1
LECTURE 5 PROBLEM SET (QSBC)
Last updated September 20, 2012
The balance sheet for P Ltd. as at December 31, 2012 is as follows:
Assets
Marketable securities (FMV $250,000)
Accounts receivable (FMV $90,000)
Inventory (FMV $710,000)
Fixed assets (FMV $100,000)
Investment in S Ltd. (FMV $857,000)
Liabilities and Shareholder’s Equity
Account payable and accrued liabilities
Retained Earnings
Share Capital
200,000
90,000
410,000
125,000
175,000
$1,000,000
$300,000
699,000
1,000
$1,000,000
All of the assets of P Ltd. are used directly in an active business in Canada except for the
marketable securities and the Investment in S Ltd. P Ltd. purchased all of the issued and
outstanding shares of shares of S Ltd. in 1990 for $175,000. 95% of the FMV of S Ltd.
assets are used directly in an active business carried on in Canada. The proportion of
assets has been the same in each company for the last two years.
P Ltd. and S Ltd. are both private corporations and were incorporated in Canada. P Ltd.
was incorporated in 1981 by issuing 100 common shares to Mr. P. Mr. P has owned all
of the P Ltd. shares continuously since 1981 and has always been a Canadian resident.
Required:
Mr. P plans to sell the shares of P Ltd. Determine whether the shares of P Ltd. are
qualified small business corporation (QSBC) shares as at December 31, 2012. If the
shares are not QSBC shares indicate the steps that should be taken to purify P Ltd.
Copyright © Joanne Magee/Jason Fleming
2
Answer
The FMV of the assets of P:
AR
Inventory
Fixed assets
Subtotal
Investment in S Inc.
Subtotal
Marketable securities
Total
%
FMV FMV
90,000
710,000
100,000
900,000 44.8%
857,000
1,757,000 87.5%
250,000 12.5%
$ 2,007,000 100%
SBC Test
Test: At the time of sale, P Ltd. must be a SBC
- A SBC is defined as a CCPC having all or substantially all (at least 90%) of the
FMV of its assets used either principally in an active business carried on primarily in
Canada, or shares or debt of a connected SBC, or a combination of the two
Conclusion
- P Ltd. and S Ltd. are both CCPCs since Mr. P, who is a Canadian resident, controls both
(private Canadian) companies either directly or indirectly
- P Ltd. is connected to S Ltd. because P Ltd. controls S Ltd.
- P Ltd. only has 87.5% of assets used in an active business and/or invested in shares of
connected SBC
- S Ltd. is a SBC since it meets the 90% test (95% given in facts)
Conclusion: P Ltd. does not meet the SBC test
Holding Period Test
- Test: Throughout the 24 months preceding the sale, the shares cannot be owned
by anyone other than Mr. P or a related person
- Conclusion: since Mr. P has owned the shares of P Ltd. continuously since 1981, i.e.,
throughout the past 24 months, this test is met
Basic Asset Test
-Test: P Ltd. needs to be a CCPC and to have > 50% of the FMV of its assets used in an
active business carried on primarily in Canada for the 24 months preceding the sale
- P Ltd. is a CCPC (as mentioned in the SBC Test (above)
- P Ltd. has only 44.8% (see chart above) of its assets used in an active
- but it does have shares of a connected corporation
Conclusion: the basic asset test is not met. Try the modified basic asset test.
Copyright © Joanne Magee/Jason Fleming
3
Modified Basic Asset Test
Test: Allows shares or debt of a connected CCPC to be included along with active
business assets. Also requires that either P Ltd. meet a 90% test and S Ltd. meet a 50%
test or vice versa.
(P Ltd. meets a 50% and S Ltd. meets a 90% test, hence the modified basic asset test can
be used)
- P Ltd. has met the 50% test since 87.5% of its assets are used throughout the 24 month
holding period in an active business or are shares or debt of a connected SBC
-S Ltd. has met the 90% test since 95% of its assets are used throughout the 24 month
holding period in an active business
Conclusion: the modified basic asset test has been met since throughout the 24 month
holding period more than 50% (i.e., 87.5% see above) of P Ltd. assets (at FMV) are used
in an active business or are shares or debt of a connected CCPC
B) Steps that could or should be taken to purify:
- He can purify P Ltd. by selling the marketable securities and removing the cash
Calculation of marketable securities to be sold
= $2,007,000 – ($1,757,000/90%) = $54,778.
- Sale of securities will cause a capital gain that is taxed in the year of the sale
- ½ of capital gain is a taxable capital gain subject to tax
- ½ of capital gain is an addition to the capital dividend account
- Use after-tax cash to invest in active business assets
- or pay off liabilities or
- pay tax-free capital dividends
- payment of taxable dividends would result in personal tax
- The FMV of the marketable securities may change which would change the amount that
would be required to sell.
This would need to be verified and adjusted for on the day of the sale
Due to the risk of fluctuation of asset values, the client may wish to sell more than the
minimum amount computed above (and do something with the cash)
Copyright © Joanne Magee/Jason Fleming