Chapter 16 & 17 Problems

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<p>CHAPTER 16</p> <p>Income Deferral: Rollover on Transfers to a Corporation and PitfallsSolution 1 (Basic)Land(1) ......................................................................................... Marketable securities(2) ................................................................ Building(3) ................................................................................... Equipment(4) ................................................................................ Furniture and fixtures(5) ................................................................ Licence(6)..................................................................................... Min. elected amount $ 60,000 60,000 70,000 45,000 7,000 80,000 Income Nil $ 2,500 Nil 5,000 Nil Nil Max. boot $ 60,000 55,000 70,000 40,000 7,000 80,000</p> <p>NOTES TO SOLUTION(1) (a) Minimum elected amount: Greater of: (i) FMV of boot ..................................................................................................... (ii) Lesser of: (A) FMV of property ................................................................. $ 75,000 (B) ACB ................................................................................... $ 60,000 $ 60,000 (60,000) Nil (b) Income: Proceeds .......................................................................................................................... Cost................................................................................................................................. Capital gain/loss .............................................................................................................. (2) (a) Minimum elected amount: Greater of: (i) FMV of boot ..................................................................................................... (ii) Lesser of: (A) FMV of property ................................................................. $ 65,000 (B) ACB ................................................................................... $ 55,000 (b) Proceeds .......................................................................................................................... Cost................................................................................................................................. Gain ................................................................................................................................ Taxable capital gain ......................................................................................................... (3) (a) Minimum elected amount: Greater of: (i) FMV of boot ..................................................................................................... (ii) Least of: (A) FMV of property ................................................................. $ 95,000 (B) UCC of class ....................................................................... $ 70,000 (C) Cost of property .................................................................. $ 85,000 (b) Taxable capital gain: Proceeds .................................................................................................................. Cost ......................................................................................................................... Gain/Loss................................................................................................................. Terminal loss/Recapture: UCC ........................................................................................................................ Less: lesser of: (i) Capital cost ......................................................................... $ 85,000 (ii) Proceeds ............................................................................. $ 70,000 Nil</p> <p>$</p> <p>50,000</p> <p>$</p> <p>60,000</p> <p>$</p> <p>60,000</p> <p>$ $ $ $</p> <p>55,000 60,000 55,000 5,000 2,500</p> <p>$ $</p> <p>55,000 70,000</p> <p>$</p> <p>70,000 (85,000) Nil 70,000</p> <p>$</p> <p>70,000</p> <p>269</p> <p>270</p> <p>Introduction to Federal Income Taxation in Canada(4) (a) Minimum elected amount: Greater of: (i) FMV of boot ..................................................................................................... (ii) Least of: (A) FMV of property ................................................................. $ 50,000 (B) UCC of property.................................................................. $ 40,000 (C) Cost of property .................................................................. $ 65,000 (b) Taxable capital gain: Proceeds .................................................................................................................. Cost ......................................................................................................................... Recapture: UCC ........................................................................................................................ Less: lesser of: (i) Capital cost ......................................................................... $ 65,000 (ii) Proceeds ............................................................................. $ 45,000 Recapture ................................................................................................................. (5) (a) Minimum elected amount: Greater of: (i) FMV of boot ..................................................................................................... (ii) Least of: (A) FMV of property ................................................................. $ 10,000 (B) UCC of class ....................................................................... $ 7,000 (C) Cost of property .................................................................. $ 15,000 (b) Taxable capital gain: Proceeds .................................................................................................................. Cost ......................................................................................................................... Gain/Loss................................................................................................................. Recapture/Terminal loss: UCC ........................................................................................................................ Less: lesser of: (i) Capital cost ......................................................................... $ 15,000 (ii) Proceeds ............................................................................. $ 7,000 Recapture (6) (a) Minimum elected amount: Greater of: (i) FMV of boot ..................................................................................................... (ii) Least of: (A) FMV of property ................................................................. $ 100,000 (B) 4/3 of CEC ........................................................................... $ 80,000 (C) Cost of property .................................................................. $ 82,500 (b) CEC ................................................................................................................................ Proceeds: 3/4 $80,000 ....................................................................................................