.
2. A fire destroyed the building and most of the contents
It was an involuntary disposition since the destruction was caused by a fire.
The income effect will have to be reported in the year in which the proceeds are agreed to, i.e., 2010 (this is
the initial year).
As a result, they have 24 months from the end of the initial year in which to replace the building and
equipment, in order to get the benefit of the replacement property rules.
In order to get the replacement property rules, the building and equipment must be replaced within
24 months of the end of 2010.
The equipment qualifies for the replacement property rules since this is an involuntary disposition.
The replacement property must be used in the same or similar business by Holdco or a related person
[ssec. 44(5)].
3. Equipment lease with an option to buy
The equipment lease will probably be an operating lease according to IT-233R.
The option must be exercised by the end of 2012, in order to qualify for the replacement property rules.
Holdings would have to exercise the option under the lease for the property to be replacement property
since Holdings is the taxpayer which owned the original property.
If the lease is a capital lease, then it would qualify as a replacement property if Holdings held the lease.
o Effects of subsection 13(5.2) not considered (knowledge not required).
4. Business interruption insurance
The business interruption insurance proceeds are included in income under section 9.
5. Sale of land with warranty
Sale of land recognized in July 2010.
Full amount of the proceeds recognized; no reserve is available for the warranty.
Any amount that has to be paid back to the purchaser will be treated as a capital loss under section 42.
The capital gain reserve is only available if part of the proceeds are not yet due.
Ideally, any payments under this warranty would be paid before the three-year carry back for net capital
losses expires.
6. Option to acquire land
If Holdings exercises the option to acquire the land then the option price will be added to the cost of the
land under subsection 49(3).
If the option is not exercised then the cost of the option will be treated as a capital loss.
Since the original land was not disposed of involuntarily, they only have one year from the end of the initial
year in which to exercise the option and replace the land in order to get the replacement property rule.

Federal Income Taxation: Fundamentals

142
Case 2: Mac Tosh

ADVISORY CASE DISCUSSION NOTES

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

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

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

Since Mac is carrying on a farming business, the taxable capital gains incurred on the disposition of the
farmland qualifies for the capital gains exemption. For this purpose, the trees will be considered part of the land.
The available capital gains exemption is $375,000 (1/ 2 of $750,000). Assuming that Mac does not have any
current capital losses from any other property, his annual gains limit is $211,500, and the CGE will completely
offset his taxable capital gain on the farm. The CGE is allowed in computing taxable income, not net income.
The only adjustment the CRA will uncover is the $15,000 business income, as this is the only item Mac did
not treat correctly.

CHAPTER 9

Other Sources of Income and Deductions

in Computing Income
Solution 1 (Basic)
(A) Future Value of the investment
(i) Tax-Free Savings Account:
Note: The $4,500 is immediately taxable to the individual at his or her current marginal tax rate.
Taxpayer A:
After-tax amount invested = $4,500 (1 - 0.45)
FV of investment = $2,475 (1 + 0.08)10
Taxpayer B:
After-tax amount invested = $4,500 (1 - 0.40)
FV of investment $2,700 (1 + 0.08)10
Taxpayer C:
After-tax amount invested = $4,500 (1 - 0.27)
FV of investment = $3,285 (1 + 0.08)10

=
=

$2,475
$35,854

per year

=
=

$2,700
$39,114

per year

=
=

$3,285
$47,588

per year

(ii) RRSP contribution: Note: The original contribution is taxable at the withdrawal date only (in 10 years).
Each taxpayer will accumulate the same amount over the 10-year period as their original contribution
and their marginal tax rate at Year 10 are the same.
Taxpayers A, B, and C:
FV of investment = $4,500 (1.08)10 = $65,190
After-tax cash = $65,190 (1 - 0.4) = $39,114
(B) As shown in the above calculations, taxpayer A should definitely contribute to an RRSP because his or her
after-tax accumulation in an RRSP is greater than what would be accumulated in a savings account.
Taxpayer B is indifferent between the two alternatives as the after-tax accumulation on both is equal. This
individual could wait until his/her income is higher and, thus, the marginal tax rate is higher, before
contributing to an RRSP. Taxpayer C should use the TFSA, as the current marginal tax rate of 27% is much
less than the tax rate on withdrawal of 40%.

143

Federal Income Taxation: Fundamentals

144
Solution 2 (Advanced)

2008
Earned income
Salary
Rental income
Alimony
Loss from partnership
18% of earned income
Unused RRSP deduction room:
lesser of
1. RRSP limit
2. 18% of prior year earned income
Therefore, unused RRSP deduction room
Pension adjustment
Unused deduction from previous year
Unused deduction room available for the year
(assuming that there was no RRSP contribution
in the prior year)

$130,000
7,000
10,000
(30,000)
$117,000
$ 21,060

2009

2010

$135,000
18,000
10,000
(20,000)
$143,000
$ 25,740

$21,000
21,060
21,000
(4,000)

$22,000
25,740
22,000
(7,000)
16,000

$17,000

$31,000

As per subsection 146(5), the maximum RRSP contribution that Diana can deduct for 2010 is the lesser of:
(i) actual contribution within 60 days after year end
(ii) RRSP deduction limit

$10,000
$31,000

Therefore, the maximum RRSP deduction in 2010 taxation year is $10,000.

Solutions to Chapter 9 Assignment Problems

145

Solution 3 (Basic)
Sibbalds net income for tax purposes would be calculated as follows:
Employment income:
Gross salary (subsection 5(1))
Directors fees (paragraph 6(1)(c))
Association fees (paragraph 8(1)(i))
Property income:
T-bill interest
Other income:
RRSP withdrawal (400 $20) (subsection 56(1))
Net income for tax purposes

48,000
600
(280)
3,200

8,000
59,520

Notes:
1. The cost of uniforms is non-deductible as an employment expense.
2. Parking expenses are personal and are also not deductible.
3. In accordance with paragraph 18(11)(b), interest on funds borrowed to make RRSP contributions is not
deductible.
Tax planning opportunities:
1. In the future, Sibbald should consider funding any household purchases by making a withdrawal from her
T-bill account rather than her RRSP. A T-bill withdrawal of $8,000 would have no effect on taxable income
in the year of withdrawal, while any amount withdrawn from an RRSP is fully taxable. In addition, $8,000
left in an RRSP would compound annually on a pre-tax basis, while investments outside of the plan
accumulate at a much lower after-tax rate of return.
2. Assuming that Sibbald will continue to invest in both shares and T-bills, it may be preferable to hold T-bills
within her RRSP, and hold shares personally. As the above example demonstrates, any associated gains
realized on shares held in an RRSP are fully taxable as income in the year of withdrawal. However, if the
same shares were held personally, any gains would receive preferential tax treatment. For example, dividend
income is eligible for a dividend tax credit, and only one-half of capital gains are taxable.
3. It would also be beneficial for Sibbald to pay out her RRSP loan as quickly as possible considering that the
related interest expense is not deductible. In the future, if Sibbald needs to borrow money, she should
consider only doing so to purchase investments. As the investments would be purchased for the purpose of
earning property income, any interest expense related to the loan would be fully deductible.

Federal Income Taxation: Fundamentals

146
Solution 4 (Advanced)
Part (a):
Business income (Schedule 1)
Rental loss (Schedule 2)
Child care benefit (two children $100 12 mos.)
Total income
Subdivision e deductions:
Child care expenses (Schedule 4)
Moving expenses
Net income for tax purposes

$61,700
(1,125)
2,400
$62,975
(9,600)
(1,900)
$57,475

Schedule 1 Business income

Fees received
Deduct:
Salaries and benefits
Office
Interest expense
Courses
Insurance
Capital cost allowance
Office equipment (Schedule 3)
Automobile expenses
Operating expense
Capital cost allowance (Schedule 3)

$145,000
$55,500
1,200
10,500
1,400
5,000

(73,600)
(6,200)

1,000
6,000
$ 7,000
(3,500)

Less: 50% personal use

(3,500)
$ 61,700

Net business income

Schedule 2 Rental income from office building

Rent revenue
Deduct:
Interest
Operating expense
Capital cost allowance (Schedule 3)
Rental income
Net rental loss (loss shared 50/50)
Mariah
Sister

24,000

(6,250)
(20,000)
0
($ 2,250)
($ 1,125)
(1,125)
($ 2,250)

Schedule 3 Capital Cost Allowance

UCC Dec. 31 prior year

Additions current year
CCA current year
UCC Dec. 31 current year

Business
Class 10.1:
Class 8:
30%
20%
$20,000
$30,500

1,000
$20,000
$31,500
(6,000)
(6,200)
$14,000
$25,300

Property
Class 1:
Class 8:
4%
20%

$500,000
$3,000
$500,000
$3,000

$500,000
$3,000

Mariah cannot claim any CCA on the rental property since there is a rental loss before capital cost allowance
(ITR 1100(11)).
Schedule 4 Childcare expenses deduct the least of:
The actual amount
Allowable (2 $7,000)
earned income ($61,700 )
The least of the three amounts is

$ 9,600
$14,000
$41,133
$ 9,600

Part (b):
Mariahs claim for moving expenses may or may not be allowed. Only an eligible relocation qualifies for
moving expenses. To quote the definition of eligible relocation at subsection 248(1), the first qualification is
the relocation occurs to enable the taxpayer to carry on a business at a location in Canada. The question is
unclear as to whether Mariah can meet the enables requirement. She was already carrying on her consulting
business and its location did not change. Perhaps though, it was moved in a previous year (we dont know).
Would she have been unable to carry on the consulting business if she had not moved?

Solutions to Chapter 9 Assignment Problems

147

Solution 5 (Advanced)
(A) Since Mrs. Rui withdrew $6,000 from her RRSP in 2010, Mr. Rui must include in income the lesser of
$6,000 and the sum of the amounts paid by him as premiums to her RRSP in 2010, 2009, and 2008
[ssec. 146(8.3)].
The lesser amount is $4,000, the sum of the amounts paid by him in those three years.
(B) Since all of the employers contributions have vested, he is entitled to contribute $2,000 for each of the
16 pre-96 years of employment (a partial year of employment, 1980, counts as a full year for this purpose).
Therefore, Mr. Rui can deduct a $32,000 contribution to his RRSP in respect of his retiring allowance, not the
full $55,000 contributed [par. 60(j.1)].
Mr. Rui can deduct a $9,880 RRSP contribution in 2010 [par. 60(i)] (lesser of 18% of $66,000 = $11,880 or
$22,000 less 2009 PA of $7,000 plus unused RRSP deduction room of $5,000).
Since he has already made a $2,000 contribution to Mrs. Ruis plan and has overcontributed $23,000 in
respect of his retiring allowance, he should not make any additional contributions.
(C) Since Mr. Rui has earned income in 2010 of $52,300,(1) his tax-deductible RRSP contribution for 2011
is $8,814 (the lesser of 18% of his 2010 earned income of $52,300 and $22,450, less his 2010 PA of $600).
According to the information in Part (B), his net overcontribution in 2011 is $6,306 calculated as follows:
Contributions in respect of 2010 and 2011:
Retiring allowance ................................................................................................................
Spousal RRSP .......................................................................................................................

$ 55,000
2,000
$ 57,000

Deductions in respect of 2010 and 2011:

Retiring allowance .............................................................................................
2010 deduction ...................................................................................................
2011 deduction ...................................................................................................
Net overcontribution ..................................................................................................

$ 32,000
9,880
8,814

(50,694)
$ 6,306

Part X.1 tax of $43.06 per month (1% per month ($6,306 - $2,000 overcontribution limit)) for months
or part thereof from starting at the end of January 2011 onwards that the excess overcontribution is left
in the plan.
The Minister of National Revenue may waive the penalty tax in respect of the overcontribution if
Mr. Rui can establish that the excess amount arose as a result of a reasonable error and reasonable steps
are taken to eliminate the excess [ssec. 204.1(4)].
Mr. Rui should withdraw the $4,306 excess as soon as possible to avoid additional penalty tax.
Withdrawals of overcontributions are deductible in computing income if they are made in the year in
which the overcontribution is made, the year in which the notice of assessment for the excess
contribution year is sent, or in the year following either of those years [ssec. 146(8.2)].
The $2,000 of overcontribution that is not subject to the penalty cannot be deducted in a future year in
this case because his RRSP must be terminated at the end of 2011. As a result, the $2,000 amount will
be taxable when it is paid out of the RRSP and will not have been deducted. Therefore, the $2,000
should also be withdrawn in 2011 and the deduction should be taken [ssec. 146(8.2)].
(D) Because Mr. Rui turns 71 in 2011:
Unless he buys an RRSP annuity or RRIF by December 31, 2011, his entire RRSP will be included in
his 2011 income.
2011 will be the last year in which he can make his annual contribution to his own RRSP.
Mr. Rui may continue to make an annual contribution to his spouses RRSP (subject to his earned
income limitation) until the end of the year in which Mrs. Rui turns 71.
NOTE TO SOLUTION
(1) His 2010 earned income is computed as follows [ssec. 146(1)]:
Employment income.........................
RPP contribution ..............................
Farming income (business)...............
Rental income...................................
Royalty income ................................
Total .................................................

7,000
300
20,000
10,800
14,200
$ 52,300

Federal Income Taxation: Fundamentals

148
Solution 6 (Advanced)
Paragraph 3(a): Income
Sec. 5
Sec. 5
Par. 6(1)(a)
Par. 6(1)(a)
Par. 6(1)(k)
Par. 6(1)(e)

Par. 8(1)(f), 67.1

Par. 8(1)(m)

Employment Income Subdivision a

Salary gross ...............................................................
Commission income.......................................................
Christmas present, including HST (>$500) ...............
Fitness Club(1) ................................................................

$ 150,000
30,000
750
1,300

Car benefit:
$0.24 10,000 km ......................................................... $ 2,400
6,132
(10,000/20,004) $18,400(2)...................................
$ 8,532
less: payroll deduction ............................................
(2,400)
Salespersons expenses (50% $8,300) ........................
RPP ................................................................................

6,132
$ 188,182
(4,150)
(6,000)

$ 178,032

Property Income Subdivision b

Par. 12(1)(c)

Interest ...........................................................................

Par. 12(1)(j)

Dividends taxable Canadian corporations grossed

up @ 44% ...................................................................
Dividend U.S. corporation (Cdn$) ............................
Bonds minors: (2 $120) .........................................

Par. 12(1)(k)
Ssec. 74.1(2)
Par. 20(1)(bb)
Par. 20(1)(c)
Spar. 56(1)(a)(ii)
Ssec. 248(1)
Par. 56(1)(d)

Less: Investment counsellors fee .................................. $

Interest shares ..................................................
Other income Subdivision d

1,100

10,800
800
240
$ 12,940
1,100
850

1,950

Retiring allowance re loss of office ...........................

$ 28,000

Annuity ..........................................................................

2,000

Paragraph 3(b): Taxable Capital Gain Subdivision c

House:
Par. 40(2)(b)
P of D ($188,000 + $12,000) .........................................
ACB ............................................................................... $ 90,000
SC ..................................................................................
12,000
Gain ...............................................................................
( 3)
Exempt portion 1 + 12 $98,000 ...............................
14
Capital gain ....................................................................
TCG ( $7,000)..........................................................
Total income [pars. 3(a) and (b)] .......................................................................

10,990

30,000

$ 200,000
(102,000)
$ 98,000
(91,000)
$

7,000
3,500
$ 222,522

Paragraph 3(c): Deductions Subdivision e

Par. 60(a)
Capital portion of annuity ..............................................
Par. 60(j.1)
Transfer of retiring allowance to RRSP .........................
Par. 60(i)
RRSP..............................................................................

650
20,900(4)
13,600(5) $ (35,150)
$ 187,372

Paragraph 3(d): Losses

Rental loss..........................................................................................................
Partnership loss ..................................................................................................
Division B income .............................................................................................

3,500
3,200

(6,700)
$ 180,672

NOTES TO SOLUTION
(1) The membership in the Fitness Club paid by Clothes to You Ltd. will be a taxable benefit [par. 6(1)(a)]
unless Ms. Sui can demonstrate that the primary benefit was to Clothes to You Ltd. and not to herself.
(2) A standby reduction is available since the business usage was more than 50%, i.e., 75%. Note that the
election [par. 6(1)(k)] of reporting the operating cost benefit as of the standby charge is available, because the

Solutions to Chapter 9 Assignment Problems

149

car is driven primarily for business. However, the election is not beneficial, because it results in an operating cost
benefit of $3,066 (i.e., 1/ 2 $6,132 which is greater than the benefit based on personal kilometres driven.
(3) Years designated cottage 19721998 (no need to designate 1999 with 1 + rule).
Years designated house 19992010 = 12 years.
(4) Deductible retiring allowance transfer to RRSP in respect of loss of office payment [ssec. 248(1)] from
previous employer cannot exceed the lesser of:
(a) sum of:
(i) $2,000 10 (i.e., 1986 to 1995, inclusive) ..................................................................... $ 20,000
900
(ii) $1,500 .6 (i.e., 3 years before 1989: 20% of 3) ..........................................................
$ 20,900
(b) total RRSP premium contribution .......................................................................................... $ 28,000
lesser amount deductible ............................................................................................................... $ 20,900
(5) Lesser of (a)

18% $170,000 = $30,600

$22,000 - $7,000 = $15,000

(b)

dollar limit: $22,000

Of the $34,500 ($28,000 + $6,500) contribution in 2010, $20,900 represents a transfer of the retiring
allowance and $13,600 is deductible under paragraph 60(i). The remaining $1,400 may be carried forward as
unused contribution room deducted in a future taxation year.
Other:

The Private Health Insurance premium paid by Clothes to You Ltd. is not a taxable benefit due to the
exception [spar. 6(1)(a)(i)].

The unexercised stock options will not trigger any tax effect in the year [sec. 7]. Any tax impact will
occur in a subsequent year depending on other facts.

The Employment Insurance premiums and Canada Pension Plan contributions would generate a tax
credit [Division E, sec. 118.7 of the Act].

150

Federal Income Taxation: Fundamentals

Solution 7 (Advanced)
Deductible Moving Expenses
Travel expenses:(1)
Food, 7 days @ $100 (vs. $51 2 7 = $714) ................................. $
Accommodation, 7 days @ $80 ...........................................................
Vehicle expenses, including gasoline ($0.505 2,000 kms) ................
Par. 62(3)(b)
Transporting household effects ..................................................................... $
Storage ..........................................................................................................
Par. 62(3)(c)
Staying near new residence:(2)
Staying in Toronto prior to possession but after closing of new home:
Food, 11 days @ $100 (vs. $51 2 11 = $1,122)........................... $
Accommodation, 11 days @ $80.......................................................
Total 2010 deductible moving expenses paid in 2010 ..............................................................
Par. 62(3)(e)
Selling costs of old residence:(3)
Legal fees old home ........................................................................
Par. 62(3)(f)
New residence legal fees ........................................................................ $
land transfer tax .............................................................
Total 2010 deductible moving expenses paid in 2011 ..............................................................
Total deductible moving expenses (sum of (A) and (B)) ..........................................................
Par. 62(3)(a)

714
560
1,010
5,000
250

1,122
880

$ 2,284
5,250

2,002
$ 9,536 (A)
$ 2,000

2,500
1,000

3,500
$ 5,500 (B)
$15,036

Deduction for Moving Expenses:

2010:
Paragraph 22 of IT-178R3 indicates that all eligible moving expenses may not have been incurred by the
time a taxpayers return for the year of the move is filed. If additional moving expenses incurred are deductible
from income earned at the new location in that year or in the following year, the taxpayer should provide
particulars and available receipts to the local taxation office and request an adjustment of the tax returns.
The moving expenses that were paid in 2011 would be known at the time of filing the 2010 tax returns.
However, unlike most expenditures made by individuals, which are only deductible at the time of payment, the
moving expenses paid for in 2011 would be eligible for deduction in 2010 (to the extent of income earned at the
new location), because they were incurred in that year.
The moving allowance of $10,000 must be included in Georges income from employment in 2010
[par. 6(1)(b)]. Since this is his only income in the new work location for the year, he can deduct $10,000 of the
moving expenses in 2010.
2011:
George or Sue can claim the balance of $5,036 against 2011 income earned in Toronto.(4) Since George will
be in a higher tax bracket it will be preferable for George to claim the deduction.
Loss Reimbursement
Where the employee has begun employment at the new work location, the employee is required to include in
2011 income, the year of receipt [ssec. 6(20)] one-half of the amount in excess of $15,000 paid in respect of a
decrease in value of the employees residence. In this case, the income inclusion for the loss reimbursement
would be $2,500 (i.e., 1/ 2 ($20,000 - $15,000)). Note that the loss was $20,000 and the other $7,000 was for the
real estate commission.
NOTES TO SOLUTION
(1) Seven days of travel (between Halifax and Toronto) do not seem unreasonable, since they experienced
bad weather delays and their new home was not ready in any case. If they had reached Toronto in, say, 2 days,
they would have incurred similar costs of meals and accommodation near their new residence and would have
qualified for a deduction [par. 62(3)(c)] for up to a total of 15 days.
Paragraph 12(a) of IT-178R3 indicates that eligible moving expenses include:

travelling costs, including reasonable amounts for meals and lodging, in the course of moving the
taxpayer and members of the household.

unreceipted maximum (by the CRA administrative practice)

$17 per meal per person
$51 per day per person
$51 2 7 = $714

but reasonable receipted amounts higher

(2) The week on the house-hunting trip prior to the purchase (closing) of the new residence would not be
allowed [IT-178R3, par. 13]. The 11 days spent near the new residence result in deductible expenditures
[par. 62(3)(c)].

Solutions to Chapter 9 Assignment Problems

151

Paragraph 12(c) of IT-178R3 indicates that eligible moving expenses include:

costs of up to 15 days for temporary board and lodging near either residence.

unreceipted maximum (by the CRA administrative practice)

$51 per day 2 persons 11 days = $1,122

but reasonable receipted amounts higher

(3) The selling costs of the old residence may be deducted as a moving expense or a cost of the disposition
in arriving at the capital gain or loss [pars. 12 and 16 of IT-178R3]. However, since NorthAm Co. is reimbursing
the loss excluding legal costs, only the legal costs were included as moving expenses.
(4) Any moving expenses otherwise deductible that were not deductible by virtue of this section in the
preceding year are deductible in the year following the move [par. 62(1)(d)].

Federal Income Taxation: Fundamentals

152
Solution 8 (Advanced)
(A)

Nina
Salary and taxable benefits .............................................................................................
Business income .............................................................................................................
Earned income [sec. 63] .................................................................................................

Len

$ 53,000
$ 53,000

$ 120,000
$ 120,000

Since Len has the higher net income ($119,000), his claim for child care expenses is limited [ssec. 63(2)] to
the lesser of:
(a) $13,600, being the least of:
(i) Eligible child care expenses ($250 50 + ($100 2 4 weeks(1)) + $300(2))
(ii) $4,000 2 children................................................................................... $ 8,000
14,000
$7,000 2.................................................................................................
(iii) 2/ 3 earned income ($120,000)
(b) the sum of:
(i) 2 $100 13 weeks................................................................................. $ 2,600
4,550
(ii) 2 $175 13 weeks.................................................................................

$ 13,600
$ 22,000
$ 80,000

7,150

Lens deduction is the lesser amount: $7,150.

Ninas claim for child care expenses is limited [ssec. 63(1)] to the least of:
(a) Eligible child care expenses (as above)..
(b) $4,000 2 children ..........................................................................................
$7,000 2 children ..........................................................................................
(c)

$ 13,600
$

8,000
14,000

/ 3 earned income ($53,000) ( / 3 $53,000)

$ 22,000
$ 35,333

Ninas deduction is:

The least amount
Minus Lens deduction..
Ninas deduction

$ 13,600
7,150
$ 6,450

Note that the sum of the two deductions is equal to the amount paid with the camp limitation.
(B)
If Nina went to school part-time, Len could deduct a more limited amount:
[($175 2 children) + ($100 2 children)] 4 months during which child care expenses incurred =
Ninas claim would be for the remaining amount: $13,600 - $2,200 = $11,400.

2,200

NOTES TO SOLUTION
(1) The deduction for the overnight camp for Trevor and James is restricted to $100 per week each
[ssec. 63(3)].
(2) Since Lindsay is not under age 18, payments made to her constitute eligible child care expenses
[ssec. 63(3)]. Note also that she is not an eligible child for the purposes of part (ii) of the calculation.

Solutions to Chapter 9 Assignment Problems

153

Solution 9 (Advanced)
Eds net income for tax purposes in Canada would be calculated as follows:
Employment income:
Gross salary (Note 1)
Moving expenses (Note 2)
Child care expenses (Note 3)
Net income for tax purposes

$ 62,000

6,800
$ 55,200

Notes:
1.

Ed is only a Canadian resident since the time he entered Canada on a permanent basis. Accordingly, his
English earnings are not relevant for Canadian tax purposes.

2.

In accordance with subsection 62(1), moving expenses are only deductible if a taxpayer moves from a
residence within Canada. In this case, Ed cannot deduct his moving expenses since he moved from a
residence outside of Canada.

3.

In most situations where there is more than one supporting person, childcare expenses must be claimed by
the taxpayer with the lower income. However, as Laura is in full-time attendance at school, Ed may
claim the childcare. Eds deduction would be limited to the least of:
(a) amount paid (5 months $1,360)
(b) $7,000 per eligible child under age seven (3 $7,000)
(c)

/ 3 of earned income ($62,000 / 3 )

$6,800
$21,000
$41,333

(d) $175 per eligible child under age seven multiplied by the
20 weeks (estimated at 5 months 4). Laura was in full-time
attendance at school ($175 3 20)
$10,500
Lauras scholarship income of $500 will be fully exempt, so her income is zero.

Federal Income Taxation: Fundamentals

154
Solution 10 (Advanced)
Subdivision d
Spar. 56(1)(a)(ii)
Subdivision e
Par. 60(b)
Ssec. 60.1(2)
Par. 60(j.1)

Par. 60(i)

Severance ................................................................................................................

$41,538

Support paid to husband per agreement ..................................................................

Rental payments(1) ...................................................................................................
Transfer of retiring allowance to RRSP Amount
designated not exceeding lesser of:
(a) $2,000 11 years(2) employee .......... $ 22,000
3,000 $ 25,000
$1,500 2 years(3) not vested ...........
(b) RRSP contributions other than direct
transfer..............................................
$ 40,000
RRSP ssec. 146(5) lesser of:
$22,000 ........................................................................ $ 22,000

(2,000)
(3,000)

18% of earned income of previous year

(18% of $120,000)......................................................
Par. 60(o)
Sec. 62

Sec. 63

21,600

(25,000)

21,600

less: pension adjustment of previous year ....................

(9,500)
Legal fees on appeal of tax assessment ...................................................................
Moving expenses:
travelling costs [pars. 62(3)(a) and (c)]:
65
vehicle expenses, including gasoline ($0.54 120 kms) ....... $
hotel (near new residence) .....................................................
200
204
meals (near new residence) (flat rate: 2 days $51 2) .......
transportation of household effects [par. 62(3)(b)] ............................
600
selling costs on old residence [par. 62(3)(e)] .....................................
13,050
costs on purchase of new residence [par. 62(3)(f)].............................
4,100
Child care expense least of
amount paid [$8,976 + (2 $175) + 720]...................................

10,046

$4,000 1 child ..........................................................................

4,000

earned income (see Schedule 1)

$165,743 ..............................................................................

(12,100)
(1,200)

(18,219)

$ 110,495

(4,000)

Total Subdivisions d and e....................................................................................................................

Total Subdivisions a, b, and c ...............................................................................................................
Total Division B income .......................................................................................................................

$ (23,981)
158,488
$ 134,507

Items not used in calculations

Direct transfer of lump-sum of $210,000 out of her RPP to an RRSP is exempt income [sec. 147.3].
RRSP overcontribution of $500, calculated as follows, will not result in a penalty of 1% per month if it is
removed in 2010:
Contributions made in 2010 in respect of 2010 ....................................................................................
Deductible amounts in respect of 2010:
Retiring allowance ................................................................................................... $ 25,000
Annual amount .........................................................................................................
12,100
Excess ......................................................................................................................
Allowable excess not subject to penalty ..........................................................................
Overcontribution subject to penalty .................................................................................

40,000

(37,100)
2,900
(2,000)
$
900

Any withdrawal of the overcontributions will be deductible as long as it is made in the year that the
overpayment is made (2010), the year in which the notice of assessment for the excess contribution year is
sent (2011), or in the year following either of those years (2012) [ssec. 146(8.2)].
Legal fees for representation during separation proceedings to establish a requirement to pay support is a capital
expenditure.
Costs of house-hunting trip are not deductible under sec. 63.
Tuition and transportation are not child care expenses [par. 63(3)(d)]; maximum deductible weekly fee for
YMCA overnight summer camp is $175 [spar. 63(3)(c)(i)].

Solutions to Chapter 9 Assignment Problems

155

Schedule 1
Earned income [ssec. 63(3)]:
Salary [par. 63(3)(a)] ............................................................................................................................
Salary [par. 63(3)(a)] ............................................................................................................................
Section 6 taxable benefits [par. 63(3)(b)] .............................................................................................
Consulting income [par. 63(3)(c)] ........................................................................................................

NOTES TO SOLUTION
(1) As long as the agreement specifically refers to ssec. 60.1(2).
(2) Years (1985-1995) need not be full years or calendar years, but they must be pre-96 years.
(3) Two years (1985-86); both pre-89 years.

$ 96,000
60,000
1,743
8,000
$ 165,743

Federal Income Taxation: Fundamentals

156
Solution 11 (Advanced)
Par. 3(a)

Belleville employment ................................................................................................

Windsor employment ..................................................................................................
Stock option (800 ($25 $17))................................................................................
Moving allowance.......................................................................................................
Dividends (1.44 $8,680) ..........................................................................................
Child care benefit ($100 12) ...................................................................................
Legal fees incurred to establish support payments (administrative practice) .............
Par. 3(b)
TCG ( ($180,000 $60,000)) ...............................................................................
Par. 3(c)
Moving expenses ........................................................................................................
Child care expenses ..............................................................................................................................
Accounting fees ....................................................................................................................................
RRSP ....................................................................................................................................................
Net income ...........................................................................................................................................
Moving Expenses
Allowable expenses [$5,925 $50 + ($0.54 600 kms)] ..................... $ 6,199
Income from new employer
Salary ...................................................................... $ 5,000
Allowance ...............................................................
8,000
$ 13,000
RRSP
Lesser of:
(1) 18% 2009 earned income ($55,000)................................... $ 9,900

6,199

(2) RRSP dollar limit ..................................................................

Child Care Expenses
$7,000 1 child (< 7 yrs) ......................................................................

$ 22,000

9,900

earned income ($74,400).................................................................

$ 49,600

Expenses incurred .................................................................................

$ 3,000

Earned income: salary ...................................................

salary ...................................................
stock option .........................................
moving allowance................................

$ 74,400

3,000

Omit
(1)
(2)
(3)
(4)
(5)
(6)
(7)

$ 55,000
5,000
6,400
8,000

55,000
5,000
6,400
8,000
12,500
1,200
(3,200)
60,000
(6,199)
(3,000)
(400)
(9,900)
$ 125,401

$ 7,000

Apartment hunting costs are not allowable moving expenses.

Food and clothing for the child do not qualify for child care expenses.
Income tax withheld of $20,000 is an instalment.
Stock option deduction of one-quarter of stock option benefit is a Division C deduction.
CPP and EI premiums and charitable donations are eligible for Division E tax credits.
The dividends are eligible for a dividend tax credit.
Child support receipts are not included.

