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CGA-CANADA

ADVANCED PERSONAL & CORPORATE TAXATION [TX2] EXAMINATION


December 2010
Marks

Time: 4 Hours
Notes:
1.
2.
3.
4.

20

This examination is based on the Canadian Income Tax Act (ITA) and its Regulations consolidated to July 2009.
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.

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 statements regarding the benefits to shareholders taxed under subsection 15(1)
is false?
1) The taxable amount is based on the fair market value of the benefit or the property.
2) The transfer of property from a corporation to a shareholder for an amount exceeding the fair
market value of the property does not give rise to a benefit under subsection 15(1).
3) The use of a corporations property for personal purposes by a shareholder gives rise to a taxable
benefit only if the shareholder has exclusive use of it.
4) A shareholder resident in Canada is liable for tax in Canada on a taxable benefit given by a
non-resident corporation.

b. Isard Inc. is the sole shareholder of Chamois Inc. Isard owns 10,000 shares of Chamois, which have
the following characteristics:
Fair market value
Adjusted cost base
Paid-up capital

$ 2,500,000
$ 350,000
$ 50,000

Mera Inc., a public corporation that deals at arms length with Isard, offers to exchange the
10,000 shares that Isard holds in Chamois for 1,000 common shares of its capital stock, which
currently have a fair market value of $2,500,000.
If the exchange of shares is carried out under the provisions of subsection 85.1(1), what will be the
adjusted cost base of the shares of Chamois for Mera?
1)
2)
3)
4)

$
0
$ 50,000
$ 350,000
$ 2,500,000

Continued...
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c.

When a taxpayer sells the assets of his or her business, including accounts receivable, an election
under section 22 may be made so that the disposition of accounts receivable will not constitute a
capital transaction. Which of the following is not a requirement in order for the election to be valid?
1)
2)
3)
4)

All or substantially all the property used in the business is sold.


The purchaser continues to carry on the business.
The election is made by attaching a letter to the tax return for the year of the sale.
Both the purchaser and the vendor must make the election.

d. On March 15, 2009, Eagle Inc. made a loan of $60,000 to Suzy, the common-law spouse of the
principal shareholder of Falcon Inc. Falcon owns 100% of the issued shares of Eagle. Suzy used the
loan to start up an Internet caf. Eagle has a January 31 year end, while Falcons year end is July 31.
What is the latest date by which the loan must be repaid to avoid having the loan added to Suzys
income?
1)
2)
3)
4)
e.

January 31, 2010


March 15, 2010
July 31, 2010
January 31, 2011

On September 1, 2010, Snow Inc., a Canadian private corporation, purchased all the shares of Frost
Inc. from a person with whom it dealt at arms length. Immediately before the purchase, Frost had a
net capital loss carryover of $40,000. Also, Frost at that time owned a non-depreciable capital
property with an adjusted cost base of $10,000 and a fair market value of $120,000. It has no intention
of selling this property. In the circumstances, which of the following is the best recommendation for
using the net capital loss?
1) An election can be made for the capital property to be deemed to have been disposed of for
$90,000 immediately before the purchase of the shares.
2) An election can be made for the capital property to be deemed to have been disposed of at fair
market value immediately before the purchase of the shares.
3) The net capital loss is not available following the purchase of the shares by Snow.
4) The net capital loss can be used against future capital gains.

f.

Jonathan became a partner of the partnership Ball & Bill on March 1, 2009. To become a partner, he
contributed $50,000 to the partnership. For the partnerships fiscal period that ended
December 31, 2009, Jonathan made withdrawals of $45,000 and the partnership allocated the
following amounts to him:
Net business income
Capital gain (100%)
Eligible dividends received
Charitable gifts

$
$
$
$

55,000
20,000
12,000
4,000

What is the adjusted cost base of Jonathans interest in the partnership as of January 1, 2010?
1)
2)
3)
4)

$78,000
$83,400
$88,000
$93,400

Continued...

