Fall 2023 Final Exam: Key Topics and Exam Guidelines

UNIVERSITY OF WINDSOR FALL SEMESTER 2023 FINAL EXAM (2.5 HOURS) ( © Province of Ontario) COURSE 4610- 91 INSTRUCTOR: DONALD E. JONES, CPA/CA/CMA/LPA/MBA/AMCT DECEMBER 11, 2023 Exam Available for Download at 3:20 pm Exam Solutions (Word doc) to be Uploaded to djones@uwindsor.ca by 6:00 pm (see below) INSERT STUDENT NAME: ______________Nahin Chowdhury________________ INSERT STUDENT I.D. NUMBER ____________110068845_________ IMPORTANT NOTES The total exam consists of 20 questions for a total of 90 marks. All questions are to be answered on this Word document file. This exam paper Word file must be submitted for grading purposes. The exam is to be completed on an individual basis without reference to the text book or any other information, whether on line or not. Reference to the Income Tax Act only is allowed. Save your work often. Every 10 minutes is recommended. 3.This exam paper Word file containing all your solutions must returned to be received by the instructor by email to djones@uwindsor.ca for grading by 6:00 pm December 11, 2023. using a subject line of: “(Insert Your Last name) 4610 Final Exam” For example, in the subject line, Robert Brown inserts: “Brown4610Final Exam” A one mark reduction per minute will be assessed on exams received after 6:00 pm. 4. UWIndsor rules on academic integrity apply to this exam so please do your own work. 1

Question # 1 (4 marks) Explain in your own words four reasons for doing an estate freeze. 1. To incorporate children into your company as shareholders 2. To provide a tax free rollover for the shareholders in order to transfer one share into another type of share 3. To allow future profit/growth to accrue to children 4. To defer and minimize tax Question #2 (2 marks) Explain in your own words four ways in which the concept of paid-up capital of a share differs from the adjusted cost base of that same share for tax purposes. 1. Paid up capital is calculated at the corporate level. It doesnt matter who own’s them. Adjusted cost base is affected by who owns the shares and what they paid for them. It is calculated at the shareholder level. 2. Paid up capital is based on the capital contributed to the corporation. Adjusted Cost Base is based on the amount paid for the shares. 3. Paid up capital is averaged among all shares of that class. ACB is unique to each shareholder. 4. PUC provides insight into the equity structure of a company and is essential for calculating metrics. It is crucial for determining the tax implications of an investment Question # 3 (2 marks) Briefly describe in your own words the nature of each of the following types of trust: 1.a testamentary trust When you pass, if your will, says, I'm going to create a trust for somebody, whoever it might be, that's called a testamentary trust. 2

2. an inter vivos trust An inter vivos trust is created while the settlor is still alive and it is defined in the Act to be a trust other than a testamentary trust. Question #4 . (2 marks) What is the effective federal income tax rate for each of the following: 1.an inter-vivos trust - 33% 2.a graduated rate estate trust – same as the graduated rates for individual tax payer Question # 5 (3 marks) Briefly describe in your own words how a bump in cost base may occur on each of the following (3 marks) 1.a vertical amalgamation On an amalgamation where a parent company owns 100% of the shares of its subsidiary company, the new amalgamated company is allowed to bump up the adjusted cost base (ACB) of any non-depreciable capital properties (shares, land, partnership units) that the subsidiary company continuously owned since the parent last acquired control of the subsidiary. 2.a hortizontal amalgamation There is no bump up benefit for a horizontal amalgamation (between a subsidiary and subsidiary) they are just combining their equity and are allowed to make the number of shares whatever they want when they merge. 3

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Q #6. (1 mark) Explain in your own words the reason for the existence of the s. 84.1 anti-avoidance rule on dividend stripping. (1 mark) The purpose of the dividend string provisions in the ITA is to prevent an individual from removing funds from a corp on a tax-free basis through transactions that take advantage of the tax-free intercorporate dividends, the capital gains exemptions and possibly utilization of a section 85 election Q #7. (1 mark) Explain in your own words the reason for the existence of the s. 55 anti-avoidance rule on capital gain stripping. (1 mark) It exists to prevent a Canadian resident corporate shareholder from convicting a capital gain on disposition of shares held in another corporation into a dividend that would not be taxable under Part I or under Part IV due to the connected corporation exemption. The provision applies to taxable dividends received by corporations resident in Canada where the dividend recipient is entitles to a Division C deduction for the dividend and one of the purposes of the dividend is to reduce a capital gain on the disposition of share. Q #8. ( 2 marks) Explain in your own words four steps to complete the payment of a dividend from a CCPC’s capital dividend account. 1. File an election with CRA 2. Calculate the balance of the capital dividend account to file this election 4

