CGA-CANADA ADVANCED PERSONAL & CORPORATE TAXATION [TX2] EXAMINATION December 2009 Marks

Notes:
1. 2. 3. 4. This examination is based on the Canadian Income Tax Act (ITA) and its Regulations consolidated to July 2008. To clarify your answers, you may reference them to the applicable provisions of the ITA and its Regulations (except for Question 1, which is a multiple-choice question). Round all calculations to the nearest dollar. All calculations must be shown in an orderly manner to obtain full marks.

Time: 4 Hours

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Question 1 Select the best answer for each of the following unrelated items. Answer each of these items in your examination booklet by giving the number of your choice. For example, if the best answer for item (a) is (1), write (a)(1) in your examination booklet. If more than one answer is given for an item, that item will not be marked. Incorrect answers will be marked as zero. Marks will not be awarded for explanations. Note:
2 marks each

a.

Which of the following is not a condition for the application of subsection 84.1(1), concerning the non-arms length transfer of shares? 1) 2) 3) 4) The vendor must be an individual residing in Canada. The consideration must consist of shares and notes. The corporation whose shares are transferred must be resident in Canada. The corporation whose shares are transferred and the corporation acquiring them must be connected after the acquisition.

b. Piwi Inc. has a fiscal period that ends on February 28. On April 3, 2007, Piwi lent $50,000 to a shareholder. Under subsection 15(2), what is the latest date by which the shareholder must repay the loan if he does not want to include the amount of the loan in his income? 1) 2) 3) 4) c. February 28, 2009 April 3, 2009 February 28, 2010 April 3, 2010

Bar Ltd. is in financial difficulty. Its sole shareholder, Hoa, had invested $200,000 in the form of a loan and $1,000 in shares. Hoa is selling his interest in Bar to Coat Ltd., a corporation that deals with Hoa at arms length, in return for $1 for the shares and $75,000 for the loan. Bar has a non-capital loss carryforward of $250,000. What are the tax consequences for Bar of Coat purchasing the loan from Hoa for $75,000? 1) 2) 3) 4) None A capital gain of $125,000 A $67,500 reduction in non-capital losses A $125,000 reduction in non-capital losses

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d. Samson owns all the shares of Hair Inc. and Stone Inc. Stone sells a non-depreciable property at its fair market value of $10,000 to Hair. The adjusted cost base of the property for Stone was $15,000. What are the tax consequences of the transaction for Stone? 1) A capital loss deemed to be nil 2) A deductible capital loss of $2,500 3) A capital loss deemed to be nil and addition of the loss to the adjusted cost base of the shares of Hair held by Samson 4) A capital loss deemed to be nil, but loss can be claimed when certain events occur e. Kan Ltd. wants to acquire all the shares of Guru Ltd. from an unrelated person. Guru has depreciable property with a fair market value of $20,000 included in Class 8, with an undepreciated capital cost of $32,000. Guru also has a non-depreciable capital property with a fair market value of $50,000 and an adjusted cost base of $40,000. What are the tax consequences for Guru with respect to these properties as a result of the purchase of the shares by Kan, assuming that the available elections (advantageous or not) are made? 1) 2) 3) 4) f. None A capital cost allowance of $12,000 in Class 8 A taxable capital gain of $5,000 A capital cost allowance of $12,000 in Class 8 and a taxable capital gain of $5,000

Which of the following provisions applicable to the exchange of shares of a corporation for shares of the same corporation requires the exchange of all the shares of a class that are held by the person making the exchange? 1) 2) 3) 4) None Subsection 51(1) Subsection 85(1) Subsection 86(1)

g. Gorgi has a 25% interest in the income of a trust created by his uncle Anton on his death. Gorgi needs money and sells his interest to Ange for $60,000. What amount must Gorgi include in his income as a result of this sale? 1) 2) 3) 4) None A taxable capital gain of $30,000 Income of $60,000 A deemed dividend of $60,000, which must be grossed up by 1/4

h. On July 1, 2008, a former business property is sold by a corporation whose fiscal period ends on October 31. By what date must a replacement property be acquired in order to defer, in whole or in part, the tax consequences of the sale of the former business property? 1) 2) 3) 4) June 30, 2009 October 31, 2009 June 30, 2010 October 31, 2010

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i.

Gerty carried out an estate freeze in favour of her only child by implementing a reorganization of the capital stock of the family corporation Screwdriver Inc. She exchanged all her common shares for 800,000 preferred shares redeemable at the holders option for $1 each. The common shares that she held had a fair market value of $950,000, an adjusted cost base of $120,000, and a paid-up capital of $10,000. The election under subsection 85(1) was not made. What amount must Gerty include in her income with respect to this transaction? 1) 2) 3) 4) None A taxable capital gain of $15,000 A taxable capital gain of $75,000 A deemed dividend of $140,000

j.