Solutions to Chapter 9 Assignment Problems

157

Advisory Cases
Case 1: Myron and Jennifer
ADVISORY CASE DISCUSSION NOTES
Memo to Myron Van Doulis
There are three issues to be considered. First, there are different severance packages available that need to be
analyzed from an after-tax cash flow perspective. Second, the issue of emigration and the transfer of assets to a
tax haven must be examined. It is important to look at how the CRA will assess residency and also look at the
income tax consequences of emigration. The last issue to be considered is the CRAs assessment of the capital
losses of trading options.
Severance Packages
Option 1: If the entire $80,000 retirement allowance is transferred to an RRSP, it will continue to accrue
interest tax free. There will be no tax payable until it is withdrawn in 20 years at the estimated marginal tax rate
in that year of 40%. The future value of the sum will be:
$80,000 (1 + 0.1)20 (1 - 0.4) = $322,920
The cash payment of $40,000 will be taxed immediately in income at Myrons current tax rate of 50%. If
this is reinvested in GICs, the after-tax interest rate is used to determine the future value of the cash:
(1 - 0.5) (40,000) (1 + 0.08 (1 - 0.5))20 = $43,822
The total future value of this option is $366,742.
Option 2: If shares are received, the FMV of the benefit received must be included in employment income.
This means that extra funds must be available to meet the cash requirement of the income tax that results from
the receipt of the shares. The FMV of the shares is $8 12,000 = $96,000. With the current income tax rate of
50%, there will be an extra $48,000 of income tax owed. Thus, only $48,000 is left, assuming 6,000 shares are
sold to pay the tax. The future value of the shares considering 4% growth and 5% dividends is:
FMV of shares
less: tax @ 50%
Balance to hold
Future value of shares
48,000 (1.05)20
less tax on capital gain (127,358 - 48,000) 50% 0.4
Future value of dividend annuity
[$48,000 (0.05) (1 t) (1.04)20 1]/.04

$96,000
(48,000)
$48,000
127,358
(15,872)
111,486
$53,600

t = tax rate on dividends = approximately 25%.

Note: This equation represents the annual dividend (5% of $48,000) multiplied by the after-tax rate
(adjusted for the dividend tax credit) accumulated at 4% (8% regular tax rate). The equation appears simplistic
because growth is at the same rate as after-tax interest.
The total value of this option is $111,486 + $53,600 = $165,086.
Other aspects that should be considered are the inherent flexibility of RRSP and the opportunity for
withdrawal at any time. With respect to the securities, there is the inherent risk associated with an investment in
securities.
Emigration
It is possible to be deemed a resident if one sojourns an aggregate of 183 days (24-hour periods) or more
in a calendar period. It is also possible to be present in Canada less than the 183 days and still be deemed a
resident. The determination of residency is based on the facts of the situation. The factors the court considers
include regularity and length of visits, the ties in Canada and other jurisdictions (or the motive for being present
or absent), ownership of a dwelling in Canada on a long-term basis, the residences of the spouse and children,
memberships of social club, banking privileges, health care and car registrations, business and employment ties
to Canada, and the general routine of the individuals life. They would also look to see if you became a resident
in another country.
In this situation, the courts would look at the fact that the children remain in Canada and that Jennifer would
be present in Canada with strong ties to the country. This includes her employment ties with the software
publishing company. With no real ties to the tax-haven country or any other country the motive for being

Federal Income Taxation: Fundamentals

158

absent from Canada appears only to be tax motivated. Also, the ownership of a house would be considered. Even
though the house is owned through the foreign corporation, this situation could possibly be defined as tax
avoidance, the deliberate planning of events and transactions to circumvent the law with the intent of reducing
taxes payable. The courts look at the economic substance of the situation and not the legal form. Tax avoidance
is a civil wrongdoing.
The facts of this situation suggest that you will be deemed a Canadian resident for tax purposes and would
subsequently be subject to Canadian tax on your worldwide income. To avoid being taxed as a resident, it is
important to sever the continuing state of the relationship with Canada.
If you were a non-resident, you would be taxed on your Canadian-source income. The severance pay would
be included in income in the year it was received and taxed accordingly. Also, you will be deemed to have
disposed of all property except for taxable Canadian property at fair market value immediately prior to ceasing
residence. Any capital gains and losses must be reported in income on the last tax return for the period prior to
departure. Taxable Canadian property includes real property, other capital property, shares in a private
corporation, and ownership of 25% of shares of any class in a Canadian public corporation. However, it is
possible to elect to treat all capital properties as not having been disposed of at the time you cease to be a
resident. This requires acceptable security to be left with the CRA as collateral.
If the election were not taken, the tax effects of the deemed disposition would be:
Penny stocks

Deemed adjusted cost base = FMV

Cost
Capital loss
Allowable capital loss (50%)

$ 4,000
95,000
$91,000
$45,500

The RRSP is not subject to the deemed disposition, and there would be no capital loss or gain to account for
on the T-Bills and bonds.
Assessment of Capital Loss from Trading Options
Income earned as a result of trading in the options and derivatives markets could be considered business
income, and not be given capital treatment, if you were able to establish a business approach to the activity.
Factors would include capital invested and/or borrowed, time spent, experience and knowledge, frequency of
trades, and similar factors. Given that you reported the previous years gain as capital, it is extremely unlikely
that, now that youve incurred losses, you will be allowed business treatment rather than capital treatment. You
can object to the reassessment but, in my opinion, your objection to the measurement will most likely be
unsuccessful.

Solutions to Chapter 9 Assignment Problems

159

Case 2: Cam Renaz

ADVISORY CASE DISCUSSION NOTES
(a) Cams revised business income:
As reported
Add nannys salary (see below)
Add cost of car expensed (see below)
Less CCA allowed (15% $18,000 .40)
Revised business income

$ 28,000
12,000
7,200
(1,080)
$ 46,120

Child Care Expenses

The situation presented in this case is similar to the Supreme Court of Canada case, Symes v. The Queen. In
this particular case, the Court overturned an earlier judgment that allowed a lawyer to deduct the actual cost of a
nannys salary against self-employment income. The Court ruled, in effect, that child care expenses are nondeductible personal or living expenses and may only be deducted as allowed under the Acts provisions.
Cams deduction is limited to $8,000, which is the least of the following amounts:
(i) the actual amount $12,000
(ii) $4,000 per eligible child (2 $4,000) $8,000
(iii) 2/ 3 of his earned income (2/ 3 $46,120) $30,747
Cams accountant was probably referring to the child care deduction and not to business expenses.
RRSP Withdrawals
A withdrawal of funds from an RRSP must be included in income in the year of withdrawal in accordance
with paragraph 56(1)(h). Accordingly, Cam must report the gross amount of his RRSP withdrawal as another
income inclusion under subdivision d. The 20% tax withheld at source will be deducted from taxes payable to
arrive at his net refund or balance owing.
Support Receipts
Generally, an amount received from an ex-spouse for support is taxable under paragraph 56(1)(b). However,
the definition of support amount at section 56.1 requires that the amount be receivable on a periodic basis.
Lump-sum payments that are settlements are not taxable (nor deductible). Cam should file a notice of objection
in respect to this part of the assessment.
Capital Cost of Vehicle
Paragraph 18(1)(b) specifically denies a deduction for an expenditure on account of capital. Cam cannot
deduct the cost of the new vehicle from his consulting income, regardless of what portion of it was used for
business purposes. However, he is allowed to deduct capital cost allowance in accordance with
paragraph 20(1)(a). The new vehicle would be depreciated as a Class 10 asset at an annual rate of 30%. The
maximum CCA that Cam may claim is as follows:
$18,000 30% 50% (half-year rule) 40% (business use) = $1,080
Taxable Dividends
Under paragraph 82(1)(b), dividends from a taxable Canadian corporation (CCPC) have to be grossed-up by
25% when reported as income. Cam will be entitled to a dividend tax credit against his tax liability, and its
assumed that the CRA allowed this on assessment.
(b) Income For Tax Purposes
Based on our above analysis, Cams revised net income for tax purposes would be calculated as follows:
Business income (as above)
RRSP withdrawal (subsection 56(1))
Dividends (as grossed-up)
Child care deduction
Net income for tax purposes

46,120
12,000
1,875
(8,000)
$ 51,995

CHAPTER 10

Computation of Taxable Income and

Taxes Payable for Individuals
Solution 1 (Basic)
(a) Paragraph 3(a) Sources of income
Sections 58
Employment income
Sections 920
Property income
Paragraph 3(b)
Taxable capital gains: Gain on ABC shares ($1,200 50%)
Section 3
Net income for tax purposes

$7,000
800
600
$8,400

The lottery winnings and the inheritance funds are not included in the computation of net income because
these are windfall gains outside the concept of income sourcing.
(b)
Section 111
Subsection 2(2)

Net income for tax purposes per paragraph (a)

Loss carryforward
Non-capital loss carryforward
Taxable income

161

$8,400
(3,000)
$5,400

162

Federal Income Taxation: Fundamentals

Solution 2 (Basic)
Sources of income (loss)
Employment income
Income from property (Note 1)
Paragraph 3(b)
Taxable capital gains (Note 2)
Paragraph 3(c)
Subdivision e deductions (RRSP)
Paragraph 3(d )
Losses
Business loss
Rental property ($25,000 $31,000)
Allowable business investment loss
Section 3
Net income for tax purposes
Section 111
Net capital loss carryforward
Subsection 2(2)
Taxable income
* Not useable, as no net taxable capital gains in year.
Paragraph 3(a)

$120,000
24,000
0
(1,000)
(7,500)
(6,000)
(6,000)
(3,000)

( 19,500)
$123,500
0*
$123,500

Note 1:

Net income from property:

Interest income
Rental income from joint ownership

$ 9,000
15,000
$24,000

Note 2:
Taxable Capital Gains
Capital gain on sale of shares (.5 10,000)
$ 5,000
Allowable capital loss (11,000 6,000 ABIL)
(5,000)**
Net taxable capital gain
$
0
** As these are described as allowable, they are already stated at the appropriate 50% figure.

Solutions to Chapter 10 Assignment Problems

163

Solution 3 (Advanced)
Employment income

per T4s ...................................................................................

ssec. 7(1) benefit(1).................................................................
interest benefit on loan [ssec. 80.4(1)](2) ................................
Property income Interest net of carrying charges(3) ....................................................
Par. 3(a) ...........................................................................................................................
Taxable capital gains(4) [par. 3(b)] ...................................................................................
Par. 3(c) and total Division B income ..............................................................................

72,000
12,000
1,764

Division C deductions:
Par. 110(1)(d) Employee stock option deduction(5) ..........................................................................
Par. 110(1)(j) Home relocation loan deduction(6) .............................................................................
Par. 111(1)(b) Net capital losses(7) ....................................................................................................
Par. 111(1)(a) Non-capital losses(8) ..................................................................................................
Total Division C deductions .................................................................................................................
Taxable income (equal to personal and employment tax credit bases: $10,382 + $1,051) ...................

$
$
$
$

$
$

85,764
4,000
89,764
4,950
94,714
6,000
441
4,950
71,890
83,281
11,433

NOTES TO SOLUTION
(1) Since she exercised the option after March 4, 2010, she cannot elect to defer the employment benefit of
$12,000 (2,000 shares ($10 $4)).
(2) Interest on all loans subject to subsection 80.4(1) computed at the prescribed rate on each loan and debt
for the period in the year during which it was outstanding (less amounts actually paid, if applicable). [$100,000
92 days/365 7%]
(3) Property income is equal to the property income earned less the expenses incurred to earn the property
income. [$5,000 $1,000]
(4) Taxable capital gain = 1/ 2 of the capital gain. [$9,900 1/ 2 ]
(5) Deduction [par. 110(1)(d)] will be equal to 1/ 2 of the benefit inclusion [ssec. 7(1)], since exercise price
is greater than or equal to the fair market value on the grant date. (1/ 2 $12,000)
(6) Where a taxpayer has included an amount in income in respect of a home relocation loan [sec. 80.4],
the home relocation loan deduction in Division C is equal to the least of:
(a) the amount of the benefit under sec. 80.4 if that section had applied only to the home
relocation loan .........................................................................................................................
(b) the amount of interest for the year that would be computed under sec. 80.4 if the home
relocation loan were in the amount of $25,000 [$25,000 92/365 7%] ..............................
(c) the amount of the benefit deemed to be received under sec. 80.4 ...........................................
Least of (a), (b) and (c) ...................................................................................................................

1,764

$
$
$

441
1,764
441

(7) Net capital losses applied are restricted to the net taxable capital gains ($4,950).
(8) Non-capital losses carryforward from 2009........................................................................... $ 78,000
Non-capital losses applied from: 2004 ....................................................... $ 24,000
2005 .......................................................
26,000
2008 .......................................................
21,890
71,890
Non-capital loss carryforward to 2011 (from 2008 balance) ................................................. $ 6,110
Note that less than the maximum non-capital loss carryforward is claimed in order to leave taxable income to
offset the personal and employment tax credit bases for the year.

Federal Income Taxation: Fundamentals

164
Solution 4 (Advanced)

2008

(A)
Income from non-capital sources (0):
Employment income ........................................................
Property income ...............................................................
Total par. 3(a) income ......................................................
Par. 3(b): Net taxable capital gains (0):
Taxable capital gains ........................................................
Allowable capital losses ...................................................
Total par. 3(b) income ......................................................
Par. 3(c): Par. 3(a) + par. 3(b) ..........................................................
Par. 3(d): Losses from non-capital sources and ABIL:
Property loss .....................................................................
ABIL ................................................................................
Division B income ...............................................................................
(B) Deduct: Net capital losses from 2006 (see Schedule 1, Part (I)
below) ..............................................................................
Net capital losses from 2009 (see Schedule 1, Part (I)
below) ..............................................................................
Taxable income ....................................................................................

2009

2010

Par. 3(a):

75,000
Nil
75,000

$
$

80,000
3,000
83,000

72,000
(9,000)
63,000
138,000

Nil
(11,250)
Nil
$
83,000

(4,000)
(18,000)
$ 116,000

Nil
(27,000)
$
56,000

(21,000)

Nil

$
$

(11,250)
83,750

Nil
56,000

$
$

90,000
Nil
90,000

80,000
(40,000)
$
40,000
$ 130,000

(6,000)
Nil
124,000
Nil

Nil
124,000

Schedule 1
(I) Net capital losses Pars. 111(1)(b) and 111(8)(a)
2008
Lesser of:
(i) Net TCGs for the year ........... $ 63,000
(ii) Total net CLs ........................ $ 32,250
Lesser amount ............................
$ 32,250

2009
Nil
Nil

2006
21,000
(21,000)
Nil

Ref.

$ 40,000
Nil
Nil

(II) Loss continuity schedule

Net CL .................................................................................
Utilized in 2008....................................................................
Available in 2010 .................................................................

2010

Par. 3(b)
(II)
Nil

2009
11,250
(11,250)
Nil

Total
$ 32,250
(32,250)
Nil

Ref.
(I)

Solutions to Chapter 10 Assignment Problems

165

Solution 5 (Advanced)
2009
Income from non-capital sources (non-negative amounts only):
Employment income....................................................................
Other business income.................................................................
Property income ..........................................................................
Other pension income .............................................................
Income from non-capital sources.................................................
Par. 3(b)
Net taxable capital gains (non-negative):
Listed personal property(1) ...........................................................
Personal-use property(2) ...............................................................
Other............................................................................................
Net taxable capital gains ..............................................................
Par. 3(a) + par. 3(b) .....................................................................
Par. 3(c)
Support payments ................................................................................
RRSP
Total par. 3(c) deductions
Par. 3(a) + par. 3(b) par. 3(c)
Par. 3(d)
Business loss .......................................................................................
Allowable business investment loss ....................................................
Rental loss ...........................................................................................
Division B...................................................................................................................
Par. 111(1)(b)
Net capital loss(5) .................................................................
Par. 111(1)(a)
Non-capital loss carried forward(6) ......................................
Taxable income (equal to personal and employment tax credit bases) .. .........

2010

Par. 3(a)

NOTES TO SOLUTION
(1) Listed personal property:

2009

$
$

$
$
$
$
$
$

30,000
Nil
10,000
7,000
47,000

500
1,000
3,000
4,500
51,500
(7,000)
(1,000)
(8,000)
43,500
(14,000)

29,500
(4,500)
(13,636)
11,364

38,000
Nil
16,000
7,000
61,000

$
$
$
$
$

10,125
Nil
(10,125)(3)
Nil
61,000
(7,000)
(3,000)(4)
(10,000)
51,000
(23,000)
(12,000) (3)
(4,000)
12,000
Nil
(567)
11,433

$6,000 $5,000 (carried forward from 2006 [sec. 41])

$1,000 1/ 2 = $500

(2) Personal-use property losses denied.

(3) Other capital property 2010

Allowable capital losses (1/ 2 $45,000) .............................................................................

Less: allowable business investment loss applied in par. 3(d) (1/ 2 $24,000) ....................
Amount which can be applied under par. 3(b) ....................................................................
Balance which can be carried forward or backward as a net capital loss ............................

22,500
(12,000)
$
10,500
10,125
$
375

(4) (a) RRSP contribution deduction for 2009 would be limited by the lesser of:
(i) 18% of 2008 earned income ($33,250) = $5,985
(ii) $21,000
Lesser amount .....................................................................................................
Minus the pension adjustment for 2008 ......................................................................
Net contribution limit ..................................................................................................
Unused RRSP contribution room to be carried forward ($5,985 $1,000).................

$
$
$

5,985
Nil
5,985
4,985

(b) RRSP deduction for 2010 would be limited to the lesser of:
(i) 18% of 2009 earned income (see below: $12,000) = $2,160
(ii) $22,000
Lesser amount .....................................................................................................
Minus the pension adjustment for 2009 ......................................................................
Unused RRSP deduction room ....................................................................................
Total available .............................................................................................................

2,160
Nil
4,985
7,145

2010 RRSP deduction limited to $3,000 contribution

Earned income for 2009 would be:
Employment income ...........................................................................................
Business loss .......................................................................................................
Rental income......................................................................................................
Deductible support payments ..............................................................................
Earned income .....................................................................................................

30,000
(14,000)
3,000
(7,000)
$
12,000

Federal Income Taxation: Fundamentals

166
(5) Net capital losses
Lesser of:
(i) Net TCGs for the year ................................
(ii) Total adjusted net CLs*..............................
Lesser amount ....................................................
* Net capital loss continuity schedule.

2009
$
$
$

2010

4,500
25,000
4,500

Net CL .....................................................................................

Nil
20,875
Nil

2007
25,000

2010

Total
$ 25,000

N/A
Utilized in 2009 .......................................................................
Available in 2010 .....................................................................
Net CL realized in 2010 ...........................................................
Total available in 2010 ............................................................
Utilized in 2010 .......................................................................
Available in 2011 .....................................................................

$
$
$

(4,500)
20,500
20,500
Nil
20,500

$
$
$

N/A
N/A
375
375
Nil
375

(6) Non-capital loss arising in 2006 ....................................................................................................

Utilized in 2009.............................................................................................................................
Utilized in 2010.............................................................................................................................
Balance at January 1, 2011............................................................................................................

( 4,500)
$ 20,500
$
375
$ 20,875
Nil
$ 20,875
$

33,000
(13,636)
(567)
$ 18,797

In each of 2009 and 2010 sufficient taxable income has been left to utilize the basic personal tax credit.

Solutions to Chapter 10 Assignment Problems

167

Solution 6 (Advanced)
(A) Personal Tax Credits
Tax credit base:
Basic ...................................................................................................................................
Spouse:(1) $10,382 ($5,000 + $100) .................................................................................
Amanda(2) (infirm): caregiver..............................................................................................
Joan(3) (under 18) ................................................................................................................
Courtney (under 18) ............................................................................................................
Canada Pension Plan ...........................................................................................................
Employment Insurance........................................................................................................
Amandas impairment credit(2) ............................................................................................
Amandas tuition, education, and textbook credits(2) ..........................................................
Joans tuition and education credits(3) .................................................................................
Employment .......................................................................................................................
Tax credit @ 15% .......................................................................................................................
Dividend tax credit on husbands dividends (18% of 1.44 $4,000) .........................................
Total non-refundable tax credits .................................................................................................

$10,382
5,282
4,223
2,101
2,101
2,163
747
7,239
2,160
5,000
1,051
$42,449
$ 6,367
1,037
$ 7,404

(B) Canada Child Tax Benefit

Mrs. Plant will qualify for the Canada Child Tax Benefit (subdivision a.1) for the following reasons:
1. Joan and Courtney meet the definition of qualified dependant [sec. 122.6]. Both are under 18 years
of age and while Joan is married, her husband is not claiming the married credit for her under sec. 118(1)(a).
2. Mrs. Plant meets the definition of eligible individual [sec. 122.6] since she:
resides with Joan and Courtney,
is their parent and she cares for them,
resides in Canada,
is not an employee of a country other than Canada [par. 149(1)(a), (b)],
is a citizen of Canada (assumed).
Paragraph (f) states that, where the dependant lives with her mother, it is presumed that the mother fulfils
the responsibility for the care and upbringing of the dependant. Therefore, it is Mrs. Plant who would claim the
benefit and not her husband.
However, even though Mrs. Plant qualifies to claim the benefit, she has to include both her and her
husbands income in the calculation of adjusted income. Since their incomes exceed $40,970 there will be a
reduction in the amount of the benefit available.
NOTES TO SOLUTION
(1) The dividend income would be attributed back to Mrs. Plant [ssec. 74.1(1)] but not the interest on the
already attributed dividends [IT-511R, par. 6]. The workers compensation payments are included in Mr. Plants
net income but not in his taxable income [pars. 56(1)(v), 110(1)(f)].
(2) The $6,000 social assistance payments are included in Amandas net income but excluded from her
taxable income [pars. 56(1)(u), 110(1)(f)]. A dependant credit is available for Amanda, due to her infirmity.
However, the amount of the credit base is $4,215 (i.e., $4,223 ($6,000 $5,992)). The caregiver credit with its
base of $4,223 is better, since Amandas income does not exceed the $14,422 threshold. Her impairment and
tuition credits can be transferred because her taxable income of nil does not exceed the basic personal amount of
$10,382. She does qualify for the $400 per month education credit and the $65 per month textbook credit since
she is a disabled student [ssec. 118.6(3)]. The amount of the transfer is computed as follows:
Lesser of: (a) Maximum amount (15% of $5,000):
(b) Tuition fee credit ............................................................................. $ 300
1,600
Education credit: $400 4 ..............................................................
260
Textbook credit: $65 4 ................................................................
$ 2,160 .15 =

$ 750

$ 324

The credit base of $2,160 can be transferred.

(3) Joans Taxable Income:
Employment income ........................................................................................................................ $
Scholarship (exempt) .......................................................................................................................
$
Moving to university*....................................................................................................... $ Nil
Moving from university ....................................................................................................
150
Net income and taxable income ....................................................................................................... $
* Limited by scholarship income.

4,200
Nil
4,200
150
4,050

Federal Income Taxation: Fundamentals

168

Joan will have no tax to pay because her basic personal amount of $10,382 exceeds her taxable income.
Therefore, all of the tuition and education tax credit will be available to transfer to Mrs. Plant. The transfer is
computed as follows:
Lesser of: (a) Maximum amount of transfer (15% of $5,000) ...........................................................
(b) Tuition fee ................................................................................... $ 3,000
3,200
Education: $400 8 ....................................................................
520
Textbook: $65 8 ......................................................................
$ 6,720 .15 =

The maximum base of $5,000 can be transferred.

750

1,008

Solutions to Chapter 10 Assignment Problems

169

Solution 7 (Basic)
Each of Angelina and Romeo has a right to claim the eligible dependant tax credit as each is a single parent
who supports a child under the age of 18, in a self-contained domestic establishment. However, under
paragraph 118(4)(b) it is provided that not more than one person is entitled to that tax credit in respect to the
same person. Paragraph 118(4)(b) goes on to provide that the two entitled persons must agree which of them is to
make the claim and that if they cannot agree, no person is entitled to that particular credit. Angelina and Romeo
should agree as to which of them will claim Maria for the eligible dependent credit. It is not in either of their
interests to disagree. The tax credit has the same value to either of them (assuming each has sufficient taxable
income).

Federal Income Taxation: Fundamentals

170
Solution 8 (Basic)

Mrs. Jacksons 2010 Non-refundable Tax Credit related to Rachel

Married equivalent tax credit(1)..............................................................................
Disability tax credit transferred from a dependant(2) .............................................
Medical expense(3) ........................................................................... $ 10,000
Less lesser of:
(a) Limit: $2,024
(b) 3% of Rachels net income (nil) = Nil
Lesser amount ..................................................................................
Nil
Total tax credit base ..............................................................................................

Total non-refundable tax credits related to Rachel ...............................................................................

Par. 118(1)(b)
Sec. 118.3
Sec. 118.2

10,382
7,239

10,000
27,621
15%
4,143

NOTES TO SOLUTION
(1) Married equivalent tax credit [par. 118(1)(b)]
An individual who, at any time in the year, is single, widowed, divorced or separated may be entitled to
claim the married equivalent tax credit if the individual, at that time, maintained (either alone or jointly) and
lived in a self-contained domestic establishment and supported therein a person who is:
(a) a resident of Canada, except where the claim is in respect of the individuals child;
(b) wholly dependent for support on the individual or the individual and any other person or persons who
jointly maintained the self-contained domestic establishment;
(c) related to the individual; and
(d) under 18 years of age or wholly dependent by reason of mental or physical infirmity, except where the
claim is in respect of the individuals parent or grandparent.
Since Rachel is severely mentally handicapped and is supported by Mrs. Jackson, Mrs. Jackson will be able
to claim the tax credit in 2010. The caregiver credit would be available instead of the equivalent-to-married
credit, but its base is only $4,223.
(2) Impairment tax credit [sec. 118.3] Rachael has a severe and prolonged mental or physical
impairment which caused her to be markedly restricted in her basic activities of daily living. As well, her
impairment has lasted for a continuous period of at least 12 months. Therefore, Rachael qualifies for the
impairment tax credit. The certificate of a medical doctor attesting to the impairment as described in
paragraph 118.3(1)(a.2) must be filed [par. 118.3(1)(b)].
Since Rachael has no income and, therefore, no use for the impairment tax credit, the amount can be
transferred to Mrs. Jackson, because Rachael is a dependant of Mrs. Jackson [ssec. 118.3(2)].
Note: If a medical expense tax credit was being claimed for full-time attendant care, the impairment tax
credit would not be available. Either the medical expense tax credit for full-time attendant care could be taken or
the impairment tax credit could be claimed, but not both.
(3) Medical expense credit [sec. 118.2] Medical expenses which have been incurred by the taxpayer, by
the taxpayers spouse, or by persons whom the taxpayer is entitled to claim as dependants may be claimed by the
taxpayer. Therefore, Mrs. Jackson may claim medical expenses incurred for Rachael. A supporting person may
claim as a medical expense the remuneration of a full-time attendant or the expenses for full-time care in a
nursing home. If a medical expense claim is made for full-time attendant care, the impairment tax credit may not
be claimed.
However, it appears from the question that only part-time attendant care has been utilized. Therefore,
slightly different rules apply. A medical expense credit for part-time attendant care is available, provided the
total expenses for such care for the year do not exceed $10,000 (or $20,000 in the year of death). The care must
be provided for a patient who is eligible for the $7,239 impairment amount (although someone else may actually
claim the impairment amount under the transfer rules), and this credit is not available if any expense is deducted
from the disabled persons income for attendant care.
As a further restriction, the maximum medical expense claim on behalf of Rachel is $10,000.
Rachael would qualify for the impairment tax credit. Therefore, Mrs. Jackson can claim $10,000 for
purposes of the medical expense tax credit.

Solutions to Chapter 10 Assignment Problems

171

Solution 9 (Advanced)
All of the medical expenses incurred or expected to be incurred qualify for the credit [ssec. 118.2(2) and
Reg. 5700].
Note also that the refundable medical expense supplement is not available in the case of the Jennings,
because their adjusted income, that is, Mr. Jennings Division B income of $55,000 is above the income level of
$45,255 where the supplement is fully eroded.
Mr. Jennings does not have enough medical expenses in 2010 ($1,485) to exceed the lesser of $2,024 and
3% of his Division B income ($1,650 = 3% of $55,000) for 2010 [ssec. 118.2(1)].
Mr. Jennings can claim his 19-year-old sons medical expenses to a maximum of $10,000, if his son is
dependent upon him for support [ssec. 118(6)].
The Jennings should incur as many of the medical expenses as they can before June 2011. This period will
give them the largest dollar amount of medical expenses to be claimed on their 2011 tax return.
If Mr. Jennings chose the 12-month period ending May 31, 2011 and paid for all of the expenses anticipated
in 2011 by that date, his medical expenses in 2011 would be computed as:
2010 June .................................................................................................................
July ..................................................................................................................
2011 February ..........................................................................................................
March ..............................................................................................................
by May 31 ($750 + $450 + $375 + $1,050).....................................................
Total (including $2,700 + $750 = $3,450 re: son) .......................................................

1,150
300
2,550
2,700
2,625
9,325

Note that the anticipated expenses must not only be paid for, but the services must be received, by May 31,
2011, in this case. Prepaid expenses for services not received are not deductible for the period ending May 31,
2011, in this case [Tax Windows Files, Document number 2005-13326117].
The medical expenses incurred for his oldest son are $3,450 ($2,700 + $750).
His 2011 medical expense tax credit can be computed as follows:
A [(B C) + D]
where A = 15%
B = $9,325 $3,450 = $5,875
C = lesser of: (a) limit: $2,024
(b) 3% of $55,000 = $1,650
= $1,650
D = $3,210 (i.e., lesser of):

$10,000

E F = $3,450 lesser of:

o $2,024
o

3% of $8,000 = $240

=$3,450 $240
= $3,210

The credit is: 15% of [($5,875 $1,650) + $3,210] = $1,115.

Federal Income Taxation: Fundamentals

172
Solution 10 (Basic)
(A) No subsection 82(3) election

Tax payable by Mr. Reid:

Mr. Reids commission income ................................................................................... $
15,000
Less: employment expenses ........................................................................................
13,000
Canadian interest ................................................................................................................................
Dividends: Gross-up of Canadian dividends (1.44 $950) .............................................................
Foreign (U.S.) dividends (680/.85)................................................................................
Division B and taxable income ...........................................................................................................
Federal tax @ 15% of $6,168 .............................................................................................................
Less tax credits:
Basic personal (15% of $10,382) ......................................................................... $
1,557
Employment (15% of $1,051) .............................................................................
158
246
Dividend tax credit (18% of 1.44 $950) ............................................................
Basic federal tax .................................................................................................................................
Tax payable by Mrs. Reid:
Mrs. Reids employment income ........................................................................................................
Canadian dividends (1.44 $2,000) ...................................................................................................
Interest ................................................................................................................................................
Division B and taxable income ...........................................................................................................
Federal tax @ 15% of $40,970.................................................................................. $
6,146
@ 22% of $16,910 ($57,880 $40,970) ................................................
3,720
Less: Basic personal tax credit .................................................................................. $
1,557
632
Married: 15% [$10,382 $6,168] .................................................................
324
CPP (15% $2,163) ........................................................................................
112
EI (15% $747)...............................................................................................
Employment (15% of $1,051) .........................................................................
158
518
Dividend tax credit (18% of 1.44 $2,000) .....................................................
Federal tax payable .............................................................................................................................

2,000
2,000
1,368
800
6,168
925

$
$

1,961
Nil
$

54,000
2,880
1,000
57,880

9,866

3,301
$

6,565

(B) With subsection 82(3) election:

In this particular case, the following items will change:
Increase in Mrs. Reids taxable income by husbands grossed-up dividends
(1.44 $950) transferred .................................................................................................................
Increase in federal tax @ 22% of $1,368 ................................................................................................
Less increase in tax credits:
Married with election
15% of [$10,382 ($6,168 $1,368)] ......................................................... $ 837
Married without election .................................................................................. $ 632 $ 205
246
Dividend tax credit (18% of 1.44 $950) ........................................................................
Decrease in basic federal tax ..................................................................................................................