3. File a copy of the director’s resolution authorizing a payment from the capital dividend account 4. Pay out dividend Question # 9 (3 marks ) Briefly explain in your own words three different ways that a loan could be made by a corporation to its shareholder without adverse tax consequences. 1. Short term loan - paid within the next year 2. Loan received by virtue of employment - person who is both a shareholder and an employee – a. employee but not a specified employee - owns less than 10% shares b. to help them acquire a home for work or, acquire unissued shares or, buy a motor vehicle for work purposes 3. Loan arising in ordinary course of lender's business : bank or trust company i.e. a loaning business 5

Question # 10 (1 mark) Explain in your own words the purpose of the “at risk” rules for tax purposes as they relate to limited partnerships. The “at risk” rules are say that you cannot write off losses for tax purposes which exceed your at risk capital, So if you invested $25000 in a partnership your at risk capital is $25000 because any amount above that is not at risk. Question #11 (3 marks) List one tax advantage and one disadvantage of doing a holdco freeze instead of on internal freeze. Advantage 1. If you have a holding company, the operating company can pay a dividend up to the holding company tax free Disadvantage 1. Companies must be incorporated to do a holdco freeze. This will cause additional costs and time associated with creating and maintaining the corporation 6

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Question # 12 (14 marks) Deal-Or-No-Deal Inc. is a Canadian-controlled private corporation which will be wound up on January 1, 2024 by its only shareholder, Mr. Howie, who purchased the shares at their paid-up capital amount of $100,000. As at December 31, 2023, its balance sheet appears as follows: Deal-or-No Deal Inc. Balance Sheet December 31, 2023 Assets Liabilities Cash $ 25,000 Bank loan $ 540,000 Accounts receivable (net of 87,500 Future income taxes 50,000 allowance of $ 15,000) Marketable securities 142,500 (F.M.V. $ 320,000) Inventories at cost 222,500 Total 590,000 (F.M.V. $ 155,000) Land at cost 110,000 (F.M.V. $ 450,000) Building at cost 350,000 Shareholder’s equity (UCC $ 75,000; Common shares (P.U.C.) 100,000 (F.M.V. $ 950,000) Retained earnings 697,500 Equipment at cost 450,000 (UCC $ 220,000; (F.M.V. $ 100,000) Goodwill (FMV $ 47,500) ___-____ _______ Total $ 1,387,500 $ 1,387,500 Additional Information: 1. The balance in the corporation’s capital dividend account was $ 40,000 as at December 31, 2023 prior to the wind-up. 2. The corporation pays corporate tax at the rate of 13% on the first $500,000 of active business income, 27% on business income not eligible for the small business deduction and an initial 40% rate on investment income, plus the additional refundable tax of 10 2/3% on investment income. The federal refundable Part I tax rate is 30.67%. The balance in the company’s GRIP is nil at December 31, 2023. 3 The buyer and seller elected under section 22 with respect to accounts receivable. 7

4. Mr. Howie’s ACB of his common shares is equal to the P.U.C. of the shares. On January 1, 2024 the assets are to be liquidated, liabilities paid and the net proceeds distributed to Mr. Howie, effective January 1, 2024. REQUIRED: Insert your responses to the following questions in the blank space indicated. (you need not show your detailed calculations) 1.The total deemed dividend on winding up will be $ ______ 1,919,125.00 __________ 2.The taxable dividend on winding up will be $ ______ 1,584,125.00 __________ 3. The capital dividend account dividend on winding up is $ ________ 335,000.00 ________ 4.The amount of income tax payable by the corporation on the winding up, after deducting any current year refundable Part I tax, is $ ______115,875________ 5.The gross amount of the RDTOH receivable prior to any deemed dividend on winding up is $ ____ 90,476.50 _________ 6.Mr. Howie’s taxable capital gain (allowable capital loss) on the disposition of his shares after winding up will be $ ________ 0 _________ 7. The total funds available for distribution on winding up are $ _______ $1,345,871.87 ____________ 8

Question # 13 (9 marks) The following income statement was prepared for Dewey, Cheatem, How and Now, a partnership comprised of four partners who share income equally: Dewey, Cheatem, How and Now Income Statement For the Year Ended December 31, 2023 Gross revenue $ 880250 Expenses Salaries and benefits – staff 229,000 Office salaries 74,000 Rent 32,000 Office supplies 27,000 Client entertainment 5,075 Donations to charities 25,000 Salaries- partners 40,000 Depreciation 18,000 450,075 430,175 Gain on sale of securities 80,000 Dividend income from taxable Canadian companies 25,000 Capital dividends 5,000 110,000 Net income for accounting purposes $ 540,175 The adjusted cost base to Mr. Cheatem of his partnership interest was $ 45,792 at the beginning of the year. His drawings for the 2023 year were $ 77,500. The dividends were received from a CCPC all of whose income was eligible for the small business deduction. Available capital cost allowance for 2023 is $ 16,222. REQUIRED: Insert your responses to each question in the spaces provided below: 9