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CGA-Canada, 2010

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g. During the year, Wednesday Inc. had to transfer to its mortgage lender a piece of land that had been
purchased a few years earlier, because Wednesday was no longer able to make the required payments.
Wednesday and the mortgage lender deal with each other at arms length. The balance of the loan at
that time was $420,000 plus $20,000 in interest. The land had an adjusted cost base of $550,000 and a
fair market value of $600,000 at the time of the transfer to its lender. What are the tax consequences of
the transfer for Wednesday?
1)
2)
3)
4)

A deductible capital loss of $55,000


A deductible capital loss of $65,000
A deductible capital loss of $90,000
A taxable capital gain of $25,000

h. George is a resident of Canada. Using a rollover under subsection 85(1), he transfers 1,000 shares of
Drizzle Inc. to Mistral Inc., a Canadian private corporation controlled by his daughter. Following the
transfer, Mistral controls Drizzle. At the time of the transfer, the paid-up capital of the 1,000 shares of
Drizzle is $10,000, their market value is $800,000, and their adjusted cost base is $510,000 following
a crystallization of the capital gains deduction ($500,000 of capital gain). The agreed amount for the
transfer was $510,000. In exchange for the 1,000 shares of Drizzle, George received a note for
$510,000 and redeemable non-voting preferred shares for $290,000 having a legal capital of $290,000.
What are the immediate tax consequences of this transfer for George?
1)
2)
3)
4)
i.

Metner Inc. issued 500 Class D shares of its capital stock to Golda for $15,000. Subsequently, Metner
issued 1,500 Class D shares to Ren for $60,000, and a few years later, 400 Class D shares to Fabian
for $18,600. At each issuance, the amount paid was entered in the books as legal capital. What is the
paid-up capital of each of the 500 shares held by Golda today?
1)
2)
3)
4)

j.

None
A deemed dividend of $500,000
A taxable capital gain of $145,000
A deemed dividend of $500,000 and a deductible capital loss of $250,000

$30.00
$37.50
$39.00
$46.40

Which of the following statements is true regarding losses incurred on the sale of shares held as
capital property?
1) The loss on the sale of shares is a 100% deductible loss.
2) The loss that an individual incurs on the sale of shares is reduced by all the dividends received by
the individual during the period in which the shares were held.
3) The loss that a corporation incurs on the sale of shares is reduced by the amount of any capital
dividend received.
4) The loss on the sale of shares is not affected by the dividends received if the shareholder has held
the shares for more than 365 days and owns, with persons with whom he or she is not dealing at
arms length, less than 5% of the shares of any class of shares.

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24

Question 2
Jeanne died on July 15, 2010. In her will, she bequeathed a cottage on Chaleur Bay in New Brunswick to
her niece Sophie, the shares of Family Holding Inc. to her nephew Paul, the shares of public corporations
to her childhood friend Anais, and the remainder of her estate to her husband Charlie. Fernando, a family
friend, is named as executor of the estate.
Since Fernando is not aware of all aspects of the settlement of an estate, especially the tax aspects, he
comes to consult you. Below is a summary of the information that he has collected on the property owned
by Jeanne at the time of her death.
Cost
Fair Market Value
Money in bank
Guaranteed investment certificate
Shares:
Family Holding Inc.
Public corporations
Registered retirement savings plan
Cottage Chaleur Bay
Residence

7,000
300,000

10,000
140,000
250,000
20,000
100,000

7,000
300,000
350,000
156,000
345,000
350,000
730,000

Fernando also gives you the following additional information:


1. At the time of her death, Jeanne had a job. The salary for the year paid up to the date of death was
$45,000. A bonus of $20,000 had been declared by the employer at the end of its fiscal period in April
2010 and was to be paid to Jeanne on August 1, 2010. The estate received that amount.
2. The guaranteed investment certificate was taken out on March 1, 2008 for a five-year term, and it
bears interest at the rate of 5%. The interest is paid annually on the anniversary date of the investment.
3. Family Holding was a corporation wholly owned by Jeanne before her death. The adjusted cost base
and the paid-up capital of the shares are $10,000. This corporation was initially formed to carry on a
landscaping consultation business. In 2007, the business was sold and all that remains in the
corporation are investments. Its last balance sheet is as follows.
FAMILY HOLDING INC.
Balance Sheet
June 30, 2010
Assets
Cash
Investments (at cost)

Liabilities
$ 30,000
285,000

$ 315,000

Accounts payable
$ 5,000
Shareholders Equity
Capital stock
10,000
Retained earnings
300,000
$ 315,000

Family Holding has no capital dividend account or general rate income pool.
4. At the time of the death, eligible dividends amounting to $5,000 on shares of public corporations had
been paid to Jeanne.
5. There is no beneficiary designation for the registered retirement savings plan.
6. The cottage, acquired in 1990, has been used by Jeanne and her family every summer. The cottage has
never been rented out.
7. The residence, acquired in 1988, has always been occupied by Jeanne and her family.
8. Jeanne never claimed the capital gains deduction.
9. Jeanne and her husband have never designated a property as their principal residence.
Continued...
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Required
12

a.