1,368

301

451
$

150

Solutions to Chapter 10 Assignment Problems

173

Solution 11 (Basic)
(a) Per paragraph 118.5(1)(c), Pamela can claim the tuition fees in calculating her tax payable under Part I. The
criteria she must satisfy are:

1) she resided in Canada throughout the year near the Canada-U.S. border;
2) she was a student at a U.S. educational institution that is a university providing courses at a
post-secondary level (she is taking a Masters degree);
3) she commuted to the U.S.;
4) the fees exceed $100; and
5) she paid the fees herself, i.e., they were not paid on her behalf by an employer.
IT-516R2, paragraphs 5 to 7, provides additional information for Pamela.
(b) Subsections 118.6(2) and (2.1) outline the formula for calculating the education and textbook tax credits and
the criteria. Pamela may qualify for the full-time education credit, which is $400, and the textbook credit,
which is $65, times the number of months in the year she is in full-time attendance at a designated
educational institution and enrolled in a qualifying educational program if the enrolment is proven by filing
with the Minister a certificate in prescribed form, issued by the designated educational institution and
containing the prescribed information. Subsection 118.6(1) contains the definitions of designated
educational institution and qualifying educational program. From these definitions, Pamela qualifies for
the full-time education and textbook credits. The prescribed forms are T2202 and T2202A.

174

Federal Income Taxation: Fundamentals

Solution 12 (Advanced)
(1) Tuition fees which qualify for a tax credit
(A) Only the academic portion of the tuition fee and ancillary fees levied on all students is allowed for tax
purposes as reflected by the official receipt for tax purposes. Normally, student union and athletic fees will be
excluded.
(B) The tuition fees for Harvard University, except for July and August 2009, qualify for a tax credit
[par. 118.5(1)(b)], since the courses lead to a degree and exceeded 13 weeks. The JulyAugust 2009 course does
not meet this latter requirement. The re-read fee also qualifies [IT-516R2 par. 27(d)].
(C) The tuition fee for the University of Toronto taxation course would also qualify as a deduction
[par. 118.5(1)(a)], even though Stuart did not pay this amount, since Stuarts father would have the tuition fee
included in his taxable income [IT-470R par. 20; IT-516R2 par. 7].
(D) The fitness course taken at a local secondary school would not qualify for either the tuition or the
fitness credits.
(2) Allowable tuition fee credit.
Qualified tuition fees must be paid in respect of the year to provide a tax credit for the year. Therefore, if the
fees for a full academic year (fall and winter terms) are paid in, say, September of that year, they would provide a
tax credit for the year to which the fees relate [IT-516R2 par. 24].
Note that the tuition fee tax credit and the education tax credit can be transferred to a spouse, a parent or a
grandparent. Alternatively, they can be carried forward indefinitely by the student.

Solutions to Chapter 10 Assignment Problems

175

Solution 13 (Advanced)
(A)
Employment income (Subdivision a) .................................................................................................
Dividend from taxable Canadian corporations, grossed-up: 1.44 $480 ...........................................
University scholarship received [par. 56(1)(n)]: (exempt)..................................................................
Workers Compensation payments .....................................................................................................
Child care expenses: least of:
(a) Actual expense ............................................................................................. $
2,400
8,000
(b) $4,000 2 .................................................................................................... $
16,667
(c) 2/ 3 earned income ($25,000) ..................................................................... $
Least amount ...............................................................................................................................
Income under Division B....................................................................................................................
Workers Compensation [par. 110(1)(f)] ............................................................................................
Taxable income ..................................................................................................................................
Tax calculation
Tax @ 15% of $23,291.......................................................................................................................
Basic personal credit ................................................................................................... $
10,382
Equivalent-to-married credit .......................................................................................
10,382
Child tax credit(1) ........................................................................................................
4,202
Canada Pension Plan contributions .............................................................................
1,064
Employment Insurance contributions .........................................................................
433
University tuition ........................................................................................................
600
360
Education credit ($120 3) .........................................................................................
60
Textbook credit ($20 3) ...........................................................................................
Employment credit .....................................................................................................
1,051
$ 28,534
15%
Dividend tax credit (18% of 1.44 $480) ......................................................................
Basic federal tax .................................................................................................................................
Provincial tax*....................................................................................................................................
Total tax..............................................................................................................................................
Less: tax withheld ...............................................................................................................................
Balance owing (refundable)................................................................................................................
*Provincial tax @10% of $23,291 ...............................................................................
Less: provincial tax credits @10% of $28,534 .......................................................... $
2,853
provincial dividend tax credit @ 12% of $691.................................................
83
Net provincial tax ........................................................................................................
(1)

25,000
691
Nil
9,000

(2,400)
32,291
(9,000)
23,291

3,494

$
$

(4,280)
(124)
Nil
Nil
Nil
(700)
(700)
2,329

(2,936)
Nil

$
$

It appears from the legislation [par. 118(1)(b.1)] that the child tax credit is available in addition to the equivalent-to-married credit.

(B)
Refundable Good and Services Tax Credit [sec. 122.5]:
To qualify for this credit the taxpayer must be an eligible individual as defined in sec. 122.5(1). Patty
meets that definition, since she is has attained the age of 19 years (assumed) or she is a parent who resides with
her child. Her two children meet the definition of qualified dependant since they are her children, they live
with her and they are under 19 years old.
Pattys net income of $32,291 is less than the threshold of $32,506, so there will be no reduction in the
credit based on income.
Canada Child Tax Benefit [sec. 122.6]:
Patty will qualify for the Canada Child Tax Benefit (subdivision a.1) for the following reasons:
1. The two children will meet the definition of qualified dependant [sec. 122.6]. Both are under 18 years of age.
2. Patty meets the definition of eligible individual [sec. 122.6] since she:
resides with the children,
is their parent and she cares for them,
resides in Canada,
is not an employee of a country other than Canada [par. 149(1)(a), (b)]
is a citizen of Canada (assumed)
Paragraph (f) states that, where the dependant lives with her mother it is presumed that the mother, fulfils
the responsibility for the care and upbringing of the dependant. Therefore it is Patty who would claim the benefit
and not her husband.
Since her income ($32,291) does not exceed $40,970 there will not be a reduction in the amount of the
Canada Child Tax Benefit available.

Federal Income Taxation: Fundamentals

176
Solution 14 (Basic)
Income and Taxable Income
Old Age Security benefits ..............................
Pension ...........................................................
Dividends .......................................................
Gross-up, 1/ 4 ...........................................................................
Net income before par. 60(w) deduction ........
Par. 60(w) deduction (see calculation of Part
I.2 tax below)(1) ......................................

Clare
6,000
52,000

...............................................

Alan
6,000

52,000
13,000
71,000

(640)
70,360

...............................................
...............................................
$

58,000

Nil
58,000

...............................................

Tax
Federal ........................................

6,146
3,747
Basic personal tax credit ................................
Spouse ............................................................
Age(2) ..............................................................
Pension ...........................................................
Dividend tax credit .........................................
Basic federal tax .............................................
Part I.2 tax(1) ...................................................
Total tax(3) ......................................................

$
$

9,893
(1,557)
(1,557)
(2,622)
(300)
Nil
3,857
Nil
3,857

............................ $ 6,146
............................
6,466
...............................................
...............................................
...............................................
...............................................
(2/ 3 of $13,000) .............
...............................................
...............................................
...............................................

$
$

12,612
(1,557)
(1,557)
(672)
Nil
(8,667)
159
640
799

NOTES TO SOLUTION
(1) Part I.2 tax
Clare
Lesser of:
(a) Old Age Security benefits ..............
(b) Income under Division B without
par. 60(w) deduction .......................
less..................................................
excess, if any ..................................
15% of excess, if any ..............

Alan

6,000

...............................................

58,000
(66,733)
Nil
Nil

...............................................
...............................................
...............................................
...............................................

6,000

71,000
(66,733)
$
4,267
640

(2) Since Alan has net income less than $75,479 (i.e., ($6,446/.15) + $32,506), he can claim an age credit
of $672 ($6,446 .15 ($71,000 $32,506)). Clare can claim $2,622 ($6,446 .15 ($58,000 $32,506).
(3) Alan pays the lesser personal income tax but has more Old Age Security clawed back; also, the
corporation which Alans son manages would have likely paid corporate income tax on its earnings prior to the
payment of dividends. Neither Clare nor Alan will be subject to minimum tax.

Solutions to Chapter 10 Assignment Problems

177

Solution 15 (Basic)
Taxable income ...................................................................................................................
Add: 30% of capital gains (30% $500,000) ...................................................................

59,000
150,000

$
Less: Dividend gross-up ....................................................................................................
Adjusted taxable income......................................................................................................
Basic exemption ..................................................................................................................
Net .......................................................................................................................................
Minimum tax before minimum tax credit (15% $160,200) ..............................................
Less basic minimum tax credits:
Basic personal ........................................................................................ $
1,557
CPP contributions (15% of $1,931) .......................................................
290
Employment (15% of $1,051) ...............................................................
158
Minimum amount ................................................................................................................
Regular federal tax on $59,000 ($6,146 + 22% ($59,000 $40,970)) .................................
Less personal tax credits:
Basic personal ...................................................................................... $
1,557
CPP contributions credit ......................................................................
290
Employment ........................................................................................
158
5,184
Dividend tax credit (18% of 1.44 $20,000) .......................................
Regular federal tax...............................................................................................................

209,000
(8,800)
$ 200,200
(40,000)
$ 160,200
$
24,030

$
$

2,005
22,025
10,113

7,189
$

2,924

Thus, minimum tax adds $19,101 ($22,025 $2,924) to his federal tax.
The $19,101 is available as a carryforward to the next seven years to reduce the excess of regular tax over
minimum tax in those years.
She does not have an EI credit since we have assumed that she would not pay any EI as the owner of the
company. However, it is possible that she would qualify for specified EI benefits, so she should be encouraged to
apply for coverage, if the benefits would apply in her case.

CHAPTER 11

Computation of Taxable Income and Tax After

General Reductions for Corporations
Solution 1 (Basic)
2007
Par. 3(a)

Income from business .......................... $

54,000
Income from property ..........................
42,500
$
96,500
Par. 3(b)
Taxable capital gains ...........................
11,000
Allowable capital losses ......................
(2,000)
Par. 3(c)
$ 105,500
Par. 3(d)
ABIL ...................................................
(3,750)
Business loss........................................
n/a
Par. 3(e)
Income from Division B ..................... $ 101,750
Sec. 112
Inter-company dividends .....................
(42,500)
$
59,250
Sec. 110.1
Charitable donations:(2)
Carryover......................................
n/a
Current..........................................
(23,000)
$
36,250
Par. 111(1)(b)
Net capital losses(3) ..............................
(9,000)
$
27,250
Par. 111(1)(a)
Non-capital losses(4).............................
(27,250)
Taxable income ....................................................................
Nil

2008
$
$

$
$

2009

32,000
Nil
22,500
$
18,000
54,500
$
18,000
2,500
5,000
(2,500)(1)
(3,500)
54,500
$
19,500
n/a
n/a
n/a
(75,000)
54,500
Nil
(22,500)

32,000
Nil

(9,000)
$
23,000

$
23,000
(23,000)
Nil

Nil
(1,500)
Nil

Nil

2010
$
$

$
$

62,500
10,500
73,000
9,000
Nil
82,000
n/a
n/a
82,000
(10,500)
71,500

(3,000)
(13,000)
$
55,500
(500)
$
55,000
(24,750)
$
30,250

NOTES TO SOLUTION
(1)

A maximum of $2,500 can be deducted in 2008.

(2)

Charitable donations:
2007: Lesser of:

2008: Lesser of:

2009: Lesser of:

2010: Lesser of:

(a) 75% of $101,750 = $76,313

(b) $23,000
Carryforward: Nil
(a) 75% of $54,500 = $40,875
(b) $9,000
Carryforward: Nil
(a) 75% of Nil = Nil
(b) $3,000
Carryforward: $3,000
(a) 75% of $82,000 = $61,500
(b) $3,000 + $13,000 = $16,000
Carryforward: Nil

(3) Net capital losses

1999 net capital loss converted to 2007 rates: $13,500 / ...............................................
Net capital loss deducted in 2007 to the extent of net taxable capital gains................................
2008 net capital loss not utilized .................................................................................................
2009 net capital loss deducted to the extent of net taxable capital gains ....................................
2010 remaining net capital loss deducted in 2010 to the extent of net taxable capital gains
Available for carryforward .........................................................................................................

179

9,000
(9,000)
Nil
$
2,000
(1,500)
$
500
(500)
Nil

Federal Income Taxation: Fundamentals

180
(4) Non-capital losses

Par. 3(d) Loss from business in 2009 ............................................................... $ 75,000

Dividends deducted under section 112 ..............................................
18,000
Add: net capital loss deducted ...................................................................................................
Less: par. 3(c): par. 3(a) dividends ....................................................................
par. 3(b) taxable capital gain ....................................................

$
$

93,000
1,500
94,500

19,500
75,000

18,000
1,500

Losses utilized: 2007 ......................................................................................... $ 27,250

2008 .........................................................................................
23,000
2010 .........................................................................................
24,750
Closing balance..........................................................................................................................

75,000
Nil

Solutions to Chapter 11 Assignment Problems

181

Solution 2 (Advanced)
The data given in the problem statement can be summarized as follows:
carryforward losses

non-capital losses

2009repair business

$40,000

rental property

$2,000

current deemed
year-end losses

from non-capital
sources

business

$60,000

property

$5,000

recapturebuilding
TCGland
building

$5,000

2,000
allowable capital
losses
$10,000

rental property

potential elections

net capital losses

potential offset
business income

10,000

5,000
$22,000
taxable capital gain

$3,000

potential offset

expiration
after deemed
year-end
$5,000

potential
offset

$30,000
40,000
$70,000

Expected Results from Summary of Data

(a) No Election
Note that if no election is made, there is no income to offset the current business loss of $60,000 or the non-capital
loss carryforward of $40,000. Therefore the non-capital loss available to carry forward from October 31, 2010 is
$100,000 (i.e., $60,000 + $40,000). Note that the $2,000 of non-capital loss carryforward from a property loss expires.
(b) Maximum Election
If the maximum election is made, the $3,000 of recapture offsets the business loss, leaving $57,000 (i.e.,
$60,000 $3,000) of net business loss. The $70,000 of taxable capital gain offsets the $22,000 of expiring losses,
leaving $48,000 (i.e., $70,000 $22,000) to offset the remaining $57,000 of business loss. There is no remaining
taxable capital gain to offset some of the $40,000 non-capital loss carryforward. As a result, the non-capital loss
available for carry forward from October 31, 2010 is $40,000.
(c) Partial Election
If only a partial election is made, it should be enough to offset only $20,000 of the $22,000 of expiring
losses. The other $2,000 of expiring loss is the property loss carryforward which can only be utilized if enough
Division B income is elected, resulting in the elimination of the current business loss, as was the case with the
maximum election. If a partial election of only $20,000 of taxable capital gain is made, the current business loss
of $60,000 is not offset and, hence, is available to carry forward, along with the $40,000 of business non-capital
losses, from October 31, 2010 for a total of $100,000.
Part A (Ignoring all possible elections)
An acquisition of control occurred when Chris acquired more than 50% of the voting shares of Transtek Inc.
from an unrelated person, Tom.
The taxation year of Transtek is deemed to end immediately before the acquisition of control, October 31,
2010 [ssec. 249(4)].
Tax returns are required to be filed for this short year (i.e., 10 months) and amounts, such as CCA (if
claimed), will have to be prorated.
It is assumed that any accrued losses in inventory and accounts receivable have been recognized in
calculating the business loss of $60,000.
There are no accrued losses on the depreciable property. Therefore, there is no adjustment required
[ssec. 111(5.1)].

Federal Income Taxation: Fundamentals

182

There is a $20,000 accrued loss on the rental property land that must be recognized. The ACB of the land is
reduced from $90,000 to $70,000 [par. 111(4)(c)]. The $20,000 reduction is deemed to be a capital loss
[par. 111(4)(d)].
The income (loss) for the taxation year ended October 31, 2010 is computed below.
Par. 3(a)
Par. 3(b)

Par. 3(c)
Par. 3(d)

Business income .............................................................................................................

Property income ..............................................................................................................
Net capital gains:
Taxable capital gains ............................................................................
Nil
Allowable capital loss: rental property ($20,000 1/ 2 ) ........................ $ (10,000)
.................................................................................................................
Business loss ............................................................................................ $ (60,000)
Property loss ............................................................................................
(5,000)
Division B income ..........................................................................................................

Nil
Nil

Nil
Nil
$ (65,000)
Nil

The net capital losses (($10,000 1/ 2 ) + $10,000 = $15,000) expire immediately following the October 31,
2010 year-end [par. 111(4)(a)].
The non-capital loss balance at November 1, 2010 is computed as follows:
Balance, Jan. 1, 2010 ..........................................................................................................................
Loss for taxation year ended Oct. 31, 2010:
from business ....................................................................................................... $
60,000
from property .......................................................................................................
5,000
$
65,000
Less Par. 3(c) amount determined above .................................................................
Nil
Balance, Oct. 31, 2010........................................................................................................................
Less: unutilized losses about to expire:
non-capital property losses ............................................................................. $
2,000
current property loss .......................................................................................
5,000
Balance, Nov. 1, 2010 ........................................................................................................................

42,000

65,000
$ 107,000

(7,000)
$ 100,000

Only the portion of the non-capital loss that may reasonably be regarded as a loss from carrying on a
business ($40,000 + $60,000 = $100,000) is deductible after October 31, 2010. Thus, the rental losses ($2,000 +
$5,000 = $7,000) expire immediately following the October 31, 2010 year-end [par. 111(5)(a)].
The $100,000 non-capital loss will be deductible only if the following condition is met the transmission
repair business is carried on for profit or with a reasonable expectation of profit throughout the taxation year in
which the losses are to be claimed [spar. 111(5)(a)(i)]. The condition appears to be met for the June 30, 2011 and
the June 30, 2012 taxation years. The transmission repair business was carried on throughout each of the years. It
was carried on for profit for the taxation year ended June 30, 2012. Due to Chriss work ethic and contacts in the
industry, it is reasonable to assume that it was carried on with a reasonable expectation of profit for the taxation
year ended June 30, 2011, despite the loss that was actually realized.
The $100,000 non-capital loss is deductible only to the extent of income from the transmission repair
business and income from a business selling similar products or providing similar services [spar. 111(5)(a)(ii)].
Thus, $54,000 of the non-capital loss incurred prior to November 1, 2010 is deductible for the June 30, 2012
taxation year. None of it is deductible for the June 30, 2011 taxation year due to the loss in that year. The
remainder ($100,000 $54,000 = $46,000) can be carried forward to 2013 subject to these same restrictions.
These restrictions do not apply to the non-capital loss ($25,000 $6,000 = $19,000) incurred in the taxation
year ended June 30, 2011. Thus $11,000 of the 2011 non-capital loss is deductible in 2012, in addition to the
$54,000 mentioned above.
Part B (i) (Maximum election)
Paragraph 111(4)(e) allows Transtek to elect to be deemed to have disposed of the repair shop land for
proceeds of $140,000 (maximum) and the repair shop building for proceeds of $230,000 (maximum). If Transtek
makes this election, the ACB of the land on November 1, 2010 will be $140,000 and the ACB of the building
will be $230,000. The new undepreciated capital cost for the building will be limited by paragraph 13(7)(f) to
$150,000 + 1/ 2 ($230,000 150,000) = $190,000.
The income for the taxation year ended October 31, 2010 will be as follows:
Par. 3(a):

Business income ..............................................................................................................

Property income ..............................................................................................................

Nil
Nil

Solutions to Chapter 11 Assignment Problems

Par. 3(b):

Par. 3(c)
Par. 3(d)

Net capital gains:

Taxable capital gains:
Repair shop land ($140,000 $80,000) 1/ 2 .......................................
Repair shop building ($230,000 $150,000) 1/ 2 ...............................
Allowable capital loss ($20,000 1/ 2 )......................................................
.................................................................................................................
Business loss ............................................................................................
Less: recapture building ($147,000 $150,000) .................................

Property loss .............................................................................................

Division B income .......................................................................................................
Division C deductions:
Par. 111(1)(a) Net capital loss from 2009 ..................................
Par. 111(1)(b) Non-capital loss:
Business..............................................................
$
(Nil)
Property ..............................................................
(Nil)
Taxable income ...................................................................................
Non-capital loss balance, Nov. 1, 2010:
Business
Balance, Jan. 1, 2010 ................................................................... $
40,000
Added in taxation year ended Oct. 31, 2010
($60K $5K $5K $57K) ...................................................
7,000
Utilized in taxation year ended Oct. 31, 2010 or expired .............
(Nil)
Remaining .................................................................................... $
47,000

183

30,000
40,000
$
70,000
(10,000)

$
$

$ (60,000)
3,000
$ (57,000)
(5,000)

(62,000)
Nil

(5,000)

(Nil)

60,000
60,000

Property
2,000

(5,000)
Nil
Total
$
42,000

Nil
(2,000)
Nil

7,000
(2,000)
47,000

The $47,000 remaining may reasonably be regarded as a loss from carrying on business and thus is
deductible in a taxation year after October 31, 2010, subject to the restrictions discussed in Part A.
By making the maximum elections possible, the non-capital loss balance of Transtek at November 1, 2010
has been significantly reduced.
Part B (ii) (Minimum election to utilize expiring losses)
The following losses will expire October 31, 2010, if not utilized:
The 2009 net capital loss ....................................................................................................
The Oct. 31, 2010 allowable capital loss ............................................................................
The rental loss portion of the 2009 non-capital loss ...........................................................
The Oct. 31, 2010 rental loss ..............................................................................................

5,000
10,000
2,000
5,000
22,000

It is impossible to utilize the rental loss portion of the 2009 non-capital loss of $2,000 without triggering
sufficient income under paragraph 3(c) to utilize the entire October 31, 2010 business loss. This would not be
beneficial. Therefore, only $20,000 of the expiring losses will be used.
To utilize these losses in the taxation year ending October 31, 2010, a capital gain of 2 $20,000 = $40,000
is needed. To avoid recapture, the election should be made on the land, not the building.* Thus, Transtek will
elect under paragraph 111(4)(e) to be deemed to have disposed of the repair shop land for proceeds of $120,000,
i.e., (2 $20,000) + 80,000. The ACB of the land at November 1, 2010 will be $120,000.
* An alternative is considered below.

The income for the taxation year ended October 31, 2010 will be as follows:
Par. 3(a)

Business income .......................................................................................

Property income .......................................................................................
Par. 3(b) Net capital gains:
Taxable capital gain:
Repair shop land ($120,000 $80,000) 1/ 2 ...........................................
Allowable capital loss ($20,000 1/ 2 )......................................................
Par. 3(c) .......................................................................................................................
Par. 3(d) Business loss ............................................................................................
Property loss .............................................................................................
Division B income .......................................................................................................

Nil
Nil

20,000
(10,000)

$ (60,000)
(5,000)

$
$

10,000
10,000
(65,000)
Nil

Federal Income Taxation: Fundamentals

184

Division C deductions:
Par. 111(1)(a) Net capital loss from 2009 ............................................................
Taxable income ...........................................................................................................

$ (5,000)
Nil

The net capital loss claimed has no effect on taxable income, but it will increase the non-capital loss balance.
The non-capital loss balance at November 1, 2010 is computed as follows:
Balance, Jan. 1, 2010 ...................................................................................................
Par. 3(d) Loss for taxation year ended Oct. 31, 2010:
from business .............................................................................................
from property .............................................................................................
Add: Net capital loss deducted ....................................................................................
Less: Par. 3(c) amount determined above ....................................................................
Balance, Oct. 31, 2010.................................................................................................
Less: the unutilized non-capital property loss..............................................................
Balance, Nov. 1, 2010 .................................................................................................

$
60,000
5,000
$ 65,000
5,000
$ 70,000
(10,000)

42,000

60,000*
$ 102,000
(2,000)
$ 100,000

* Exactly equal to the business loss above.

Only the portion of the non-capital loss that may reasonably be regarded as a loss from carrying on a business
($40,000 + $60,000 = $100,000) is deductible after October 31, 2010. It is subject to the restrictions discussed in Part A.
Summary:
The three alternatives presented above are summarized as follows for comparative purposes:
Taxable Income for the Deemed Taxation Year Ended October 31, 2010:
No election
Par. 3(a) Income from non-capital sources ( 0)
Nil
Par. 3(b) Net taxable capital gains ( 0):
Deemed taxable capital gains (elective):
land..............................................
Nil
building .......................................
Nil
Accrued allowable capital loss (automatic):
rental land.................................... $(10,000)
Nil
Par. 3(c) Par. 3(a) + par. 3(b)......................
Nil
Par. 3(d) Losses from non-capital sources and ABILs:
Loss from business operations ............ $(60,000)
Recapture (elective): building .............
Nil
Loss from property ..............................
(5,000) (65,000)
Division B income ......................................
Nil
Optional net capital loss deducted ...............
Nil
Non-capital loss deducted:
From property .....................................
Nil
From business .....................................
Nil
Nil
Taxable income ..........................................
Nil

Maximum election
Nil

$ 30,000
40,000
(10,000)

$(60,000)
3,000
(5,000)

$ 20,000
Nil
$ 60,000
$ 60,000

(62,000)
Nil

(5,000)
Nil
Nil

Partial election
Nil

(Nil)
Nil

(10,000)

$ 10,000
$ 10,000

$(60,000)
Nil
(5,000) (65,000)
Nil
(5,000)
Nil
Nil

Nil
Nil

Non-Capital Losses Available for Carryforward at Deemed Taxation Year Ended October 31, 2010:
Balance from Jan. 1, 2010 ............................
Non-capital loss Oct. 31, 2010:
Par. 3(d) losses see above ................
Add: net capital losses deducted ...........
Less: par. 3(c) income see above .....

No election
$ 42,000
$ 65,000
Nil
$ 65,000
Nil

Less: losses utilized at Oct. 31, 2010 ...........

Nil
losses not utilized but expired:
Current property loss .................... $ 5,000
Carryforward property loss ...........
2,000
Available for carryforward from Nov. 1, 2010
Net Capital Losses available for Carryforward

65,000
$ 107,000

Maximum election
$ 42,000
$ 62,000
5,000
$ 67,000
60,000

7,000
$ 49,000

Nil

7,000
$ 100,000
Nil

Nil
2,000

Partial election
$ 42,000
$ 65,000
5,000
$ 70,000
10,000

60,000
$ 102,000

Nil

2,000
$ 47,000
Nil

Nil
2,000

2,000
$ 100,000
Nil

Solutions to Chapter 11 Assignment Problems

185

The results of the above comparison of the three alternatives are further summarized as follows:
Options
Taxable income .....................................................................
Net capital loss deducted .......................................................
Non-capital loss balance, Nov. 1, 2010 .................................
ACB of repair shop land ........................................................
ACB of repair shop building..................................................
UCC of repair shop building..................................................

(A)

(B)(i)

Nil
Nil
100,000
80,000
150,000
147,000

Nil
5,000 $
47,000
140,000
230,000
190,000 *

(B)(ii)
Nil
5,000
100,000
120,000
150,000
147,000

* $147,000 + $3,000 + 1/ 2 ($230,000 $150,000)

Option B (ii) is better if the non-capital loss can be offset by income generated in the next 20 years. The
resultant lower ACB of the land and building under this option is only relevant on a disposition. The lower UCC
on the building only represents an opportunity loss of CCA at a 4% declining balance rate.
Consider the alternative of electing deemed proceeds of disposition of $190,000 (i.e., (2 $20,000) + $150,000)
on the repair shop building. Income under paragraph 3(b) would be the same as for Part B (ii). However, the business
loss under paragraph 3(d) would be only $57,000 (i.e., $60,000 $3,000 recapture), since recapture would be triggered.
This would reduce the non-capital loss balance at November 1, 2010 by $3,000 to $97,000. However, the UCC of the
repair shop building could be increased from $147,000 to $170,000 (i.e., +$3,000 of recapture + $20,000 of taxable
capital gain). The increased CCA base would begin to shelter income from tax, in this case, in the year ended June 30,
2011, when the corporation earns a profit. If, for example, the corporation uses a discount rate of 10% and faces a tax
rate of 20%, the present value of the tax shield on the incremental UCC base of $23,000 (i.e., $170,000 $147,000) at
the 4% CCA rate is:
$23,000 .04 .20
= $1,314
.04 + .10

The value of the extra $3,000 in the non-capital loss balance in the same year and at the same assumed tax
rate of 20% is $600 (i.e., 20% of $3,000).

Federal Income Taxation: Fundamentals

186
Solution 3 (Advanced)

The data given in the problem statement can be summarized as follows:

carryforward losses
2007
2008
2009
current deemed
year-end losses

non-capital losses
$60,000
45,000
25,000
$130,000
from non-capital
sources

ACL
businessoperations
inventory
equipment

property

$12,000

allowable capital
losses
$2,000

2,000

$10,000
20,000
16,000
$46,000

potential elections

$5,500
potential offset
business income

recapturebuilding

$20,000

TCGland
building

net capital losses

$6,000
4,000
2,000
$12,000

expiration
after deemed
year-end

potential offset

5,500
$19,500
taxable capital gain
potential
offset
$20,000
5,000
$25,000

The two election options to consider are the maximum election and the partial election.
(a) Maximum Election
If the maximum election is made, the $20,000 of recapture offsets the business loss, leaving $26,000 (i.e.,
$46,000 $20,000) of net business loss. The $25,000 of taxable capital gain offsets the $19,500 of expiring
losses, leaving $5,500 (i.e., $25,000 $19,500) to offset the remaining $26,000 of business loss, leaving $20,500
of that business loss. As a result, the non-capital loss available for carry forward from June 30, 2010 is $150,500
(i.e., $20,500 + $130,000).
(b) Partial Election
If only a partial election is made to offset the $19,500 of expiring losses, the current business loss of
$46,000 is not offset and, hence, is available to carry forward, along with the $130,000 of non-capital losses,
from June 30, 2010 for a total of $176,000. If the election is made on the land, the ACB of the land can be
increased without a tax cost.
(c) No Election
Note that if no election is made there is no income to offset the current business loss of $46,000 or the noncapital loss carryforward of $130,000. Therefore, the non-capital loss available to carry forward from June 30,
2010 is $176,000 (i.e., $46,000 + $130,000), which is the same as in the partial election, but there is no increase
in any cost value.
Deemed Year-end
Buscat Ltd. is deemed to have a taxation year ending June 30, 2010, immediately before the acquisition of
control by Buns Plus Ltd. on July 1, 2010 [ssec. 249(4)]. Tax returns will have to be filed for this short taxation
year (i.e., 6 months) and amounts such as CCA will have to be prorated. In addition, the short taxation year will
cause the counting of a carryforward year for the non-capital losses from 2007, 2008, and 2009.
Loss from Non-capital Sources
Losses from non-capital sources for the deemed taxation year ended June 30, 2010, before any elections and
options are computed as follows:

Solutions to Chapter 11 Assignment Problems

187

Loss from business ..............................................................................................................

Add: Inventory loss [ssec. 10(1)] ($85,000 $65,000) .....................................................
Bakery equipment Deemed CCA ($86,000 $70,000) .......................................
Total business losses ............................................................................................................
Add: Property loss (will expire unless utilized by June 30, 2010) ....................................
Total losses from non-capital sources ..................................................................................

$
$

10,000
20,000
16,000
46,000
5,500
51,500

Maximum Election
Division B income and taxable income
Par. 3(a)
Par. 3(b)

Income from non-capital sources ......................................................................................

Net taxable capital gains: ..................................................................................................
Election on land [($195,000 $155,000) 1/ 2 ] ........................................................
Election on building [($75,000 $65,000) 1/ 2 ] ......................................................

Less: Allowable capital loss ......................................................................................

Sum of par. 3(a) plus par. 3(b) less any Subdivision e deductions (nil) ............................
Property loss ................................................................................................. $
5,500
Business losses .............................................................................................
46,000
$ 51,500
Less: Building recapture...............................................................................
(20,000)
Sec. 3 income........................................................................................................................................
Division C deductions:
Net capital losses: 2007 .......................................................................................... $
6,000
2008 ..........................................................................................
4,000
2009 ..........................................................................................
2,000
Taxable income ....................................................................................................................................
Par. 3(c)
Par. 3(d)

Nil
$ 20,000
5,000
$ 25,000
(2,000)
$ 23,000

31,500
Nil

$ 12,000
Nil

Non-capital losses available for carryforward after acquisition of control:

Balance July 1, 2010
2007 non-CL ............................................................................................................
2008 non-CL ............................................................................................................
2009 non-CL ............................................................................................................
Non-CL from deemed taxation year before acquisition of control:
Total par. 3(d) loss (see above calculation) ..............................................................
Add: Net capital loss deducted .................................................................................