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(A)The following items from the above financial statement should be added to “net income for accounting purposes” to calculate net partnership income for tax purposes (add more items to the list below as needed). Item Amount ($) 1. Client Entertainment 5,075 2. Taxable Capital Gain 40,000 3. Donations to Charities 25,000 4. Depreciation 18,000 (B) The following items from the above financial statement should be deducted from “net income for accounting purposes” to calculate net partnership income for tax purposes (add more items to the list below as needed). Item Amount ($) 1. Gain on Sale 80,000 2. Dividend from CCPC 25,000 3. Client Entertainment 2,537.5 4. Capital Dividends 5,000 5. CCA 16,222 10

( C) Mr. Cheatem’s adjusted cost base of his partnership interest at December 31, 2023 is $ _______________ Division B Income to be allocated $499,490.50 Number of partners 4 Mr. Cheatem's $124,872.63 Nature of Income: all Partners Mr. Cheatam's share TCG @ 50% 40,000.00 10000 Dividends 25,000 6250 ABI $434,490.50 $108,622.63 $499,490.50 $124,872.63 Question # 14 (13 marks) Julstan Multi-Enterprise Limited (JML) is a Canadian-controlled private corporation that was incorporated in Ontario in 2003. It has operated with a December 31 year-end since that time. At its December 31, 2003 tax year-end, the balance in its capital dividend account was nil, with no negative amounts carried for future offset. The company now wants to calculate its capital dividend account as at December 31, 2023. The following transactions occurred in the indicated taxation years after December 31, 2003. 2005: Disposed of bonds resulting in a capital gain os $ 10,000 2006: Received a taxable dividend of $ 2000 and capital dividend of $ 5,000 2007: Disposed of shares resulting in a capital loss of $ 4,000 2010: Disposed of equipment resulting in a capital gain of $ 6,000 and recapture of $ 3,000 2011: A customer list was purchased for $ 40,000 11

2014: Sold shares resulting in a capital gain of $ 20,000 2016: Received life insurance proceeds of $100,000 on the life of the president pursuant to a term life insurance policy under which the ACB was $ 20,000 2017: Paid capital dividends of $ 50,000 2019: Sold a customer list for $ 100,000. The company’s class 14.1 balance at the time of the sale was $ 25,000. 2021: Sold shares resulting in a capital gain of $ 37,500. Required: Insert your answers in the spaces provided below. (A)The following items will increase the capital dividend account balance (add more items as required) from December 31, 2003 to December 31, 2023. Item Amount ($) 1. Equipment - capital gain $ 6,000 2. Capital dividend $ 5,000 3. Capital gain 3000 4. Capital gain , sold shares 20,000 5. Sold shares, capital gain 37500 (B)The following items will decrease the capital dividend account balance (add more items as required) from December 31, 2003 to December 31, 2023. Item Amount ($) 1. Paid capital dividends $ 50,000 2. Customer list 75000 3. Capital loss 4000 12

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(C )The following items will not increase or decrease the capital dividend account balance from Decmeber 31, 2003 to December 31, 2023 (add more items as required). 1. Taxable dividend 2000 (D). The CDA balance at December 31, 2023 is $ ______________________ Question #15 (3 marks) XYZ Limited, a CCPC owned solely by Mr. A, redeemed all of the special class B shares owned by Mr. A on March 1, 2023. The pertinent details are as follows: Redemption proceeds - $ 20,000 Total PUC of shares - 18,000 Total ACB of shares - 100 The shares are not qualifying small business corporation shares. Required: Insert your answers to the following questions in the space provided below: (you may insert your calculations for possible part marks) 1.The deemed dividend arising on the share redemption is $ ______ 2,000 _________ 2.The taxable capital gain arising on the share redemption is $ _____ 8,950 __________ 3. The allowable capital loss arising on the share redemption is $ ___0____________ Question # 16 (4 marks) 13