Irina acquired the shares of Fleuri Boutique Inc. in 2004 for $50,000. To purchase the shares, she borrowed $35,000 from the bank. This loan carries interest at the rate of 9% per year. Irina sold her shares of Fleuri Boutique for $20,000 in December 2008 to a person with whom she was dealing at arms length. At the time, the unpaid portion of the loan amounted to $24,000. She used the $20,000 from the sale of the shares to make the down payment on a condominium for her personal use. On what amount can Irina continue to claim the interest deduction? 1) 2) 3) 4) None $ 4,000 $14,400 $24,000

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Question 2 Galette Ltd. is a Canadian-controlled private corporation (CCPC) that carries on a business producing and distributing bakery products. All of the 10,000 common shares issued by the corporation are held by Brian, who acquired them for $10,000 when they were issued in 1975. This amount of $10,000 was entered in the books of the corporation as paid-up capital for the shares. Brian, who is your client, has never claimed the capital gains deduction. Since he is nearing retirement age and is thinking about selling the shares of Galette in a few years, he wants to know whether he will be able to claim the capital gains deduction when the shares are sold. He has come to consult you about this. As of today, the balance sheet of Galette is as follows: GALETTE LTD. Balance Sheet Assets Cash Accounts receivable Inventory Investments Capital property 30,000 420,000 325,000 700,000 635,000 $ 2,110,000 $

Liabilities Accounts payable Bank loans Shareholders equity Share capital 10,000 common shares Retained earnings

50,000 650,000

10,000 1,400,000 $ 2,110,000

You also have the following information in your files:

The cash is needed to carry on an active business. The investments consist of guaranteed investment certificates with a fair market value of $700,000. The fair market value of the capital property is $1,625,000. The fair market value of the goodwill related to the business is $400,000. The income of Galette earned and realized after 1971 corresponds to the retained earnings. Investments have never accounted for more than 40% of the fair market value of the assets.

Required 6 a. Discuss the three main criteria that must be met in order for the shares to be considered qualified small business corporation shares giving entitlement to the capital gains deduction. On the basis of those criteria, determine whether the shares of Galette qualify for the capital gains deduction at this time.

10

b. Indicate a way to transfer the investments of Galette to a new corporation with no immediate tax consequences in order to purify Galette. Give detailed explanations with supporting figures at each stage of the planning. Assume that the fair market value of the shares of Galette is currently $280 per share. c. If the transfer of the investments to the new corporation for the purpose of purifying Galette were done following an offer to purchase the shares of Galette by a third party unrelated to Brian or Galette, explain whether the tax consequences would be different from those in part b). Identify any elections that could be made to reduce the tax consequences.

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Question 3 On December 27, 2008, Estel died. She was single. In her will, she left all her assets to her niece Fanny, who is also the executor of her estate. Fanny is an adult who was not Estels dependant. Fanny asks you to prepare Estels final income tax return. You obtain the following information: Estels salary up to December 12, 2008, which was the last pay period before her death, totalled $42,000. The salary for the pay period ended December 28, 2008, which was $1,600 before payroll deductions, was paid to the estate on January 2, 2009. On March 15, 2009, Estels former employer paid her estate the amount of $8,000 in recognition of her long and loyal service. Estel received an interest payment of $4,000 on December 31 of each year from Fanny, to whom she had lent $120,000. On her death, Estel owned the following assets: Cost Registered retirement savings plan Shares of public corporations Amount to be received from Fanny $ 45,000 Fair Market Value $ 240,000 $ 95,000 $ 120,000

In 2008, Estel received $4,000 in eligible dividends from the shares of public corporations. She was also entitled to receive, at the time of her death, an eligible dividend of $1,200. The latter dividend was declared on December 15, 2008 and was paid on January 15, 2009. Required 7 a. Explain how Estels income for 2008 should be reported in order to minimize the income tax payable. Give an explanation for each element that you will not include when computing the income. Make all the allowable elections to minimize Estels income.

b. Indicate the final date for submitting any return that would be filed on behalf of Estel.