60,000
45,000
25,000

$ 130,000

31,500
12,000
$ 43,500
Less: Par. 3(c) income above ...................................................................................
(23,000)
Total non-capital losses ........................................................................................................................

20,500
$ 150,500

The $150,500 loss carryforward balance must reasonably be regarded as its loss from carrying on a
business.
2007, 2008, and 2009 loss carryforwards from a business as stated in the question .....................
June 30, 2009 business loss net of recapture............................................................ $ 26,000
Less portion of this loss used against par. 3(c) income* ..........................................
(5,500)
* Par. 3(c) income ....................................................................................................
Less:
Property losses .................................................................... $ 5,500
Net capital losses restored as business losses ......................
12,000

$ 130,000
20,500
$ 150,500

$ 23,000

(17,500)
5,500

The non-capital losses will expire in 20 taxation years, including the deemed taxation year, from the year of
the loss as follows, assuming that Buscat Ltd.s fiscal year-end after the acquisition of control returns to
December 31.
2007 non-CL on December 31, 2026
2008 non-CL on December 31, 2027
2009 non-CL on December 31, 2028
2010 deemed taxation year on December 31, 2029

Federal Income Taxation: Fundamentals

188

The adjusted cost base/capital cost of the properties which were deemed to be sold at their fair market values
would be:
Capital cost
Bakery equipment ............................................................. $ 100,000
Land ..................................................................................
n/a
Building* (Class 1) ...........................................................
70,000

UCC
70,000
n/a
70,000

Adjusted cost base

$ 100,000
195,000
75,000

* $65,000 + 1/ 2 ($75,000 $65,000).

In order for these non-capital losses to be deductible in subsequent fiscal periods, two conditions in
subparagraph 111(5)(a)(i) must be met:
(a) the bakery business which generated the loss must be carried on throughout the taxation year in which
the non-capital loss is deducted; and
(b) the bakery business must be carried on for profit or with a reasonable expectation of profit.
It would appear that both conditions will be met, since the Buscat business is being carried on and Buns Plus
expects that the Buscat bakery business will earn a profit of $65,000 in 2011.
If the conditions of subparagraph 111(5)(a)(i) are met, then the non-capital losses may be deducted from
income of the bakery business that generated the loss plus the income from the sale of similar products or
services. If it can be assumed that the bakery business, transferred to Buscat Ltd., sells similar products and/or
services as the Buscat bakery business, then the maximum $90,000 of non-capital losses can be deducted on
December 31, 2010 as follows:
Lesser of:
(a) Net income for year .............................................................................................................
(b) Income from: the loss business ...................................................................
Nil
the sale of similar products ................................................... $ 130,000

90,000

$ 130,000

The remaining $60,500 ($150,500 $90,000) of non-capital losses can be carried forward to 2011 subject to
the deductibility tests discussed above.
Partial election
The minimum amount to be elected upon under paragraph 111(4)(e) (i.e., proceeds of disposition) should be
an amount equal to 2 times the sum of:
(a) the allowable capital loss of $2,000 which is about to expire,
(b) the net capital losses of $12,000 which would otherwise expire, and
(c) the property loss of $5,500 which otherwise expires plus the adjusted cost base of the property to be
elected upon.
If the land was chosen as the asset to trigger all of the taxable capital gain, then the deemed proceeds would
be determined as:
[2 ($2,000 + $5,500 + $12,000) + $155,000] or $194,000
The resulting taxable income computation would be:
Par. 3(a)
Par. 3(b)

Non-capital sources of income

Net taxable capital gain:
Land, 1/ 2 ($194,000 $155,000) .............................................................. $ 19,500
Allowable capital loss ..............................................................................
(2,000)
Par. 3(c) Sum of par. 3(a) plus par. 3(b) less any Subdivision e deductions (nil) ..........................
Par. 3(d) Property loss ............................................................................................. $
5,500
Business loss ............................................................................................
46,000
$ 51,500
Less: Building recapture...........................................................................
Nil
Sec. 3 income......................................................................................................................................
Division C
Net capital loss ...................................................................................................................................
Taxable income ..................................................................................................................................
Non-capital losses available for carryforward after the acquisition of control:
Balance, July 1, 2010 ..........................................................................................................................
Non-capital losses from the deemed taxation year ended June 30, 2009 ..................... $ 51,500
Add: Net capital losses deducted above.......................................................................
12,000
$ 63,500
Less: Par. 3(c) income above .......................................................................................
(17,500)
Total non-capital losses ......................................................................................................................
* Exactly equal to the business loss above.

Nil

$
$

17,500
17,500

51,500
Nil
$

12,000
Nil

$ 130,000

46,000*
$ 176,000

Solutions to Chapter 11 Assignment Problems

189

Summary
The two alternatives presented above are summarized as follows for comparative purposes:
Taxable Income for the Deemed Taxation Year Ended June 30, 2010:
Maximum election
Partial election
Par. 3(a) Income from non-capital sources ( 0) ............
Nil
Nil
Par. 3(b) Net taxable capital gains ( 0):
Deemed taxable capital gains (elective):
land .................................................... $ 20,000
$ 19,500
building .............................................
5,000
Nil
Allowable capital loss ...............................
(2,000) $ 23,000
(2,000) $ 17,500
Par. 3(c) Par. 3(a) + par. 3(b) .......................................
$ 23,000
$ 17,500
Par. 3(d) Losses from non-capital sources and ABILs:
Loss from business .................................... $ (46,000)
$ (46,000)
Recapture (elective): building ....................
20,000
Nil
Loss from property ....................................
(5,500)
(31,500)
(5,500)
(51,500)
Division B income ...........................................................
Nil
Nil
Optional net capital loss deducted....................................
(12,000)
(12,000)
Non-capital loss deducted ................................................
Nil
Nil
Taxable income ................................................................
Nil
Nil
Non-Capital Losses available for Carryforward at Deemed Taxation Year ended June 30, 2010:
Maximum election
Partial election
Balance, Jan. 1, 2010 .......................................................
$ 130,000
$ 130,000
Non-capital loss June. 30, 2010:
Par. 3(d) losses see above ................................... $ 31,500
$ 51,500
Add: net capital losses deducted ..............................
12,000
12,000
$ 43,500
$ 63,500
Less: par. 3(c) income see above ........................
(23,000)
20,500
(17,500)
46,000
$ 150,500
$ 176,000
Less: losses utilized at June 30, 2010 ............................
Nil
Nil
losses not utilized but expired ..............................
Nil
Nil
Nil
Nil
Available for carryforward from June. 30, 2010 ..............
$ 150,500
$ 176,000
Net Capital Losses available for Carryforward ...............
Nil
Nil

The results of the above comparison of the two alternatives are further summarized as follows:
Options
Taxable income ........................................................................
Net capital loss deducted .........................................................
Total non-capital losses available for carryforward .................
ACB of land .............................................................................
UCC of building (Class 1) .......................................................
ACB of building.......................................................................

(a)
0
$ 12,000
150,500
195,000
70,000
75,000

(b)
0
$ 12,000
176,000
194,000
45,000
65,000

Difference
0
0
$ 25,500
(1,000)
(25,000)
(10,000)

Option (b) is better if the additional $25,500 of non-capital loss can be offset by income generated in the
next 20 years. The resultant lower ACB of the land under this option is only relevant on a disposition. The lower
UCC on the building only represents a loss of CCA at a 4% declining balance rate. On the other hand, if an
additional $25,500 of income cannot be generated in the next 20 years (i.e., business losses continue),
alternative (a) is better. Note that 20 years is a long time to sustain continued business losses without generating
at least $25,000 of business income. It is unlikely that alternative (a) is better, unless the land and building will
be sold in the near future.

Federal Income Taxation: Fundamentals

190
Solution 4 (Basic)

Net income before income taxes .........................................................................................................

Add: Loss on the sale of investment [ssec. 9(3)] ....................................................... $
10,000
Depreciation and amortization [par. 18(1)(b)]..................................................
104,900
Interest on income tax payments [par. 18(1)(t)] ...............................................
435
Club dues [par. 18(1)(l)]...................................................................................
1,750
Political contributions [par. 18(1)(n)]...............................................................
2,500
Charitable donations [par. 18(1)(a)] .................................................................
22,500
Property tax on vacant land [ssec. 18(2)] .........................................................
3,000
Life insurance premium [pars. 18(1)(a), (b), (c)] .............................................
1,950
Subtotal ............................................................................................................
Deduct: Capital cost allowance [par. 20(1)(a)] .......................................................... $ 149,500
Gain on sale of land [ssec. 9(3)] ...................................................................
126,200
Add: Taxable capital gain on business land [sec. 38]: 1/ 2 ($200,000 $73,800) ...
Allowable capital loss on investments [sec. 38]: 1/ 2 ($75,000 $85,000): ...
Net income under Division B ......................................................................................
Less Division C deductions:
Charitable donations [sec. 110.1] .........................................................................
Dividends [sec. 112] ............................................................................................
Non-capital loss [par. 111(1)(b)] ..........................................................................
Net capital loss [par. 111(1)(a)]: $75,000 4/ 3 1/ 2 ...........................................
Taxable income ...........................................................................................................

The following items were correctly included on the accounting income statement:
(a) Landscaping costs [par. 20(1)(aa)];
(b) Site investigation fees [par. 20(1)(dd)];
(c) Dividends from taxable Canadian corporations [par. 12(1)(j)]; and
(d) Dividends from foreign corporations [par. 12(1)(k)].

342,000

147,035
489,035

(275,700)
213,335

58,100
271,435

63,100
(5,000)

22,500
42,800
73,800
50,000

(189,100)
$
82,335

Solutions to Chapter 11 Assignment Problems

191

Solution 5 (Basic)
[Reference: Chicago Blower (Canada) Ltd. v. M.N.R., 66 DTC 471 (T.A.B.)]
(A) Facts fall within Regulation 400(2)(b)
(i) the company carried on business in each province through an agent,
the agent was established in a particular place, clearly identified to the public,
occupied building with various warehouse facilities,
the agent had general authority to contract,
the agent had a stock of merchandise from which he filled orders,
the exception to this was on orders for larger fans,
thus, the condition was met at least in part,
(ii) therefore, the company does have a permanent establishment in the provinces indicated.
(B) This conclusion differs from that in the Sunbeam case which can be distinguished on its facts,
(i) in the Sunbeam case, the taxpayers representatives in Quebec did not have authority to make contracts
on the companys behalf,
(ii) there was no telephone listing in the companys name and that name did not appear on any business
signs.

Federal Income Taxation: Fundamentals

192
Solution 6 (Basic)

Income under Division B from consulting business ...........................................................................

Canadian investment royalty income ..................................................................................................
U.K. non-foreign affiliate dividend income ........................................................................................
Taxable dividend received from non-connected Canadian corporations ............................................
Taxable capital gains ..........................................................................................................................
Income under Division B ....................................................................................................................
Deduct:
Charitable donations (not exceeding 75% $305,000 = $228,750)............................................
Canadian dividends received .......................................................................................................
1999 net capital loss ($12,000 1/ 2 / 3/ 4 ; limited to taxable capital gains of $6,000) .................
Taxable income ..................................................................................................................................
Basic federal tax at 38% of $194,000 .................................................................................................
Deduct: Abatement from federal tax (see Schedule 1)........................................................................
Net ......................................................................................................................................................
Deduct:
Non-business foreign tax credit (see Schedule 2)........................................................................
Business foreign tax credit (see Schedule 3) ...............................................................................
Tax reduction (10% of $194,000) ...............................................................................................
Part I tax payable (federal) .................................................................................................................
Provincial tax:
British Columbia 11% of $77,600...............................................................................................
Alberta rate 10% of $58,200 .......................................................................................................
Total tax ..............................................................................................................................................

264,000
10,000
20,000
5,000
6,000
305,000

(100,000)
(5,000)
(6,000)
$ 194,000
$
73,720
(13,580)
$
60,140
(2,771)
(18,476)
(19,400)
$
19,493
8,536
5,820
33,849

Schedule 1: Abatement from federal tax

Gross revenues..........................................
% gr. revenues (1).....................................
Salaries and wages ....................................
% S&W (2) ...............................................

B.C.
$3,000K
30%
$500K
50%

Alberta
$3,000K
30%
$300K
30%

Total Cdn.
$6,000K
60%
$800K
80%

U.S.
$4,000K
40%
$200K
20%

Total
$10,000K
100%
$1,000K
100%

(1) + (2) ....................................................

2

40%

30%

70%

30%

100%

Abatement: 10% of 70% of $194,000 = $13,580

Allocation of income to: B.C. 40% $194,000 = $77,600
Alberta 30% $194,000 = $58,200
Schedule 2: Non-business foreign tax credit (U.K. income)
Lesser of:
(i) tax paid
income from U.K.
(ii)

income less dividends and

net capital loss carryover

$20,000
$305,000 $5,000 $6,000
$20,000
$294,000

3,000

2,771

tax otherwise payable after

abatement minus general
tax reduction
($60,140 $19,400)
$40,740 = .........................................................................

Lesser amount is $3,000.

Schedule 3: Business foreign tax credit (U.S. income)

Least of:
(i) tax paid and unused credit ($16,000 + $3,000) .......................................................................
tax otherwise payable
income from U.S.
(ii)
minus general tax
income less dividends and
net capital loss carryover
reduction
$100,000
$305,000 $5,000 $6,000
$100,000
$294,000

$ 19,000

($73,720 $19,400)
$54,320 = .........................................................................

(iii) tax otherwise payable before any reduction or credits plus surtax less non-business tax credit
($73,720 $19,400 $2,771) .................................................................................................
Least amount is $18,476.

$ 18,476
$ 51,549

Solutions to Chapter 11 Assignment Problems

193

Solution 7 (Basic)
(A) The maximum investment tax credit is
20% [$1,700,000 + $300,000] = $400,000
Note that the used equipment is not a qualified expenditure for the purposes of subsection 127(9)
because it is not new property [Reg. 2902(2)(iii)].
(B) Taxable income before sec. 37 deduction........................................................................ $ 3,200,000
Section 37 deduction .......................................................................................................
(2,200,000)
Taxable income ............................................................................................................... $ 1,000,000
Net tax 18% ..................................................................................................................... $
180,000
Investment tax credit .......................................................................................................
(180,000)
Net federal tax payable under Part I ................................................................................
Nil
(C) The remaining investment tax credit of $220,000 (i.e., $400,000 $180,000) may be carried back three
and forward 20 taxation years.
(D) Section 37 SR&ED expenditures in first year ................................................................. $ 2,200,000
Section 37 deduction in first year ....................................................................................
(2,200,000)
Balance at the beginning of the second year ...................................................................
Nil
Less: ITC claim for first year ..........................................................................................
(180,000)
Recapture in second year [par. 12(1)(t)] ..........................................................................
180,000
Balance after recapture ....................................................................................................
Nil
If no further SR&ED expenditures are made in the following year, the income inclusion would be
$180,000 [par. 12(1)(t)].

Federal Income Taxation: Fundamentals

194
Solution 8 (Basic)

Income under Division B:

Operating profits .................................................................................................................................
Dividends from taxable Canadian corporations ..................................................................................
Canadian investment income (i.e., interest income) ............................................................................
Foreign investment income ($61,000 + $10,000) ...............................................................................

$
Add: donations .................................................................................................................................
Division B income ..............................................................................................................................
Less: Division C deductions:
Taxable dividends deductible under sec. 112 ................................................................. $ 85,000
Donations (max. 75% of $718,255 = $538,691) ............................................................
9,755
Non-capital losses ..........................................................................................................
255,545
Taxable income ...........................................................................................................................................
Federal tax (38% of $367,955) ...................................................................................................................
Federal abatement (10% of $367,955) ........................................................................................................
Federal tax after abatement .........................................................................................................................
Less: M&P profits deduction............................................................................................... $ 36,796
Foreign non-business tax credit(1) ..............................................................................
10,000
Tax rate reduction(2) ...................................................................................................
Nil
Federal tax before investment tax credit .....................................................................................................
Investment tax credit (10% of $250,000) ....................................................................................................
Part I federal tax payable ............................................................................................................................
New Brunswick tax @ 13% of $367,955 ....................................................................................................
Total tax liability.........................................................................................................................................

500,000
85,000
52,500
71,000
708,500
9,755
718,255

(350,300)
367,955
139,823
(36,796)
$ 103,027
$
$

(46,796)
$
56,231
(25,000)
$
31,231
47,834
$
79,065

NOTES TO SOLUTION
(1) Foreign non-business tax credit
Lesser of:
(i) Amount paid ................................................................................................................
$71,000
(ii)
$103,027 ...................................................................................
$718,255 $85,000
(2)

Tax reduction
Taxable income .........................................................................................................................
Less: M&P profits .....................................................................................................................
Net.............................................................................................................................................

10,000

11,551

367,955
(367,955)
Nil

Therefore, there is no tax rate reduction, since all taxable income is eligible for the M&P profits deduction.

Solutions to Chapter 11 Assignment Problems

195

Solution 9 (Advanced)
Net income under Division B ...........................................................................................................
Division C deductions: Dividends from taxable Canadian corporations .......................................
Charitable donations (max. 75% $2,097,000) ......................................
Net capital losses ($9,000 1/ 2 / 3/ 4 ) .......................................................
Non-capital losses ....................................................................................
Taxable income ................................................................................................................................
Tax @ 38% .......................................................................................................................................
Federal abatement(1) ..........................................................................................................................
Non-business foreign tax deductions(2) .............................................................................................
Business foreign tax deductions(3) ....................................................................................................
Manufacturing and processing profits deduction (given)..................................................................
Tax reduction(4) .................................................................................................................................
Federal tax before investment tax credit ...........................................................................................
Investment tax credit(5) .....................................................................................................................
Federal Part I tax payable .................................................................................................................
Provincial tax payable: Ontario @ 12% $963,340 .....................................................................
Alberta @ 10% $196,600 .....................................................................

$ 2,097,000
(15,000)
(50,000)
(6,000)
(60,000)
$ 1,966,000
$
747,080
(115,994)
$
631,086
(3,000)
(200,000)
(79,446)
(117,154)
$
231,486
(30,000)
$
201,486
$
115,601
19,660
$
135,261

NOTES TO SOLUTION
(1) Federal abatement:
Gross revenue
Salaries & wages
Amount
%
Amount
%
Average percentage
Ontario ............ $ 6,000,000
54.6 % $ 2,540,000
43.3 % 1/ 2 (54.6% + 43.3%) = 49.0%
1
Alberta ............
400,000
3.6
960,000
16.4
/ 2 (3.6% + 16.4%) = 10.0%
1
$ 6,400,000
58.2
$ 3,500,000
59.7
/ 2 (58.2% + 59.7%) = 59.0%
U.S. .................
4,600,000
41.8
2,360,000
40.3
Total................ $ 11,000,000
100.0 % $ 5,860,000
100.0 %
Allocation of taxable income to each province:
Ontario ..................................................................................... 49% $1,966,000 =
$
963,340
Alberta...................................................................................... 10% $1,966,000 =
196,600
Taxable income earned in a province or territory .....................
$ 1,159,940
Abatement is 10% $1,159,940 = $115,994.

(2)

Non-business foreign tax deduction:

lesser of:
(a) tax paid
foreign non - business income
(b)
Div. B income - par.111(1)(b) - sec.112

$20,000
($631,086 $117,154)
$2,097,000 $6,000 $15,000

(3)

3,000

................................................................ $

4,951

tax otherwise payable

(basic abatement general reduction)

Business foreign tax deduction:

least of:
(a) tax paid ..............................................................................................................................
foreign business income
(b)
tax otherwise payable
(basic general reduction)
Div. B income - par.111(1)(b) - sec.112

(4)

200,000

$800,000
($747,080 $117,154)
.............................................................. $
$2,097,000 $6,000 $15,000

242,746

(c) tax otherwise payable minus non-business foreign tax deduction

($747,080 $117,154 $3,000) .....................................................................................

626,926

Tax reduction
Taxable income
Less: M&P profits.....................................................................................................................
Net ............................................................................................................................................
10% of $1,171,541....................................................................................................................

$ 1,966,000
(794,459)
$ 1,171,541
$
117,154

(5) Investment tax credit: 20% $150,000 = $30,000

Since all $150,000 of the expenditure was deducted in 2010, all $30,000 of the ITC claimed in 2010 will be
included in income in 2011 [par. 12(1)(t)].

Federal Income Taxation: Fundamentals

196
Advisory Case
King Enterprises Inc.

ADVISORY CASE DISCUSSION NOTES

This case deals primarily with the issues surrounding acquisition of control and the adjustment to, and carry
forward of, the losses of Royal.
1. Deemed year-end

Day before the closing.

This uses up one of the years for the carryover of losses unless the AOC occurs on the same date,
or very close to it, as the year end of Royal.
Can choose any new year-end within 12 months.

2. Accrued but unrealized losses

Accrued terminal losses, if CCA has been claimed in the past, but did not cover full decline in
value.

If the allowance for doubtful accounts was not fully claimed last year then it needs to be.

Is there an accrued loss on ECP or non-depreciable capital property?

3. Election

Do any of the assets have a fair market value in excess of their tax values?

Designation available under paragraph 111(4)(e) to use up losses that will expire on the AOC or
that might expire before they can be utilized.

4. Expiry of losses on the AOC

Property losses, net capital losses, ABILs.

Did the sale of land and building cause a net capital loss?
They have had six years of losses, so the carry forward period getting shorter, especially, with the
deemed year-end on acquisition of control counting as one taxation year.
o not a major problem with a 20-year carry forward

5. Utilization of losses

Need to meet 3 conditions in order for the business losses to be available after the AOC:
i) The business that generated the loss must be carried on throughout the year. The forms
business of Royal must be continued.

ii) The forms business must be carried on with a reasonable expectation of profit. Ian
seems to think that he can make it profitable.
iii) The losses carried over can be applied against income only from the same business
or from the sale of similar products or services. The forms losses of Royal can only
be used against the profits from the forms business or from the sale of forms. There
could be some grey area here, but Ian should not assume that he can use Royals
losses against Kings profits.

CHAPTER 12

Integration for Business and Investment Income

of the Private Corporation
Solution 1 (Basic)
[Note: The facts of this case are those of The Queen v. Cadboro Bay Holdings Ltd., 77 DTC 5115
(F.C.T.D.). However, the legislation, under which the case was decided, did not contain a definition of active
business or specified investment business.]
Under the current legislation, an active business [ssec. 125(7)] is any business other than a specified
investment business [ssec. 125(7)] or a personal services business [ssec. 125(7)]. As a result, if a business is
not a specified investment business or a personal services business, it is an active business.
Consider the definition of specified investment business. It is a business other than a business carried on
by a credit union. This case does not involve a credit union. The business of leasing property other than real
property, i.e., the leasing of movable property, is not a specified investment business. However, the facts of this
case indicate the leasing of real property, i.e., land and buildings in a small shopping centre. This activity fits the
definition of a specified investment business. Furthermore, the principal purpose of the business is to derive
income from rents. Since the facts of the case do not indicate that there are more than five full-time employees of
the taxpayer corporation, the exception in paragraph (a) of the definition in subsection 125(7) is not met. Since
there is no indication of an associated corporation providing services to the taxpayer corporation that would
otherwise be performed by more than five full-time employees of the taxpayer corporation, the exception in
paragraph (b) of the definition in subsection 125(7) is not met.
It can be concluded that the taxpayer corporation is carrying on a specified investment business. It is not
carrying on a personal services business because it is not reasonable to regard the principal officer of the
taxpayer corporation who negotiated the leases as an employee of the persons to whom the taxpayer corporation
provided services.

197

198

Federal Income Taxation: Fundamentals

Solution 2 (Basic)
(A) Leah Ltd. and Elaine Ltd. are associated because Leah Ltd. controls Elaine Ltd. [par. 256(1)(a)].
(B) Abigail Ltd. and Ethan Ltd. are associated because they are controlled by the same person
[par. 256(1)(b)].
(C) Clare Ltd. and Philip Ltd. are associated because they are controlled by the same group of persons,
namely, Ms. Irene and Mr. Mordechai [par. 256(1)(b)].
(D) Jay Ltd. is considered to be controlled by the group, Mrs. Lyn and Mrs. Sarah [spar. 256(1.2)(b)(i)].
Then paragraph 256(1)(b) applies to associate the corporations, despite the fact that Mrs. Lyn controls Jay Ltd.
[spar. 256(1.2)(b)(ii)].
(E) Stan Ltd. and Jonathan Ltd. are associated because they are controlled by the same group of persons,
namely Janna Ltd. and Rayna Ltd. [par. 256(1)(b)].
(F) Rick Ltd. and Daniel Ltd. are associated because each company is controlled by one person and the
person who controls Rick Ltd. is related [par. 251(6)(a)] to the person who controls Daniel Ltd. and that person
owns not less than 25% of the shares, other than of a specified class, of each corporation [par. 256(1)(c)].
(G) Gord Ltd. and Rebecca Ltd. are associated because Gord Ltd. is controlled by one person, Mr. Joshua,
and he is related to each member of a group of persons (Mr. Joshua [ssec. 256(1.5)] and Ms. Dahlia
[par. 252(2)(b) or 251(6)(b)] that controlled Rebecca Ltd. Mr. Joshua owns not less than 25% of the issued
shares, other than of a specified class, of the other corporation [par. 256(1)(d)]. By the same rules, Rosalyn Ltd.
and Rebecca Ltd. are associated. Therefore, Gord Ltd. and Rosalyn Ltd. are associated, unless Rebecca Ltd.
elects not to be associated with Gord Ltd. and Rosalyn Ltd. [ssec. 256(2)]. The election has the dual effect of
denying Rebecca Ltd. the small business deduction and dissociating Gord Ltd. and Rosalyn Ltd. for purposes of
section 125 only (the small business deduction) and only for the election year. If an election is made, it must be
made annually to apply in a particular taxation year.
(H) Mrs. Yael controls Benjamin Ltd. Mrs. Yael controls, indirectly, 25% of the shares of Livi Ltd. through
her holdings of Benjamin Ltd. shares. She also controls another 30% of the shares of Livi Ltd. directly, thereby
controlling a total of 55% of the shares of Livi Ltd. Therefore, Benjamin Ltd. and Livi Ltd. are associated
[par. 256(1)(b)]. Association is also possible because Mrs. Yael controls Benjamin Ltd. and she is related to the
group of persons (Benjamin Ltd. [spar. 251(2)(b)(i)] and herself [ssec. 256(1.5)]) that controls Livi Ltd. and she
owns not less than 25% of the shares, other than shares of a specified class, of the other corporation
[par. 256(1)(d)].
(I) The corporations are associated [par. 256(1)(b)] because Ms. Daniella is deemed [par. 256(1.4)(a)] to
be in the same position as if she owned the shares on which she holds an option. Therefore, she controls Ava Ltd.
in addition to controlling Elizabeth Ltd.
(J) Since both corporations are controlled by groups, paragraph 256(1)(e) is the only possible set of
conditions for association. Ethan Ltd. is controlled by a related group consisting of Mr. and Mrs. Jonathan who
are related by marriage [par. 251(6)(b)]. Maya Ltd. is also controlled by a related group consisting of any three of
the three brothers and one sister who are related by blood [par. 251(6)(a)]. Each of Mr. and Mrs. Jonathan is
related to each of the brothers and the sister. Mr. Jonathan is related by blood to his brothers and sister.
Mrs. Jonathan is related to her brothers-in-law and sister-in-law [pars. 251(6)(a) and 252(2)(b) or (c) or
par. 251(6)(b)]. Mr. Jonathan, who is a member of both related groups, owns in respect of the other corporation
not less than 25% of the shares, other than of a specified class. Therefore, all conditions for association are met.

Solutions to Chapter 12 Assignment Problems

199

Solution 3 (Advanced)
(A) A Ltd. and B Ltd. are associated [par. 256(1)(b)]. They are both controlled by the same group, i.e.,
Rachel and Monica. Rachel and Monica may be considered as a group controlling B Ltd., even though Rachel
controls B Ltd. on her own also [spars. 256(1.2)(b)(i) and (ii)].
(B) A Ltd. and B Ltd. are associated [par. 256(1)(c)]. A Ltd. is controlled by Charlie. B Ltd. is controlled
by Claudia. Charlie and Claudia are related. Charlie owns in respect of each of A Ltd. and B Ltd. not less than
25% of the issued shares of any class, other than a specified class. Charlie is deemed to own 80% of 40% = 32%
of the shares of B Ltd. [par. 256(1.2)(d)].
(C) A Ltd. and B Ltd. are associated [par. 256(1)(d)]. B Ltd. is controlled by Bert. Bert is related to each
member of a group of persons that control A Ltd. Bert owns not less than 25% of the issued common shares of
A Ltd. Bert is deemed to own 1/ 3 of 100% = 33.3% of the shares of A Ltd. [par. 256(1.2)(e)].
(D) A Ltd. and C Ltd. are associated [par. 256(1)(d)]. A Ltd. is controlled by Anne. Anne is related to each
member of a group of persons that control C Ltd. Anne owns not less than 25% of the issued common shares of
C Ltd. Anne is deemed to own 100% of 40% = 40% of the shares of C Ltd. [par. 256(1.2)(d)].
B Ltd. and C Ltd. are associated [par. 256(1)(d)]. B Ltd. is controlled by Barbara. Barbara is related to each
member of a group of persons that control C Ltd. Barbara owns not less than 25% of the issued common shares
of C Ltd. Barbara is deemed to own 100% of 40% = 40% of the shares of C Ltd. [par. 256(1.2)(d)].
Since A Ltd. and B Ltd. are not associated by any other provision, subsection 256(2) deems them to be
associated because of their common association with C Ltd. However, if C Ltd. elects not to be associated with
A Ltd. and B Ltd., then C Ltd. will be deemed to have a business limit of nil and all three corporations will be
deemed not to be associated for purpose of section 125.
(E) A Ltd. and B Ltd. are associated [par. 256(1)(b)]. They are both controlled by the same group, i.e.,
Brandon and Claire. Brandon and Claire may be considered as a group controlling B Ltd., even though Claire
controls B Ltd. on her own also [spars. 256(1.2)(b)(i) and (ii)].
B Ltd. and C Ltd. are associated [par. 256(1)(b)]. They are both controlled by Claire.
Since A Ltd. and C Ltd. are not associated by any other provision, subsection 256(2) deems them to be
associated because of their common association with B Ltd. However, if B Ltd. elects not to be associated with
A Ltd. and C Ltd., then B Ltd. will be deemed to have a business limit of nil and all three corporations will be
deemed not to be associated for purpose of section 125.
(F) A Ltd. and B Ltd. are not associated, since the conditions of paragraph 256(1)(e) cannot be met. A Ltd.
and B Ltd. are not controlled by one person but by groups of unrelated persons. Valerie and her two nieces are
not related for tax purposes [sec. 251]. Dilon and his nephew also are not related for tax purposes [sec. 251].
Therefore, A Ltd. and B Ltd. are not associated under the technical rules in section 256. However, careful
consideration should be given to a possible assessment under the anti-avoidance provision [ssec. 256(2.1)].
(G) Each of the corporations is controlled by a person; F Ltd. is controlled by Father and S Ltd. is
controlled by Sean. Father and Sean are related. Father is deemed to own 100% 30% = 30% of the issued
preferred shares of S Ltd. [par. 256(1.2)(d)]. However the preferred shares are shares of a specified class
[ssec. 256(1.1)]. Therefore, the preferred shares do not count towards the 25% ownership required for the
corporations to be associated.
Where shares are owned by a child under age 18, for the purpose of determining associated corporations, the
shares are deemed to be owned by the parent unless it can reasonably be considered that the child manages the
business and affairs of the corporation and does so without a significant degree of influence by the parent
[ssec. 256(1.3)]. Therefore, it is likely the Father will be deemed to own the 100% of the common shares of
S Ltd. which are owned by Sean. Therefore F Ltd. and S Ltd. will be associated [par. 256(1)(b)] as both
corporations are controlled by the same person.