During 2023 Magico Inc., a Ontario CCPC, made the following transactions: (Net of HST) Amount Taxable supplies in Ontario $ 300,000 Taxable supplies exported 100,000 Supplies purchased from a HST registrant (30,000) Salary expenses (70,000) Interest expenses (20,000) $ 280,000 The company uses the long form method to calculate its HST liability. Required: Insert your answers to the following questions in the space provided: 1.The gross amount of HST payable on taxable supplies for 2023 before claiming any input tax credits is $ _____ 39,000 _________ 2.Total input credits allowable for HST purposes for 2023 are $ ______ -3,900 ___________ 14

Q 17. ( 5 marks) ABC Company wants to transfer a building to its subsidiary corporation, WWW Inc., on a tax deferred basis using section 85 of the Income Tax Act. Details of the building are as follows: Cost - $400,000 UCC - $ 250,000 FMV - $ 500,000 Required: What is your recommendation for each of the following: 1.The value to be assigned to any shares issued by WWW Inc. on the transfer of the building ? 250,000 2.The value to be assigned to any debt issued by WW Inc. on the transfer of the building ? 250,000 4. What is a price adjustment clause ? A purchase price adjustment clause is a clause sometimes used by parties to purchase agreements to help allocate risk in the event that the value of underlying assets and liabilities change between the signing of the agreement and the transaction closing. 15

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Q 18. (3 marks) Required: Answer the following questions in your own words. a)What is the purpose of the Tax on Split Income rules ? The purpose of the tax on split income rules is to reduce the income tax advantages that owner/managers of businesses can take by making their minor children, directly/indirectly through trust, shareholders of the corporations. b) What is the purpose of the RDTOH rules ? To track the "extra" corporations pay on investment income, and to preserve their right to claim a tax credit when they pay a taxable dividend to a shareholder. c) What is the purpose of the Capital Dividend Account ? The purpose of capital dividend accounts is to accumulate the non-taxable half of capital gains and deduct the non-allowable portion of capital losses. So there's a cumulative balance which is ran in that account. The account can be negative. Public companies don't have such an account. Only private companies do. 16

Question # 19.( 6 marks) Explain, in your own words , the meaning of any three of the following six terms or concepts: (2 marks for each explanation) 1. “PUC grind” 2. Amalgamation “bump” Refers to when a parent and subsidiary are amalgamaitng and parents tax value is more than the subs' then you are allowed to bump up the ACB of any non-depreciable capital property owned by the subsidiary to make up the difference. The bump up is only allowed if the parent owns 100% of the subsidiary. 3. Partnership interest The partner capital account for accounting purposes is called a partnership interest for tax purposes. Partnership interest is a capital asset If your not a partner in accounting firm, you can not sell your partnership interest. 4. “Hi Lo” Shares 17

5. Safe income Safe income refers to the portion of a corporation's investment income that is eligible for certain tax benefits, such as the payment of tax-free inter-corporate dividends. It is essentially the income on which a corporation can declare tax-free dividends to its shareholders. 6. QSBC shares 20. (10 marks) 1.How is the residence of a trust determined ? (1 mark) To determine the residency of the trust, you have to look at where are the trustees of the trust. Most people that set up trust in Canada, the trustees are actually in Canada. If you have beneficiaries outside of Canada then the estate has the potential of being taxed as a non residential estate. 2.What is common as to how income is calculated for each partner in a partnership and how income is calculated for each beneficiary of a trust ? (1 mark) The different sources of income are distributed along side proportionate tax that each person has to pay. 3.Explain the meaning of purification of a CCPC’s assets. (2 marks) It means to increase the percentage assets used in an active business in Canada. 18

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4.Explain the 21 year rule as it relates to trusts.(1 mark) The 21 year rule says that in the 21st year after a trust has been established, the trust has deemed to dispose all its Assets at fair market value, which means you will have potential tax to pay either in the trust or those gains will be allocated to the beneficiaries and the beneficiaries would pay the tax. 5.List the three most common methods used by CRA in assessing transfer pricing between related corporations (3 marks) 1. Comparable uncontrolled method (CUP) 2. The resale price method (commonly used for distributor) and 3. Cost plus method 6.Why do rules exist in the Income Tax Act with respect to shareholder loans ? ( 1 mark) When a shareholder draws money from the corporation, it is not a dividend and not a salary; not interest and rent either. Just money taken out of business. They exist so that shareholders cant just enjoy tax free money whenever they like. 7.What is the latest date that the terminal tax return for an employed individual who passed away on November 15, 2023 must be filed with CRA to avoid penalties? It's the latter of six months after the date of death or the normal filing date. So, the normal filing date is either way, April 30th for most people or June 15th if they're carrying on an unincorporated business. Remember – Email your completed exam to djones@uwindsor.ca to be received by Prof Jones by 6:00 pm latest 19

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2023 Fall Final Exam (Word Doc)

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