Calculate Jeannes taxable income for the year of death if no election is made and no particular action
is taken. Then explain to Fernando what can be done to reduce Jeannes taxable income and, if
possible, defer payment of income tax by the heirs. Consider the market values indicated to be
accurate for purposes of your calculations.

10

b. State the tax consequences of winding up Family Holding after the shares are transferred to Paul,
assuming that the balance sheet remains the same and the fair market value of the investments is
$325,000. If necessary, consider the following tax rates:
Corporate tax rate (federal and provincial combined):
Active business income eligible for the small business deduction (SBD)
Active business income not eligible for the SBD $500,000 and over
Other income

27

c.

20%
34%
50%

Fernando tells you that the indicated fair market value for the cottage and the residence are values that
he estimated based on municipal assessments. He asks you to confirm these values, since he does not
want to have problems with the tax authorities for having made a poor estimate. Briefly explain how
you would respond to him.

Question 3
Since 2003, Alex has owned all 1,000 Class A shares issued by Legrand Inc., a corporation in the business
of manufacturing and selling fine chocolates in Canada. Alex also owns all the shares of Invermore Inc., a
corporation that is considered a specified investment business.
Legrand has been profitable since its incorporation, and now has sizable investments in addition to its
business assets. Based on the market value of the assets, 56% of the assets were used in the business
throughout the corporations fiscal period ended November 30, 2009, and the other 44% consisted of
investments. By January 2010, as a result of changes in the market, the proportion of assets used in the
business had declined to 45% and has remained at that percentage.
Alex would like to transfer the investments to Invermore. The investments held by Legrand are as follows:
Cost
Shares of public corporations
Property:
Land
Building

Fair Market Value

$ 155,000

$ 100,000

50,000
285,000

125,000
600,000

The building is included in Class 1, which has an undepreciated capital cost of $215,000.
The consideration paid by Invermore will be in notes and Class B shares redeemable at the holders option
for $1 each. The legal capital of each issued share will be $1.
Required
12

a.

Explain how to proceed in order to transfer the investments to Invermore, keeping immediate tax
consequences to a minimum. Your answer should specify:

Which provision of the Income Tax Act applies and how to apply it to each investment
How the consideration for each investment should be allocated between notes and shares,
considering that the maximum possible should be allocated in the form of a note
The tax consequences of the transfer of each investment for Legrand
The cost or capital cost of each investment for Invermore
Continued...

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CGA-Canada, 2010

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b. Explain, with supporting figures, the tax consequences of the redemption of the Class B shares issued
in the transfer.

c.

14

Following the transfer of the investments, explain whether the shares of Legrand are qualified small
business corporation shares.

Question 4
Otto recently sold his business and collected $5,000,000 after paying his taxes. Otto has a common-law
partner, Myriam, and a four-year-old child, Udine.
Myriam has no personal property other than a small bank account. She wants to open a womens clothing
shop, and Otto is willing to lend her $100,000 so that she can purchase the initial inventory and the
necessary furniture.
Also, in order to transfer income to his child, Otto is thinking of creating a corporation to which he would
lend $3,000,000 interest-free. The amount would be invested in income-producing investments. The
common shares of the corporation would be issued to a trust that would be created for the benefit of Udine
and her descendants. Each year, dividends would be paid to the shareholder from the income generated by
the $3,000,000.
The trust created for Udines benefit would be created by Myriam with a gift of $100. This amount would
be used to purchase the shares of the corporation to which Otto would lend the money. According to the
terms of the trust, the trustee has full discretion regarding the amount of income payable each year to
Udine (or to her guardian for as long as she is a minor). The trust capital must be transferred to Udine
when she reaches the age of 30. However, the trustee has discretion to distribute the capital before that
time.
Required
2

a.

b. If Otto creates the corporation and lends it $3,000,000 interest-free, briefly explain whether there
could be tax consequences for him.

c.

d. Explain whether the answer to part (c) would change if the $30,000 dividend is payable to Udine.

e.

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If Myriam accepts Ottos loan to start up her business, explain who will be liable for tax on the
income from the womens clothing shop.

Assuming that the corporation paid the trust a non-eligible dividend of $30,000 and the trustee did not
exercise his or her discretion to make this income payable to Udine, explain how the dividend will be
taxed.

Explain what tax consideration might induce the trustee to distribute the trust capital to Udine before
the date provided for in the trust deed.