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Question 4 Damien, a resident of Canada, had a heart attack at the start of 2009. He was very shaken by this event and decided to reorganize his affairs without consulting anyone. Having calmed down, he comes to see you, a CGA, to find out the tax consequences of the actions that he has taken and to learn whether there is anything he can do to reduce any tax consequences. Before the series of transactions, Damien was the sole shareholder of Square Holdco Inc., a corporation that he created in 1984 and in which he subscribed for 1,000 common shares for $50,000. Square Holdco held all the shares of Triangle Inc., a small business corporation. The 5,000 shares of Triangle, with a paid-up capital of $5,000, had been acquired in 1985 from a person dealing with Damien at arms length for $200,000. Square Holdco also owned all the shares of Diamond Inc., a corporation that owned only investments with an adjusted cost base of $720,000 and a fair market value of $690,000. The shares of Diamond were issued to Square Holdco for $1,000 when Diamond was incorporated. All the corporations have a December 31 year end. Damien also personally owned a commercial property that he leased out. That property had the following characteristics at the start of 2009: Land Cost Fair market value Undepreciated capital cost $ 150,000 $ 200,000 Building $ 625,000 $ 790,000 $ 510,000

In May 2009, Public Inc., a large Canadian public corporation with several million shares issued and outstanding, made an offer to purchase the shares of Triangle for $3,200,000, an offer that Square Holdco promptly accepted. Square Holdco and Public dealt at arms length with each other before and after the transaction. According to the agreement, Public issued 32,000 common shares of its capital stock, which were then listed on the stock exchange at $100 per share, in exchange for the 5,000 shares of Triangle held by Square Holdco. The agreement states that no prescribed form is to be completed. In June 2009, Damien decided to wind up Diamond. The winding-up of Diamond was completed in October 2009. Also in June, Damien transferred the real property that he owned personally to Square Holdco for $990,000 ($200,000 for the land and $790,000 for the building) in exchange for $600,000 cash and 390,000 non-voting, non-participating Class B preferred shares redeemable at the holders option for $1 each. The amount of $390,000 was entered as reported capital of the shares in the legal books of share issuances. Finally, in July 2009, Damien carried out an estate freeze in favour of his common-law partner, Vivianne, and his two minor children. He exchanged his 1,000 common shares of Square Holdco for 4,000,000 voting, non-participating Class D preferred shares redeemable at the holders option for $1 each, with a non-cumulative dividend of 1%. The fair market value of the common shares exchanged was $4,000,000. Damien then created a discretionary trust with his spouse and children as the income and capital beneficiaries, contributing $1,000 to the trust. The trust used this amount to subscribe for the new common shares of Square Holdco. The trustee is a family friend in whom Damien has complete confidence.

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Required 8 a. Determine the tax consequences for Square Holdco only of the transactions concerning Triangle and Diamond. If elections are possible, discuss them, providing explanations and detailed calculations, and make a recommendation on whether or not those elections should be made.

16

b. Determine the tax consequences of the transfer of the real property to Square Holdco for Damien and Square Holdco. If elections are possible, discuss them, providing explanations and detailed calculations, and make a recommendation on whether or not those elections should be made. Assume that the transactions are completed and cannot be changed. Your answer should include, for each possible treatment, the following:

The tax consequences of the disposition The adjusted cost base of the Class B shares for Damien and their paid-up capital The cost of the property for Square Holdco

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c.

If a dividend of $30,000 is paid to the trust by Square Holdco on December 1, 2009 and the trustee, exercising his discretionary power, pays $15,000 to each of the children on December 24, 2009, explain how the dividend of $30,000 will be taxed. If elections are possible, state what they are and make a recommendation as to whether or not they should be made.

d. Damien asks your advice on an investment in a limited partnership that has been proposed to him. Your spouse is one of the promoters of this limited partnership. Briefly explain how you should respond.

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Question 5 Cecile had been in partnership with Petro for five years. The partnership operated under the name Cetro and carried on a computer consulting business. Its fiscal period ended on December 31. In November 2008, Petro received a good job offer abroad and agreed to sell his share of the partnership to Cecile for $60,000 cash. The transaction was completed on January 1, 2009. Cecile took on the liabilities, kept all the assets, and continued to carry on the business on her own. You have been Cetros accountant since the partnership began operating. Cecile wants to consult you to find out the tax consequences of her acquisition of Petros interest, both for her and for Petro. Cetros balance sheet as at December 31, 2008 was as follows: Assets Cash Accounts receivable Computer equipment Liabilities Accounts payable Capital Cecile Petro $ 16,000 140,000 35,000 $ 191,000 $ 16,000

110,000 65,000 $ 191,000

You also have the following information in your files:

The computer equipment was acquired at a cost of $55,000 and is included in Class 45, which has an undepreciated capital cost of $25,000. The adjusted cost base of Ceciles interest on January 1, 2009 was $95,000, and the adjusted cost base of Petros interest was $58,000.

