CHAPTER 11

194

Introduction to Federal Income Taxation in Canada193Solutions to Chapter 11 Assignment Problems

CHAPTER 11

Computation of Taxable Income and Tax AfterGeneral Reductions for Corporations

Solution 1 (Basic)2008200920102011

Par. 3(a)Income from business

$54,000$32,000Nil$62,500

Income from property

42,50022,500$18,00010,500

$96,500$54,500$18,000$73,000

Par. 3(b)Taxable capital gains

11,0002,5005,0009,000

Allowable capital losses

(2,000)(2,500)(1)(3,500)Nil

Par. 3(c)$105,500$54,500$19,500$82,000

Par. 3(d)ABIL

(3,750)n/an/an/a

Business loss

n/an/a(75,000)n/a

Par. 3(e) Income from Division B

$101,750$ 54,500Nil$82,000

Sec. 112Inter-company dividends

(42,500)(22,500)(10,500)

$59,250$32,000Nil$71,500

Sec. 110.1Charitable donations:(2)

Carryover

n/a(3,000)

Current

(23,000)(9,000)(13,000)

$36,250$23,000Nil$55,500

Par. 111(1)(b)Net capital losses(3)

(9,000)(1,500)(500)

$27,250$23,000Nil$55,000

Par. 111(1)(a)Non-capital losses(4)

(27,250)(23,000)(24,750)

Taxable income

NilNilNil$30,250

NOTES TO SOLUTION

(1)A maximum of $2,500 can be deducted in 2009.

(2)Charitable donations:

2008: Lesser of:(a) 75% of $101,750 = $76,313

(b) $23,000

Carryforward: Nil

2009: Lesser of:(a) 75% of $54,500 = $40,875

(b) $9,000

Carryforward: Nil

2010: Lesser of:(a) 75% of Nil = Nil

(b) $3,000

Carryforward: $3,000

2011: Lesser of:(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 2008 rates: $13,500 ( /

$9,000

Net capital loss deducted in 2008 to the extent of net taxable capital gains

(9,000)

Nil

2009 net capital loss not utilized

$2,000

2010 net capital loss deducted to the extent of net taxable capital gains

(1,500)

$500

2011 remaining net capital loss deducted in 2011 to the extent of net taxable capital gains(500)

Available for carryforward

Nil

(4) Non-capital losses

Par. 3(d)Loss from business in 2010

$75,000

Dividends deducted under section 112

18,000$93,000

Add: net capital loss deducted

1,500

$94,500

Less: par. 3(c): par. 3(a) dividends

$18,000

par. 3(b) taxable capital gain

1,50019,500

$75,000

Losses utilized:2008

$27,250

2009

23,000

2011

24,75075,000

Closing balance

Nil

Solution 2 (Advanced)The data given in the problem statement can be summarized as follows:

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, 2011 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, 2011 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, 2011 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, 2011 [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)].

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, 2011 is computed below.

Par. 3(a)Business income

Nil

Property income

Nil

Par. 3(b)Net capital gains:

Taxable capital gains

Nil

Allowable capital loss: rental property ($20,000 ( 1/2)

$(10,000)Nil

Par. 3(c)

Nil

Par. 3(d)Business loss

$(60,000)

Property loss

(5,000)$(65,000)

Division B income

Nil

The net capital losses (($10,000 ( 1/2) + $10,000 = $15,000) expire immediately following the October 31, 2011 year-end [par. 111(4)(a)].

The non-capital loss balance at November 1, 2011 is computed as follows:

Balance, Jan. 1, 2011

$42,000

Loss for taxation year ended Oct. 31, 2011:

from business

$60,000

from property

5,000

$65,000

Less Par. 3(c) amount determined above

Nil65,000

Balance, Oct. 31, 2011

$107,000

Less: unutilized losses about to expire:

non-capital property losses

$2,000

current property loss

5,000(7,000)

Balance, Nov. 1, 2011

$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, 2011. Thus, the rental losses ($2,000 + $5,000 = $7,000) expire immediately following the October 31, 2011 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, 2012 and the June 30, 2013 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, 2013. 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, 2012, 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, 2011 is deductible for the June 30, 2013 taxation year. None of it is deductible for the June 30, 2012 taxation year due to the loss in that year. The remainder ($100,000 $54,000 = $46,000) can be carried forward to 2014 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, 2012. Thus $11,000 of the 2012 non-capital loss is deductible in 2013, 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, 2011 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, 2011 will be as follows:

Par. 3(a):Business income

Nil

Property income

Nil

Par. 3(b):Net capital gains:

Taxable capital gains:

Repair shop land ($140,000 $80,000) ( 1/2

$30,000

Repair shop building ($230,000 $150,000) ( 1/2

40,000

$70,000

Allowable capital loss ($20,000 ( 1/2)

(10,000)$60,000

Par. 3(c)

$60,000

Par. 3(d)Business loss

$(60,000)

Less: recapture building ($147,000 $150,000)

3,000

$(57,000)

Property loss

(5,000)(62,000)

Division B income

Nil

Division C deductions:

Par. 111(1)(a)Net capital loss from 2010

$(5,000)

Par. 111(1)(b)Non-capital loss:

Business

$ (Nil)

Property

(Nil)(Nil)(5,000)

Taxable income

Nil

Non-capital loss balance, Nov. 1, 2011:BusinessPropertyTotal

Balance, Jan. 1, 2011

$40,000$2,000$42,000

Added in taxation year ended Oct. 31, 2011

($60K $5K $5K $57K)

7,000Nil7,000

Utilized in taxation year ended Oct. 31, 2011 or expired

(Nil)(2,000)(2,000)

Remaining

$47,000Nil$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, 2011, subject to the restrictions discussed in Part A.

By making the maximum elections possible, the non-capital loss balance of Transtek at November 1, 2011 has been significantly reduced.

Part B (ii)(Minimum election to utilize expiring losses)

The following losses will expire October 31, 2011, if not utilized:

The 2010 net capital loss

$5,000

The Oct. 31, 2011 allowable capital loss

10,000

The rental loss portion of the 2010 non-capital loss

2,000

The Oct. 31, 2011 rental loss

5,000

$22,000

It is impossible to utilize the rental loss portion of the 2010 non-capital loss of $2,000 without triggering sufficient income under paragraph 3(c) to utilize the entire October 31, 2011 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, 2011, 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, 2011 will be $120,000.

* An alternative is considered below.

The income for the taxation year ended October 31, 2011 will be as follows:

Par. 3(a)Business income

Nil

Property income

Nil

Par. 3(b)Net capital gains:

Taxable capital gain:

Repair shop land ($120,000 $80,000) ( 1/2

$20,000

Allowable capital loss ($20,000 ( 1/2)

(10,000)$10,000

Par. 3(c)

$10,000

Par. 3(d)Business loss

$(60,000)

Property loss

(5,000)(65,000)

Division B income

Nil

Division C deductions:

Par. 111(1)(a) Net capital loss from 2010

$(5,000)

Taxable income

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, 2011 is computed as follows:

Balance, Jan. 1, 2011

$42,000

Par. 3(d)Loss for taxation year ended Oct. 31, 2011:

from business

$60,000

from property

5,000

$65,000

Add: Net capital loss deducted

5,000

$70,000

Less: Par. 3(c) amount determined above

(10,000)60,000*

Balance, Oct. 31, 2011

$102,000

Less: the unutilized non-capital property loss

(2,000)

Balance, Nov. 1, 2011

$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, 2011. 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, 2011:

No electionMaximum electionPartial election

Par. 3(a) Income from non-capital sources ( 0)

NilNilNil

Par. 3(b) Net taxable capital gains ( 0):

Deemed taxable capital gains (elective):

land

Nil$30,000$20,000

building

Nil40,000Nil

Accrued allowable capital loss (automatic):

rental land

$(10,000)Nil(10,000)$60,000(10,000)$10,000

Par. 3(c) Par. 3(a) + par. 3(b)

Nil$60,000$10,000

Par. 3(d) Losses from non-capital sources and ABILs:

Loss from business operations

$(60,000)$(60,000)$(60,000)

Recapture (elective): building

Nil3,000Nil

Loss from property

(5,000)(65,000)(5,000)(62,000)(5,000)(65,000)

Division B income

NilNilNil

Optional net capital loss deducted

Nil(5,000)(5,000)

Non-capital loss deducted:

From property

NilNilNil

From business

NilNilNil(Nil)NilNil

Taxable income

NilNilNil

Non-Capital Losses Available for Carryforward at Deemed Taxation Year Ended October 31, 2011:

No electionMaximum electionPartial election

Balance from Jan. 1, 2011

$42,000$42,000$42,000

Non-capital loss Oct. 31, 2011:

Par. 3(d) losses see above

$65,000$62,000$65,000

Add: net capital losses deducted

Nil5,0005,000

$65,000$67,000$70,000

Less: par. 3(c) income see above

Nil65,00060,0007,00010,00060,000

$107,000$49,000$102,000

Less: losses utilized at Oct. 31, 2011

NilNilNil

losses not utilized but expired:

Current property loss

$5,000NilNil

Carryforward property loss

2,0007,0002,0002,0002,0002,000

Available for carryforward from Nov. 1, 2011$100,000$47,000$100,000

Net Capital Losses available for CarryforwardNilNilNil

The results of the above comparison of the three alternatives are further summarized as follows:

Options(A)(B)(i)(B)(ii)

Taxable income

NilNilNil

Net capital loss deducted

Nil$5,000$5,000

Non-capital loss balance, Nov. 1, 2011

$100,00047,000100,000

ACB of repair shop land

80,000140,000120,000

ACB of repair shop building

150,000230,000150,000

UCC of repair shop building

147,000190,000*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, 2011 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, 2012, 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:

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).

Solution 3 (Advanced)The data given in the problem statement can be summarized as follows:

SHAPE \* MERGEFORMAT

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, 2011 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, 2011 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 non-capital loss carryforward of $130,000. Therefore, the non-capital loss available to carry forward from June 30, 2011 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, 2011, immediately before the acquisition of control by Buns Plus Ltd. on July 1, 2011 [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 2008, 2009, and 2010.

Loss from Non-capital Sources

Losses from non-capital sources for the deemed taxation year ended June 30, 2011, before any elections and options are computed as follows:

Loss from business

$10,000

Add:Inventory loss [ssec. 10(1)] ($85,000 $65,000)

20,000

Bakery equipment Deemed CCA ($86,000 $70,000)

16,000

Total business losses

$46,000

Add:Property loss (will expire unless utilized by June 30, 2011)

5,500

Total losses from non-capital sources

$51,500

Maximum Election

Division B income and taxable income

Par. 3(a)Income from non-capital sources

Nil

Par. 3(b)Net taxable capital gains:

Election on land [($195,000 $155,000) ( 1/2]

$20,000

Election on building [($75,000 $65,000) ( 1/2]

5,000

$25,000

Less: Allowable capital loss

(2,000)

Par. 3(c) Sum of par. 3(a) plus par. 3(b) less any Subdivision e deductions (nil)

$23,000

Par. 3(d)Property loss

$5,500

Business losses

46,000

$51,500

Less: Building recapture

(20,000)31,500

Sec. 3 income

Nil

Division C deductions:

Net capital losses:2008

$6,000

2009

4,000

2010

2,000$12,000

Taxable income

Nil

Non-capital losses available for carryforward after acquisition of control:

Balance July 1, 2011

2008 non-CL

$60,000

2009 non-CL

45,000

2010 non-CL

25,000$130,000

Non-CL from deemed taxation year before acquisition of control:

Total par. 3(d) loss (see above calculation)

$31,500

Add: Net capital loss deducted

12,000

$43,500

Less: Par. 3(c) income above

(23,000)20,500

Total non-capital losses

$150,500

The $150,500 loss carryforward balance must reasonably be regarded as its loss from carrying on a business.

2008, 2009, and 2010 loss carryforwards from a business as stated in the question

$130,000

June 30, 2010 business loss net of recapture

$26,000

Less portion of this loss used against par. 3(c) income*

(5,500)20,500

$150,500

* Par. 3(c) income

$23,000

Less:

Property losses

$5,500

Net capital losses restored as business losses

12,000(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.

2008 non-CL on December 31, 20272009 non-CL on December 31, 20282010 non-CL on December 31, 2029 2011 deemed taxation year on December 31, 2030The adjusted cost base/capital cost of the properties which were deemed to be sold at their fair market values would be:

Capital costUCCAdjusted cost base

Bakery equipment

$100,000$70,000$100,000

Land

n/an/a195,000

Building* (Class 1)

70,00070,00075,000

* $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 2012.

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, 2011 as follows:

Lesser of:

(a)Net income for year

$90,000

(b)Income from:the loss business

Nil

the sale of similar products

$130,000$130,000

The remaining $60,500 ($150,500 $90,000) of non-capital losses can be carried forward to 2012 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)Non-capital sources of incomeNil

Par. 3(b)Net taxable capital gain:

Land, 1/2 ($194,000 $155,000)

$19,500

Allowable capital loss

(2,000)$17,500

Par. 3(c)Sum of par. 3(a) plus par. 3(b) less any Subdivision e deductions (nil)

$17,500

Par. 3(d)Property loss

$5,500

Business loss

46,000

$51,500

Less: Building recapture

Nil51,500

Sec. 3 income

Nil

Division C

Net capital loss

$12,000

Taxable income

Nil

Non-capital losses available for carryforward after the acquisition of control:

Balance, July 1, 2011

$130,000

Non-capital losses from the deemed taxation year ended June 30, 2010

$51,500

Add: Net capital losses deducted above

12,000

$63,500

Less: Par. 3(c) income above

(17,500)46,000*

Total non-capital losses

$176,000

* Exactly equal to the business loss above.