200

Federal Income Taxation: Fundamentals

Solution 4 (Advanced)
[Reference: Warren Packaging Limited and Bradford-Penn Oil Inc. v. M.N.R., 83 DTC 1 (T.R.B.)]
(A) First, consider the possible application of subsection 256(5.1), on the basis that Mr. Warren had direct
or indirect influence resulting in control in fact of his wifes corporation. Since the provision did not exist at the
time of the actual case, no evidence was presented on this specific issue. However, the facts of the case indicate
that both companies were directed by the same person in the same premises. Both corporations had the same
year-end and were supplied by the same supplier. If the facts of this situation are sufficient for a finding of
control in fact of both corporations by Mr. Warren, then paragraph 256(1)(b) would apply to associate the
corporations.
(B) If, based on an assessment of the facts, control in fact is not found to exist, then subsection 256(2.1)
must be considered. In order to escape the application of the deemed association rules in subsection 256(2.1), the
taxpayer must meet the condition that tax reduction was not one of the main reasons for the separate existence of
the corporations.
In this case, there are good business reasons for the separate existence of the two corporations. Each had a
separate clientele which was serviced with a separate brand. Those brands could not be traced to the same
corporation if the two different markets were to be maintained. The business was risky because there was only
one supplier which was also a competitor. Having two separate corporations limited this risk. Furthermore, the
risk of a personal guarantee for a bank loan to one of the corporations was limited, in the opinion of Mr. Warren,
by having a separate corporation owned solely by the other spouse.
These arguments would probably outweigh the facts that the corporations were directed by the same person
using the same premises and were supplied by the same supplier. In view of the business reasons for the separate
existence of the corporations, the latter facts do not necessarily indicate that one of the main reasons for the
separate existence of the corporations was tax reduction.
Furthermore, there is evidence in the testimony of Mr. Warren that taxation was not considered when he
decided to separately incorporate the two companies. From the business arguments in favour of separate
existence, it does not appear that taxation was one of the main reasons for separate incorporation.
In this case, it can be concluded that the two corporations should not be deemed to be associated
[ssec. 256(2.1)]. If the facts are such that subsection 256(5.1) cannot be applied regarding the influence of one
spouse over the other, the corporations would not be technically associated. Since they are not technically
associated under subsection 256(1), they need not share the business limit of $500,000 for the small business
deduction.

Solutions to Chapter 12 Assignment Problems

201

Solution 5 (Basic)
Part I tax payable:
Taxable income ............................................................................
Tax @ 38% of $316,000 ................................................................
Deduct: Federal abatement (10% of $316,000) ............................
Net ................................................................................................
Additional refundable tax 62/3% of lesser of:
(a) AII ($12,000 + $5,000 $2,000) .........................................
(b) TI income eligible for SBD (Schedule 1)
($316,000 $310,000) ......................................................
62/3% of $6,000
Total .............................................................................................
Deduct: Non-business foreign tax credit (assumed) .....................
Small business deduction (Schedule 1) .....................................
General tax reduction (Schedule 2) ...........................................
Part I tax payable

$316,000
$120,080
31,600
$ 88,480
$15,000
$ 6,000
400
$ 88,880
$ 1,800
52,700
Nil

54,500
$ 34,380

Schedule 1: Small business deduction

17% of lesser of:
(a) Income from an active business ............................................

$320,000

(b) Taxable income ....................................................................

Less: 10/3 NBFTC (10/3 $1,800) .................................

$316,000
6,000

(c) Business limit (before reduction) .........................................

Less: ($11,900,000 - $10,000,000) .00225
$500,000*
$11,250
17% of $310,000 = $52,700

$500,000
190,000

$310,000

$310,000

Schedule 2: General reduction

Taxable income .............................................................................
Less: 100/17 SBD (100/17 $52,700) .......................................
AII .....................................................................................
Net ................................................................................................
9% of Nil = Nil
* Alternatively,

$11,900,000 $10,000,000
$5,000,000

$500,000

$316,000
$310,000
15,000
$

325,000
Nil

Federal Income Taxation: Fundamentals

202
Solution 6 (Advanced)
(A) Qualifying SR&ED Expenditures [ssec.37(8)]

Current expenditures:
Salaries for research technicians and assistants ..........................................................
Salary for Natalia ($80,000 25%) ...........................................................................
Bonus for Natalia [ssec. 37(9)] ..................................................................................
Materials consumed ...................................................................................................
Supplies consumed .....................................................................................................
Actual overhead expenses (using simplified method) ................................................

$
Capital expenditures:
Small equipment ........................................................................................................
Machine ....................................................................................................................
Total SR&ED expenditures .......................................................................................

600,000
20,000
0
200,000
40,000
0
860,000

80,000
100,000
$
180,000
$ 1,040,000

The overhead expense related to the SR&ED has not been included as the actual amount is unknown. The
overhead would be deducted in the computation of income as an ordinary expense. The difference is the limited
period of carryforward for ordinary expenses (i.e., 20 years for non-capital losses), as compared to the indefinite
carryover for the SR&ED expenditure pool.
Capital expenditures are included in the SR&ED pool only if it is intended at the time of acquisition that
they will be used all or substantially all of their useful life in SR&ED [ssec. 37(8)].
(B) ITCs and Refundable ITCs
Nature
Current ..................................................................
Capital...................................................................
PPA (below)(treated as a current expense) ...........

Amount
860,000
180,000
403,000
$ 1,443,000
$

ITC rate
35%
35%
35%

ITC
$ 301,000
63,000
141,050

Refundable ITC
(100%) $ 301,000
(40%)
25,200
(100%)
141,050
$ 467,250

Since NAL does not expect to have taxable income this year, it can apply for a refund of the ITCs.
Alternatively, the ITCs may be carried back and applied to reduce federal tax payable in any of the three
preceding years or carried forward and applied to reduce federal tax in any of the 20 subsequent years.
ITCs that are deducted or refunded in the year must be included in income for the following year in respect
of current SR&ED expenditures [par. 12(1)(t)] or deducted from the capital cost of qualifying depreciable
property acquisitions [ssec. 13(7.1)].
Prescribed Proxy Amount (PPA) [Reg. 2900(4)]
Salary for research technicians & assistants ........................................................................
Salary for Natalia for time spent on SR&ED (25% $80,000) ...........................................

$ 600,000
20,000(1)
$ 620,000
65%
$ 403,000

The PPA cannot exceed $500,000, the overhead expenses [Reg. 2900(6)].
Expenditure limit [ssecs. 127(10.2), (10.3)]
Maximum expenditure limit (based on previous year, 2009) ............................................
Less: 2009 taxable income of NAL ......................................................... $ 100,000
2009 taxable income of associated corporations ............................
0
Total
$ 100,000
Threshold (for previous year, 2009) ............................................... $ 500,000
Greater of total and $500,000 (for 2009)........................................ $ 500,000
10
2010 expenditure limit for the associated group ................................................................
Less: Allocated to associated corporations ........................................................................
2010 expenditure limit for NAL ........................................................................................

$ 8,000,000

5,000,000
$ 3,000,000
0
$ 3,000,000

NOTE TO SOLUTION
(1) Regulation 2900(7) limits the amount included in respect of salary of an employee who owns 10% or
more of the shares (a specified employee) to the lesser of:
(a) 75% of Natalias salary $80,000 = $60,000, and
(b) 2.5 2010 CPP maximum pensionable earnings = 2.5 $47,200 = $118,000.

Solutions to Chapter 12 Assignment Problems

203

Solution 7 (Advanced)
Analysis of Division B Income

Source
Manufacturing ..............
Other Cdn. business ......
Dividend .......................
Rental............................
Interest ..........................
Royalty .........................
Net taxable capital gains
Foreign ..........................
Division B income ........

ABI
Cdn.
Forn.
$ 74,000
85,000

Investment
Cdn.
Forn.

PSB

Dividend
Conn.
Port.

Total
$ 74,000
85,000
8,000
4,000
15,000
1,000
9,000
111,000
$ 307,000

$ 8,000
$

$ 159,000

$ 96,000
$ 96,000

Nil

4,000
15,000
1,000
9,000

$ 29,000

$ 15,000
$ 15,000

$ 8,000

Nil

Income under Division B .........................................................................................................................

Deduct:
Charitable donations ($60,000 + $10,000 carryforward; not exceeding 75% $307,000 = $230,250)
Dividends received .............................................................................................................................
1999 net capital loss ($15,000 = $10,000; but limited to 2007 taxable capital gains of
$9,000) .........................................................................................................................................
Taxable income ......................................................................................................................................
Basic federal tax at 38% of $220,000 ......................................................................................................
Deduct: Federal and provincial abatement (10% of 75% of $220,000) ...................................................
Net ...........................................................................................................................................................
Additional refundable tax (ART): 6% of the lesser of:
(a) Aggregate investment income ($29,000 + $15,000 $9,000)......................
(b) Taxable income SBD eligible income ($220,000 $150,000) ..................

$
$

$ 307,000
(70,000)
(8,000)
(9,000)
$ 220,000
$ 83,600
(16,500)
$ 67,100

35,000
70,000

Lesser amount 6% ($35,000 6%) ...........................................................................................

Deduct:
Non-business foreign tax credit (given) ..............................................................................................
Business foreign tax credit (given)......................................................................................................
Small business deduction = 17% of least of:
(a) Canadian-source active business income ..................................................... $ 159,000
(b) Taxable income .................................................................... $ 220,000
(6,667)
Less: 10/3 $2,000 non-business foreign tax credit ..........
(60,000)
$ 153,333
3 $20,000 business foreign tax credit ....................
(c) Business limit ($500,000 $350,000) .......................................................... $ 150,000
17% of $150,000 .........................................................................................................................
Manufacturing and processing profits deduction (M&P profits < amount eligible for SBD) ....................
Tax reduction* ............................................................................................................................................
Part I tax payable (federal) ..........................................................................................................................
Provincial tax @ 12% of $220,000 75% ..................................................................................................
Total tax ......................................................................................................................................................
* General tax reduction:
taxable income .....................................................................................
$ 220,000
less: M&P profits ................................................................................. $
Nil
100/17 of the small business deduction ........................................
150,000
AII ................................................................................................
35,000
(185,000)
net .............................................................................................................
$ 35,000
10% of $35,000 ........................................................................................

2,333
(2,000)
(20,000)

(25,500)
Nil
(3,500)
$ 18,433
19,800
$ 38,233

$ 3,500

Federal Income Taxation: Fundamentals

204
Solution 8 (Basic)

(A) Dividend refund:

Lesser of: (i) RDTOH at Dec. 31, 2010 (see (1), below) ....................................
(ii) 1/ 3 taxable dividends paid (1/ 3 $60,000) .................................
(1) RDTOH:
Balance Dec. 31, 2009 ...................................................................................
Dividend refund for 2009 ..............................................................................
Refundable portion of Part I tax (see (2) below)............................................
Part IV tax (see (3) below) .............................................................................
(2) Refundable portion of Part I tax:
Least of:
(a) 262/ 3 % aggregate investment income
(262/ 3 % ($20,000 + $10,000 + $30,000 $5,000)) .....................
Less: non-business foreign tax credit ............................. $ 1,500
minus: 91/ 3 % foreign investment income ....................
(933)
(91/ 3 % $10,000) ...............................................
(b) Taxable income ...............................................................................
Less: amount eligible for the SBD ..................................................
25/9 non-business FTC ($1,500) ..............................................
3 business FTC ($18,000) ........................................................

$ 29,600
$ 20,000

$ 20,000

$ 12,000
(4,000)
$ 8,000
11,155
10,667
$ 29,822

$ 14,667

(567)
$ 200,000
(100,000)
(4,167)
(54,000)

$ 14,100

262/ 3 % $41,833 = $ 11,155

(c) Part I tax................................................................................................................ $ 19,342
Refundable portion of Part I, least of (a), (b) and (c) ........................................................... $ 11,155
(3) Part IV tax:
Dividends subject to Part IV tax:
Dividends received from A Ltd. (non-connected) (331/ 3 % of $20,000)..... $ 6,667
Dividends received from B Ltd. (connected) ($5,000 80%) ...................
4,000
Part IV tax ...................................................................................................... $ 10,667
(B) If Sharp Ltd. was a private corporation and not a CCPC, the additional 62/ 3 % tax on investment income and
the refundable portion of Part I tax would not apply.
The RDTOH would increase by the Part IV tax only.
Therefore, the dividend refund would be:
the lesser of: (i) RDTOH, Dec. 31, 2010 ($8,000 + $10,667) ...................... $ 18,667
$ 18,667
(ii) 1/ 3 taxable dividends paid (1/ 3 $60,000) ...................... $ 20,000

Solutions to Chapter 12 Assignment Problems

205

Solution 9 (Advanced)
Analysis of Division B Income
Source
Manufacturing ...................
Dividend ............................
Net taxable capital gains ....
Royalties ............................
Recapture ...........................
Rental.................................
Foreign ...............................
Interest A/R...................
Division B income .............

ABI
Cdn.
Forn.
$ 191,000

PSB

Investment
Cdn.
Forn.

Dividend
Conn.
Port.
$ 11,000

$ 20,000

$ 11,000

$ 20,000

Total
$ 191,000
31,000
17,000
9,000
4,000
14,000
29,000
5,000
$ 300,000

$ 17,000
9,000
4,000
14,000
$ 6,000
5,000
$ 200,000

$ 6,000

$ 23,000
Nil

$ 40,000

$ 23,000

(A) Part I Tax on Taxable Income

Taxable income ...................................................................................................................................
Tax @ 38% of taxable income (38% of $226,000) .............................................................................
Less: Federal and provincial abatement
$1,776,000 + $238,000 = .91
$1,996,000 $254,000
.91 $226,000 = $205,660
10% of $205,660 .....................................................................................................................
Federal tax after abatement .................................................................................................................
Additional refundable tax: 62/ 3 % of lesser of:
(a) Aggregate investment income ($40,000 + $23,000 $7,000)...................... $
56,000
(b) Taxable income SBD amount ($226,000 $150,000) .............................. $
76,000
Deduct: Non-business foreign tax credit (given) ....................................................... $
3,450
Business foreign tax credit (given) ...............................................................
1,800
Small business deduction (see Schedule 1) ..................................................
34,000
M&P profits deduction (M&P profits < amount eligible for SBD) ..............
Nil
General reduction (see Schedule 2) ..............................................................
Nil
Tax before investment tax credit .........................................................................................................
Deduct: investment tax credit (10% of capital cost of qualified property = 10% of $32,000 = $3,200) ..
Part I tax payable (federal) ..................................................................................................................
Provincial tax @ 5% of $226,000 .91 ..............................................................................................
Total tax ..............................................................................................................................................
Summary of tax:
Part I tax payable (federal and provincial) ..................................................................................
Part IV tax payable (see separate calculation) .............................................................................

$
$

226,000
85,880

20,566
65,314

3,733
69,047

$
$
$
$

36,880
9,417
46,297
12,355
33,942

200,000

$
$
$

209,100
200,000
34,000

Nil

$
Less: dividend refund (see separate calculation) ......................................................................
Net tax payable ...........................................................................................................................

39,250
29,797
3,200
26,597
10,283
36,880

Schedule 1: Small Business Deduction

Income from active business carried on in Canada ....................................................................
Taxable income .................................................................................................... $ 226,000
Less sum of:
(i) 10/3 foreign investment income tax credit (10/3
$3,450) (given) ............................................................. $
11,500
(ii) 3 foreign business income credit (3 $1,800)
(given) ..........................................................................
5,400
16,900
Business limit (agreed allocation of $200,000 leaving $300,000 for the subsidiary) .................
Deduction: 17% of $200,000 .....................................................................................................
Schedule 2: General Reduction
taxable income .....................................................................
$ 226,000
less: M&P profits ................................................................ $
Nil

100/17 of the small business deduction ...................

200,000

AII
56,000
(256,000)
net..........................................................................................
$
Nil
10% of Nil ..................................................................................................................................

Federal Income Taxation: Fundamentals

206
(B) Refundable Dividend Tax on Hand, December 31, 2010
Part IV Tax on Taxable Dividends received

Non-connected taxable Canadian corporations (portfolio dividends) (331/ 3 % of

$20,000) ...............................................................................................................
Connected private corporation which triggered a dividend refund ($2,750 100%)...

6,667
2,750

9,417

2,938
12,355

$
$

24,000
12,355

Refundable Portion of Part I Tax

Least of:

(a) 262/ 3 % aggregate investment income

(262/ 3 % $56,000) ..............................................................
Less: non-business foreign tax credit .................... $ 3,450
minus: 91/ 3 % foreign investment income
91/ 3 % $23,000) ............................. (2,147)
(b) Taxable income ....................................................................
Less: Amount eligible for the SBD......................................
25/9 non-business FTC ($3,450)..............................
3 business FTC ($1,800) .........................................

14,933

(1,303)
$ 226,000
(200,000)
(9,583)
(5,400)

13,630

262/ 3 % $11,017 = $
2,938
(c) Part I tax ....................................................................................................... $
26,597
Refundable portion of Part I tax: least of (a), (b) and (c) .............................................
RDTOH as at December 31, 2010 ...............................................................................................

Dividend Refund
Lesser of:

(i) 1/ 3 dividends paid (1/ 3 $72,000) .....................................................................

(ii) RDTOH as at December 31, 2010 ........................................................................

Solutions to Chapter 12 Assignment Problems

207

Solution 10 (Advanced)
Analysis of Division B Income
Source
Wholesaling ..................
Retail ............................
Net taxable capital gains
Interest ..........................
Dividend .......................
Division B income ........

ABI
Cdn.
Forn.
$252,500*
50,000
$ 40,000

PSB

Dividend
Conn.
Port.

$ 6,000 *
20,000

5,000
$ 307,500

Investment
Cdn.
Forn.

$ 40,000

Nil

$ 26,000

$ 12,000
$ 12,000

Nil

$ 9,000
$ 9,000

Total
$ 252,500
90,000
6,000
25,000
21,000
$ 394,500

* After correction for error in original calculation.

(1) Net income is incorrect.

Federal political contributions are not deductible in the calculation of Division B net income.
Capital losses on depreciable property are not recognized. Therefore, the taxable capital gain should
be $12,000 1/ 2 = $6,000.
(2) Taxable income is incorrect.
The dividends from the foreign corporations should not be deducted.
Verify that charitable donations are limited to 75% of Division B net income.
Net capital losses should be adjusted to the 2010 inclusion rate ($13,000 1/ 2 / 3/ 4 = $8,667) limited
to taxable capital gains.
(3) The basic federal tax rate is 38%, not 40%.
(4) Abatement:
Taxable income earned in a province must be calculated using the formula in Regulation 402.
The abatement should be subtracted from tax otherwise payable, not added.
(5) Additional refundable tax:
Since Tek has aggregate investment income made up of the bond interest ($20,000), taxable capital
gain ($6,000) and foreign dividends which are not deductible under Division C ($12,000), this
additional tax should be calculated
(6) Foreign tax credits:
The foreign business tax credit must be calculated separately from the foreign non-business tax credit.
Foreign tax paid for purposes of the foreign business tax credit includes the unused foreign business
tax credits of $100.
The denominator of the formula for both the foreign business tax credit and the foreign non-business
tax credit should be net income under Division B minus dividends from taxable Canadian
corporations and net capital losses deducted in the computation of taxable income.
Tax otherwise payable for the foreign non-business tax credit is the basic tax the abatement
general tax reduction.
Tax otherwise payable for the foreign business tax credit is the basic tax general tax reduction.
The foreign business tax credit is limited also to the tax otherwise payable minus the foreign nonbusiness tax credit.
(7) Small business deduction:
Income from an active business carried on in Canada, only, is included. Thus, the foreign retail
income should not be included.
Interest on the overdue accounts receivable should be included in the active business income (ancillary).
Item (b) should be taxable income reduced by:
10/3 foreign non-business tax credit, and
3 foreign business tax credit.
Item (c) the business limit should be reduced by: $500,000 0.225% ($10,300,000
10,000,000)/$11,250 = $30,000 [or $500,000 ($10,300,000 $10,000,000)/$5,000,000].
(8) Federal political donation tax credit should be $558. It is calculated as 75% of the first $400, 50% of the
next $350, and 331/ 3 % of the remainder to a maximum credit of $650.
(9) Investment tax credits of $50,000 35% = $17,500 should be claimed with respect to the SR&ED
expenditures.
(10) The 10% general tax reduction should be nil, since the corporation does not have Canadian business
income in excess of the small business deduction limit.

Federal Income Taxation: Fundamentals

208
Solution 11 (Advanced)
Source
Consulting.............
Advertising ...........
Rental....................
Retailing ...............
Interest on A/R......
Recapture ..............
Interest income .....
Tax. cap. gain........
Dividends ..............
Foreign sources .....
Div. B Income.......

ABI
Cdn.
For n.
$ 160,000
(30,000)

PSB

Investment
Cdn.
Forn

Cdn Dividends
Conn.
Port.

Total

$ 20,000
75,000
25,000
25,000
75,000
70,000
$ 23,000
$ 255,000

$ 23,000

12,000

12,000

20,000
Nil

$ 165,000

$ 20,000

Nil

Net income for tax purposes ............................................................................

Deduct:
Charitable donations ($1,000 + $14,000) ......................... $ 15,000
Dividend income ..............................................................
12,000
Non-capital losses ............................................................
56,000
12,000
Net capital losses ($18,000 1/ 2 3/ 4 ) ............................
Taxable income................................................................................................
Federal tax @ 38% ..........................................................................................
Federal abatement (10% 90% $380,000)...................................................
Net ...................................................................................................................
Additional refundable tax:
62/ 3 % of lesser of:
(a) Aggregate investment income ($165K + $20K
$12K) ....................................................................... $ 173,000
(b) Taxable income SBD eligible income ($380K
$130K) ..................................................................... $ 250,000
Total.................................................................................................................
Less:
business income foreign tax credit (given) ....................... $
7,581
small business deduction (see Schedule 1) .......................
22,100
general reduction (see Schedule 2) ...................................
7,700
35,000
investment tax credit (35% $100,000) ..........................
Part I tax payable (federal)...............................................................................
Provincial tax @ 11.5% $380,000 90% .....................................................
Dividend refund ...............................................................................................
Total tax ...........................................................................................................

$ 160,000
(30,000)
20,000
75,000
25,000
25,000
75,000
70,000
12,000
43,000
$ 475,000

$ 475,000

95,000
$ 380,000
$ 144,400
34,200
110,200

11,533
121,733

72,381
49,352
39,330
(40,000)
$ 48,682

Schedule 1: Small business deduction

17% of least of:
Income from Canadian active business ..................................................................................
Taxable income .............................................................................................. $ 380,000
Nil
Less: non-business foreign tax credit 10/3 ..........................
22,743
22,743
business foreign tax credit 3 ($7,581 3) ........................... $
Business limit ($500,000 $370,000) ...........................................................................................
Small business deduction (17% of $130,000) ................................................................................

255,000 (A)

$
$
$

357,257 (B)
130,000 (C)
22,100

Schedule 2: General reduction

taxable income ...............................................................
less: M&P profits .........................................................
100/17 of the small business deduction ................
AII ........................................................................
net ..........................................................................................
10% of $77,000 ......................................................................

380,000

(303,000)
77,000

Nil
130,000
173,000

7,700

Solutions to Chapter 12 Assignment Problems

209

(B) Refundable Portion of Part I Tax

Least of
(a) 262/ 3 % aggregate investment income
[262/ 3 % ($165,000 +$20,000 $12,000)] ...........................................
Less: non-business foreign tax credit ...........................................
Nil
minus: 91/ 3 % foreign investment income
(1,867)
[91/ 3 % $20,000] ................................................

46,133

Nil

(b) Taxable income .............................................................................................. $ 380,000

less: income eligible for the SBD...................................................................
(130,000)
(Nil)
25/9 non-business foreign tax credit ...................................................
(22,743)
3 business foreign tax credit ($7,581) .................................................
$ 227,257
262/ 3 %
(c) Part 1 tax ................................................................................................................................
Refundable Portion of Part I tax least of (a), (b), (c) ...................................................................

Part IV Tax on Taxable Dividends Received

Taxable dividend subject to Part IV Tax ................................................
Part IV tax payable (1/ 3 $12,000) ........................................................

$
$

12,000
4,000

20,000
(9,000)
46,133
4,000
61,133

$
$
$
$

40,000
61,133
40,000
21,133

Refundable Dividend Tax on Hand

RDTOH, end of last year .......................................................................
Dividend refund for last year .................................................................
Add: refundable portion of Part I tax from above ..................................
Part IV tax ..............................................................................................
RDTOH at end of year ...........................................................................

Dividend refund Lesser of:

/ 3 taxable dividends paid (1/ 3 $120,000)

RDTOH at the end of the year ...............................................................
Dividend refund .....................................................................................................
RDTOH carryforward ($61,133 $40,000)...........................................................
1

46,133

60,602

$
$

49,352
46,133

Federal Income Taxation: Fundamentals

210
Solution 12 (Advanced)
Carl

Vince

100%

100%

Compunet
AII

ABI

Vitamins
PSBI

ABI
Services

100%
Warehouse
Divs
Mindblasters
ABI
Warehouse

Types of Income:
Compunet has three sources of income:
(a) personal services business income (PSBI),
(b) aggregate investment income (AII), and
(c) active business income (ABI).
Computer Consulting Services:
The computer consulting fee earned from Vitamins Inc. is personal service business income. It meets all the
tests [ssec. 125(7)] as outlined below:
(a) Compunet is in the business of providing computer consulting services;
(b) Carl who performs the services on behalf of Compunet is a specified shareholder, since he owns not
less than 10% of the issued shares [ssec. 248(1)];
(c) Sulee who also performs services on behalf of Compunet is related to Carl;
(d) both Carl and Sulee would reasonably be regarded as employees of Vitamins Inc. but for the existence
of Compunet (refer to the three tests used in Chapter 3 to determine whether they would be regarded as
employees);
(e) Compunet does not employ more than five full-time employees in the computer consulting business;
and
(f) Compunet and Vitamins Inc. are not associated corporations.
Personal services business income is taxed at full corporate rates under Part I. Deductions from this source
of income are restricted [par. 18(1)(p)].
Rental Income:
Rent received from Vitamins Inc. is property income. Rent received from Mindblasters is deemed by
subsection 129(6) to be active business income, since it is deductible in computing the active business income of
an associated corporation. Compunet controls Mindblasters and thus the two are associated [par. 256(1)(a)].
Property income is taxed initially at full corporate rates. It is also subject to 62/ 3 % additional tax on
investment income. 262/ 3 % of the property income is credited to Compunets refundable dividend tax on hand
(RDTOH). The RDTOH is refunded to Compunet, upon the payment of dividends to Carl, at a rate of one dollar
for every three dollars of taxable dividends paid.
The active business income is eligible for the small business deduction under subsection 125(1), to the
extent of the portion of the $500,000 business limit for calendar year 2010 allocated to Compunet. Mindblasters
and Compunet, being associated corporations, must share the business limit. The active business income in
excess of Compunets allocation of the business limit is taxed at full corporate rates.
Dividend Income:
Dividends received from Mindblasters is property income.
Taxable dividends received from taxable Canadian corporations are deducted in the computation of taxable
income [sec. 112] and thus are not subject to tax under Part I. Such dividends are not included in investment
income and thus are not subject to the additional 62/ 3 % tax.
Dividends received by private corporations are generally subject to Part IV tax. The Part IV tax rate is
331/ 3 %. The Part IV tax is credited to Compunets RDTOH and refunded upon the payment of dividends as
discussed above.
Mindblasters is connected with Compunet [par. 186(4)(a)]. Because of this, the dividends received will be
subject to Part IV tax to the extent the payment thereof results in Mindblasters receiving a dividend refund.
As Mindblasters earns active business income only, it will not receive a dividend refund. Thus the dividends
received by Compunet will not be subject to Part IV tax. In other words, they will be received tax-free.

Solutions to Chapter 12 Assignment Problems

211

Solution 13 (Advanced)
Association
Lemon Ltd. and Rental are associated, since Les has de jure control of both corporations (i.e., 100% of the
shares). [par. 256(1)(b)]
Lemon Ltd. and Cheap are also associated since Les has de jure control of both corporations (i.e., 100% of
Lemon Ltd. and 55% of Cheap: 25 shares directly and 30 shares indirectly through his 100% ownership of
Lemon Ltd.). [pars. 256(1)(b) and (1.2)(d)]
Cheap and Rental would also be associated on the same basis as Lemon Ltd. and Cheap as described above.
Note that in both association situations with Cheap, the basis could also be paragraph 256(1)(d), since Cheap
is controlled by a related group, either Les, Lucy and Lemon Ltd. or Les and Lemon Ltd., and since Les meets
the 25% cross-ownership test.
Since Lemon Ltd., Rental, and Cheap are all associated, they must share the business limit for the small
business deduction. [ssec. 125(3)]
Sources of Income and Federal Tax Rates
Toys-4-U Ltd.
Active business income which also qualifies for a manufacturing and processing deduction: 11.0%(1)
Federal tax rate:

$500,000 11.0%(1)
> $500,000 18.0%(2)

Lemon Ltd.
The income from Toys-4-U Ltd. is from personal services business [ssec. 125(7)] because:
(a) Les can reasonably be considered to be an employee of Toys-4-U Ltd., since he was a former vicepresident of administration and finance and is now performing similar services;
(b) Les is a specified shareholder, since he owns not less than 10% of the outstanding shares of Lemon Ltd.
and related corporations [ssec. 248(1)];
(c) Lemon Ltd. does not have more than five full-time employees; and
(d) Lemon Ltd. and Toys-4-U Ltd. are not associated.
The tax consequences are:
(a) Federal tax rate for this source of income is 18.0%.(3)
(b) Deductions from this source of income are restricted [par. 18(1)(p)] to:
(i) salary, wages and other remuneration paid to the incorporated employee (i.e., Les Lemon);
(ii) benefits or allowances for the incorporated employee;
(iii) legal expenses paid by Lemon Ltd. in collecting the management fees from Toys-4-U Ltd.; and
(iv) contractual expenses of the incorporated employee which are incurred in respect of the negotiating
of contracts or the selling of property, similar to paragraph 8(1)(f). If Les negotiates contracts for
Toys-4-U Ltd., the rent paid to Rental may be deductible.
The management fees from the associated corporations would be active business income by virtue of the
associated corporation exception in the definition of a personal services business [ssec. 125(7)]. The federal tax
rate would be 11.0% or 18.0%, as calculated in notes (1) and (3), below, depending on whether any of the
business limit has been allocated to Lemon Ltd.
Cheap Leasing Ltd.
Cheaps income from the leasing business (80%) is active business income, since the specified investment
business definition excludes property income derived from the leasing of movable property. The federal tax rate
would be either 11.0% or 18.0% depending on the allocation of the business limit.
The interest income received from Toys-4-U Ltd. would be property income subject to federal tax at 28.0%
plus the additional refundable tax of 62/ 3 % initially, with a refund of 262/ 3 % of the income in the ratio of 1:3
when dividends are paid.
RentalLtd.
The rental income appears to be property income and not active business income, since Rental is not
actively engaged in the rental operations. The federal tax would be at 28.0% plus the additional refundable tax of
62/ 3 % subject to a 262/ 3 % refund when dividends are paid in the ratio of 1:3.
However, some of the rental income would be deemed to be active business income, since some of this
income was deducted from the active business income of an associated corporation. [ssec. 129(6)]
Lemon Ltd. (50% of 10%) ....................................................................................................
Cheap Leasing Ltd. (80% of 25%)........................................................................................

The federal rate of tax would be the same as discussed above.

NOTES TO SOLUTION
(1) 38% 10% 17%
(2) 38% 10% 10%
(3) 38% 10% 10%

5%
20%

Federal Income Taxation: Fundamentals

212
Solution 14 (Advanced)
Investment income received directly

Interest income (8% of $200,000) ....................................................