Cecile tells you that the computer equipment had a fair market value of $20,000 on January 1, 2009 and all accounts receivable were collected within the following 60 days. Required Write a letter to Cecile that includes the elements of a tax opinion, explaining all the tax consequences of acquiring Petros share, both for her and for Petro. You should also state the cost of the assets for Cecile.

END OF EXAMINATION 100

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ADVANCED PERSONAL & CORPORATE TAXATION [TX2] EXAMINATION

TX2
Before starting to write the examination, make sure that it is complete and that there are no printing defects. This examination consists of 8 pages. There are 5 questions for a total of 100 marks.

READ THE QUESTIONS CAREFULLY AND ANSWER WHAT IS ASKED.

To assist you in answering the examination questions, CGA-Canada includes the following glossary of terms. Glossary of Assessment Terms Adapted from David Palmer, Study Guide: Developing Effective Study Methods (Vancouver: CGA-Canada, 1996). Copyright David Palmer.
Calculate Mathematically determine the amount or number, showing formulas used and steps taken. (Also Compute). Examine qualities or characteristics that resemble each other. Emphasize similarities, although differences may be mentioned. Compare by observing differences. Stress the dissimilarities of qualities or characteristics. (Also Distinguish between) Express your own judgment concerning the topic or viewpoint in question. Discuss both pros and cons. Clearly state the meaning of the word or term. Relate the meaning specifically to the way it is used in the subject area under discussion. Perhaps also show how the item defined differs from items in other classes. Provide detail on the relevant characteristics, qualities, or events. Create an outcome (e.g., a plan or program) that incorporates the relevant issues and information. Calculate or formulate a response that considers the relevant qualitative and quantitative factors. Give a drawing, chart, plan or graphic answer. Usually you should label a diagram. In some cases, add a brief explanation or description. (Also Draw) This calls for the most complete and detailed answer. Examine and analyze carefully and present both pros and cons. To discuss briefly requires you to state in a few sentences the critical factors. This requires making an informed judgment. Your judgment must be shown to be based on knowledge and information about the subject. (Just stating your own ideas is not sufficient.) Cite authorities. Cite advantages and limitations. In explanatory answers you must clarify the cause(s), or reasons(s). State the how and why of the subject. Give reasons for differences of opinions or of results. Identify Distinguish and specify the important issues, factors, or items, usually based on an evaluation or analysis of a scenario. Illustrate Make clear by giving an example, e.g., a figure, diagram or concrete example. Interpret Translate, give examples of, solve, or comment on a subject, usually making a judgment on it. Justify Prove or give reasons for decisions or conclusions. List Present an itemized series or tabulation. Be concise. Point form is often acceptable. Outline This is an organized description. Give a general overview, stating main and supporting ideas. Use headings and sub-headings, usually in point form. Omit minor details. Prove Establish that something is true by citing evidence or giving clear logical reasons. Recommend Propose an appropriate solution or course of action based on an evaluation or analysis of a scenario. Relate Show how things are connected with each other or how one causes another, correlates with another, or is like another. Review Examine a subject critically, analyzing and commenting on the important statements to be made about it. State Clearly provide a position based on an evaluation, e.g., Agree/Disagree, Correct/Incorrect, Yes/No. (Also Indicate) Summarize Give the main points or facts in condensed form, like the summary of a chapter, omitting details and illustrations. Trace In narrative form, describe progress, development, or historical events from some point of origin. Explain

Compare

Contrast

Criticize

Define

Describe Design

Determine

Diagram

Discuss

Evaluate

CGA-CANADA ADVANCED PERSONAL & CORPORATE TAXATION [TX2] EXAMINATION December 2009 SUGGESTED SOLUTIONS Marks
20 Question 1 Note:
2 marks each

Time: 4 Hours

Sources: a. 2) Topic 3.1 (Level 1); ITA, subsection 84.1(1)

b. 1) Topic 1.2 (Level 1); ITA, subsection 15(2.6) c. 4) Topic 6.1 (Level 1); ITA, subsections 80(3), 80.01(6) to (8)

d. 4) Topic 2.3 (Level 1); ITA, subsection 40(3.4) e. f. 4) Topic 6.4 (Level 1); ITA, subsection 111(5.1) 4) Topic 3.3 (Level 1); ITA, subsection 86(1)

g. 3) Topic 9.6 (Level 1); ITA, section 106 h. 2) Topic 6.2 (Level 1); ITA, paragraphs 44(1)(b) and (d) i. j. 2) Topic 3.2 (Level 1); ITA, subsection 86(2) 3) Topic 6.1 (Level 1); ITA, subsection 20.1(1)