</p> <p>$ $ $</p> <p>45,000 40,000 50,000 (65,000) Nil 40,000 45,000</p> <p>$</p> <p>$</p> <p>5,000</p> <p>$</p> <p>5,000</p> <p>$ $</p> <p>7,000 7,000 (15,000) Nil 7,000 7,000 Nil</p> <p>$</p> <p>$ $ $</p> <p>15,000 80,000 60,000 60,000 Nil</p> <p>Solutions to Chapter 16 Assignment Problems</p> <p>271</p> <p>Solution 2 (Basic)Section 85 rollover Elijah has only two assets eligible for a subsection 85(1) rollover: the office equipment and the goodwill. To ensure that no income arises on transferring these assets to the corporation, the total elected amount to be agreed on between him and the corporation should not exceed $10,001. The maximum non-share consideration that Elijah can receive while deferring the maximum amount of gain is $10,001.Asset Office equip. Goodwill Tax Value $10,000 Nil $10,000 FMV $12,000 20,000 $32,000 Elected Amount $10,000 1 $10,001 Assumed Debt $9,000 $9,000 New Debt $1,000 1 $1,001 Shares $ 2,000 19,999 $21,999</p> <p>Other transferred property (non-section 85)Asset Cash Accounts receivable** FMV Transfer $ 5,000 $15,000 $20,000 Consideration received $ 5,000 note payable to Elijah $15,000 note payable to Elijah $20,000</p> <p>** An election should be filed under section 22 with regard to the transfer of the receivables. Failure to file the election will result in any bad debts realized by the company being considered capital losses rather than losses on income account.</p> <p>Elijahs income arising on the transfer The only income realized by Elijah is the $1 from the disposition of the goodwill. The taxable portion of the disposition of that, through the CEC account, is $0.50. Tax Values of Assets Owned by the CorporationAssets Cash Accounts receivable Office equipment Goodwill ( $1.00) $ 5,000.00 15,000.00 10,000.00 0.75 $30,000.75</p> <p>Note that transfer of the bank loan to the corporation requires the approval of the bank. If the bank did not approve, a note payable to Elijah can be substituted in the rollover.</p> <p>272 Solution 3 (Basic)</p> <p>Introduction to Federal Income Taxation in Canada</p> <p>The following assets cannot or should not be transferred using section 85:Tax value $ 22,000 44,000 $ 66,000 FMV $ 22,000 39,500 $ 61,500 Minimum transfer price $ 6,000 45,000 8,000 $ 59,000 Transfer price $ 22,000 39,500 $ 61,500 Debt $ 22,000 39,500 $ 61,500 Income Effect Nil $ (4,500) $ (4,500)</p> <p>Cash (not eligible) ........................................... Inventory(1) ......................................................</p> <p>The following assets should be transferred using section 85:Consideration Debt Shares $ 6,000 $ 2,000 45,000 10,000 8,000 22,000 $ 59,000 $ 34,000 Income Effect Nil Nil Nil</p> <p>Furniture &amp; fixtures ..................... Building ...................................... Land............................................ Total ...........................................</p> <p>Tax value $ 6,000 45,000 8,000 $ 59,000</p> <p>FMV $ 8,000 55,000 30,000 $ 93,000</p> <p>There should be no adverse tax consequences on this transfer, since the FMV of the consideration received (i.e., debt and shares) was exactly equal to the FMVs of the transferred assets. In addition, the non-share consideration did not exceed the tax values of the transferred assets.Cost of shares received as consideration: Elected transfer price .............................................................................................................. $ 59,000 Deduct: non-share consideration.............................................................................................. 59,000 Adjusted cost base of shares .................................................................................................... Nil Legal stated capital before reduction.............................................................................................. $ 34,000 Subsection 85(2.1) reduction in PUC: (a) increase in LSC ........................................................................................... $ 34,000 (A) (b) elected amount ........................................................................ $ 59,000 less: boot ................................................................................ 59,000 excess, if any .............................................................................................. Nil (B) PUC reduction (A B)................................................................................................................... 34,000 Tax PUC after reduction ................................................................................................................ Nil</p> <p>The tax PUC after reduction reflects the fact that the tax-paid cost of the assets transferred has been recovered through the debt assumed. The tax basis of all assets was $59,000, which was also the amount Pete elected for the transfer price and was the amount of non-share consideration Pete wished to assume. This nonshare consideration reduces the tax PUC of the common shares to nil, which is a logical result, as all the tax-paid value of the assets is now in the form of the debt which Pete can withdraw tax-free as he wishes and as funds become available. NOTE TO SOLUTION (1) Since there is no possible income to defer on a transfer to the corporation, section 85 does not have to be used. The transfer could be made through a direct sale, taking back debt consideration equal to the fair market value, i.e., $39,500.</p> <p>Solutions to Chapter 16 Assignment Problems</p> <p>273</p> <p>Solution 4 (Advanced)Note: Ms. Hart must transfer the business assets to Hart Ltd. at FMV in order to avoid the application of section 69. If the property is transferred at less than FMV, paragraph 69(1)(b) will still deem Ms. Harts proceeds to be FMV.(A) Income for tax purposes if section 85 not used: Shares in public companies [$6,000 $ 11,000 = $5,000 capital loss denied [par. 40(2)(g)], because it is a superficial loss [sec. 54]; added to the adjusted cost base of the property owned by the corporation [par. 53(1)(f)] .............................................................................................................................. Nil Accounts receivable (capital property) Include last years reserve .................................................................................................... $ 1,000 [$10,000 $14,000 = $4,000 capital loss denied because it is a superficial loss, as above] Nil Inventory Business income .......................................................................................................... 1,000 Land (inventory) Business income ($220,000 $100,000)............................................................................... 120,000 Prepaid insurance Business income (loss) ($600 $600) .................................................................................. Nil Building Terminal loss denied [ssec. 13(21.2)] ................................................................................... Nil Land (capital property) Taxable capital gain [1/2 ($160,000 $140,000)]................................................................ 10,000 Goodwill Business income [2/3 3/4 ($80,000 0)] ........................................................................... 40,000 Total income ............................................................................................................................... $ 172,000 (B) Items not transferred under section 85: FMV Shares ................................................................. (do not transfersee below) Accounts receivable ............................................ $ 10,000 (use section 22 for full business loss of $4,000) Land (inventory) ................................................. (do not transfersee below) Prepaid insurance ................................................ 600 (not capital property) Building..........</p>