Summary

The two alternatives presented above are summarized as follows for comparative purposes:

Taxable Income for the Deemed Taxation Year Ended June 30, 2011:

Maximum electionPartial election

Par. 3(a)Income from non-capital sources ( 0)

NilNil

Par. 3(b)Net taxable capital gains ( 0):

Deemed taxable capital gains (elective):

land

$20,000$19,500

building

5,000Nil

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

20,000Nil

Loss from property

(5,500)(31,500)(5,500)(51,500)

Division B income

NilNil

Optional net capital loss deducted

(12,000)(12,000)

Non-capital loss deducted

NilNil

Taxable income

NilNil

Non-Capital Losses available for Carryforward at Deemed Taxation Year ended June 30, 2011:

Maximum electionPartial election

Balance, Jan. 1, 2011

$130,000$130,000

Non-capital loss June. 30, 2011:

Par. 3(d) losses see above

$31,500$51,500

Add: net capital losses deducted

12,00012,000

$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, 2011

NilNil

losses not utilized but expired

NilNilNilNil

Available for carryforward from June. 30, 2011

$150,500$176,000

Net Capital Losses available for Carryforward

NilNil

The results of the above comparison of the two alternatives are further summarized as follows:

Options(a)(b)Difference

Taxable income

000

Net capital loss deducted

$12,000$12,0000

Total non-capital losses available for carryforward

150,500176,000$25,500

ACB of land

195,000194,000(1,000)

UCC of building (Class 1)

70,00045,000(25,000)

ACB of building

75,00065,000(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.Solution 4 (Basic)Net income before income taxes

$342,000

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)]

1,950147,035

Subtotal

$489,035

Deduct:Capital cost allowance [par. 20(1)(a)]

$149,500

Gain on sale of land [ssec. 9(3)]

126,200(275,700)

$213,335

Add:Taxable capital gain on business land [sec. 38]: 1/2 ( ($200,000 $73,800)

$63,100

Allowable capital loss on investments [sec. 38]: 1/2 ( ($75,000 $85,000):

(5,000)58,100

Net income under Division B

$271,435

Less Division C deductions:

Charitable donations [sec. 110.1]

$22,500

Dividends [sec. 112]

42,800

Non-capital loss [par. 111(1)(b)]

73,800

Net capital loss [par. 111(1)(a)]: $75,000 ( 4/3 ( 1/2

50,000(189,100)

Taxable income

$82,335

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)].

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.

Solution 6 (Basic)Income under Division B from consulting business

$264,000

Canadian investment royalty income

10,000

U.K. non-foreign affiliate dividend income

20,000

Taxable dividend received from non-connected Canadian corporations

5,000

Taxable capital gains

6,000

Income under Division B

$305,000

Deduct:

Charitable donations (not exceeding 75% ( $305,000 = $228,750)

(100,000)

Canadian dividends received

(5,000)

1999 net capital loss ($12,000 ( 1/2 / 3/4; limited to taxable capital gains of $6,000)

(6,000)

Taxable income

$194,000

Basic federal tax at 38% of $194,000

$73,720

Deduct: Abatement from federal tax (see Schedule 1)

(13,580)

Net

$60,140

Deduct:

Non-business foreign tax credit (see Schedule 2)

(2,573)

Business foreign tax credit (see Schedule 3)

(17,486)

Tax reduction (11.5% of $194,000)

(22,310)

Part I tax payable (federal)

$17,771

Provincial tax:

British Columbia 10% of $77,600

7,760

Alberta rate 10% of $58,200

5,820

Total tax

$31,351

Schedule 1: Abatement from federal tax

B.C.AlbertaTotal Cdn.U.S.Total

Gross revenues

$3,000K$3,000K$6,000K$4,000K$10,000K

% gr. revenues (1)

30%30%60%40%100%

Salaries and wages

$500K$300K$800K$200K$1,000K

% S&W (2)

50%30%80%20%100%

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$3,000

(ii)

tax otherwise payable afterabatement minus general tax reduction

($60,140 $22,310)

$37,850 =

$2,573

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)

$19,000

(ii)

tax otherwise payableminus general tax

reduction

($73,720 $22,310)

$51,410 =

$17,486

(iii)tax otherwise payable before any reduction or credits plus surtax less non-business tax credit ($73,720 $22,310 $2,573)

$48,837

Least amount is $17,486.

