AFM 361
[cover page]
Spring 2010
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AFM 361
Spring 2010
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Instructions:
1. Assume tax rates for 2009 apply in other years as well.
2. Calculators and one copy of the Income Tax Act is allowed.
You can write in your Act and use very small tabs (less than 10 square centimetres). Written
notes and formulae in the Act is acceptible.
However, no paper can be added to the Act in any way! For example, pages (even original
ones) cannot be taped into the Act.
Calculators are also allowed (with no other functionality); and no other electronic devices are
permitted.
3. Time allotments are provided at the beginning of each question as a guide to ensure
that you spend the appropriate amount of time on each question. Do not exceed these
times.
4. Do not cite sections of the Act unless specifically required. However, where reasonable
choices could be made within the law, provide brief reasons for you choice indicating
justification for the tax treatment determined.
5. Indicate clearly all calculations whether or not they seem relevant to the final answer,
particularly include all parts of computations where only one is relevant (for example, all
portions of a “lesser of..” provision).
6. If you feel you require more information in a fact situation, outline the exact information you
need and specify how it would affect your decision, but do not contradict fact or assume the
abnormal.
7. There are 4 questions and 10 pages in this examination.
8. Answer all questions in the examination booklets provided.
AFM 361
Spring 2010
3 of 10
Problem One (20 marks, 20 minutes)
Kevin and Tracy graduated from the MAcc program at the University of Waterloo in 2009. They
wrote the UFE in September 2009 and settled into full time employment shortly thereafter. During
the Master’s program, they were secretly in love and married over Christmas, 2009.
When starting their jobs, Kevin received a salary of $75,000 and Tracy, who always did better in
school, started at $85,000. Due to such a short period of work in 2009, both of their Federal-Ontario
combined marginal tax rates for 2009 were 21.05%. They have no other sources of income.
As a wedding present, the couple received $10,000. They plan to invest the money for a few years
before buying a house. Being knowledgeable in tax, they decide to invest it in an RRSP in January,
2010. Either Kevin or Tracy can invest it and it can be deducted in either 2009 or 2010. No matter
who invests it, half will be put in a spousal RRSP so they each retain rights to half the money. Both
have adequate RRSP room based on co-op work terms.
Assume the tax refund will be received in early 2010 if it is deducted on a 2009 tax return, or in early
2011 if it is deducted on a 2010 tax return.
Required
Determine their optimal tax strategy by computing the after-tax cost of the RRSP investment under
each alternative.
Assume a discount rate of 10%, and federal credits of $2,100 and Ontario credits of $700.
AFM 361
Spring 2010
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Problem Two (45 marks, 45 minutes)
Phil is a salesperson for MPR Ltd. It is now February, 2010. He has correctly drafted his 2009 tax
computation as follows. He has only employment income.
Salary
Bonus based on Phil’s sales1
$ 100,000
30,000
Taxable benefits2—Group life insurance (3 times salary)
Deductions under 8(1)(f)
Car-related expenses3
Meals and entertainment (at 50%)
Support staff
Eligible home office expenses
Deduction claimed
Deductions under 8(1)(i)
Taxable income
Tax payable:
Federal tax, with $2,100 in credits
Ontario basic tax, with $700 of credits
Ontario surtaxes
$ 130,000
500
8,400
9,000
16,000
2,000
35,400
( 30,000)
( 7,000)
$ 93,500
$ 16,101
7,111
1,198
$ 24,410
1. The bonus is 1% of Phil’s sales, which were $3 million in 2009. The bonus will be
paid on June 27, 2010.
2. In addition to the taxable benefits, Phil receives $600 worth of non-taxable group
extended health benefits, and pays 100% of the $420 premiums for the group
accident benefit plan that replaces 60% of salary if Phil becomes unable to work.
Both the group life and group accident benefits are based on Phil’s $100,000
salary; the extended health benefits are not based on salary.
3. Car-related expenses deductible under 8(1)(f) are as follows:
Lease of vehicle at the lesser of:
a 



12, 000  30, 000 1.13
 10, 000 10, 000
b 85% of greater
of (i) 30, 000 1.13 100 85


(ii) 47,860

Fuel
2,500
Maintenance
1,500
14,000
Employment use at 15,000 / 25,000
8,400
800 1.13  365 30  10,999
Phil’s sales have been growing recently and he has asked his employer if he can change his
compensation structure for 2010 and following. After some discussion and thought by his manager,
the company has offered Phil the following compensation: $45,000 salary plus 3% of Phil’s sales.