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Question 2 a. To be considered as qualified small business corporation shares on the sale of the shares, three conditions must be satisfied. 1. The shares must not have been held by persons other than the individual or a related person within the 24-month period preceding the transaction. This is the case with Brian, since he has held them since 1975. Thus, this first condition is satisfied. 2. At the time of the sale, the shares must be small business corporation (SBC) shares. This means that the corporation must be a Canadian-controlled private corporation (CCPC), and all or substantially all of its assets, valued at their fair market value, must be used in an active business carried on primarily in Canada. This criterion is not currently satisfied. The investments of $700,000 account for 20% of the assets valued at their fair market value ($700,000 / $3,500,000). 3. Throughout the part of the 24-month period preceding their disposition, the shares must be shares of a CCPC and more than 50% of the assets valued at their fair market value must have been used in a business that the corporation carried on primarily in Canada. This is the case with Galette, whose investments have never exceeded 40% of the fair market value of the assets. Therefore this criterion is satisfied. In conclusion, since the second criterion is not satisfied, the shares of Galette are not eligible for the capital gains deduction.

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b. To transfer the investments to another corporation and purify Galette, it would be necessary to proceed as follows: 1. A new corporation, Baba Inc., must be created by Brian, who will own all the common shares. 2. Using a rollover under subsection 85(1), Brian transfers 2,500 common shares of Galette to Baba as consideration for 700,000 preferred shares redeemable at the holders option for $1 each, having a paid-up capital of $2,500. The agreed amount on the rollover is $2,500, which is the adjusted cost base of the 2,500 shares, so as to avoid any immediate tax consequences. Proceeds of disposition paragraph 85(1)(a) Adjusted cost base Capital gain $ 2,500 (2,500) $ 0

Under paragraph 85(1)(g), the adjusted cost base of the preferred shares received on the rollover will be $2,500, and under the definition of paid-up capital in subsection 89(1) and paragraph 84.1(1)(a), their paid-up capital will also be $2,500. 3. Galette transfers to Baba the $700,000 in investments in exchange for a $700,000 note.

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4. By mutual agreement, Galette purchases the 2,500 common shares of its capital stock held by Baba in exchange for a $700,000 note. The redemption of the 2,500 shares has the following consequences: Deemed dividend subsection 84(3) Amount received Paid-up capital of the 2,500 shares Deemed dividend Capital gain Proceeds of disposition section 54 Amount received Deemed dividend subsection 84(3) Adjusted cost base

$ 700,000 (2,500) $ 697,500

$ 700,000 (697,500)

2,500 (2,500) $ 0

The deemed dividend will be deductible from the income of Baba under subsection 112(1) and will not be subject to Part IV tax unless Galette receives a dividend refund, since the corporations are connected in that both are controlled by Brian. 5. Galette and Baba owe each other $700,000. Thus, to cancel the debts, an exchange of cheques can be arranged. Note:
Other solutions are acceptable.

c.

Subsection 55(2) might apply to the deemed dividend on the redemption of the shares of Galette, since:

A taxable dividend would be received by a corporation resident in Canada. The dividend received would be deductible by the corporation under subsection 112(1). The dividend would be received in the course of a transaction, an event, or a series of transactions or events, one of the results of which, since this is a dividend under the terms of subsection 84(3), would be to substantially reduce the portion of the capital gain which, without the dividend, would have been realized on the disposition of a share at fair market value immediately before the dividend, in this case the shares of Galette. The capital gain may be attributable to anything that is not income earned or realized by the corporation after 1971, since the market value of the shares of Galette is greater than the income earned or realized after 1971. The purchaser is not related to Brian, Baba, or Galette, so the exception provided for in paragraph 55(3)(a) does not apply.

Thus, the taxable dividend would be deemed not to be a dividend received by Baba and instead considered as proceeds of disposition of the shares. This would result in a capital gain of $697,500 ($700,000 $2,500), of which $348,750 would be taxable. A choice could be made under paragraph 55(5)(f) to designate a separate dividend corresponding to the income earned and realized after 1971 attributable to the 2,500 shares, namely $350,000 (2,500 / 10,000 $1,400,000). This would make it possible to reduce the capital gain resulting from the application of subsection 55(2) by that amount. The final result would then be: Deemed dividend Taxable capital gain $347,500 50% $350,000 $ 173,750