Grossed-up dividend (5% of $550,000 5/ 4 ) ...................................
Taxable capital gain (10.5% of $550,000 1/ 2 ................................................
Incremental income and taxable income ..........................................
Federal tax on taxable income of $109,250 (i.e., $79,250
incremental income + $30,000 other income); $15,159 on the
first $81,942 + 26% on the next $27,308) ................................
Less: dividend tax credit (131/ 3 % of $34,375)............. $ 4,583
other personal tax credits....................................
2,100
Basic federal tax ...............................................................................
Provincial tax
$9,014 on first $81,942 + 15% on next $27,308 ......................
less: personal tax credits .......................................................
dividend tax credit (6% of $34,375) ..........................
Total tax payable ..............................................................................

(a)
16,000
34,375
28,875
79,250

22,259

$
$

(6,683)
15,576

13,110
(1,400)
(2,292)
24,994

Tax @ 41%
Corporation
Interest income ........................................................... $ 16,000
Dividend income (5% of $550,000) ...........................
27,500
Taxable capital gain ...................................................
28,875
Corporation income.................................................... $ 72,375 $ 72,375*
Less: inter-corporate dividends [sec. 112]..................
27,500
Taxable income .......................................................... $ 44,875
Corporation tax under Part I @ 41% / @ 40% ........... $ 18,399
Part IV tax @ 33% of $27,500 ................................
9,167
Additional refundable tax (6% ($16,000 +
$28,875) .............................................................
2,992
Total tax ............................................................................................
(30,558)
Corporation retention* (excluding non-taxable portion of capital
gain which can be distributed tax-free) ..................................... $ 41,817
Potentially refundable tax:
Part I tax (26% of ($16,000 + $28,875)) ......... $ 11,967
Part IV tax ..........................................................
9,167 $ 21,134
Potentially available for taxable dividend ......................................... $ 62,951(1)

22,259

(6,683)
15,576

4,583
2,100

13,110
(1,400)
(2,292)
$ 24,994

Investment income received through a corporation:

(i)

(b)
16,000
34,375
28,875
79,250

Tax @ 40%
$

$
$

16,000
27,500
28,875
72,375
27,500
44,875
17,950
9,167

72,375*

2,992
(30,109)

42,266

21,134
63,400

11,967
9,167

(ii) Shareholder

Grossed-up dividend from corporation ($62,951 5/ 4 ) / ($63,400

5
/ 4 ) .............................................................................................
Federal tax on income from grossed-up dividend + $30,000;
$15,159 on the first $81,942 + 26% on the remainder) .....................
Less: dividend tax credit (13% of $78,689) /
(13% of $79,250) ............................................ $ 10,492
other personal tax credits....................................
2,100
Basic federal tax ................................................................................
Provincial tax
$9,014 on first $81,942 + 15% on remainder ............................
less: personal tax credits ..........................................................
dividend tax credit (6% of grossed-up dividend)..........
Total tax payable ...............................................................................................

78,689

79,250

22,114

22,259

(12,667)
9,592

$
(12,592)
$
9,522

10,567
2,100

13,026
(1,400)
(5,246)
$ 15,902

13,110
(1,400)
(5,283)
$ 16,019

24,994

24,994

9,424
15,902
25,326
332

8,975
16,019
24,994
Nil(2)

Comparison of taxes:
Investment income received directly........................................................
Investment income received through corporation:
Corporate tax .............................................................. $ 30,558
Less: refund to corporation ........................................
21,134
Individual tax ...................................................................................
Total tax ...........................................................................................
Tax cost of using corporation...........................................................................

$
$

30,109
21,134

Solutions to Chapter 12 Assignment Problems

213

Other considerations:
Advantages of incorporating
Estate planning considerations:
Possible income splitting by having his wife and children subscribe for the
shares of the investment company if they have their own source of
capital to buy the shares.
Disadvantages of incorporating
Initial prepayment of tax:
Tax on corporate income ..............................................................
Tax on individuals $30,000 of existing income
[$7,500(3) ($2,100 + $1,400)]

$
Less: tax on total income received directly ..................................
Prepayment through corporation ..................................................

30,558
4,000
34,558
24,994
9,564

$
$

30,109
4,000
34,109
24,994
9,115

Administrative costs of a corporation;

Corporate losses not available to shareholder to offset personal income.
NOTES TO SOLUTION
(1) Note that a dividend of $62,951 will result in a dividend refund of only $20,984 (i.e., $62,951 1/ 3 ), not
the $21,134 that was added to the RDTOH for the year. This deficiency results from imperfections in the tax
rates. A larger dividend of $63,402 (i.e., 3 $21,134) would have to be paid, using other sources of funds, to
clear the RDTOH. Alternatively, the maximum dividend that can be paid in this case is $62,726, determined
algebraically, as follows:
R = 1/ 3 D
D =NT+R
= N T + 1/ 3 D
= (N T) 3/ 2
= ($72,375 $30,558) 3/ 2
= $62,726

where:
R = dividend refund
D = dividend
N = Division B net income
T = total tax

R = $20,909

(2) Note how integration is perfect when the combined net corporate rate of tax is 20% (i.e., 40% + 62/ 3
262/ 3 %).
(3) $7,500 on $30,000 @ 25% (combined federal and provincial).

Federal Income Taxation: Fundamentals

214
Solution 15 (Advanced)
DRAFT MEMO
To:
From:
Re:

Susan Taylor
Staff Accountant
Incorporation Enquiries

In response to your enquiries relating to the proposed incorporation of both the investment holding company
(High Income Limited), as well as the scarf retail business, please find below a detailed analysis of the tax
consequences of incorporation as well as a discussion of some pertinent related tax issues. In addition, I have
provided advice on some of the quantitative and qualitative pros and cons of incorporation that should be
considered when deciding upon the right form of organization for your business(es).
High Income Limited

The ultimate effect of incorporating your investment portfolio is a small tax cost (relative to earning the
income directly) on both the interest income and the capital gain, and no cost or benefit relating to either
receipt of dividends.

Additionally, income earned by High Income Limited from GIC interest, portfolio dividends, and capital
gains would need to be paid out to you in the year to avoid a prepayment on taxes on this income. The tax
liability on the dividends received from the connected corporation Stage can be deferred by leaving the
dividends in High Income Limited. This indicates that if you intend to keep the money for reinvestment in the
company, there is a prepayment of taxes on all of the sources of income excepting the Stage dividends.
Further, from a tax perspective, there is no benefit to earn income from those sources. See Schedule 1 for
detailed calculations.
o Based on the small tax cost and the potential for a prepayment of taxes on all the sources of
investment income, except the Stage dividends, it is advised that you should not incorporate the
investment holding company. If distribution is delayed, the prepayment of taxes that would
magnify the small tax cost of incorporation due to the opportunity cost of using those prepaid taxes
for a more productive purpose. In addition, it is important to note that incorporation is also costly
(for example, legal and accounting fees).
o If dividends are paid from Stage then the holding company will receive the dividend without either
Part I or Part IV tax. If no dividends are paid from High Income Limited then tax can be deferred
indefinitely or until dividends are paid out to you personally as part of your compensation
planning.

The tax system in Canada has rules, such as the Additional Refundable Tax on Aggregated Investment
Income (e.g., interest income, the taxable portion of capital gains), and the Part IV tax on certain dividend
income, to discourage the deferral of taxes on investment income earned in a corporation.
If incorporated, High Income Limited (HIL) would be considered to be carrying on a specified investment
business (SIB) under the definition of that term in subsection 125(7) of the Act. This means that the
investment income earned by the company would not be considered active business income (ABI) and
would, therefore, be ineligible for the small business deduction normally allowed to Canadian-controlled
private corporations (CCPC) on their first $500,000 of ABI.
(A)

Incorporation of investment income

The following is a description of the effects of incorporation on the four different types of income:
GIC Interest & Capital Gains
When received by a corporation, of the capital gain would be put into a capital dividend account and would
not be subject to tax. This mirrors the treatment of a capital gain received by an individual (only taxable).
Capital dividends could then be issued to you from this account tax-free after filing the proper election.
The taxable portion of the capital gain and the GIC interest would then be pooled together as aggregate
investment income (AII). They would both be initially taxed at 48% (38% basic federal rate less the 10%
federal abatement plus the
6 additional refundable tax plus the assumed 14% provincial rate). Of this,
26% is a refundable portion that goes into the Refundable Dividend Tax on Hand account to be refunded
when dividends are paid out to you. When dividends are paid out eventually, for each dollar of taxable
dividends, the company receives $0.33 dividend refund.

Solutions to Chapter 12 Assignment Problems

215

Upon paying this income to you in the form of dividends, the corporation is refunded a portion of the taxes at
a rate of 26% of the income, resulting in an ultimate corporate tax rate of 22% (48% - 26%) on this
income.
There is a small tax prepayment (no deferral benefit) because earning this type of income directly is taxed at
46%, while it would be taxed at 48% if earned by a corporation.
The refundable tax mechanism ensures that the total tax paid by the corporation on the income and you on the
dividends will be similar in amount as the tax that you would pay earning the investment income personally.
Since the investment income is ultimately taxed at 22% (higher than 20% needed for perfect integration),
there will be a small tax cost in using the corporation to earn investment income.
Dividends paid out of the investment income of CCPCs are not considered eligible dividends and are
subject to the 25% gross up to arrive at the total amount taxable at your marginal tax rate. A federal and
provincial dividend tax credit (approximately the amount of tax paid at the corporate level) will apply to
reduce the personal taxes payable.
Dividends
Portfolio investment in public corporation shares
The $10,000 dividend received from the publicly traded company is subject to Part IV tax at 33%. This tax
takes away the advantage of tax deferral. In fact, when compared to a situation where you receive these
dividends directly, earning this income through the holding company results in a tax prepayment of
$1,109.33.
The Part IV will be added to the Refundable Dividend Tax on Hand (RDTOH) and refunded at $1 for each $3
of taxable dividends paid to Susan.
This dividend received from the publicly traded company is considered to be an eligible dividend for tax
purposes and will be added to the General Rate Income Pool (GRIP) of the corporation. When you receive
dividends from this account, you must include in your income a 44% gross up to arrive at the taxable amount
and you are eligible to deduct a dividend tax credit. The effective tax rate on dividends from GRIP is about
22.24% in the top combined federal and provincial personal tax bracket.
Investment in 40% common shares of Stage
The holding company does not pay tax on the dividends received from Stage because dividends are exempt
from Part I tax and there is no Part IV tax since the two corporations are connected.
Since this dividend comes out of the after-tax earnings of Stage, which has been taxed at 16% (all income
earned by Stage is subject to the small business deduction), this dividend will come out of the Low Rate
Income Pool (LRIP). It is not an eligible dividend and is therefore subject to the 25% gross-up when
received by you personally and a dividend tax credit can be claimed. You will pay a 32.5% effective tax rate
on dividends from LRIP.
Since the holding company does not pay tax on dividends received from a connected corporation for which
the connected corporation did not receive a dividend refund, the tax liability can be deferred indefinitely
while the dividends are left in the holding company. For this reason, it is advisable to receive this source of
income through High Income Limited. The benefit of having a holding company is discussed earlier in this
memo. However, you should be aware that High Income Limited will not be able to claim the capital gains
deduction when it sells the Stage shares in the future. If you expect Stage to increase in value significantly
then you should consider not holding these share in High Income Limited.
(B)

Incorporation of the Scarf Retail Business

If the scarf business were to be incorporated, the corporation would be a Canadian-controlled private
corporation earning active business income.
The effective total federal and provincial tax rate after claiming the small business deduction would be 16%.
Compared to the 46% total personal tax rate (your current personal tax rate), there is a tax saving of $5,400 as
well as a deferral of $60,000 in tax payable. See Schedule 2 for a detailed calculation.
o Based on this information, it is recommended that the scarf retail business be incorporated to take
advantage of the tax savings and deferral opportunities.
If incorporated, the scarf retail business would be considered to be a CCPC eligible for a small business rate
of 16% on the first $500,000 of active business income (38% basic federal rate less the 10% federal
abatement less the 17% federal small business deduction plus the assumed 5% net provincial rate after
provincial small business deduction). Since the business would not meet the definition of a specified

Federal Income Taxation: Fundamentals

216

investment business or a personal services business [ssec. 125(7)] all $200,000 of taxable income would be
considered to be from an active business.
When paid to you, the $168,000 in non-eligible dividends would be grossed up by 25% to arrive at the
taxable amount in your hands. The federal and provincial dividend tax credits which combined are equal to
the amount of the gross-up are then deducted to arrive at the taxes payable by you.
(C) Discussion of Pros and Cons of Incorporation
Advantages
The most obvious qualitative benefit of incorporation is the limited liability offered to shareholders unless
personal properties are pledged to financing sources. Shareholders of a corporation are only liable to creditors
up to the amount of their investment in the business unless another arrangement is agreed to by both parties.
Directors of the corporation can still be held personally liable for certain required payments, such as
employee source deductions and GST/HST when they are judged not to have exercised due care in
making all necessary remittances but they are not held personally liable for unpaid Part I tax.
The creation of a separate legal entity (the corporation) allows for a number of benefits relating to the
continuity of the business beyond the life or involvement of the owner as well as in the transferability of
ownership.
Another advantage of the corporate form of ownership is the greater ability to regulate income flows to the
individual by paying a regular salary or a bonus payment from the corporation. The bonus payment is fully
deductible, as long as it is paid to the individual within 179 days of the end of the year in which it was
accrued.
Incorporation allows for the deferral of income tax on business income in situations where the applicable
corporate tax rate is lower than that for the individual. For example, business income eligible for the small
business deduction or for other business income where the individual is in a higher tax bracket.
In certain provinces and territories, incorporation may be a benefit to a business involved in manufacturing
and processing as they can be eligible for a provincial or territorial rate reduction on M&P income not
otherwise eligible for the small business deduction.
There are potential tax savings through income splitting (subject to attribution rules) by allowing non-minor
family members to purchase shares in the company.
For situations where a combined corporate tax rate of less than 20% applies, incorporation provides tax
savings compared to earning income directly by an individual.
The ability to sell shares in the corporation makes it potentially easier to acquire financing.
The ability to defer recognition of capital gains on transferring shares to a spouse by utilizing convertible
properties.
Shareholders are allowed to deduct for tax purposes the interest on funds borrowed to invest in the common
shares of the corporation.
An enhanced investment tax credit of 15% is available for scientific research and experimental development
expenditures, subject to certain restrictions, for CCPCs that is not available to unincorporated businesses.
Shareholders can use the capital gains exemption to shelter up to $750,000 of the capital gain on disposing of
their qualifying shares in a small business corporation as defined in subsection 248(1) of the ITA.
o Further to this, capital losses that result from the disposition of qualified small business corporation
shares are treated as business investment losses (BIL). The allowable portion of these losses (ABILs)
can be deducted against all sources of income.
o Any amount of the BIL that had benefited from a capital gains deduction in prior years is deducted
before calculating the ABIL and a portion of the disallowed amount based on the capital gains
inclusion rate in the year the deduction took place is added to the regular allowable capital losses
for the year.
Disadvantages
A major disadvantage to the individual is the loss of business and investment losses available to offset the
individual's other sources of income.
Incorporation can result in a net tax cost on business income if corporate tax rates are greater than 20%.
Incorporation results in a prepayment of taxes on income for which the individual is subject to a lower
marginal tax rate than the corporation. For example, investment income earned through a corporation which

Solutions to Chapter 12 Assignment Problems

217

is subject to the additional refundable tax or the Part IV tax, or business income not eligible for the small
business deduction where the individual is in a lower tax bracket.
The requirement to collect and remit source deductions as well as the other time and money costs related to
the creation and maintenance of the corporation.
Corporations are subject to provincial payroll and capital taxes.
Schedule 1 Tax consequences of incorporating High Income Limited
GIC
Interest

High Income Limited

Income
Tax @ 48% on investment
income [Part I]
Tax @ 33% on portfolio
dividends [Part IV]

Dividends
Public
company
Stage

Capital Gains
NonTaxable taxable
10,000 10,0001

5,000

10,000

20,000

(2,433)

(4,866)

2,567

(3,333)
6,667

20,000

5,134

Refund on payment of dividend:

@ 26% of investment income
@ 33% of portfolio dividends

1,333
-

3,333

2,666
-

Available for payment of dividend

3,900

10,000

20,000

7,800

3,900

10,000

20,000

7,800

Susan (assumes 46% combined rate)

Dividend received
Gross-up (44% on eligible dividends
25% on other-than-eligible dividends)

975

4,400

5,000

1,950

Income for taxes

4,875

14,400

25,000

9,750

Tax @ 46%
Less: eligible dividend tax credit
(assume 10/17 Fed & 7/17 Prov)
non-eligible dividend tax credit ()
(assume Fed & Prov)

2,243

6,624

11,500

4,485

(4,400)

(975)

(5,000)

(1,950)

Net tax paid

1,268

2,224

6,500

2,535

Summary of tax paid

High Income Limited (net after refund)
Susan
Total

1,100
1,268
2,368

2,224
2,224

6,500
6,500

2,200
2,535
4,735

Tax paid on equivalent amount of

income if received directly by Susan (a)

2,300

2,2242

6,500

4,600

68

135

2,433

3,333

4,867

(133)

(1,109)

6,500

(267)

Cost /(Benefit) of incorporation

Tax paid by High Income Limited
before paying dividend
(b)
Deferral / (prepayment) of tax
through High Income Limited (a)-(b)

1 - This amount would be added to the corporations capital dividend account and can be distributed to Susan tax-free
after filing an election
2 - The calculation would be identical to the one presented above where dividends flow to Susan through the
corporation.

218

Federal Income Taxation: Fundamentals

Schedule 2 - Tax consequences of incorporating the scarf retail business

Corporation
Income from active business
Corporate tax (@ 16%)
Available for dividend
Susan
Dividend
Add: gross up (25%)
Income subject to tax
Personal tax before credit (@ 46%)
Dividend tax credit (assume equal to gross up)
Net tax
Add: tax paid by corporation
Total tax
Tax on income if unincorporated
Tax cost/(savings) of incorporation
Tax deferral/(prepayment) available through incorporation ((B) (A))

$200,000
(32,000)
$168,000
$168,000
42,000
210,000
96,600
(42,000)
54,600
32,000
86,600
$ 92,000
$(5,400)
$ 60,000

(A)
(B)

Solutions to Chapter 12 Assignment Problems

219

Advisory Case
Waterloo Group
ADVISORY CASE DISCUSSION NOTES
The main issue in this case is whether the companies are associated.
1. Shareholder agreements
The mandatory buyout option on retirement will cause the buyout to have been deemed to have taken
place for purposes of the associated company rules. [IT-64R4; ssec. 256(1.4)]
2. Holdco and Sales Co.
Mickey and Joe are not related.
Holdco and Sales should be associated only by the buy/sell provisions of the shareholder agreement [par. 256(1)(a)].
If Joe owns another company, then that company may be associated with Sales Co. and, therefore,
associated with all the other companies by subsection 256(2).
The preference shares are specified shares [ssec. 256(1.1)] and should not cause any association of companies.
Need to consider de facto control [ssec. 256(5.1)].
3. Retail One Inc. and Retail Two Inc.
Holdco and Fred are a group which controls both companies so Retail One and Retail Two are associated
[par. 256(1)(b)].
4. Holdco and Retail One
Holdco and Retail One are associated because one controls the other [par. 256(1)(a)].
5. Holdco and Retail Two
Holdco and Retail Two are associated since they are both associated with Retail One [ssec. 256(2)]. However,
they can elect out with the result that Retail One does not receive the Small Business Deduction.
6. Sales and Retail One
Sales and Retail One are associated since they are both controlled by Holdco as a result of Holdco
controlling sales through the buy/sell provisions.
7. Ours Inc. and Mine Inc.
Nicki is deemed to own 60% of Ours Inc.
o therefore, the cross-ownership test is met and they are associated [par. 256(1)(d)].
8. Trust
Each of the children is deemed to own the shares of Kids are Fun Inc. [par. 256(1.2)(f)].
Each of Mickey and Nicki are deemed to own the shares of the children [ssec. 256(1.3)].
With that deemed ownership by each of the parents, Kids are Fun Inc. will be associated with all of
Mickeys companies and Nickis companies.

CHAPTER 13

Planning the Use of a Corporation and

Shareholder-Manager Remuneration
Solution 1 (Basic)
Subsection 15(1)
If Pump You Up Ltd. pays the rent for the condominium, Mia will receive a benefit from the corporation.
Benefits conferred on a shareholder by a corporation are included in the shareholders income [ssec. 15(1)].
There are a few specific exceptions in that subsection, but they relate to the disposition or acquisition of
additional shares, none of which is applicable to this particular case. The benefit could not be considered an
employee benefit, which would be included in employment income [par. 6(1)(a)], because the rental payment by
the corporation would be made because of Mias capacity as a shareholder. (It would be unlikely that the
corporation would offer similar arrangements to other non-related employees.)
Paragraph 18(1)(a)
In addition to the amount being taxable to Mia, the amount would not be deductible for tax purposes to
Pump You Up Ltd. An expense is not deductible unless it was incurred for the purpose of earning income from
the business. In this case, it is clear that there is no such purpose. The expense would be a personal or living cost.
Alternative Plan
Instead of having the company pay the rent on the condo, Mia should consider receiving additional salary or
a bonus to cover the rental cost. As long as the additional remuneration is reasonable, the amounts will be
deductible by the corporation.

221

Federal Income Taxation: Fundamentals

222
Solution 2 (Basic)

Benefit on share purchase loan

As there are bona fide arrangements in place for repayment of the share purchase loan within a reasonable
time, and the loan is one of those within the exceptions of subsection 15(2), the loan amount is not included in
Kristies income.
Interest benefit under section 80.4
Year 1

Year 2

Year 3

$150,000 6% 275/ 365 =

Less actual interest paid at 4% 275/ 365
Taxable benefit
$125,000 6%
Less actual interest paid at 4%
Taxable benefit
$100,000 6%
Less actual interest paid at 4%
Taxable benefit

$6,781
4,521
$2,260
$7,500
5,000
$2,500
$6,000
4,000
$2,000

Under section 80.5, the taxable benefit is deemed to be interest paid for the purposes of paragraph 20(1)(c).
As the loan is for investment purposes, the actual interest paid, plus the taxable benefit interest, is deductible by
Kristie in determining her income for tax purposes.
Benefit on the other loan
As the loan for the motor home and boat is not within one of the exceptions provided for at subsection 15(2),
and it was not repaid within one year after the Year 1 fiscal year end, it is fully included in Kristies Year 1
income. No imputed interest benefit applies to this loan as subsection 80.4(3) exempts any loan included in
income from the imputed interest benefit. In Year 3, Kristie will be able to deduct the $25,000 she repaid as a
deduction under paragraph 20(1)(j).

Solutions to Chapter 13 Assignment Problems

223

Solution 3 (Advanced)
(A) Deductibility of Expenses
(a) Salary deductible if considered reasonable in the circumstances [sec. 67], and paid by June 28, 2011,
which is 179 days after Skies Limiteds year-end [ssec. 78(4)];
(b) To be deductible in 2010, and not added back in 2013, the royalty must be paid by December 31, 2012,
(i) if it is not paid by that date, it must be added to the corporations income for the 2013 taxation year
[par. 78(1)(a)],
this would leave the amount payable as a legal liability,
(ii) alternatively, Mr. Scott and the corporation can jointly elect by June 30, 2014 (which is the date on
which the 2013 return is due); the effect of the election is [par. 78(1)(b)]:
the royalty is deemed to have been paid by the corporation and received by Mr. Scott at the
beginning of 2013,
the royalty is deemed to have been lent back to the corporation such that when the corporation
repays the amount there will be no further tax consequences,
if the election is filed late (i.e., after June 30, 2014), then 25% of the royalty will be added
back to the corporations 2013 income [ssec. 78(3)], but Mr. Scotts position will remain
unchanged;
(c) A contribution made to a money purchase RPP by an employer is deductible, as long as it was made in
accordance with the plan as registered [par. 147.2(1)(a)],
in this case, the overall limit of employer and employee contributions of $22,000 for 2010 is not
exceeded since the sum of the matching contributions is $6,000.
(B) Treatment of shareholder loans
Since the Scotts are shareholders, the application of subsection 15(2) must be considered in respect
of the inclusion of the principal amounts of the loans.
(a) Share purchase loan
(i) paragraphs 15(2.4)(c) and (f) would exclude the principal amount of this loan from income because
of its purpose and because bona fide arrangements were made, when the loan was granted, for
repayment within a reasonable time. However, paragraph 15(2.4)(e) further requires that
Mr. Scotts son must receive the loan in his capacity as an employee, not as a shareholder.
Therefore, the loan must be included in the sons income,
(ii) if, however, the son received the loan in his capacity as an employee, there would be no
subsection 15(2) inclusion, but subsection 80.4(1) would apply to impute an interest benefit to the
son for 2009, computed as follows:
61*/365 .05 $180,000 =
92 /365 .05 $180,000 =

$ 1,504
2,268
$ 3,772

however, section 80.5 deems this imputed interest to be interest paid pursuant to a legal
obligation and, therefore, it will be deductible, since the shares can be expected to produce
income from property [spar. 20(1)(c)(i)];
* The day on which the loan is granted is counted, but the last day of the loan is not counted, under
normal commercial practice followed by the CRA.

(b) Home purchase loan

(i) paragraphs 15(2.4)(b) and (f) would exclude the principal amount of this loan from income
because the house is for his habitation and because bona fide arrangements were made, when the
loan was granted, for repayment within a reasonable time. However, if Mr. Scott is acting in his
capacity as a shareholder, then this exception is overridden by paragraph 15(2.4)(e) and the loan
must be included,
(ii) if, however, loan received by virtue of being an employee (rather than a shareholder)
subsection 80.4(1) applies to impute an interest benefit for 2010 computed as follows:
lesser of [ssec. 80.4(4)];
1. interest at the prescribed rate in effect during the quarterly period in the year the loan was
outstanding, and
2. interest at the prescribed rate in effect at the time the loan was made.
this lesser of choice can be made on a quarter-by-quarter comparison of interest rates. In
this case, the 4% prescribed rate in June 2010, when the loan was received, is less than the
rate for the other two quarters of 2010 in which the loan was outstanding. Therefore, the
benefit would be based on the following calculation:

224

Federal Income Taxation: Fundamentals

214
.04 $270,000 = ................................................................. $
365
less: interest paid for the year ( 214 .03 $270,000 ) ...........................
365

net benefit .................................................................................... $

6,332
4,749
1,583

while section 80.5 deems this interest benefit to be interest paid pursuant to a legal obligation
to pay interest, it is not deductible, because the purpose of the loan was not to produce income
[par. 20(1)(c)];
since Mr. Scott only moved a few blocks, his loan to purchase a house does not apply as a
home relocation loan [ssec. 248(1)] and, hence, there is no deduction [par. 110(1)(j)].
(c) car purchase loan
(i) the principal amount of this loan is included in Mr. Scotts income, because although the purpose
satisfies the conditions of paragraph 15(2.4)(d), bona fide arrangements for repayment within a
reasonable time, as required by paragraph 15(2.4)(f), were not made at the time the loan was made,
and Mr. Scott is acting in his capacity as a shareholder:
since the loan was not repaid within one year of the end of 2010 as required [ssec. 15(2.6)], it
cannot be excluded from Mr. Scotts income in 2010 (he will have to file an amended return);
however, paragraph 20(1)(j) will permit him to deduct any repayment in the year it is made as
long as it is not part of a series of loans and repayments;
since the principal amount of the loan is included in 2010 income, the loan becomes an
exception to the imputed interest rules in subsections 80.4(1) or (2) [par. 80.4(3)(b)];
thus, any previously imputed interest benefit and related deduction included in 2010 income
should be reversed;
in the initial 2010 return, interest would have been imputed by section 80.4 because the
principal amount of the loan would have been excluded by subsection 15(2.6), since the oneyear repayment period would not have elapsed at the time of filing for 2010;
that imputed interest benefit would have been calculated as follows:
interest at prescribed rates in effect during the period in the year
that the loan was outstanding ( 92 .05 $24,000 ) ................................................... $ 302
365
less: interest paid for the year ( 92 .04 $24,000 )..................................................
365

interest benefit ................................................................................................ $

242
60

section 80.5 will deem imputed interest to be interest paid in the year for the purposes of
subparagraph 8(1)(j)(i) and, therefore, a part of the $60, based on business usage, will be
deductible because the car is used for employment.
(ii) even if the loan is received by virtue of being an employee, the exclusion in paragraph 15(2.4)(d)
will not apply because of the lack of bona fide repayment arrangements.
therefore, the treatment of the loan will be the same as for (i), above.

Solutions to Chapter 13 Assignment Problems

225

Solution 4 (Advanced)
(A) Subsection 15(2): Inclusion of the $100,000 in income in 2008
Since Stuart is a shareholder, subsection 15(2) will apply to include the $100,000 in his 2009 income unless
one of the three exception tests is met (i.e., either subsection 15(2.3), 15(2.4), or 15(2.6)).
The only exception test that can apply is subsection 15(2.6) that is, repayment of loan within one
year of the year that the loan was made (December 31, 2010 deadline).
The other two exception tests do not apply:
subsection 15(2.3) does not apply since lending money is not Stuart Publishings ordinary
business; and
paragraph 15(2.4)(b) does not apply because:
even though the loan was made to purchase a house and Stuart is an employee, it is not
reasonable to conclude that he received the loan because of his employment since it is not a
company policy to make such loans to employees and no other loans have been made to
employees on similar conditions [paragraph 15(2.4)(e)].
Conclusion: The $100,000 principal amount of the loan will, therefore, be included in Stuarts income,
ultimately, in 2009 unless it is repaid by December 31, 2010 [ssecs. 15(2), (2.6)].
If the $100,000 is included in income in 2009 under subsection 15(2), the $20,000 repayment on
May 1, 2010 will be deductible in 2010 [par. 20(1)(j)].
Recommendation: Repay the $100,000 loan by December 31, 2010.
Section 80.4 Interest benefit
On December 31, 2009, it is not known whether the one-year condition will be met, because Stuart has until
December 31, 2010 to repay the loan. As a result, Stuart could exclude the $100,000 from his income for 2009.
Since the loan is received by virtue of Stuarts shareholding, the interest benefit is computed under the rules
in subsection 80.4(2) and included in Stuarts income from property [ssec. 15(9)].
The interest benefit in 2009 is:
May to June: 61/ 365 $100,000 8% ................
July to Sept.: 92/ 365 $100,000 9% ................
Oct. to Dec.: 92/ 365 $100,000 7% ................

$ 1,337
2,268
1,764
$ 5,369

Conclusion: If the principal amount of the loan is included in income under subsection 15(2) (because the
loan is not repaid by December 31, 2010), there will be no interest benefit from the loan [par. 80.4(3)(b)].
the 2009 return would be initially filed to include the $5,369 interest benefit,
the 2009 return will have to be amended to include the $100,000 benefit and remove the $5,369 interest
benefit,
the 2010 situation will be known before the 2010 return has to be filed.
(B) Subsection 15(2): Inclusion of the $100,000 in income in 2009
The subsection 15(2.4) employee exception test applies because:
the loan used to purchase a dwelling for Stuarts inhabitation [par. 15(2.4)(b)];
Note that one of the three purpose tests in paragraph 15(2.4)(b), (c), or (d) must apply, since Stuart
meets the definition of a specified employee in subsection 248(1), that is, because he is a majority
shareholder; he owns more than 10% of the shares;
it is reasonable to conclude that Stuart received the loan by virtue of employment since it is a company
policy to make such loans to employees and other loans have been made to employees on similar
conditions [par. 15(2.4)(e)];
there are bona fide arrangements (made at the time of loan) for repayment within a reasonable time and
the loan is not a series of loans and repayments [par. 15(2.4)(e)];
a mortgage would qualify as a bona fide arrangement because taking back a mortgage as security is
normal commercial practice for a housing loan; and
a five-year term with annual repayments of 1/ 5 each year is reasonable (perhaps more than reasonable)
compared to commercial practice.