Phil is excited about the offer since he had already planned to spend more time selling in 2010
(which he will do whether or not he accepts the new contract). He expects that most employment-
AFM 361
Spring 2010
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related expenses will be the same except that he will travel 18,000 km for employment, rather than
15,000 km; and as a result only travel 9,000 km personally, rather than 10,000 km. The increasd
driving will increase fuel costs to approximately $2,700, and the maintenance will increase to $1,700.
He also expects to spend $20,000 on meals and entertainment, rather than only 18,000.
He estimates that, with this increased effort, he will sell at least $3.5 million and maybe $4 million if
all goes well.
Phil would like you to advise him on whether he should accept the new contract or keep the old one.
Please consider both numberical and qualitative aspects.
Required
Provide an analysis of the two alternatives to aid Phil in his decision.
For ease of computations, assume the whole year’s salary is paid in the middle of the year, on
approximately June 27, bonuses are always paid on June 27 of the following year, and that taxes are
paid on the same day as the salary or bonus. If necessary, use a discount rate of 10%.
You can also assume that the contract used and expenses incurred in 2010 will continue unchanged
in 2011 and future years.
AFM 361
Spring 2010
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Problem Three (35 marks, 35 minutes)
Fred and George have come to you for advice. They are joint owners of Weasley’s Wizard
Wheezers, a store that sells practical joke novelties. A summary income statement for 2008 is
presented below.
Weasley’s Wizard Wheezers
Income Statement for Tax Purposes
Year ended November 30, 2008
Revenue
Cost of goods sold
Gross profit
Operating expenses
CCA correctly computed
Interest expense—business operations
Tax expense
$ 160,000
70,000
90,000
$ 17,300
29,700
47,000
43,000
( 7,000)
$ 36,000
Among the assets is the store land and building, located in Diagon Alley. In 2007, the land was
purchased for $750,000 and the building for $250,000. The building has CCA of $14,550 in 2008
and a UCC of $227,950 at the beginning of fiscal 2009.
On January 4, 2009, the store was partially destroyed by an explosion. Quotes received by Fred and
George estimate that it will cost $120,000 to fix the store, but Gringotts Wizarding Bank only paid
$90,000 in settlement of the insurance claim. Before Fred and George fix the store, they are
considering whether they would like to purchase a store down that street that has recently become
available. The new store is somewhat smaller, but the location is even better.
They have found a tentative buyer for their damaged store. He will pay $900,000 for the land and
$175,000 for the building in its present condition. Fred and George would use the proceeds of the
sale, $1,075,000, plus the $90,000 insurance proceeds, to buy the new location. The cost of the new
location is $1,000,000 for the land, plus $250,000 for the building.
The new store location will allow the owners to increase their sales, and gross profits, by 20%, and
they will be closed for only 2 months instead of the 6 months that are needed to rebuild the present
location.
Required
A. Determine income for 2009 under the two alternatives. Assume that monthly gross profit will
be the same as 2008 if they remain in the present location, and that monthly gross profit will
increase 20% if the new location is used.
B. Identify other considerations that will help Fred and George with their decision.
AFM 361
Spring 2010
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Problem Four (50 marks, 50 minutes)
You have accepted a position in the tax compliance department of Canada Revenue Agency
(CRA) after spending the first three years of your career working for a large national accounting
firm. As part of the training in your first week with the CRA, you are completing an exercise to
help develop your skills in identifying non-compliance with the Income Tax Act by corporations
and individuals. As part of this exercise, you have been provided with some information about
Sally Rounds, a fictional taxpayer, who owns Rounds Services Limited (RSL), a fictional
company (Exhibit I).
The exercise contains a set of RSL’s financial statements (Exhibit II). It is to be assumed that
the financial statements were prepared by Sally Rounds. You have also been provided with
information about the 2009 income tax returns that have been filed by RSL and Sally (Exhibit
III).
The exercise requires you to complete a memo to the course instructor that includes an analysis
of the taxpayers’ information and to calculate any preliminary adjustments to taxable income for
both RSL and Sally Rounds for 2009.
RSL was incorporated 3 years ago and it is presumed that it is currently August 30, 2010.
Required:
Prepare the memo.