CGA-Canada, 2010

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15

Question 5
Cispadane Inc. is a Canadian private corporation with an October 31 year end. Cispadane is in the business
of recovering and recycling paper.
In the fiscal period ended October 31, 2010, Cispadane was involved in various transactions that had tax
consequences.
Preet, a CGA, has prepared Cispadanes tax return for the fiscal period ended October 31, 2010. He would
like your opinion on the various tax issues.
Required
For each of the following items relating to Cispadanes tax return for the year, state whether you agree or
disagree with the tax treatment chosen by Preet and explain why, showing any calculations.
2

a.

In 2007, Cispadane purchased the common shares of Partage Inc. for $100,000. At that time, it
borrowed $50,000 from the bank at a rate of 6%. In November 2009, Cispadane sold the shares for
$10,000. At that time, $30,000 remained to be paid on the loan, and no amount of principal was repaid
when the shares were sold. The $10,000 obtained from the sale was reinvested in the business carried
on by Cispadane. Preet deducted all the interest paid on the loan for the fiscal period ended
October 31, 2010.

b. Cispadane is associated with two other corporations in a partnership involved in glass recycling. Its
share of the partnerships income and losses is 20%. The partnerships fiscal period ends on July 31.
According to the financial statements approved by the partners, which were provided to Preet, the
partnership had the following income:
Business income before capital cost allowance
Dividends of Canadian corporations

$ 400,000
$ 80,000

The partners had agreed not to claim capital cost allowance in the partnership even though a
maximum of $30,000 could have been claimed.
Preet included $90,000 as property income in Cispadanes income [20% ($400,000 + $80,000
$30,000)].
7

c.

In June 2010, Republic Inc., a wholly owned subsidiary of Cispadane, carried out a reorganization of
capital in which it exchanged the 1,000 common shares of Republic held by Cispadane for a sum of
$100,000 and 340,000 preferred shares redeemable for $1 each. The legal paid-up capital of the
340,000 preferred shares totals $10,000. One thousand new common shares were issued, 60% to
Cispadane and 40% to a corporation controlled by three employees.
Before the reorganization of capital, the 1,000 common shares held by Cispadane had a fair market
value of $440,000 and an adjusted cost base and a paid-up capital of $10,000. No preferred shares
were issued before the reorganization of capital.
No election under section 85 was made with respect to the exchange of shares.
Preet included a dividend of $90,000 in Cispadanes income.
END OF EXAMINATION

100

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CGA-Canada, 2010

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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 7 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

Compare

Contrast

Criticize

Define

Describe
Design

Determine

Diagram

Discuss

Evaluate

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.

Explain

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. To explain
briefly requires you to state the
reasons simply, in a few words.
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.

CGA-CANADA
ADVANCED PERSONAL & CORPORATE TAXATION [TX2] EXAMINATION
December 2010
SUGGESTED SOLUTIONS
Marks
20

Time: 4 Hours
Question 1
Note:
2 marks each

Sources:
a.

3) Topic 1.1 (Level 1); ITA, subsections 15(1) and 15(7)

b. 2) Topic 3.4 (Level 1); ITA, paragraph 85.1(1)(b)


c.

3) Topic 6.2 (Level 1); ITA, subsection 22(1)

d. 4) Topic 1.2 (Level 1); ITA, subsection 15(2.6)


e.

1) Topic 6.4 (Level 2); ITA, subsection 111(4)

f.

3) Topic 7.3 (Level 1); ITA, paragraphs 53(1)(e) and 53(2)(c)

g. 1) Topic 5.3 (Level 1); ITA, subsection 79(3)


h. 4) Topic 3.1 (Level 1); ITA, subsections 84.1(1) and (2)

STX2D10

i.

3) Topic 1.4 (Level 1); ITA subsection 89(1), and definition of paid-up capital

j.

4) Topic 6.1 (Level 1); ITA, subsection 112(3.01)

CGA-Canada, 2010

Page 1 of 9

24
12

Question 2
a. Jeannes income if no election is made and no particular action is taken:
Employment income
Salary
Bonus
Interest
Received
Accrued $300,000 5% 137/365 [70(1)]

$ 45,000
20,000
15,000
5,630

Eligible dividends $5,000 1.45


Capital gains
Shares of Family Holding Inc.:
Proceeds of disposition [70(5)]
Adjusted cost base
Capital gain
Taxable capital gain (1/2)

7,250

$ 350,000
(10,000)
$ 340,000
170,000

Shares of public corporations:


Proceeds of disposition [70(5)]
Adjusted cost base
Capital gain
Taxable capital gain (1/2)

$ 156,000
(140,000)
$ 16,000

Cottage:
Proceeds of disposition [70(5)]
Adjusted cost base
Capital gain
Taxable capital gain (1/2)

