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Lecture 9
Last updated October 14, 2014
Question 1
It is now early April, 2014 and you, CPA, work for Maximum Accounting Inc. (MAI) a
professional corporation. Mark Vale is a vice president at MAI and he has called you into
his office.
No Cost Inc. (NCI), a Canadian private company with a June 30th year-end, has made an
offer to acquire all of the shares of Don’t Call Inc. (DCI) from its parent corporation,
Clad Companies Inc. (CCI). CCI is a long-time client of your professional corporation.
CCI is a private Canadian corporation with a May 31st year-end.
Mark wants you to draft a memo to him discussing the income tax implications of the
proposed sale of DCI shares. Mark has provided you details on the proposed sale (see
Exhibit I) and background information on CCI (see Exhibit II).
Mark reminds you to look into whether 55(2) may apply to any deemed dividend. Mark
also says to assume that NCI does not get a dividend refund from any (deemed) dividends
triggered. Mark says that for now you should assume all the safe income relates to the
preferred shares (i.e., ignore any allocation of safe income between the common shares
and the preferred shares).
Exhibit I
Proposed Sale Terms
CCI and NCI

Under the proposed sale agreement CCI will sell all of its common shares of DCI
to NCI on May 15, 2014 on a tax-deferred basis by electing under s. 85(1). The
elected amount will be $15,000 and CCI will take back preference shares of NCI
with a redemption/retraction amount of $900,000 as consideration
o These preference shares would represent 15% of all the voting rights and
fair market value of NCI

Immediately following this s. 85(1) transaction, NCI would redeem the preference
shares held by CCI for fair market value
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Exhibit II
Background Information
CCI

Currently CCI owns all of the common shares of DCI, a private Canadian
corporation. These shares have an adjusted cost base and paid up capital of
$15,000 in aggregate and a fair market value of $900,000 in aggregate
o The FMV of the DCI shares is expected to remain stable for the next
several months

NCI has realized and retained earnings for tax purposes since 1971 (i.e., safe
income) of $580,000