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Spring 2010
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EXHIBIT I
INFORMATION ABOUT ROUNDS SERVICES LIMITED (RSL) AND SALLY ROUNDS
RSL was incorporated on January 2, 2007 and has a December 31 year end. RSL provides
human resource services to businesses, including advising governments and boards of directors
of larger corporations on compensation packages and short-term placements. Sally Rounds
owns 100% of RSL, which she started in 2007 after spending 20 years in various human resource
positions with large corporations and has been designated as a professional human resource
manager by the Federal Association of Human Resource Professionals (FAHRP).
RSL has four full-time employees and two contract consultants who provide the services on
behalf of RSL. RSL hired the two consultants two years ago and has always paid them as
independent contractors.
Sally receives an annual salary from RSL of $80,000. In addition she is entitled to a bonus based
on revenue from new service contracts. At December 31, 2009, the bonus payable to Sally was
$15,000. $10,000 is to be paid in February 2010 and the remaining $5,000 was paid in August
2010. The $12,000 bonus payable to Sally at December 31, 2008 was paid in May 2009.
Sally drives a Lexus SUV which is leased for her by RSL under a three-year lease agreement
that commenced January 2, 2009. The manufacturer’s list price for the vehicle is $54,000. The
annual lease payments are $13,000 plus 5% GST and 8% PST. The insurance, maintenance and
gasoline for the car amounted to $6,000 for 2009. RSL pays all of these costs as well. Sally
drove the SUV 32,000 kilometres in 2009, 60% of these kilometres were employment related and
the remaining 40% were personal.
RSL pays Sally’s annual FAHRP dues ($410) as well as her annual dues to the local golf club
($5,200). Many of RSL’s contacts have resulted from contacts Sally has met at the golf club.
In order to obtain the lucrative contracts, Sally spends many of her evenings entertaining
executives from various clients and potential clients. RSL reimburses Sally for these expenses
which amounted to $12,000 in 2009.
RSL provides all employees with private heath insurance coverage, including a dental plan, as
well as term life insurance equal to three times salary.
RSL has a defined-contribution Registered Pension Plan (RPP). In 2009, each employee was
entitled to contribute 3% of their salary to the RPP. RSL matches the employee contributions.
RSL incurred the following costs to provide these benefits for Sally in 2009: group health
insurance $280, dental plan $340, life insurance $4,000, and RPP $2,400.
AFM 361
Spring 2010
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EXHIBIT II
Rounds Services Limited
Balance Sheet
December 31, 2009
2009
2008
Assets
Current assets
Cash
Accounts receivable
Prepaid expenses
Property and equipment
Investment
Liabilities
Current liabilities
Accounts payable
Bonus payable
Current portion of long-term debt
$ 21,000
48,000
9,000
78,000
285,100
140,000
$ 503,100
500
42,000
6,000
48,500
178,000
90,000
$ 316,500
$ 80,000
15,000
–
95,000
$ 92,000
12,000
15,000
119,000
30,400
149,400
100
408,000
408,100
$ 503,100
100
167,000
167,100
$ 316,500
Long-term debt
$
Shareholder’s equity
Common shares
Retained earnings
Rounds Services Limited
Excerpts from the Income and Retained Earnings Statement
For year ended December 31, 2009
Revenue
Less: operating expenses
Add: other income
* Income before taxes
Less: income taxes
Net income
Retained earnings, beginning of period
Retained earnings, end of period
2009
$ 840,000
595,000
30,000
275,000
34,000
241,000
167,000
$ 408,000
* RSL’s income includes amortization expense of $23,000.
2008
$ 760,000
596,000
30,000
194,000
27,000
167,000
–
$ 167,000
AFM 361
Spring 2010
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EXHIBIT III
INFORMATION IN THE TAXPAYERS’ FILES
T2-Schedule 1
Net income per financial statements
Add:
Provision for income taxes
Amortization
50% of entertainment and golf fees
Deduct:
Capital cost allowance
Income for tax purposes
(
2009
2008
$ 241,000
$ 167,000
34,000
23,000
8,600
27,000
13,000
7,600
14,000)
$ 292,600
(
10,000)
$ 204,600
Personal Tax Return (2009)
Sally reported 2009 taxable income on her personal income tax return of $89,400, consisting of
salary from RSL of $80,000, plus 9,400 for taxable benefits relating to the SUV. The
employment income of $89,400 is on a T4 prepared by RSL.