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ADMS 4562
Winter 2016
Assignment 2
Worth: 10%
Due: by Monday, April 4, 2016 at 5:00pm
Hand in to Atkinson room 282

(Attention: Jason Fleming)

Please use this coversheet. The assignment question is after the coversheet.

Section (M,N,O)

Last Name

First Name

Student #

You must attach this coversheet to your solution


Your assignment solution can be prepared individually or in groups of up to five
students. You must identify group members on this coversheet. Please list names
alphabetically by last name. You can form a group with students in any section. Each
group must work independently from other groups. Assignments can be submitted
(prior to the deadline) in class or to Atkinson room 282.
Late assignments will not be accepted and will receive a 0. Follow the directions
otherwise you will lose marks.

Your answers, including calculations and appendices, must:

not exceed 6 pages (maximum). Note: the coversheet does not count in the
page limit but all other pages do count. You should number your pages;
be double spaced;
be Times New Roman (or an equivalent sized) font;
have 12 point font (minimum);
have normal margins (i.e., margins of at least one inch on the top, bottom and
each side); and
have Portrait as the page layout (and not Landscape).

Marks will be deducted if any of the above instructions are not followed
It is now March 2016 and you, CPA, work at an accounting firm in Canada.
You and your partner, Saul, have just finished a meeting with your client,
Mrs. Gail.
Mrs. Gail is a 52 year-old resident of Canada who plans to sell her Gail Inc.
(GI) shares that she inherited several years ago from her father. Mrs. Gail is
hoping to minimize income tax on this sale. Additional information about Mrs.
Gail and her GI shares is provided in the Exhibit.
Saul wants you to describe and calculate the federal income tax
consequences to Mrs. Gail and to the purchaser from the proposed sale of GI
shares. Show all your calculations. You should give Income Tax Act (ITA)
section, subsection and paragraph (where applicable) references in order to
support your answer. Do not list multiple ITA references. Saul says you do not
have to discuss the acquisition of control rules.
As part of your analysis of the proposed share sale Saul wants you to explain
in detail why section 84.1 will, or will not, apply to the share sale. Saul wants
you to discuss all of the conditions of section 84.1 in your answer. Also, even
though Mrs. Gail does not want to use subsection 85(1), Saul wants you to
state how s. 85(1) would be better for Mrs. Gail and the purchaser in this
situation. [Note: s. 85(1) is not being used. Saul just wants to know how s.
85(1) would be better, in this case, if it were used. Also, give ITA references,
if applicable, to support your answer.]
After selling all of her GI shares, Mrs. Gail will consider starting up a new
Canadian business. Mrs. Gail will own 100% of this new business. This new
business will operate separately from GI and this new business is expected to
earn $100,000 of Canadian active business income each year. Mrs. Gail
wants to know if there will be any income tax savings or cost in 2017 from

earning $100,000 of Canadian active business income personally versus


earning it in a new Canadian corporation (Operating Company). See the
Exhibit for additional details. Saul wants you to answer this question for Mrs.
Gail and he says that you should assume that Operating Company will pay all
after-tax cash out to Mrs. Gail as a dividend. Saul also reminds you that the
top federal personal income tax rate has been increased from 29% to 33%.
Show all relevant calculations and round to the nearest dollar. You can ignore
the basic personal tax credit. You do not need to give ITA references but you
must consider federal and provincial income taxes (provincial tax rates are
given in the Exhibit). Note: you will lose 1 mark for each incorrect item
included in your analysis of income tax savings or cost.
Saul asks you to look into one more issue for him, relating to Mr. Frank. Mr.
Frank is another client of your accounting firm and for his 2015 personal tax
return Mr. Frank has asked your firm to do the following:
When you prepare my personal tax return, which is filed electronically, I
would like you to add $7,500 of union dues so that I can get a larger
deduction on my return. Even though I didnt incur any union dues and do
not have any receipts, given that we file tax returns electronically we may
not need receipts. If I get audited then Ill pay any extra tax owing but Im
fine with this risk. If you help me with this, in addition to my regular fees, Ill
also pay your firm half of any tax savings that I get with regards to the extra
deduction for union dues. This way we can both benefit.
Saul wants your advice on what specifically should be done in this situation
and why? No calculations and no ITA references are needed.
Note: You can ignore any tax changes from the March 22, 2016
federal budget (for purposes of this assignment).