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Question 3 a. The amount of employment income accumulated, but not owing, at the time of death is considered a periodic payment and must be added to the income earned since the start of the calendar year on Estels final income tax return [subsection 70(1)]. The amount of $8,000 paid to the estate by the former employer is a death benefit taxable in the hands of the beneficiary if the amount exceeds $10,000 [sub-paragraph 56(1)(a)(iii); definition of death benefit in subsection 248(1)]. This amount does not affect Estels income. The interest receivable is a periodic payment and must be added on Estels final income tax return [subsection 70(1)]. The value of the registered retirement savings plan must be included on Estels final return. Under subsection 70(5), there is a deemed disposition of the shares at their fair market value. It is therefore necessary to include a taxable capital gain of $25,000 [$95,000 $45,000 = $50,000 50% = $25,000] on Estels final return. The dividends received by Estel before her death must be added to her income on her final income tax return. The unpaid dividends constitute a right or thing and must be reported on a separate return [subsection 70(2)]. Final return Employment income ($42,000 + $1,600) Eligible dividends ($4,000 1.45) Interest ($4,000 361 / 365) Registered retirement savings plan Taxable capital gain on the shares Total income Separate return Eligible dividends ($1,200 1.45) $ 1,740 $ 43,600 5,800 3,956 240,000 25,000 $ 318,356

b. Since Estel died on December 27, 2008, the final return must be filed within the six months following the death, that is, no later than June 27, 2009 [paragraph 150(1)(b)]. The separate return for income from rights or things is due either one year after the date of death or within 90 days following the mailing of any notice of assessment concerning the taxpayers income tax for the year of his death, whichever is later [subsection 70(2)].

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Question 4 a. Exchange of shares between Square Holdco Inc. and Public Inc.:

Section 85.1 applies to the exchange of shares. There is a disposition of shares of one corporation in exchange for newly issued shares of another corporation. The acquirer, Public, is a Canadian corporation. The shares exchanged are shares of a taxable Canadian corporation. Square Holdco and Public deal with each other at arms length, both immediately before the exchange and afterward. No election under subsection 85(1) was made or will be made; the agreement states that no prescribed form is to be completed. Square Holdco did not receive any consideration other than Public shares of a single class.

Thus, there is a rollover. Under paragraph 85.1(1)(a), the adjusted cost base of the shares of Triangle becomes the adjusted cost base of the 32,000 shares of Public, that is, $6.25 per share. Square Holdco could choose to dispose of the shares of Public at their fair market value, in which case it would realize a capital gain of $3,000,000 ($3,200,000 $200,000), half of which is taxable. It would then have to pay income tax immediately, which is not desirable. The recommendation is not to make the election so as to avoid paying income tax immediately. Winding-up of Diamond Inc.: This is the winding-up of a wholly-owned subsidiary, to which subsection 88(1) applies. Under paragraph 88(1)(c), Square Holdco acquires the investments of Diamond at their cost amount of $720,000. Under paragraph 88(1)(b), Square Holdco is deemed to have disposed of the shares of Triangle for proceeds equal to the greater of: i) The lesser of the following amounts: The paid-up capital of the shares The cost amount of the assets distributed to Square Holdco ii) The adjusted cost base of the shares: Proceeds of disposition Adjusted cost base Capital gain $ 1,000 $ 720,000 $ 1,000 $ 1,000 $ 1,000 (1,000) $ 0

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b. Transfer of the real property Damien: The disposition was made at fair market value, and subsection 69(1) does not apply. Damien must include the following amounts in his income for 2009: Land Proceeds of disposition Adjusted cost base Capital gain Taxable capital gain 50% Building The lesser of: Capital cost Proceeds of disposition Less: Undepreciated capital cost Recapture of undepreciated capital cost Proceeds of disposition Adjusted cost base Capital gain Taxable capital gain 50% Adjusted cost base of the 390,000 Class B shares Paid-up capital of the 390,000 Class B shares Square Holdco: Cost of land Cost of building Capital cost for capital cost allowance purposes Subparagraph 13(7)(e)(ii) $625,000 + 50% ($790,000 $625,000) $ 200,000 $ 790,000

$ 200,000 150,000 $ 50,000 $ 25,000

$625,000 $790,000

$ 625,000 (510,000) $ 115,000 $ 790,000 (625,000) $ 165,000 $ 82,500 $ 390,000 $ 390,000

