Assignment 3 ACCT 73120 FAll 2023 with solutions

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Conestoga College *

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Finance

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Jan 9, 2024

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Assignment 3 Question 1 (20 mrks) Case One - Land with a cost of $423,000 and a FMV of $647,000 is sold to a corporation in exchange for $47,000 in NSC and $600,000 in preferred shares (FMV and legal capital). Case Two - Inventories with a FMV of $87,400 and a cost of $63,200 are sold in exchange for $70,000 in NSC and $17,400 in common shares (FMV and legal capital). Case Three - Depreciable property with a FMV of $124,000, an ACB and capital cost of $115,000, and a UCC of $52,992, is sold for NSC of $100,000, preferred shares with a FMV and legal capital of $10,000, and common shares with a FMV and a legal capital of $14,000. Required : For each of the three Cases provide the following information: A. The minimum and maximum elected amount under the provisions of ITA 85.(1) B. Assuming the minimum elected amount is chosen, the amount of capital gain or business income to be included in the income of the seller. C. Again assuming that the minimum elected amount is chosen, determine the ACB and PUC of the preferred share and common share consideration. 1

Question 2 (10 Marks) Monique Tabor has a depreciable property that she wishes to sell to a new corporation using ITA 85(1). The property has an ACB and capital cost of $450,000, a UCC of $225,000, and a FMV of $675,000. The transfer will take place at an elected amount of $400,000. Ms. Tabor is considering the following alternative forms of consideration: Alternative One Two Three Promissory Note $150,000 $375,000 $300,000 Preferred Shares 150,000 300,000 Nil Common Shares 375,000 Nil 375,000 Total $675,000 $675,000 $675,000 All of the amounts in the preceding table are shown at their respective FMVs. Required: A. For each of the three alternatives, determine the ACB of the consideration received. B. For each of the three alternatives, determine the legal capital and PUC of the share consideration. Question 3 (20 marks) Several years ago, Ms. Jennifer Bond acquired a business location that included land and a building for a total of $950,000. At the time, it was estimated that the FMV of the land was $220,000 and the FMV of the building was $730,000. Ms. Bond carried on the business for several years as a sole proprietor and, during this period, CCA was claimed on the building. As there were years in which she experienced losses, she did not always claim the maximum amount of CCA. Ms. Bond has agreed to take your advice and incorporate the business. She will use ITA 85(1) to sell the land and building to the new corporation in January of 2023. At the time of the sale, the building had a UCC of $625,000. Other relevant amounts were as follows: Elected Property Tax Cost FMV Amount Land $220,000 $ 510,000 $220,000 Building 625,000 980,000 730,000 Total $845,000 $1,490,000 $950,000 There is a $400,000 mortgage on the property that will be assumed by the new corporation. In addition, the new corporation will issue a $500,000 promissory note to Ms. Bond. The remaining consideration will be in the form of common shares with a FMV and legal capital of $590,000. The new corporation does not have a balance in its GRIP account in any of the taxation years under consideration. Required: A. What are the income tax consequences of making this sale at an elected amount of $950,000? Your answer should include amounts to be included in Ms. Bond's income as a result of the sale, as well as the corporation's tax costs for the land and building. 2

B. Compute the ACB of the consideration that Ms. Bond has received from the corporation. C. Compute the PUC of the common share consideration. D. What amounts would be included in Ms. Bond's 2023 net income if, in 2023, she sells the common shares for $650,000? 3

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Solution 1: Case One - Land A. The acceptable range of elected amounts is between the ACB of $423,000 and the FMV of $647,000. B. Using the minimum elected amount of $423,000 would result in no additional income. C. The ACB of the preferred shares would be calculated as follows: Elected Amount $423,000 FMV of NSC ( 47,000) ACB - Preferred Shares $376,000 The PUC reduction would be calculated as follows: Increase in Legal Capital $600,000 Less The excess, if any, of: Elected Amount ($423,000) Over FMV of NSC 47,000 ( 376,000) PUC Reduction $224,000 This would leave the PUC of the preferred shares at $376,000 ($600,000 - $224,000). There are no deemed dividends under ITA 84(1) or shareholder benefits under ITA 15(1) since the FMV of the property sold equals the FMV of the consideration received. Case Two - Inventories A. The range of values would be between the $70,000 in FMV of NSC and the FMV of $87,400. B. Using the minimum $70,000 elected amount would result in business income of $6,800 ($70,000 - $63,200). C. The ACB of the common shares would be calculated as follows: Elected Amount $70,000 Less: FMV of NSC ( 70,000) ACB - Common Shares Nil The PUC reduction would be calculated as follows: Increase in Legal Capital $17,400 Less the excess, if any, of: Elected Amount ($70,000) Over the FMV of NSC 70,000 ( Nil) PUC Reduction $17,400 This would leave the PUC of the common shares at nil ($17,400 - $17,400). There are no deemed dividends under ITA 84(1) or shareholder benefits under ITA 15(1) since the FMV of the property sold equals the FMV of the consideration received. 4