Exhibit
Additional Information
Mrs. Gail

Mrs. Gail already earns more than $250,000 per year in income before
considering the $100,000 of additional business income that she may
also earn. Mrs. Gail is married and has two adult children

Mrs. Gail currently owns 10,000 common shares of GI1. Mrs. Gails
father, Paul, originally incorporated GI in Ontario in 1978. GI has a
December 31st year-end. In 1978 Paul subscribed for 10,000 common
shares of GI for $8,000 (in aggregate)
o In 1994 Paul elected to trigger a capital gain of $100,000 on his
GI shares in order to increase the adjusted cost base (ACB) of his
shares by $100,000, in aggregate. This election did not affect the
paid-up capital (PUC) of Pauls shares
o In 2010, when the fair market value (FMV) of GI was $1,300,000,
Paul passed away and left all of his GI shares to Mrs. Gail. (Pauls
terminal tax return did not utilize Pauls QSBC capital gains
exemption, with respect to his GI shares, on his death.)

GI operates and active business in Canada and it earns more than


$500,000 of Canadian active business income each year
o Currently GI is not associated with any other company and its
taxable capital has always been less than $10 million
The current FMV of Mrs. Gails GI shares is $4,750,000 in aggregate
VP Inc. (VPI), a private company incorporated in Ontario, is interested
in buying all of Mrs. Gails GI shares
o Mrs. Gail and VPI deal at arms length prior to the share sale
o VPI has a December 31st year-end
o VPI is controlled by the Smithers Family Trust which owns 100%
of the voting common shares of VPI

GI currently has 10,000 common shares issued and outstanding. GI has not issued any
other shares.

o The current FMV of VPI is $20,000,000 in aggregate


o The ACB and PUC of the Smithers Family Trusts VPI common
shares is $30,000 in aggregate
o Mrs. Gail and the Smithers Family Trust deal at arms length at all
times

VPI will purchase all of Mrs. Gails shares in 2016 and it will pay by
issuing 4,750,000 non-voting preferred shares of VPI to Mrs. Gail each
redeemable and retractable for $1

After the 2016 sale of Mrs. Gails GI shares, the only shares that Mrs.
Gail will own are
o the non-voting preferred shares of VPI and
o if she incorporates a new company in 2017 (called Operating
Company) she will also own the Operating Company shares

No one related to Mrs. Gail owns any shares of VPI

Mrs. Gail does not want to file a subsection 85(1) election

Mrs. Gail has already used up all of her QSBC capital gains exemption
room on a past sale of XYZ Inc. shares (a QSBC)

If Mrs. Gail incorporates a new Canadian corporation, Operating


Company, she will be the sole-shareholder and the company will have
a December 31st year-end. You can assume that the corporation will be
incorporated on January 1, 2017. Operating Company will have taxable
capital of less than $10M

Mrs. Gail lives in a province with the following provincial tax rates
effective for 2016 and 2017:
o Personal tax rate on income over $100,000
21%
o Personal tax rate on income equal to and below $100,000
11%
o Dividend tax credit on taxable amount of eligible dividends
10%
o Dividend tax credit on taxable amount of non-eligible dividends
4.3%
o The dividend gross-up equals the federal dividend gross-up

o Corporate tax rate on active business income of $500,000 or less


4.5%
o Corporate tax rate on all other income
11.5%

Mrs. Gail is not an active trader of securities and she does not have
any specialized knowledge about stocks or bonds

Assume that the prescribed interest rate for all periods is 2%