$ 707,500

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Election Since Damien received a consideration consisting of shares, it is possible to make an election under subsection 85(1), staying within the limits provided and filing the prescribed form T-2057 within the prescribed time limit or even later, paying the penalty. In the present case, the form should be filed no later than April 30, 2010. Since Damien received a non-share consideration (NSC) of $600,000, it will be possible for him to defer entirely taxation on the transfer of the property by making an appropriate allocation of the $600,000 between the land and the building. The NSC attributed to the land must not exceed the adjusted cost base of $150,000 and the NSC attributed to the building must not exceed $510,000, so that the agreed amount will not exceed these amounts. One solution might be the following, although other solutions are acceptable: Fair Market Value Land Building $ 200,000 790,000 $ 990,000 Agreed Amount $ 150,000 510,000 $ 660,000 Cash $ 150,000 450,000 $ 600,000 Preferred Shares $ 50,000 340,000 $ 390,000

Land Proceeds of disposition [paragraph 85(1)(a)] Adjusted cost base Capital gain Building The lesser of: Capital cost Proceeds of disposition [paragraph 85(1)(a)] Undepreciated capital cost Recapture of undepreciated capital cost Adjusted cost base of the 390,000 Class B shares:

$ 150,000 (150,000) $ 0

$ 625,000 $ 510,000

$ 510,000 (510,000) $ 0

Under paragraph 85(1)(g), the adjusted cost base of the 300,000 Class B shares is the lesser of: i) Fair market value of the shares ii) Agreed amount less fair market value of the non-share consideration $660,000 $600,000 = $60,000 $ 390,000 $ 60,000

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Paid-up capital of the 390,000 Class B shares: Under paragraph 85(2.1)(a), there is a reduction of the PUC equal to: (A B) where A = Increase in the paid-up capital of all the shares following the transfer = $390,000 B = Agreed amount less fair market value of the non-share consideration = $660,000 $600,000 = $60,000 = Increase in the paid-up capital of the class of shares received in consideration of the rollover = $390,000
$ $ , , C A

($390,000 $60,000)

$ 330,000 $ 390,000 (330,000) $ 60,000

Legal paid-up capital Reduction under subsection 85(2.1) Paid-up capital for tax purposes Cost of the property for Square Holdco Land paragraph 85(1)(a) Building subsection 85(5) Capital cost Deduction for capital cost allowance deemed to have been taken Undepreciated capital cost

$ 150,000 $ 625,000 (115,000) $ 510,000

The recommendation should be to make the election under subsection 85(1), since this allows deferral of taxation on the transfer.

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10

c.

The trust created by Damien is an inter vivos trust whose taxation rate is the highest taxation rate for individuals (29%) and whose year end is December 31. This trust is discretionary as to the payment of income. According to the data, for the first fiscal period, ending December 31, 2009, an amount of $30,000 would be considered payable to the beneficiaries within the meaning of subsection 104(24) and could be deducted from the trust of the income under paragraph 104(6)(b). If the amount is deducted from the income of the trust, it must be included in the income of the beneficiaries; and since this is a dividend, it may be treated as such by the beneficiaries under subsection 104(19). However, since the beneficiaries are under 18 years of age and the dividend comes from an unlisted corporation, the tax on split income would apply and the beneficiaries would pay tax at the highest rate for individuals, as is the case for the trust [section 127.4]. Since the dividend would be subject to the tax on split income, the attribution rules contained in sections 74.3 and 74.2 will not apply for allocating income to Damien [subsection 74.5(13)]. It is possible not to deduct the income payable, in whole or in part, from the trust income, in which case the non-deducted amount does not have to be included in the income of the beneficiaries in proportion to their share of the income [subsections 104(13.1) and (13.2)]. In the present case, the taxation rate is the same regardless of whether the income is taxed in the trust or in the hands of the beneficiaries. From a strictly fiscal standpoint, there would therefore be no advantage in recommending that the income payable not be deducted from the income of the trust.

d. CGAs have an obligation to act in the interest of their clients and must not take advantage of any privileged situation without the clients consent or knowledge. A CGA must avoid any situation involving conflict of interest. In this case, the CGA should advise the client that her spouse is involved as a promoter in the limited partnership proposal and leave the client to decide whether he still wants advice from her.

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15 6 (2) (4)

Question 5 The content, presentation, and style of the letter may vary from one individual to another. The 6 marks for professionalism in written communication are allocated as follows:

For presentation (letter form, spelling, grammar, clarity, and logical order) For including the essential elements of a tax opinion:
A description of the terms of reference A presentation of the facts and assumptions on which the comments and conclusions expressed in the letter are based, as well as the source of this information An analysis and conclusion on the tax consequences of acquiring the interest (9 marks are allocated for technical knowledge of taxation, as detailed below) A mention that the tax consequences discussed in the letter are limited to those provided for in the ITA consolidated to the date of the transaction.