226

Federal Income Taxation: Fundamentals

Conclusion: Since the subsection 15(2.4) exception test is met, Stuart will have no subsection 15(2)
inclusion in income.
Section 80.4: Interest benefit
Since subsection 15(2) does not apply, Stuart will report an interest benefit.
Since the loan is made by virtue of employment, the interest benefit will be calculated under
subsection 80.4(1) and included in employment income under subsection 6(9).
Since the loan is calculated under subsection 80.4(1) and it is for the purchase of a home, it will qualify as a
home purchase loan [par. 80.4(7)(a)], which means that, for the entire five-year term, the 8% prescribed rate
effective in May 1, 2009 can be used to compute the benefit if it is lower than the prescribed rate in effect in that
particular quarter [ssec. 80.4(4)]. In this case, the prescribed rate for the fourth quarter is lower, i.e., 7%.
The subsection 80.4(1) interest benefit for 2009 is:
May to June: 61/ 365 $100,000 8%...................
July to Sept.: 92/ 365 $100,000 8%...................
Oct. to Dec.: 92/ 365 $100,000 7% ...................

1,337
2,016
1,764
5,117

The subsection 80.4(1) interest benefit in 2010 is based on the 6% prescribed interest rate in effect for
that year, since it is less than the 8% rate in effect when the loan was granted:
Jan. to Apr.: 120/ 365 $100,000 6% .......................................
May. to Dec.: 245/ 365 $80,000 6% .......................................

$ 1,973
3,222
$ 5,195

(C) Subsection 15(2): Inclusion of the $100,000 in income in 2009

Since Stuart now owns less than 10% of the shares of Sunshine Publishing Limited, he is no longer a
specified employee [par. 15(2.4)(a)]. His loan, therefore, does not have to meet any purpose test [par. 15(2.4)(b),
(c), or (d)] in order to be exempt from subsection 15(2) as long as it meets the conditions in
paragraphs 15(2.4)(e) and (f).
Therefore subsection 15(2) does not apply to include Stuarts $100,000 loan to purchase a rental property in
his 2009 income.
Section 80.4: Interest benefit
Subsections 80.4(1) and 6(9) apply because the loan received is received by virtue of employment; the
interest benefit is therefore included as employment income. However, the loan cannot be a home purchase loan
because it is a loan to buy a rental property.
The amount of the subsection 80.4(1) benefit is, therefore, the same as the amount of the subsection 80.4(2)
benefit: $5,369 in 2009 (Part (A)), and $5,195 in 2010 (Part (B)).

These imputed interest benefits are deemed to be interest paid [sec. 80.5]. Therefore, the interest may be
deducted from rental income [par. 20(1)(c)].

Solutions to Chapter 13 Assignment Problems

227

Solution 5 (Basic)
(A) Income earned directly
Personal tax
Business income..........................................................................................................................
Tax 1st................................................................................ $ 127,021
$ 26,880
Balance...............................................................................
22,979 @ 29%
6,664
Less: federal personal tax credits ................................................................................................
Provincial tax (17% of ($150,000 127,021) + $15,776) ...........................................................
Less: Provincial personal tax credits ...........................................................................................
Total personal tax ........................................................................................................................
Income earned through corporation
Corporate tax
Business income before salary ....................................................................................................
Salary ..........................................................................................................................................
Taxable income ...........................................................................................................................
Federal tax @ 11% (38% 10% 17%) $100,000..................................................................
Provincial tax (5% $100,000) ..................................................................................................
After-tax retained earnings ..........................................................................................................
Personal tax
Salary received ............................................................................................................................
Tax 1st................................................................................ $ 40,970
$ 6,146
Balance...............................................................................
9,030 @ 22%
1,987
Less: Federal personal tax credits ...............................................................................................
Provincial tax (12% of ($50,000 $40,940) + $4,097) ...............................................................
Less: Provincial personal tax credit.............................................................................................
Total personal tax ........................................................................................................................
(B) Tax deferral on $84,000 in after-tax retained earnings
$50,000 salary + $84,000 dividend 1.25 .......................................................................
Tax 1st ....................................................................................... $ 127,021
$ 26,880
Balance ......................................................................................
27,979 @ 29%
8,114
Less: Personal tax credits ....................................................................................................................
DTC (131/ 3 % of $84,000 1.25) ........................................................................................................
Provincial tax (17% of ($155,000 $127,021) + $15,776) .................................................................
Less: Provincial personal credit ........................................................................................................
Provincial dividend tax credit (6 2/ 3 % of $84,000 1.25) ......................................................
Total tax ..............................................................................................................................................
Less tax paid on $50,000 salary (above) .............................................................................................
Amount of personal tax deferred until payment of dividend ...............................................................
Comparison
Personal tax paid now on $150,000 ....................................................................................................
Tax paid now if incorporated
Corporate tax ...............................................................................................................................
Personal tax on $50,000 salary ....................................................................................................

$ 150,000
$

33,544
(2,100)
31,444
19,682
(1,400)
$ 49,726

$ 150,000
(50,000)
100,000
(11,000)
(5,000)
$ 84,000
$
$

8,133
(2,100)
6,033
5,181
(1,400)
$
9,814
$ 155,000
$

34,994
(2,100)
(14,000)
18,894
20,532
(1,400)
(7,000)
31,026
(9,814)
$ 21,212
$

49,726

16,000
9,814
25,814
21,212
47,026
2,700

Tax paid later on dividend...........................................................................................................

Tax saving from incorporation ($49,726 $47,026)...........................................................................

50,000

$
$

Note that if Nancy received the dividend today, she would pay $2,700 less than if she earned the income
directly (or received a $150,000 salary from her company). This is because the combined federal and provincial
corporate tax rate is 16%. There is perfect integration of personal and corporate taxes, i.e., no tax savings or cost,
when the combined federal provincial corporate tax rate is 20%.

228

Federal Income Taxation: Fundamentals

Solution 6 (Advanced)
(A) Income Earned Directly
Personal tax
Business income..................................................................................................................................
Personal tax: 1st $127,021 .......................................................................................... $ 26,880
bal. 82,979 @ 29% ................................................................................
24,064
Less federal personal tax credits .........................................................................................................
Provincial tax (17% of ($210,000 $127,021) + $15,776) .................................................................
Less: Provincial personal tax credits ...................................................................................................
Total personal tax................................................................................................................................
Income Earned through Corporation
Corporate tax
Business income before salary ............................................................................................................
Salary ..................................................................................................................................................
Taxable income ...................................................................................................................................
Federal tax @ 11% (38% 10% 17%) ............................................................................................
Provincial tax @ 7% of $160,000 .......................................................................................................
Retained earnings ................................................................................................................................
Personal tax
Salary received ....................................................................................................................................
Personal tax: 1st $40,970 ............................................................................................ $ 6,146
bal. 9,030 @ 22% ..................................................................................
1,987
Less federal personal tax credit ...........................................................................................................
Provincial tax (12% of ($50,000 $40,970) + $4,097) .......................................................................
Less: Provincial personal tax credit ....................................................................................................
Total personal tax................................................................................................................................
After-tax personal cash ($50,000 $9,314) ........................................................................................
Comparison
Personal tax paid now on $210,000 ....................................................................................................
Tax if incorporated:
corporate tax ($17,600 + $11,200) ..............................................................................................
personal tax on $50,000 salary ....................................................................................................
Annual cash-flow advantage if incorporated, ignoring personal tax eventually paid on dividend ......

$ 210,000
$

50,944
(2,400)
$ 48,544
29,882
(1,600)
$ 76,826

$ 210,000
(50,000)
$ 160,000
(17,600)
(11,200)
$ 131,200
$

50,000

8,133
(2,400)
$
5,733
5,181
(1,600)
$
9,314
$ 40,686
$

76,826

(28,800)
(9,314)
$ 38,712

(B) Tax Deferral on $131,200 in Retained Earnings

Salary ($50,000) + dividend ($131,200) 1.25 ..................................................................................

Personal tax: 1st $127,021 .......................................................................................... $ 26,880
bal. 86,979 @ 29% ................................................................................
25,443
Less federal personal tax credits .........................................................................................................
Dividend tax credit @162/ 3 % of $131,200 .........................................................................................
Provincial tax (17% of ($214,000 $127,021) + $15,776) .................................................................
Less: Provincial personal tax credits ................................................................................................
Provincial dividend tax credit (81/ 3 % of $131,200) ................................................................
Total tax ..............................................................................................................................................
Less tax paid on $50,000 salary (above) .............................................................................................
Tax deferred ........................................................................................................................................

$ 214,000
$

52,104
(2,400)
(21,867)
$ 27,837
30,562
(1,600)
(10,933)
$ 45,866
(9,314)
$ 36,552

(C) Comparison
Personal tax paid now on $210,000 ....................................................................................................
Tax if incorporated:
corporate tax ($17,600 + $11,200) ..............................................................................................
personal tax on $50,000 salary ....................................................................................................
tax on payment of $131,200 dividend .........................................................................................
Annual tax saving (cost) if incorporated .............................................................................................

76,826
(28,800)
(9,314)
(36,552)

$ (2,160)

Solutions to Chapter 13 Assignment Problems

229

(D) She could split income with her family members through one or more of the following ways:
(1) By arranging to have her family members become shareholders in her corporation and receive
dividends: Tax savings would result, because her family members currently pay no tax. Thus, they could each
receive up to $35,925 of dividends with minimal tax (see Exhibit 13-5). Since Mrs. Edwards tax rate on
dividends is 32.5% [(1.25 46% 25%)], she would save $11,676 per family member. The tax cost associated
with this is $2,596 ($10,382 .25), because Mrs. Edwards loses the federal and provincial married credit if Mr.
Edwards earns more than $10,382 of income. The familys tax position with respect to any credits for university
tuition and the education credit available to the children would be the same, since any credits that cannot be
claimed by a student can be transferred to a parent (or carried forward).
In order for the income-splitting to be effective, the family members must purchase the shares with their
own funds. Also, the corporation must be a small business corporation to avoid corporate attribution.
The decision of the Supreme Court of Canada in the case of Neuman v. The Queen, 98 DTC 6297, supports
this approach to family income-splitting, by clarifying that subsection 56(2) does not apply to prevent incomesplitting. However, the Supreme Court of Canada did not consider the applicability of corporate attribution
[sec. 74.4] or the general anti-avoidance rule (GAAR) [sec. 245], neither of which were legislated at the time of
the Neuman case transactions.
(2) By having her family members work in the business and paying them a reasonable salary: Tax savings
would result because her family members currently pay no tax. Thus, up to $10,382 can be earned by each of
them on a tax-free basis in 2010. Any additional amounts will be taxed at the 15% (federal) rate until the family
members taxable income reaches $40,970. The tax costs would be the same as in (1), above. In addition, there
would be payroll taxes (Canada Pension Plan, Employment Insurance and provincial payroll taxes) if family
members worked in the business and were paid a salary.
(3) By making a deductible RRSP contribution to a spousal plan for Mr. Edwards: If Mr. Edwards
withdraws amounts from his RRSP, the amounts will be taxed in his hands, so long as Mrs. Edwards has not
made RRSP contributions to his RRSP in the year of withdrawal or the previous two years.

Federal Income Taxation: Fundamentals

230
Solution 7 (Advanced)

If a salary of $47,200 is paid to maximize her CPP contribution then, based on the assumption given, her
RRSP contribution will be $8,496. In order for her to retain $40,000 after tax she will need to pay a dividend of
$10,778.
Salary
RRSP contribution
Dividend
Gross-up

Federal tax
DTC
Credits
CPP credit
Provincial tax
DTC
Credits
CPP credit
Total tax paid
CPP paid

Tax on Income
$47,200
(8,496)
10,778
2,695
$52,177
$(8,612)
1,797
2,100
324
(5,442)
898
1,400
216
$(7,319)

Cash
$47,200
(8,496)
10,778

(7,319)
(2,163)
$40,000

With a corporate tax rate of less than 20% (16%) all compensation over the amount required for CPP/RRSP
should be taken as dividends. This compensation plan will maximize the cash available in the company, leaving
it with $52,757 of after-tax cash available for future dividends.
Income before salary and taxes
Salary paid
Employer CPP contribution
Income taxes @ 16%
Dividend
After-tax cash

$125,000
(47,200)
(2,163)
75,637
(12,102)
(10,778)
$52,757

Solutions to Chapter 13 Assignment Problems

231

Solution 8 (Basic)
Part (A)
The FMV of the assets of K Ltd. is as follows:
FMV
Active business assets ....................................................................................
Shares of Cyber Corp ....................................................................................
Term deposits ................................................................................................

Nil
$ 1,450,000
100,000
$ 1,550,000

%
Nil
94.0 %
6.0 %
100.0 %

The FMV of the assets of Cyber Corp. is as follows:

Active business assets:
Cash ...............................................................................................................
Accounts receivable .......................................................................................
Inventory ........................................................................................................
Prepaid expenses ............................................................................................
Fixed assets ....................................................................................................
Goodwill ........................................................................................................
Other: marketable securities ..................................................................................
Total ......................................................................................................................

FMV
4,500
780,000
920,000
1,000
150,000
200,000
$ 2,055,500
700,000
$ 2,755,500

74.6 %
25.4 %
100.0 %

In order for the shares of K Ltd. to qualify as QSBC shares, the following tests must be met.
(1) SBC Test
At the time of sale, K Ltd. must be a small business corporation (SBC). A SBC is defined as a CCPC having
all or substantially all (i.e., at least 90%) of the FMV of its assets either used principally in an active business
carried on primarily in Canada, or shares or debt of a connected SBC, or a combination of the two [ssec. 248(1)].
K Ltd. is a CCPC since all the shares are owned by Karen who is a resident of Canada.
Cyber Corp. is connected to K Ltd., because K Ltd. controls Cyber Corp. But Cyber Corp. is not a SBC as it
does not meet the 90% test, i.e., 74.6%.
Thus, K Ltd. does not meet the SBC test.
(2) Holding Period Test
Throughout the 24 months preceding the sale, the shares cannot be owned by anyone other than Karen or a
person related to Karen. Karen has owned the shares of K Ltd. since 1994. Thus, this test is met.
(3) Basic Asset Test
In order to meet this test, K Ltd. needs to have more than 50% of the FMV of its assets used in an active business
carried on primarily in Canada for the 24 months preceding the sale. K Ltd. does not have any of its assets used in an
active business, but it does have shares of a connected corporation. Therefore, the modified asset test must be used.
(4) Modified Asset Test
This test requires that K Ltd. and Cyber Corp. both meet the 50% test throughout the 24 months preceding
the sale and that either K Ltd. or Cyber Corp. meet the 90% test throughout the 24 months preceding the sale.
On reviewing Cyber Corp., it can be seen that more than 50% of its assets are used principally in an active
business carried on primarily in Canada, i.e., 74.6% of its assets are used in this way.
On reviewing K Ltd., it can be seen that at least 90% of the FMV of its assets are shares of a connected
corporation, Cyber Corp., meeting the 50% test, i.e., 94%.
Thus, this test is met.
Conclusion:
K Ltd. meets both the holding period test and the modified asset test, but fails the SBC test. Therefore, the
shares of K Ltd. are not QSBC shares and thus Karen will not qualify for the capital gains deduction.
Part (B)
In order for K Ltd. to become a SBC, Cyber Corp. must be a SBC. The following alternative could be
considered as a way to have Cyber Corp. become a SBC immediately before the sale of the shares.
Approximately $471,600* of the marketable securities could be sold on the open market and the cash used
to reduce the liabilities. However, the sale of the marketable securities would result in a capital gain which would
be subject to full corporate tax net of refundable tax if dividends are paid prior to the sale of shares.
Be careful not to become too precise when doing this calculation. Remember, the fair market value of the
assets, especially goodwill, is subject to challenge. If your fair market values are too high, then you will not have
sold enough securities to meet the 90% test.
* Total assets including $2,055,500 of active business assets ($2,055,500 .90)
Less: active business assets
Maximum value of marketable securities
Current marketable securities
Maximum marketable securities
Sell marketable securities

$2,283,889
2,055,500
$ 228,389
$ 700,000
(228,389)
$ 471,611

Federal Income Taxation: Fundamentals

232
Solution 9 (Advanced)

Part (A)
The first step is to analyze the fair market value of the assets of each of the companies. The analysis would
be as follows:
Julie Inc. (Julie) assets:
Shares of Opco Inc. at FMV .....................................................................
Shares of RE Inc. at FMV ........................................................................
Portfolio investments at FMV ..................................................................
Opco Inc. (Opco) assets and liabilities:
Active business assets at FMV .................................................................
Term deposits ...........................................................................................
Liabilities .................................................................................................
RE Inc. (RE) assets and liabilities:
Land and building at FMV .......................................................................
Portfolio investments at FMV ..................................................................
Mortgage ..................................................................................................

$ 850,000
800,000
75,000

49.3 %
46.4 %
4.3 %

$ 900,000
50,000
(100,000)

94.7 %
5.3 %

$ 800,000
200,000
(200,000)

80 %
20 %

In order for the shares of Julie to qualify as QSBC shares, the following tests must be met:
(1) SBC Test
At the determination time, Julie must be a small business corporation, which means that all or substantially
all (generally 90%) of the fair market value of its assets must be used in an active business carried on primarily in
Canada by the corporation or a related corporation, or invested in shares or debt of a connected SBC. In this case,
Julie has 4.3% of the fair market value of its assets held in portfolio investments which are not used in an active
business. While Julie has 95.7% of its assets invested in Opco and RE, it still needs to be determined whether
these two subsidiaries are connected SBCs. Since both are owned 100% by Julie, they are both connected
corporations to Julie. In this case, Opco is a SBC, since 94.7% of its assets are used principally in an active
business carried on primarily in Canada by the corporation or a related corporation. RE, on the other hand, is not
a SBC, but the real estate is used principally in the active business of Opco, a related corporation. As a result,
RE meets the 50% test. Then, since only 49.3% of the assets of Julie are invested in connected SBCs, Julie is not
a SBC.
(2) Holding Period Test
To meet this test, Rogo or a related party must have owned the shares of Julie throughout the 24 months
preceding their disposition. This test is met by the facts given in the question.
(3) Basic Asset Test
In order to meet this test, Julie needs to have more than 50% of its assets used in an active business carried
on primarily in Canada for the previous 24 months. In this particular case, Julie does not have any of its assets
used directly in an active business, but it does have shares of connected corporations. Therefore, the modified
asset test must be used.
(4) Modified Asset Test
If Julie meets the 90% test with a combination of its own active business assets (it has none) and shares or
debt of connected corporations that meet the 50% test, the modified asset test is met.
This test requires, in this particular case, both of the connected corporations meet the 50% test throughout
the 24 months preceding the determination time and that Julie meets the 90% test throughout the 24 months
preceding the determination time.
If RE is reviewed, it can be seen that the real estate is used principally in an active business carried on by RE
or by a related company, Opco. Therefore, its main or principal use is in the active business of Opco. However,
the land and building only represent 80% of REs assets. Thus, RE only meets the 50% test.
On reviewing Opco, it can be seen that more than 50% of its assets are used principally in an active business
carried on primarily in Canada, i.e., 94.7% of its assets are used in this way.
Finally, on reviewing Julie, it can be determined that since both Opco and RE meet the 50% test, Julie must
meet the 90% test with the shares of both RE and Opco considered. Julie has 95.7% of its assets invested in the
shares of Opco.
As a result, Julie will meet the modified basic asset test with the shares of Opco considered.

Solutions to Chapter 13 Assignment Problems

233

If the facts were somewhat different, such that Julie did not meet the 90% test, but Julie did not need to
include the shares of either Opco or RE to meet the more than 50% asset test, then the following interpretation
would apply. According to a private CRA technical interpretation, only the assets of the corporation whose
shares help Julie meet the 50% test must meet the 90% test. According to this interpretation, the assets of both
corporations must meet the 90% test only if the shares of both corporations are needed to help Julie meet the
50% test. In the case at hand, this is not necessary, because the assets of Julie meet the 90% test.
Conclusion:
Julie meets both the holding period test and the modified basic asset test, but fails the SBC test. Therefore,
the shares of Julie are not QSBC shares at this time.
Part (B)
In order for Julie to become a SBC it can look at a number of different options. It can dispose of the shares
of RE. Another option is to cause RE to decrease the proportion of portfolio investments to less than 10%.
By disposing of the shares of RE, Julie will possibly create a significant tax liability on any capital gain
realized. The net proceeds would first be used to pay any tax liability on the sale and then could be used to pay
off the liabilities in Opco. After that, the excess funds will have to be paid as a dividend with the resulting tax
liability to Rogo. If this option is chosen, then the shares of RE should be sold to someone who would continue
to rent the property to Opco.
If RE were to dispose of $112,000 of its portfolio investments, then it would have 90% of its assets
($800,000 out of $888,000) used in the active business of a related corporation but only if the $112,000 of cash
proceeds is used to pay off part of the mortgage to reduce it to $88,000. In this way, a non-qualified asset is
eliminated by reducing a liability.

Federal Income Taxation: Fundamentals

234
Solution 10 (Basic)
Section 110.6

(A) Unused lifetime deduction in 2010:

Lifetime cumulative deduction limit ...........................................................................................
Less: prior years deductions
Capital gains deduction claimed in 1999 .........................................................................
Capital gains deduction available for 2010 .................................................................................
(B) Annual gains limit for 2010:
Net taxable capital gains for 2010 ...............................................................................................
Minus:
Net capital losses deducted in 2010.............................................................. $
8,000(3)
ABILs realized in 2010 ................................................................................
Nil

$ 375,000
$
8,000(1)
$ 367,000
$

82,000(2)

8,000
74,000

(C) Cumulative gains limit:

Cumulative net taxable capital gains ($12,000 + $82,000) ......................................................... $ 94,000
Minus:
Cumulative net capital losses deducted ........................................................ $
8,000(3)
Cumulative ABILs realized ..........................................................................
2,000(3)
Cumulative capital gains deductions ............................................................
12,000
Cumulative net investment loss ....................................................................
29,600(4)
(51,600)
$ 42,400
(D) Least of (A), (B) and (C)..................................................................................................................... $ 42,400

NOTES TO SOLUTION
(1) The 1999 deduction was based on a 3/ 4 inclusion rate. Therefore, the deduction must be adjusted by
multiplying by 2/ 3 to correspond with the 2010 inclusion rate of .
(2) This amount is the lesser of:
(a) Net taxable capital gains for the year
($185,000 $21,000) ..........................................................................................

82,000

(b) Net taxable capital gains for the year only taking into account gains
and losses on QSBC shares ( $185,000) ...............................................................

92,500

(3) 2009 BIL (before ssec. 39(9) deduction)......................................................................................... $

Disallowed portion (see below)...................................................................................................
BIL after reduction ......................................................................................................................

20,000
(16,000)
$
4,000

ABIL ( $4000) ......................................................................................................................

2,000

20,000

$
$

16,000
Nil
16,000

8,000

The disallowed portion of the BIL is the lesser of:

(a) BIL ..............................................................................................................................
(b) adjustment factor times the cumulative capital gains deduction of
previous year ($12,000 4/ 3 ) ......................................................................................
minus: the cumulative disallowed BIL of prior years ..................................................
Disallowed BIL ...................................................................................................................
This disallowed portion of the BIL reverts to a capital loss and after adjustment for inclusion rate
can be claimed as a net capital loss in 2010 as:
$16,000 =

Note that the taxpayer could choose not to deduct the net capital losses in 2010, thereby increasing the
capital gain deduction for 2010 to $50,400 (i.e., $42,400 + $8,000).
(4) Cumulative net investment loss:
Investment expenses:
Cumulative net rental losses ($15,000 + $13,000, + $1,000) ............... $ 29,000
Cumulative interest expense and carrying charges ($1,475 + $2,000) .
3,475
Investment income:
Cumulative investment income ($825 + $200 + $200 + $1,650) ................................

32,475

2,875
29,600

Solutions to Chapter 13 Assignment Problems

235

Solution 11 (Basic)
Section 74.4
The corporate attribution rules may apply for the following reasons:
(1) An individual, Bob, transferred property to a corporation, Holdco Inc., in which a designated person,
Betty, was a specified shareholder (she owned 50% of the common shares).
(2) While Holdco Inc. would have been a small business corporation at the time of the transfer, since its
only asset was shares of the small business corporation, Smith Inc., once Smith Inc. has sold the
property and paid the dividend to Holdco Inc., the balance sheet of Holdco Inc. would have investments
of $150,000 and shares of Smith Inc. worth $800,000. Then only 84.2% of the fair market value of the
assets of Holdco is invested in the small business corporation while 15.8% is invested in non-active
assets. As a result, as of the date of the dividend, July 1, Holdco is no longer a small business
corporation, since it fails the 90% test.
If Holdco Inc. is not a small business corporation, then Bob will be deemed to have received interest in 2010
of the following amount:
Outstanding amount (the value of the preference shares) ...........................................................
Prescribed rate ............................................................................................................................
Proportion of the year that Holdco was not an SBC ...................................................................
Deemed interest ($600,000 4% 184/365) .............................................................................
Less: 5/ 4 dividends paid to Bob (5/ 4 $6,000).........................................................................
Net imputed benefit to Bob .........................................................................................................

$ 600,000
4%
184/365
12,099
7,500
$

4,599

It may be possible to argue that the corporate attribution rules do not apply on the basis that one of the main
purposes of the transfer 13 years ago was not to reduce the income of Bob and benefit Betty. This may be a
difficult argument to support, since why else would he have transferred the shares of Smith Inc. to a holding
company in which his wife owns 50% of the common shares?

Federal Income Taxation: Fundamentals

236
Solution 12 (Advanced)

The following attempts to apply the logic represented in Exhibit 13-12. The particular application of the
logic and the conclusions reached are a matter of judgment, in the absence of interpretation of the law by the
courts.
(1)
(a) Does any other provision of the Act or other rule
of law apply to stop the taxpayer from achieving
the intended advantage? .........................................
(b) Does the transaction result, directly or indirectly,
in a tax benefit, as defined in ssec. 245(1), i.e., a
reduction, avoidance or deferral of tax or an
increase in a refund? ..............................................
(c) Is the transaction part of a series of transactions
which would result, directly or indirectly, in a tax
benefit? ..................................................................
(d) Can the transaction reasonably be considered to
have been undertaken or arranged primarily for
bona fide purposes other than to obtain the
benefit? ..................................................................
(e) Can it reasonably be considered that the
transaction would result, directly or indirectly, in a
misuse of the provisions of the Act or an abuse
having regard to the provisions of the Act read as
a whole? .................................................................

(2)
(3)
(4)
(5)
(answers should be read down the columns)

No(1)

No(6)

No(11)

No(13)

No(18)

Yes(2)

Yes(7)

Maybe(12)

Yes(14)

Maybe(19)

Yes(3)

Yes(8)

Maybe

Yes(15)

Maybe

No(4)

No(9)

Maybe

No(16)

Maybe

Yes(5)

No(10)

Maybe

No(17)

Maybe

NOTES TO SOLUTION
(1) The contribution and the withdrawal are specifically permitted under the Act.
(2) A deferral of tax will be achieved with the contribution and, depending upon the marginal tax rate in the
year of withdrawal, there may be a tax saving.
(3) Since each transaction hinges on the other, these transactions could be considered a series. However,
since the answer to (b) was yes, then (d) can be addressed directly after (b).
(4) It may be possible to argue that the contribution was made for bona fide reasons, but an unanticipated
need for cash necessitated the withdrawal. This argument is not likely to be successful when the withdrawal
follows the contribution within a short period of time or when the same transactions are repeated over a period of
years.
(5) Each transaction is specifically permitted under the Act. However, there may be a misuse of these
provisions or an abuse of the Act read as a whole. In paragraph 5 of Information Circular 88-2, the CRA states
that transactions that rely on specific provisions, whether incentive provisions or otherwise, for their tax
consequences, or on general rules of the Act can be negated if these consequences are so inconsistent with the
general scheme of the Act that they cannot have been within the contemplation of Parliament. In this case, it can
be argued that the RRSP provisions were intended to allow for a sheltered funding of retirement using the
deferral mechanism of a deduction or contribution and taxation on withdrawal and that the quick withdrawal is
an abuse. On the other hand, what was accomplished in this case was a one-year deferral of income and a
deferral of income is contemplated by the scheme of the Act pertaining to an RRSP.
(6) A gift to a spouse that does not result in the funds producing income from property is not subject to the
attribution rules. The use of the gift to pay tax would not be considered to produce income from property.
(7) The fact that second generation income generated by the loan is not taxed to the husband reduces his
tax.
(8) The cash gift to pay the taxes resulted in the wife having more cash to reinvest which would create
more second-generation income. However, since the answer to (b) was yes, then (d) can be addressed directly
after (b).
(9) It may be possible to argue that the loan was primarily for a bona fide business, investment or family
purpose, as indicated in paragraph 4 of Information Circular 88-2. However, facts must be adduced to show that
a tax benefit was not the primary purpose of the transaction.

Solutions to Chapter 13 Assignment Problems

237

(10) IT-511R suggests, in paragraph 6, that compound interest, i.e., income on attributed income or secondgeneration income is not subject to income attribution. The CRA, thereby, suggests that this transaction is not a
misuse or abuse of provisions of the Act. As a result, the GAAR should not apply.
(11) Section 74.4 only applies to transfers to a corporation by an individual.
(12) There may be no tax benefit from this transaction. The loan capital was paid from earnings of Wells
Ltd. that had been taxed. That capital will earn income in Stieb Ltd. that will be taxed at the corporate rate
applicable to the type of income generated. On the other hand, it might be possible to argue that the surplus in
Wells Ltd. would otherwise have been distributed to Mrs. Hogart in the form of dividends which would have
been taxed. Then, if she loaned the funds to Stieb Ltd., the corporate attribution rules would have applied.
(13) As long as the sale of the investments was at fair market value, then the Act has no prohibition on this
transaction. The borrowing to purchase investments is specifically contemplated in paragraph 20(1)(c).
(14) What was non-deductible interest is now technically tax-deductible.
(15) See (13), above.
(16) Having borrowed to purchase the house rather than to finance the investments initially, the restructuring of the debt could be regarded as a transaction to obtain the tax benefit of interest deductibility.
(17) There may be a misuse of provisions or an abuse of the Act read as a whole.
(18) Subsection 56(4.1) only deals with individuals.
(19) Case similar to situation (3). See Note (12). In this case, if the statement that the loan was made to
avoid subsection 56(4.1) is taken literally, then there may be a misuse or an abuse in answer to (e).

238

Federal Income Taxation: Fundamentals

Solution 13 (Basic)
This problem is meant to bring out the CRAs stated position on these issues as provided in Information
Circular 88-2. In particular, this question addresses the issue of what the CRA views as a misuse of the
provisions of the Act or an abuse having regard to the provisions of the Act read as a whole.
(1) Paragraph 11 states that there is nothing in section 125 (which provides for the small business
deduction) or elsewhere in the Act that prohibits an individual from incorporating his or her business. The
incorporation is consistent with the Act read as a whole and, therefore, subsection 245(2) would not apply to the
transfer of the business to the corporation.
(2) Paragraph 17 states that there is no provision in the Act requiring a salary to be paid in these or any
other circumstances and the failure to pay a salary is therefore not contrary to the scheme of the Act read as a
whole. Subsection 245(2) would not apply to deem a salary to be paid by the corporation or received by the
individual.
(3) Paragraph 19 states that the borrowing by the parent corporation is for the purpose of gaining or
producing income as required by paragraph 20(1)(c) of the Act, and subsection 245(2) would, therefore, not
apply.
(4) Paragraph 5 of Supplement 1 states that the Explanatory Notes to Draft Legislation and Regulations
Relating to Income Tax Reform issued by the Minister of Finance in June 1988 state that the transfer of income
between related corporations that is accomplished using transactions that are legally effective would not usually
result in a misuse of the provisions of the Act or an abuse of the Act read as a whole. The transactions between
Profitco and Lossco, which are related corporations, would not therefore be considered an abuse of the Act read
as a whole. This interpretation does not address the deductibility of interest payable by Profitco to its bank or to
Lossco. Such interest will be deductible pursuant to paragraph 20(1)(c) of the Act provided that Profitco acquires
the shares of Lossco for the purpose of earning income from the shares.
(5) Paragraph 14 states that as the transfer of shares to the Newco is part of an arrangement undertaken to
avoid the tax required by Part IV of the Act to be paid in respect of dividends received on portfolio shares, the
transfer of the shares would be a misuse of a provision of the Act or an abuse of the Act read as a whole, and
subsection 245(2) would be applied.
(6) Paragraph 24 states that as the interposition of the intermediary is made solely to enable the owner of
the property to defer recognition of the gain, the sale of the real property to the intermediary would be subject to
subsection 245(2).