Case Three - Depreciable Property A. The range would be between the FMV of the NSC of $100,000 and the FMV of $124,000. B. Using the $100,000 elected amount would result in business income (recapture) of $47,008 ($100,000 - $52,992). C. The ACB of the preferred shares and common shares would be calculated as follows: Elected Amount $100,000 Less: FMV of NSC ( 100,000) ACB - Preferred Shares and Common Shares Nil The PUC reduction on the preferred and common shares would be calculated as follows: Increase in Legal Capital ($10,000 + $14,000) $24,000 Less the excess, if any, of: Elected Amount ($100,000) Over the FMV of NSC 100,000 ( Nil) PUC Reduction $24,000 The PUC of both the preferred and common shares would be nil ($24,000 - $24,000). The allocation of the PUC reduction would be $10,000 and $14,000 respectively resulting in nil PUC for both classes of shares. There are no deemed dividends under ITA 84(1) or shareholder benefits under ITA 15(1) since the FMV of the property sold equals the FMV of the consideration received. Solution 2 Part A - ACB of Consideration The ACB of the consideration, under the three alternatives, would be calculated as follows: Alternative One Two Three Elected Amount $400,000 $400,000 $400,000 Less: FMV of NSC ( 150,000) ( 375,000) ( 300,000) Available for Share Consideration $250,000 $ 25,000 $100,000 Less: ACB - Preferred Stock ( 150,000) ( 25,000) N/A ACB - Common Stock (Residual) $100,000 N/A $100,000 The ACB of the NSC is equal to its FMV. Part B - Legal Capital and PUC The legal capital for the two classes of shares would be as follows: Alternative One Two Three Preferred Shares $150,000 $300,000 Nil Common Shares 375,000 Nil $375,000 Total Legal Capital $525,000 $300,000 $375,000 The required PUC reduction would be calculated as follows: Alternative One Two Three Increase in Legal Capital - All Shares (A) $525,000 $300,000 $375,000 5

Elected Amount ($400,000) ($400,000) ($400,000) FMV of NSC 150,000 375,000 300,000 Elected Amount, Less NSC (B) ( $250,000) ($ 25,000) ($100,000) Required PUC Reduction (A - B) $275,000 $275,000 $275,000 Alternative One - In Alternative One, the PUC reduction would have to be split between the two classes of shares on the basis of their relative FMVs. The relevant calculation would be as follows: Preferred Shares: [($275,000)($150,000 ÷ $525,000)] = $78,571 Common Shares: [($275,000)($375,000 ÷ $525,000)] = $196,429 This would leave PUC of $71,429 ($150,000 - $78,571) for the preferred shares, and PUC of $178,571 ($375,000 - $196,429) for the common shares. Alternative Two - In Alternative Two, the entire PUC reduction of $275,000 would be allocated to the preferred shares, leaving PUC of $25,000 ($300,000 - $275,000). Alternative Three - In Alternative Three, the entire PUC reduction of $275,000 would be allocated to the common stock, leaving PUC of $100,000 ($375,000 - $275,000). 6

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Solution 3 Part A - Income Tax Consequences of Sale With respect to the land, the $220,000 elected amount will be both the POD to Ms. Bond and the ACB to the corporation. As the elected amount is equal to Ms. Bond's ACB, there will be no income tax consequences resulting from the sale of the land. The elected amount and POD for the building is its original cost, an amount that is in excess of its UCC. This will result in Ms. Bond having to include recapture of $105,000 ($730,000 - $625,000) in her 2023 income. However, with the elected amount at Ms. Bond's original cost for the building, both the capital cost and the UCC will be equal to the elected amount of $730,000. Part B - ACB of Consideration The ACB of all consideration received by Ms. Bond will be the total elected amount of $950,000. It will be allocated as follow: Elected Amount $950,000 FMV of NSC ($400,000 Assumed Debt + $500,000 Promissory Note) ( 900,000) ACB of Common Shares $ 50,000 Part C - PUC of the Share Consideration The calculation of PUC would be as follows: Increase in Legal Capital (FMV) $590,000 Less Excess of: Elected Amount ($950,000) Over the FMV of NSC 900,000 ( 50,000) PUC Reduction $540,000 The PUC of the common shares would be reduced to $50,000 ($590,000 - $540,000). Part D - Sale of Common Shares The increase in 2023 net income from a sale of the shares received as consideration for $650,000 would be as follows: POD $650,000 ACB ( 50,000) Capital Gain $600,000 Inclusion Rate 1/2 Taxable Capital Gain $300,000 7

Income Tax Consequences of Redemption The income tax consequences of a redemption of the shares issued as consideration for $650,000 would be as follows: Proceeds of Redemption $650,000 Less: PUC ( 50,000) ITA 84(3) Deemed Dividend (Non-Eligible) $600,000 There would be no capital gain on this redemption as shown in the following calculation: Redemption Proceeds $650,000 Less: ITA 84(3) Deemed Dividend ( 600,000) Modified POD $ 50,000 ACB ( 50,000) Capital Gain Nil The amount to be included in income for 2023 would be $690,000, the $600,000 deemed non-eligible dividend grossed up by 15%. There would also be a federal dividend tax credit of $62,308 [(9/13)(15%)($600,000)]. 8