Tax consequences: For Petro: Proceeds of disposition ACB Capital gain Taxable capital gain (1/2) For Cecile: Subsection 98(5) applies. Disposition of the interest in the partnership: Proceeds of disposition = The greater of the following amounts: i) Adjusted cost base of the interest ($95,000 + $16,000) Cost of the interest acquired from Petro $ 111,000 60,000 $171,000 $181,000 $ 181,000 (171,000) $ 10,000 $ 5,000 $ 60,000 (58,000) $ 2,000 $ 1,000

ii) Cost amount of the assets received from the partnership ACB of the interest after acquisition of Petros interest Capital gain Taxable capital gain (50%) Cost of assets received by Cecile Cash Accounts receivable Computer equipment Capital cost Capital cost allowance deemed deducted UCC

$ 16,000 140,000 $55,000 (30,000) 25,000 $ 181,000

100

END OF SOLUTIONS

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CGA-CANADA ADVANCED PERSONAL & CORPORATE TAXATION [TX2] EXAMINATION December 2009 EXAMINERS COMMENTS

General comments
The pass rate for this examination was not satisfactory. As mentioned on several occasions in the past, candidates must read the case facts and the questions carefully before they answer. To pass the examination, candidates must answer the questions as they are posed. They receive no marks for answers that do not relate directly to the questions posed. In their answers, candidates must apply the rules to the facts of the case presented. Candidates who only list the rules without applying them to the case receive few or no marks because the goal is generally to assess their ability to apply rules to specific situations.

Specific Comments
Question 1 Multiple choice (Level 1 for all topics) Performance on this question was satisfactory. Parts (e), (i), and (j) posed the greatest difficulty. These questions dealt with the following topics: (e) Module 6, Topic 6.4, Acquisition of control; ITA, subsection 111(5.1) (i) Module 3, Topic 3.2, Reorganization of capital; ITA, subsection 86(2) (j) Module 6, Topic 6.1, Purchase or sale of a business, interest when the source of income ceases to exist; ITA, subsection 20.1(1) Question 2 Capital gains deduction, rollover under subsection 85(1), deemed dividends, deemed proceeds or capital gain under subsection 55(2) (Level 1) Performance on this question was not satisfactory. Candidates did very well on part (a). Most candidates knew the three eligibility criteria well and applied them correctly to the case. A few candidates lost marks because they did not apply the criteria to the case. Candidates did not do as well on parts (b) and (c). Several candidates disregarded the question, which specified that the investments needed to be transferred to a corporation in order to carry out the purification, and suggested that the corporations debts could be paid or that dividends could be paid to the shareholder. These answers were unacceptable. Question 3 Taxes at death (Level 1) Performance on this question was satisfactory. The main difficulty was that candidates considered the periodic payments taxable under subsection 70(1) as amounts that could be included in the separate return for income from rights or things under subsection 70(2). In fact, the amounts taxable under subsection 70(1) are included in the regular return.

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Question 4 Exchange of shares, winding-up of a wholly-owned subsidiary, rollover under subsection 85(1), taxation of a trust and of its beneficiaries, attribution rules and ethics (Level 1) Performance on this question was not satisfactory. In part (a), most candidates identified that one transaction was subject to the application of section 85.1 and the other transaction was subject to the application of subsection 88(1). However, they were not always able to explain all of the tax consequences. Candidates did not do well on part (b). Several candidates did not take into account that the transaction was first a sale of assets with no election being made, which made their answers incomplete. Concerning the rollover, some candidates changed the amount of the non-share consideration, which could not be modified because the transaction had already been completed. Candidates did rather well on part (c), which dealt with the taxation of a trust and attribution rules, except for several candidates who considered that the attribution rules applied in a way that Damien, the father, would pay tax on the dividend paid by the trust. In fact, the dividend would be subject to the tax on split income under section 120.4, and in this case, the attribution rules did not apply. In part (d), most candidates identified correctly the presence of a conflict of interest because the CGAs spouse was one of the promoters of the limited partnership. Question 5 Writing a tax opinion, dissolution of partnerships: rule under subsection 98(5) (Level 1) Performance on this question was satisfactory. The majority of candidates respected the various elements of a tax opinion in their responses. The dissolution of the partnership was subject to subsection 98(5) because the partnership was dissolved and the business was carried on as a proprietorship. Most candidates identified the applicable provision, but several did not apply it correctly, particularly with regard to the computation of the capital gain of the partner who carries on the business alone. The adjusted cost base of the disposed interest needed to be adjusted to take into account the liabilities assumed and the amount paid to the other partner.

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