Solutions to Chapter 13 Assignment Problems

239

Advisory Cases
Case 1: Aurora Collectibles
ADVISORY CASE DISCUSSION NOTES
This case deals primarily with the integration concept and secondarily with the attribution rules.
1. Incorporate

Integrationshould John continue to use a proprietorship or should he incorporate.

Calculate whether he will have more cash left if he flows his income through a corporation or
continues to use a proprietorshipthis will determine the tax savings.

Compare whether there will be more cash left if he earns the income in a corporation and then does
not pay the dividend versus earning it in the proprietorshipthis will determine the tax deferral.

To maximize the debt repayment they will need to leave cash in the company to pay off the debt with
income taxed at the low corporate rate.

In order to buy the property, it will be cheaper to buy it with after-tax dollars earned in the
corporation.

2. Attribution rules

Loans from a spouse are subject to the attribution rules [ssec. 74.1(1)] but if interest is charged at
least at the prescribed rate, then the exception in subsection 74.5(2) should apply.

Once the business is transferred to a corporation then the loan from Alison will be to the corporation.
There may be corporate attribution [ssec. 74.4(2)] on the loan to the corporation but these rules will
not apply if the corporation is a small business corporation If it is not a SBC then the deemed interest
benefit will be reduced by the interest paid on this loan.

240

Federal Income Taxation: Fundamentals

Case 2: Charles Wong

ADVISORY CASE DISCUSSION NOTES
Tax Minimization Versus Effective Tax Planning
Tax minimization focuses on strict interpretation, whereas tax planning focuses on the object and spirit of
the Income Tax Act. Individuals who plan their affairs using tax-minimization schemes hope to avoid paying
taxes in the short term by, perhaps, circumventing the actual intent of the legislation. They do this by focusing on
the exact legal wording of the Act. In turn, this creates more legislation and adds to the complexity of the
expanding Income Tax Act. In contrast, tax planning looks at the overall intent of the legislation and works
within the conceptual framework to decrease the overall taxes paid over a multi-period time frame. The
transactions are planned within the object and spirit of the Act.
Change in Tax Minimization Objective
Charles needs to change his objective of tax minimization as the Income Tax Act and the courts are focusing
more on the concepts of business purpose and substance over form. This is evidenced by the general antiavoidance rule (section 245), which nullifies any transaction that provides a tax benefit that is not for a bona fide
purpose. As well, the courts are now ruling against transactions the economic substance of which does not fit
within the language and purpose of the legislation (see Stubart Investments Ltd. v. The Queen, 84 DTC 6305
(S.C.C.)). Since Charless transaction falls outside the spirit of the Act, he will have to repay the tax benefits he
has construed and inevitably change his attitude towards tax planning if he hopes to decrease the overall taxes he
pays in the future.
Avoiding the Application of the GAAR
By applying the concept of substance over form, taxpayers can focus on the legislative intent underlying tax
rules. By doing such, they focus on efficient tax planning rather than pure tax minimization. This ensures that
transactions will not be reversed by the anti-avoidance provision of section 245, nor will the taxpayer be guilty of
tax avoidance or tax evasion. In addition, taxpayers will enhance their ability to interpret tax rules, predict future
tax changes, and achieve a broader understanding of the underlying tax principles.

CHAPTER 14

Rights and Obligations Under the Income Tax Act

Solution 1 (Advanced)
Instalment payments are required, since the tax liability in the two previous years was in excess of $3,000
and it appears that there were no withholding taxes on the income [sec. 156.1]. Reg. 5300 does not relieve Bert
of the obligation even if there were withholding taxes, but the CRA policy allows certain deductions, such as
withholding taxes, from the instalment base. (See Form 1033-WS for the allowable deductions.)
Instalment payments are required to be made on March 15, June 15, September 15, and December 15
regardless of the option chosen [ssec. 156(1)].
An individual has three methods to choose from to determine the amount of instalments to be paid on the
above dates.
Option 1
The prior year method: one quarter of the instalment base, which is essentially taxes payable
for the immediately preceding year [spar. 156(1)(a)(ii)].
Option 2
The current year method: one quarter of the estimated tax payable for the current year
[spar. 156(1)(a)(i)].
Option 3
One quarter of the instalment base for the second preceding year (i.e., 2008) for the March
and June instalments, and for the September and December instalments, 1/ 2 of the excess of
the instalment base for the preceding year (i.e., 2009), less one-half of the instalment base of
the second preceding year (i.e., 2008) [par. 156(1)(b)].
The CRA will automatically send instalment reminders setting out the required instalments payments to
those individuals who are required to make instalments. The amount of the instalments shown on the instalment
reminders is based on Option 3.
If an individual selects the current year method (Option 2), and the actual tax liability is greater than the
estimate, the CRA will charge interest on the amount of any deficiency [ssec. 161(4.01)]. In addition, interest
will be charged if the instalments under any of the three methods are not made by the due dates [ssec. 161(2)].
The interest charge is calculated from the date each instalment is due. Interest is calculated using the prescribed
rate for the quarter [ssec. 161(2)] and is compound daily [ssec. 248(11)].
In addition to the interest charge, a penalty equal to 50% of the interest payable will be charged if the
instalment payments are late or less than the required amount. The penalty does not apply to the greater of the
first $1,000 of interest or 25% of the interest charged under section 161 as if no instalment payments had been
made in the year. In essence, a penalty is not charged if the instalment interest charges are less than $1,000
[sec. 163.1].
Based on the information provided, Mr. Logans instalments payments under each of the options available
are as follows:
March 15, 2011 ..................................................................................
June 15, 2011 .....................................................................................
September 15, 2011 ...........................................................................
December 15, 2011 ............................................................................

Option 1
Option 2
Option 3
1,910(1) $
1,380(2) $ 2,187.50(3)
1,910
1,380
2,187.50
1,910
1,380
1,632.50
1,910
1,380
1,632.50

Based on the above calculations, Option 2 results in a lower instalment requirement than the other methods.
However, as indicated above, if the 2011 actual tax liability is higher, interest will be charged on the deficiency.
NOTES TO SOLUTION
(1) 1/ 4 of $7,640 (instalment base for 2010) = $1,910
(2) 1/ 4 of $5,520 (estimated 2011 tax payable) = $1,380
(3) First two instalments: 1/ 4 of $8,750 (instalment base for 2009) = $2,187.50
Last two instalments: 1/ 2 [$7,640 (1/ 2 $8,750)] = $1,632.50

241

242

Federal Income Taxation: Fundamentals

Solution 2 (Advanced)
Part (A)
The alternatives available to Ruffle Limited are as follows:
(1) 1/ 12 of the estimated tax liability for the current year (2010) [spar. 157(1)(a)(i)]:
/ 12 $45,000 = $3,750.00
(2) / 12 of the instalment base which is defined in Regulation 5301 and which is essentially the tax payable
for the immediately preceding taxation year (i.e., 2009) [spar. 157(1)(a)(ii)]:
1

/ 12 $69,036 = $5,753.00
(3) 1/ 12 of the instalment base for the second preceding taxation year (i.e., 2008) for the first two months,
then 1/ 10 of the instalment base for the immediately preceding taxation year (i.e., 2009) net of the amount paid in
instalments for the first two months [spar. 157(1)(a)(iii)]:
1

(a) two instalments of $4,502.00 (1/ 12 $54,024);

(b) ten instalments of $6,003.20 (1/ 10 [$69,036 (2 $4,502)]).
In Ruffles situation, Alternative 1 results in the least amount to be paid each month during the year.
However, if the total of the instalment payments is less than the actual tax payable and the amount of tax that
would have been paid under Alternatives 2 and 3, Ruffle Limited will be subject to interest charges.
Part (B)
Ruffles instalment payments were based on the 2010 estimated tax liability; assuming the 2010 liability is
not greater than $45,000, a payment of $2,491.92 (based on the calculations below) will be required to be made
to stop further interest charges.

Nov. 30/09 .............................................................

Dec. 31/09 .............................................................
Jan. 31/10...............................................................
Feb. 28/10 ..............................................................
Mar. 31/10 .............................................................
Apr. 30/10 ..............................................................
May 31/10..............................................................
Jun. 30/10 ..............................................................
Jul. 31/10 ...............................................................
Aug. 31/10 .............................................................
Sep. 30/10 ..............................................................
Oct. 31/10 ..............................................................
Dec. 31/10 .............................................................

Opening
balance
Nil
Nil
Nil
Nil
Nil
Nil
Nil
Nil
$1,056.26(1)
2,118.82(2)
3,187.10(3)
3,208.83(4)
2,491.92(5)

Instalments
required
$
3,750
3,750
3,750
3,750
3,750
3,750
3,750
3,750
3,750
3,750
3,750
3,750

$ 45,000

Instalments
made
$ 3,750
3,750
3,750
3,750
3,750
3,750
3,750
2,700
2,700
2,700
3,750
4,500
2,491.92
$ 45,091.92

Closing
balance
Nil
Nil
Nil
Nil
Nil
Nil
Nil
$ 1,050.00
2,106.26
3,168.82
3,187.10
2,458.83
Nil(6)

NOTES TO SOLUTION
(1) July 1July 31 (31 days): $1,050 (1 + .07/365)31
(2) Aug. 1Aug. 31 (31 days): $2,106.26 (1 + .07/365)31
(3) Sept. 1Sept. 30 (30 days): $3,168.82 (1 + .07/365)30
(4) Oct. 1Oct. 31 (31 days): $3,187.10 (1 + .08/365)31
(5) Nov. 1Dec. 31 (61 days): $2,458.83 (1 + .08/365)61
(6) Penalty under section 163.1 is nil since the interest of $91.92 ($45,091.92 $45,000) is less than
$1,000.

243

Solutions to Chapter 14 Assignment Problems

Solution 3 (Advanced)
Part (A)
Since this corporation is not a CCPC, the normal assessment period expires four years after the receipt of the
notice of assessment for that year, or September 30, 2009. Reassessments issued after that time are not valid
unless there has been fraud or misrepresentation or where a waiver has been filed by the taxpayer within the
normal reassessment period. Even if such events have occurred, the CRA is generally not allowed to use its
collection powers for at least 90 days after the reassessment (or July 28, 2010) [sec. 225.1], and this period is
extended if a Notice of Objection is filed.
Part (B)
Date(1)
Nov. 30/09(2) .....................
Dec. 31/09(3) .....................
Feb. 28/10(4) ......................
June 30/10(5)......................
Sept. 2/10(6) .......................
Total .................................

Amount owing
(opening bal.)
Nil
$
837,078
220,259
1,834,620
1,989,668

Amount due
$ 830,000
830,000
1,560,000
123,900
Nil

Amount paid
Nil
$ 1,450,000
Nil
Nil
Nil

Amount owing
(closing bal.)
$
830,000
217,078
1,780,259
1,958,520
1,989,668

Sec. 163.1 interest penalty on deficient instalments(4)

Interest paid under secs. 161 and 162 ..............................................................................
Less greater of:
(a) dollar amount ...................................................................................................
(b) 25% of interest if no instalments (25% of $350,000) .......................................
greater amount .............................................................................................................
Excess, if any ...................................................................................................................
50% of excess ..................................................................................................................

Interest

$ 7,078
3,181

$ 10,259
$ 10,259

$ 1,000
$ 87,500
$ 87,500
Nil
Nil

Hence, the amount owing as of September 2, 2010 is $1,989,476.

NOTES TO SOLUTION
(1) The relevant dates for interest and penalty calculations are: the first date at which the instalment
payment differed from the minimum required amount (Nov. 30/09); subsequent instalment due dates
(Dec. 31/09); the remainder due date (Feb. 28/10, since this is not a Canadian-controlled private corporation); the
required filing date (June 30/10); the current date (Sept. 2/10); and any dates at which the prescribed rate of
interest has changed (e.g., Jan. 1/10).
(2) The strategy which results in the minimum instalments in this case is to pay January and February
instalments based on tax payable for the second preceding year (2007), and then pay subsequent instalments
based on tax liability for the preceding year (2008) with a catch-up to bring total instalments up to the 2009 tax
liability. Hence, the required tax instalments were $5,400,000/12 = $450,000 for January and February 2009, and
10% ($9,200,000 2 $450,000) = $830,000 for March to December 2009. Since the problem states that these
amounts were paid as required from January to October, the table begins on November 30, 2009 with $830,000
due but nothing paid.
(3) The prescribed interest rate for this purpose is 4% above the rate used for imputing interest on
employee and shareholder loans: 6% + 4% = 10%. Interest at this rate is compounded daily for the 31 days from
December 1 to December 31. Hence, the amount owing to the CRA on December 31 is initially:
$837,078 = $830,000 (1 + .10/365)31
After adding the $830,000 instalment due on that day and deducting the $1,450,000 amount paid, the
balance owing is $217,078.
(4) Since the prescribed rate for 2010 is assumed to be 5% + 4% = 9% and there are 59 days from
January 1 to February 28, the amount owing on February 28 is initially:
$220,259 = $217,078 (1 + .09/365)59
The remainder due on February 28, 2010, is the tax liability for the year of $10,760,000 less the total
minimum instalments required to be paid for the year of $9,200,000 ($450,000 2 + $830,000 10), which is
$1,560,000.

244

Federal Income Taxation: Fundamentals

A second amount which is considered to be due on February 28, 2010 [par. 161(11)(b)], is the penalty under
section 163.1 for deficient instalments. The instalment interest charged as of February 28, 2010, is the amount
owing of $220,259 less the deficiency of instalments of $210,000 (calculated as the $830,000 deficiency in
November 2009 less the $620,000 excess instalment in December 2009), which is $10,259. Hence, the penalty is
50% of the excess of $10,259 over the greater of $1,000 and 25% of $350,000 (the amount of interest payable if
no instalments were made). Thus, the deficient-instalment penalty is zero.
Since no amount was paid on that day, the total amount owing on February 28, 2010, becomes $220,259 +
$1,560,000 = $1,780,259.
(5) Since there are 122 days from March 1 to June 30, the initial amount owing in June 30 is:
$1,834,620 = $1,780,259 (1 + .09/365)122
The penalty payable under section 162 for late filing is considered to be due on June 30, 2010
[spar. 161(11)(a)(i)]. The amount of this penalty is 5% + 2 months 1% = 7% of the amount of tax unpaid. The
amount of tax unpaid excludes interest charges to date and is computed from the Amount Due and Amount
Paid columns as 2 $830,000 + $1,560,000 $1,450,000 = $1,770,000. Hence, the late-filing penalty is 7%
$1,770,000 = $123,900.
(6) Since there are 64 days from July 1 to September 2, the amount owing on September 2 is:
$1,989,668 = ($1,834,620 + $123,900) (1 + .09/365)64

245

Solutions to Chapter 14 Assignment Problems

Solution 4 (Basic)
If Bill knew that the neighbour was not reporting all of his income but prepared the tax return, anyway, then
he participated in making a false statement and, as such, could be liable to a penalty under subsection 163.2(4). If
assessed, the penalty would be, at least, $1,000 and could be as high as $100,000 plus Bills fee for preparing the
tax return. The penalty would be limited to 50% of the additional tax owing by the neighbour [ssec. 163.2(5)].
If Bill did not know that the neighbour was not reporting all of his income, but would be reasonably
expected to know, one needs to determine if his action resulted in culpable conduct.
The definition of culpable conduct requires that the accountant must have acted in a manner tantamount to
intentional conduct, or the accountant must have shown indifference as to whether the Act was complied with, or
the accountant must have shown a wilful, reckless or a wanton disregard of the law [ssec. 163.2(1)]. A person is
not considered to have acted in circumstances amounting to culpable conduct in respect of the false statement
solely because he relied, in good faith, on information provided by the taxpayer [ssec. 163.2(6)].
The following facts are relevant for this purpose: the quantum of the deduction; Bills knowledge of his
neighbours affairs; and the terms of the accounting engagement.
Normally, if an amount seemed to be questionable, it would be common for the accountant to question the
taxpayer, as Bill did in this case. However, having received a response that was not believable, Bill should have
questioned the neighbour further or refused to prepare the tax return.
Bill will likely be subject to the penalties for assisting in the understatement of tax. The filing was highly
suspect and even though Bill asked one question, the response did not address the concern. The CRAs position
is that an adviser or a tax return preparer who has knowledge of the personal circumstances of a client is
expected to recognize obvious inconsistencies in the information provided by the client [IC 01-1]. In this case,
Bill turned a blind eye to the false filing by not asking questions and obtaining plausible answers to the
question of how the neighbour could afford a house in his neighbourhood, despite having such a small income.
Use of the following flowchart present in the chapter may be helpful in analyzing this situation and reaching
this conclusion.
Yes

No

Did Bill
know?
No

Would Bill be
reasonably
expected to
know?
Yes

Yes

No

Did Bill rely in good

faith on information
provided by another
person?

Yes
No
NO PENALTY

Did Bill exhibit

culpable conduct?

PENALTY
Preparers Penalty
$1,000 < penalty < $100,000 + fee charged

Limited to 50% of
additional tax owed

246

Federal Income Taxation: Fundamentals

Solution 5 (Advanced)
Gone-Today-Here-Tomorrow is required to withhold 25% of the gross rentals and remit such amounts to the
CRA [par. 212(1)(d)]. Since this withholding tax requirement is in Part XIII of the Act, and not in Part I, no
objection or appeal is possible. The amount must be received by the CRA by the 15th of the month following the
month the rent was paid or credited [ssec. 215(1); IC 77-16R4, par. 54].
As an agent, Gone-Today-Here-Tomorrow is required to withhold the tax [ssec. 215(3)] and is liable for the
tax even if the tax is not withheld [ssec. 215(6)].
Mr. Singh can undertake to file a Canadian tax return with respect to the rental property [sec. 216]. Since
this return is filed under Part I of the Act, an objection or appeal is possible. In this case, Gone-Today-HereTomorrow may elect [ssec. 216(4)] to withhold tax on the net amount available to Mr. Singh. The undertaking
and the election are made on form NR6 (filed jointly) and must be filed before January 1 of the year in which it
applies or before the rental payment is due. The withholding tax is deemed to have been paid as Part I tax rather
than as withholding tax. Division B deductions (rental expenses, including CCA) may be taken, but no Division
C deductions or non-refundable tax credits are allowed [sec. 216].
If an NR6 has been filed, the section 216 return is required to be filed within six months from the end of the
taxation year, and then the withholding tax may be based on net rental income [ssec. 216(4)]. If the election is
not made under subsection 216(4), the filing of the return under subsection 216(1) must be made within two
years of the year-end. Since the withholding will have been made on gross rent, a refund of some of that
withholding can be expected.
Note that if either alternative under section 216 is chosen, tax will be calculated under Part I of the Act. As a
result, a tax of 48% of the Part I tax is added [ssec. 120(1)]. This additional tax replaces provincial taxes which
are not paid in this situation, because the individual is not resident in a province.

Solutions to Chapter 14 Assignment Problems

247

Solution 6 (Basic)
It is necessary to determine whether the lecturer is an employee of the Canadian university. If this is the
case, withholding tax on employment income would be required [sec. 153] and section 2 would require her to
pay Canadian tax on the employment income.
In this case, it does not appear that she is an employee, since she has been hired to provide a service rather
than to work at an employers discretion. However, withholding on fees, commissions or other amounts for
services is required [par. 153(1)(g)] and a 15% withholding tax on payments to non-residents for services
rendered in Canada is prescribed [Reg. 105(1)].
Under Article XIV of the CanadaU.S. tax treaty, income from independent personal services in Canada is
not subject to tax unless the individual has a fixed base in Canada. It is not likely that the individual in this case
would be considered to have a fixed base in Canada. (See the case of The Queen v. Dudney, 2000 DTC 6169
(F.C.A.), for support of this conclusion.) If there is no fixed base, the university can apply to the CRA on behalf
of the lecturer for permission to waive the withholding tax, or the lecturer can file a Canadian tax return and get a
refund of the tax withheld. Even if permission to waive withholding of tax is not obtained, Article XVII reduces
the withholding tax to 10% on the first $5,000.

248

Federal Income Taxation: Fundamentals

Solution 7 (Advanced)
(1) Royalties payable at Dec. 31, 2008 .....................................................................................................

2009 royalty expense ..........................................................................................................................

Minus: Amount payable at Dec. 31, 2009 ...........................................................................................
Total royalties paid in 2009.................................................................................................................
Withholding tax to be paid to the CRA: 10% thereof (per CanadaU.S. Tax Convention,
[Art. XII(2)]) .......................................................................................................................................
Net amount to be paid to U.S. designer ($50,000 $5,000) ...............................................................

$
$

10,000
60,000
(20,000)
$ 50,000
5,000
45,000

The amounts paid in 2009 are, therefore, correct.

The $20,000 royalty payable at December 31, 2009 is due on January 31, 2010 [IC 77-16R4, par. 54]. Tax
of $2,000 (i.e., 10% $20,000) should be withheld from this payment. The net royalty payment to the designer
should be $18,000.
(2) Since average payroll remittances were less than $15,000 per month, the company is allowed to remit
payroll deductions on the 15th of the month following the payment of the bonus [sec. 153, Reg. 108(1.11)], that
is, July 15, 2010. The bonus must be paid on or before June 28, 2010 [ssec. 78(4)].
(3) Since the presidents wife is self-employed, his deadline for filing returns is June 15 following the
taxation year rather than April 30 [par. 150(1)(d)]. Since the president late-filed his 2007 and 2008 returns and
had a balance due on those returns he is subject to late-filing penalties [ssec. 162(1)]. Since he has a late-filing
penalty for his 2007 return and he received a demand to file his 2008 return, his 2008 return is subject to double
penalties (ssec. 162(2)). Note that because penalties are assessed based on the persons tax payable . . . for the
year that was unpaid when the return was required to be filed, the refund for 2006 cannot be offset by the
balances owing for 2007 and 2008 in determining the amount of the penalty.
The penalties are as follows:

2006
2007

Balance Due
Refund
($20,500)
$10,000

Date Return
Due
June 15, 2007
June 15, 2008

# Full Months
Late
N/A
18 months

2008

$5,010

June 15, 2009

6 months

Total penalty

Penalty
N/A refund
$ 1,700.00

1,102.20

$10,000 @ 17%
(5% plus 1% 12
months*)
$5,010 @ 22%
(10% plus 2% 6
months**)

2,802.20

* maximum number of months per ssec. 162(1)

** double penalty per ssec. 162(2)

(4) Section 233.3 requires the president to report ownership of the U.S. stock at its cost to him ($120,000,
i.e., the fair market value at the relatives death) on a foreign reporting form (Form T1135) for 2009, which is
due on the deadline for filing his 2009 return (June 15, 2010, per par. 150(1)(d)). This is an information reporting
requirement. No tax is payable on the receipt of the stock.
The president is a reporting entity [ssec. 233.3(1)] who must report the cost, if it exceeds $100,000, of a
specified foreign property, i.e., the stock [par. (c) of the definition in ssec. 233.3(1)], since the stock is of a
non-resident corporation. The location of the stock certificates is not relevant.

249

Solutions to Chapter 14 Assignment Problems

Solution 8 (Advanced)
Mrs. Ricky
123 Anywhere Place Anywhere
Canada
Dear Mrs. Ricky
Re: Mr. Rickys Tax Returns
As requested, we have prepared this letter explaining the tax implications and filing requirements for
Mr. Ricky as a result of his death.
Filing Requirements
Mr. Rickys executor must file a regular personal income tax return for the 2009 taxation year six months
from the date of death, i.e., September 1, 2010. Mr. Rickys 2010 terminal tax return for the period January 1,
2010 to March 1, 2010, must be filed by April 30, 2011 [par. 150(1)(b) and (d)].
The executor may elect to defer payment of taxes, related to rights or things and deemed dispositions, in the
form of ten annual instalments plus interest at prescribed rates. The Minister will require security.
Generally, all income earned on a periodic basis must be accrued on a daily basis and included as income in
Mr. Rickys terminal return [par. 70(1)(a)]. Mr. Rickys capital property is deemed to be disposed of at the fair
market value at the time of death, except when such property is left to the spouse [ssec. 70(5)], in which case, a
tax-free rollover at adjusted capital cost is available.
Shares of Shining Ltd.
It is our understanding that 25% of the shares of Shining Ltd. are to be left to your son and the remaining
75% to you. As a result, a tax-free rollover is not available on the 25% left to your son. Therefore, these shares
are deemed to be disposed of at their fair market value on the date of death. The taxable portion of the capital
gain is calculated as follows:
Proceeds of disposition (25% $750,000) .................................................................
ACB (25% $55,000) ................................................................................................
Capital gain .................................................................................................................
Taxable capital gain (1/ 2 ) ............................................................................................

$ 187,500
(13,750)
$ 173,750
$ 86,875

The $86,875 may be tax-free if these shares are eligible for the remainder of the capital gains deduction of
$200,000 (i.e., ($750,000 $350,000) 1/ 2 )
The shares of Shining Ltd. would qualify for the enhanced capital gains deduction if they are considered
qualifying small business corporation (QSBC) shares. Generally, the shares must meet the following tests:
(a) The shares must be shares of a small business corporation at the time of Mr. Rickys death. Based on
the information available, it would appear that the shares meet this test.
(b) The assets held by the corporation (with a fair market value in excess of 50% of the total assets) were
used principally in an active business carried on primarily in Canada throughout the 24 months that
Mr. Ricky held the shares. It would appear that the shares meet this test.
(c) The shares were not owned by anyone other than Mr. Ricky, yourself or your son throughout the
preceding 24 months.
Therefore, on filing, the executor should apply $86,875 of the potential capital gains deduction of $200,000
against these shares. Your son will have an adjusted cost base of $187,500.
If nothing further is done, then your adjusted cost base will be $41,250 (75% of your husbands adjusted
cost base of $55,000). However, if the executor elects, your husbands shares can be deemed to be disposed of at
their fair market value on a share-by-share basis [ssec. 70(6.2)]. This procedure will enable the executor to use up
the remaining QSBC share deduction of $113,125 (i.e., $200,000 $86,575) and will step up your adjusted cost
base accordingly to reduce future capital gains on the disposition of these shares. We would recommend this
procedure and would advise that the executor elect this option on 32 shares. The taxable capital gain on a shareby-share basis would be $3,475 (i.e., [1/ 2 ($750,000 $55,000) 100]). Therefore, the executor should elect on
32 shares (i.e., $113,125 $3,475). The remaining 43 shares will be transferred to you at your husbands ACB.
In determining the ACB of all shares inherited by you, a weighted average cost is computed as follows:
Number of shares
32 (($750,000 100) 32) ........................................
43 (($55,000 100) 43) ..........................................
75 ...............................................................................
Per share:

$263,650
= $3,515.33
75

Cost
$ 240,000
23,650
$ 263,650

250

Federal Income Taxation: Fundamentals

Rental Property
As indicated earlier, the tax-free rollover will not apply as these properties are being left to your daughter.
As a result, Mr. Rickys terminal return will need to reflect a capital gain of:
P of D.....................................................................................................................
Capital cost ............................................................................................................
Capital gain ............................................................................................................
Taxable capital gain (1/ 2 ) .......................................................................................

Unit #1
$ 100,000
72,000
$ 28,000
$ 14,000

Unit #2
$ 100,000
83,000
$ 17,000
$
8,500

In addition, recapture of $22,000 for Unit #1 and $31,000 for Unit #2 would need to be included in
Mr. Rickys return.
Other Assets
Upon Mr. Rickys death, his RRSP is cancelled and the proceeds will be treated as income (refund of
premiums) in your return, since you are the designated beneficiary of Mr. Rickys RRSP. However, you may
defer tax on this income if the funds are transferred into another RRSP within 60 days of the end of the year in
which the funds are received [par. 60(l)]. Mr. Rickys contribution of $17,100 made before his death can be
deducted on the 2009 tax return.
Income
The salary of $20,000 per month is fully taxed in the year received. The January and February salary of
$20,000 per month will be taxed in 2010.
The rental income is also taxable in the year in which it accrues. The bond and savings account interest
earned must be included in Mr. Rickys tax return.
Non-refundable Tax Credits
A claim for the full personal tax credit can be made in 2010 even though Mr. Ricky died in March. A
personal tax credit can also be claimed for yourself, as a spouse, but all of your income for 2010 would be used
in reducing this credit.
Taxable Income for 2010
Before consideration of a rights or things return, Mr. Rickys 2010 taxable income will be:
Salary (2 months) .......................................................................................................................................... $ 40,000
Bonus.............................................................................................................................................................
35,000
Accrued interest on bond ...............................................................................................................................
917
Receivable interest on bond ...........................................................................................................................
500
Savings account interest ................................................................................................................................
150
Rental property income (2 months) ...............................................................................................................
8,000
Recapture on disposition of rental property to daughter:
Unit #1 ......................................................................................................................... $ 22,000
Unit #2 .........................................................................................................................
31,000
53,000
Capital gains Taxable:
Disposition of 25 shares of Shining Ltd. to son............................................................ $ 86,875
Ssec. 70(6.2) election on 32 shares of Shining Ltd. to wife (1/ 2 ($7,500 $550) 32)
111,200
Disposition of rental property to daughter
Unit #1 ........................................
14,000
Unit #2 ........................................
8,500
220,575
RRSP deduction (lesser of $20,000 and 18% of $95,000 (2007 EI))............................................................. (17,100)
Capital gains deduction on QSBC shares ...................................................................................................... (198,075)
Taxable income ............................................................................................................................................. $142,967

It is possible for the executor of the estate to make a contribution to your spousal RRSP in respect of
Mr. Rickys 2010 final return based on his 2009 earned income. This contribution must be made within 60 days
of the end of 2010, i.e., March 1, 2011, to be deductible as shown in the calculation above in the 2010 terminal
return [ssec. 146(5.1)].
Rights or Things
The bond interest of $500 in uncashed bond coupon due on January 4, 2010 is an enforceable right. In
addition, the bonus of $35,000 and $20,000 of salary, unless ordinarily paid periodically, could also be
considered an enforceable right; these would be included on a rights or things return. The rights or things
return is a separate return from the terminal return and must be filed by the later of one year after death and
90 days after the assessment of the terminal return. Including this income on the separate return will result in tax
at a lower federal tax bracket than on the terminal return (i.e., 15% vs. 29%) and there is the opportunity to claim
the same personal tax credits again.

Solutions to Chapter 14 Assignment Problems

251

Note that it is possible to assign rights or things to a beneficiary, if instructions are provided in the will
[ssec. 70(3)]. This would be beneficial, if income splitting could be done with a beneficiary in a lower bracket,
since the beneficiary would pay the tax on the assigned income.

252

Federal Income Taxation: Fundamentals

Solution 9 (Basic)
Sam should explain to his father that he would be required to register for HST purposes and to collect HST
on his taxable supplies. He will be required to remit the net tax for each reporting period to the Receiver
General. Generally, net tax is determined by adding the total amount of HST collected or collectible during the
period less the total amount of input tax credits claimed for the period.
Sam should explain that the reporting period is dependent on the size of the business. A small business
whose revenue is $6 million or less in the preceding year and in the preceding quarters ending in the current year
would be required to file an HST return on a quarterly basis. Where revenue in the preceding year does not
exceed $1,500,000, a registrant may file on an annual basis rather than on a quarterly basis. However, quarterly
instalments are required to be remitted within one month after the end of each fiscal quarter.
The returns for quarterly filers must be filed within one month following the end of the reporting period. If
Mr. Evans elects to report on an annual basis, the return is required to be filed within three months following the
end of the fiscal year.
Mr. Evans is required to maintain documentation to support input tax credits. Documentation could include
invoices, receipts, credit card receipts, written contracts, etc. Depending on the value of the purchase, the
information requirements will vary, but will generally require the vendors name, HST registration number, total
amount of HST charged, and total consideration paid.
As is the case for income tax purposes, adequate books and records are required to be maintained for the
CRAs audit purposes.