Currently NCI deals at arm’s length with DCI and CCI
Solution (Question 1)
Memo
To: VP
From: CPA
Re: Sale of DCI shares
Subsection 85(1) can allow the sale of DCI shares to occur tax-free as long as the s. 85(1)
election form is filed on time. Since all the conditions of s. 85(1) are met: (i) the shares
being sold (DCI) are eligible property; (ii) the purchaser (NCI) is a Canadian corporation;
and (iii) shares of the purchaser are taken back as consideration.
The s. 85(1) election form must be signed by both CCI (the seller) and NCI (the
purchaser) and it is due by the earliest tax return due date for either party [s. 85(6)].
Hence it is due November 30th, 2014 (i.e., 6 months after CCI’s May 31st year-end).
Subsection 85(1) will lead to the following tax consequences:
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CCI will dispose of its DCI shares for P of D equal to the elected amount $15k
ACB
$15k
Capital gain
$0
CCI will acquire $900,000 worth of preferred shares of NCI with an:
ACB equal to the elected amount ($15k) less boot ($0) =
PUC equal to: [using the intuitive approach] the elected
amount ($15k) less boot ($0) =
NCI acquires the DCI shares with an:
ACB equal to the elected amount =
$15k
$15k
$15k
And PUC is unchanged =
$15k
Share Redemption
When NCI redeems its preferred shares the following tax consequences will occur:
Subsection 55(2) applies because:
(i)
Vendor of shares, CCI, is a corporation;
(ii)
Vendor (CCI) and purchaser (NCI), are not related;
(iii) on the redemption of the shares, CCI receives a dividend deductible
under s. 112; and
(iv)
one of the purposes or results of the dividend was to effect a significant reduction
of the capital gain on the sale (redemption) of NCI shares
Intercorporate Canadian dividends can be received free of Part I tax and the (deemed)
dividend can be received free of Part IV tax since the companies are connected and there
was no dividend refund received by the payer (NCI).
CCI owns 15% of NCI and hence it has more than 10% of the votes and FMV and they
are connected.
As long as an optimal s. 55(5)(f) election is filed (and this should be done) CCI will have
a tax-free deemed dividend of $580,000 from NCI and a taxable capital gain of $152,500
on the share redemption in 2014 as can be seen below:
Step 1 – Deemed dividend on redemption
Redemption price
PUC
s. 84(3) Deemed Dividend
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900,000
(15,000)
885,000
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Less
s. 55(5)(f) dividend designated as a separate dividend
attributable to post 71 income
Amount deemed not to be a dividend under s. 55(2)
Step 2 – Capital gain
P of D
Deemed dividend (from above)
Adj. P of D [before 55(2)]
Add: additional P of D [55(2)]
Less: ACB
C.G.
T.C.G.
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(580,000)
305,000
900,000
(885,000)
15,000
305,000
320,000
(15,000)
305,000
152,500
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QUESTION 2 – Partnerships
Klassen Limited and Bonacini Inc. formed B&K Partnership (the “Partnership”) on
January 1, 2014. The Partnership is in the restaurant business and currently owns three
restaurants. Klassen contributed $440,000 to the Partnership while Bonacini contributed
$660,000. Both partners are active in the operation of the business. The partners each
agreed to share in the profits and losses of the partnership in the same proportion as their
initial capital contributions.
The following partnership income statement was prepared by a bookkeeper:
B&K Partnership
INCOME STATEMENT
For the year ending December 31, 2014
Gross revenue
Cost of goods sold
Gross Profit
$2,929,250
1,025,238
1,904,012
Less:
Rent
Salaries & wages
Partner distributions (Note 1)
Interest expense
Meals & entertainment
Depreciation (Note 2)
Charitable donations
Other income:
Gain on sale of marketable securities
Non-eligible dividends from taxable
Canadian corporations
Capital dividends
Net income
$326,000
399,750
222,000
133,250
45,000
217,000
22,000
1,365,000
$539,012
$17,000
11,000
8,000
36,000
$575,012
Notes:
1. The distributions allocated to each of the partners is as follows: Klassen $88,800; and Bonacini - $133,200.
2. The capital cost allowance claimed for the taxation year ending December 31,
2014 is $196,000.
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Other tax information:
1. Klassen has non-capital losses carried forward arising from a separate business of
its own of $67,000 incurred in 2013.
2. Klassen’s income for income tax purposes from this separate business for the
taxation year-ending December 31, 2014 is $247,000.
Required:
A. Compute the partnership’s net income for income tax purposes for the fiscal yearending December 31, 2014.
B. Compute the adjusted cost base of Bonacini’s partnership interest on January 1, 2015.
C. Compute Klassen’s minimum taxable income for its taxation year ending December
31, 2014.
D. How would your answer change if Klassen was an individual rather than a
corporation?
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Solution – Question 2
PART A
Partnership income:
Net income per financial statements
Add:
$575, 012
partnership distribution
meals and entertainment ($45,000 x 50%)
depreciation
charitable donations
TCG ($17,000 x ½ )
222,000
22,500
217,000
22,000
8,500
492,000
1,067,012
Deduct:
CCA
accounting gain
capital dividend
196,000
17,000
8,000
received
Net income for tax purposes
221,000
846,012
PART B
ACB of Bonacini Inc's partnership interest:
Capital contribution
$ 660,000
Add: current year's partnership inc. (60% x 846,012)
507,607
untaxed portion of TCG
(60% x $8,500)
5,100
capital dividends (60% x $8,000)
4,800
charitable donations (60% x $22,000)
13,200
drawings
133,200
517,507
$1,177,507
Deduct:
ACB
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146,400
$1,031,107
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Note: Everyone finds the ACB calculation much more difficult than the income
calculation. The ACB of a partner’s partnership interest is reduced by the partner’s %
share of any charitable donations or political donations made by the partnership. It is
useful to think of this as a “non-cash” draw. Instead of cash, the partner gets a donation
to claim on the partner’s tax return.
PART C
Klassen Ltd.'s taxable income:
Allocation of partnership income (40% x $846,012)
338,405
Additional business income
247,000
Div. B income
585,405
Less:
Taxable Dividends (40% x 11,000)
Charitable donation (40% x 22,000)
4,400
8,800
Non-capital losses (carried forward)
67,000
Taxable income
80,200
505,205
PART D
If Klassen was an individual, Klassen's Division B income would be $586,197 as it
would include an additional $792 for the 18% gross-up on his/her share of the dividends
(i.e., $4,400). Klassen’s only Division C deduction would be the non-capital loss
deduction of $67,000. Therefore his/her taxable income would be $519,197 (i.e.,
$586,197 – $67,000). And he/she would have a charitable donation of $8,800 (eligible
for a tax credit) and a federal dividend tax credit of $572; i.e., 13/18 x gross up ($792)
available for a tax credit.
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