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 16.5%

$165,000

Investment tax credit

(165,000)

Net federal tax payable under Part I

Nil

(C)The remaining investment tax credit of $235,000 (i.e., $400,000 $165,000) 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 $165,000 [par. 12(1)(t)].

Solution 8 (Basic)Income under Division B:

Operating profits

$500,000

Dividends from taxable Canadian corporations

85,000

Canadian investment income (i.e., interest income)

52,500

Foreign investment income ($61,000 + $10,000)

71,000

$708,500

Add:donations

9,755

Division B income

$718,255

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(350,300)

Taxable income

$367,955

Federal tax (38% of $367,955)

$139,823

Federal abatement (10% of $367,955)

(36,796)

Federal tax after abatement

$103,027

Less: Foreign non-business tax credit(1)

6,807

Tax rate reduction (11.5% of $367,955)

42,315(49,122)

Federal tax before investment tax credit

$53,905

Investment tax credit (10% of $250,000)

(25,000)

Part I federal tax payable

$28,905

New Brunswick tax @ 11% of $367,955

40,475

Total tax liability

$69,380

NOTE TO SOLUTION

(1)Foreign non-business tax credit

Lesser of:

(i)Amount paid

$10,000

(ii)

$6,807

Solution 9 (Advanced)Net income under Division B

$2,097,000

Division C deductions:Dividends from taxable Canadian corporations

(15,000)

Charitable donations (max. 75% ( $2,097,000)

(50,000)

Net capital losses ($9,000 ( 1/2 / 3/4)

(6,000)

Non-capital losses

(60,000)

Taxable income

$1,966,000

Tax @ 38%

$747,080

Federal abatement(1)

(115,994)

$631,086

Non-business foreign tax deductions(2)

(3,000)

Business foreign tax deductions(3)

(200,000)

Tax reduction (11.5% of $1,966,000)

(226,090)

Federal tax before investment tax credit

$201,996

Investment tax credit(4)

(30,000)

Federal Part I tax payable

$171,996

Provincial tax payable:Ontario @ 11.5% ( $963,340

$110,784

Alberta @ 10% ( $196,600

19,660

$130,444

NOTES TO SOLUTION

(1)Federal abatement:

Gross revenueSalaries & wages

Amount%Amount%Average percentage

Ontario

$6,000,00054.6%$2,540,00043.3%1/2 (54.6% + 43.3%) = 49.0%

Alberta

400,0003.6960,00016.41/2 (3.6% + 16.4%) = 10.0%

$6,400,00058.2$3,500,00059.71/2 (58.2% + 59.7%) = 59.0%

U.S.

4,600,00041.82,360,00040.3

Total

$11,000,000100.0%$5,860,000100.0%

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$3,000

(b)

(tax otherwise payable(basic abatement general reduction)

$3,902

(3)Business foreign tax deduction:

least of:

(a)tax paid

$200,000

(b)

(tax otherwise payable(basic general reduction)

$ 200,767

(c)tax otherwise payable minus non-business foreign tax deduction ($747,080 $226,090 $3,000)

$517,980

(4)Investment tax credit: 20% ( $150,000 = $30,000Since all $150,000 of the expenditure was deducted in 2011, all $30,000 of the ITC claimed in 2011 will be included in income in 2012 [par. 12(1)(t)].

Advisory CaseKing Enterprises Inc.

ADVISORY CASE DISCUSSION NOTESThis 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.

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.

potential offset

potential

offset

taxable capital gain

potential offset

business income

allowable capital losses

from non-capital sources

40,000

$30,000

10,000

$10,000

5,000

$3,000

$5,000

$60,000

2,000

$5,000

$5,000

$2,000

$40,000

TCGland

building

recapturebuilding

potential elections

property

business

rental property

current deemed

year-end losses

rental property

2010repair business

expiration after deemed year-end

net capital losses

non-capital losses

carryforward losses

$22,000

$70,000

$5,500

ACL

business income

potential offset

potential

offset

taxable capital gain

allowable capital losses

from non-capital sources

5,000

$20,000

2,000

$2,000

5,500

$20,000

$12,000

TCGland

building

recapturebuilding

potential elections

property

businessoperations

inventory

equipment

current deemed

year-end losses

expiration after deemed year-end

net capital losses

non-capital losses

carryforward losses

$19,500

$25,000

potential offset

2008

2009

2010

$60,000

45,000

25,000

$130,000

$6,000

4,000

2,000

$12,000

$10,000

20,000

16,000

$46,000

177

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