$ 350,000
(20,000)
$ 330,000

8,000

Registered retirement savings plan [146(8.8)]

165,000
345,000
$ 780,880

There are no tax consequences with respect to the principal residence, since it is bequeathed to the
spouse. Under subsection 70(6), it is deemed to be disposed of at the adjusted cost base.
To reduce the tax consequences, it would be necessary to do the following:
1. File a separate return for rights or things under subsection 70(2), in which a bonus of $20,000
would be declared. The separate return is considered to be that of another person. Thus, the
progressive rates apply to the income reported in this return. Also, the personal tax credits in the
regular return may also be claimed in the separate return.
2. Designate the spouse, Charlie, as the beneficiary to the registered retirement savings plan by filing
form T2019 so that the value of the property in the registered retirement savings plan will be
excluded from Jeannes income and included in her spouses income [subsections 146(8),
146(8.1), 146(8.8), 146(8.9), and the definitions of benefit and refund of premiums in
subsection 146(1)]. To defer payment of the tax, Charlie can transfer the amount added to his
income to his own registered retirement savings plan under subsection 60(l), which makes it
possible to defer taxation of the amounts transferred until the spouse or common-law partner
receives them.

Continued...

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Page 2 of 9

3. The cottage could be designated as the principal residence for all the years in which it was owned.
However, the residence also qualifies for the same years, and the capital gain on it is higher. Even
if there is a rollover to Charlie, he can make a principal residence designation for the years when
the property was held by Jeanne. Considering that the calculation of the portion exempt from
capital gain on a principal residence adds one year to the designated years, the executor could also
claim the principal residence deduction on the cottage for one year. This would serve to reduce
the capital gain on the cottage by 2/20 and retain the total deduction on the residence.
10

b. Winding-up of Family Holding


Impact for Family Holding:
Disposition of the investments at FMV [69(5)]
Proceeds of disposition
ACB based on median
Capital gain

$ 325,000
(285,000)
$ 40,000

Taxable capital gain (1/2)

$ 20,000

Tax (50%)
Refundable dividend tax on hand (26.67%)

$ 10,000
$ 5,334

Value of property available on the winding-up:


Cash
Fair market value of the investments
Accounts payable
Taxes payable
Dividend refund 1
1

$ 30,000
325,000
355,000
(5,000)
(10,000)
340,000
5,334
$ 345,334

A corporation is entitled to a dividend refund of all the refundable tax on hand only if there is a
sufficient taxable dividend on the winding-up.

Effect on the capital dividend account:


Opening balance
Taxable capital gain investments 50% ($325,000 $285,000)
Balance on the winding-up

0
20,000
$ 20,000

For Paul:
Deemed dividend [84(2)]
Value of property received
Paid-up capital of the shares
Deemed dividend

$ 345,334
(10,000)
$ 335,334

Continued...
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Distribution of the dividend [88(2)]


Deemed dividend
Dividend on the CDA if the election under subsection 83(2) is made
Taxable dividend

$ 335,334
(20,000)
$ 315,334

Under paragraph 82(1)(b), this dividend must be grossed up by 1/4 when it is included in Pauls
income. This dividend cannot be designated as an eligible dividend, since Family Holding has no
general rate income pool.
Capital gain on disposition of the shares:
Value of the property received
Less: Dividend on the CDA
Taxable dividend
POD under 54
ACB [70(5)(b)]

27
12

c.

$ 345,334
$ 20,000
315,334

(335,334)
10,000
(350,000)

Capital loss before application of 112(3)


Reduction [112(3)]
Capital loss

(340,000)
(20,000)
$ (320,000)

Deductible capital loss (1/2)

$ (160,000)

Property valuation is a specialized field. Unless you have the required training and skills, you should
refuse to give your opinion on the values and refer the client to a professional appraiser.

Question 3
a. Shares of public companies:
Transfer of the shares of public companies at their fair market value, since their adjusted cost base is
greater than the fair market value.
Proceeds of disposition
Adjusted cost base
Capital loss

$ 100,000
(155,000)
$ (55,000)

Since Invermore Inc. and Legrand Inc. are affiliated corporations, the loss is deemed nil under
paragraph 40(3.4)(a), but under paragraph 40(3.4)(b) it can be claimed by Legrand when one of the
following events occurs:

The subsequent disposition of the shares to a person not affiliated with Legrand
A change in the tax status of Legrand (it becomes non-resident or tax-exempt)
An acquisition of control of Legrand
A winding-up of Legrand, other than under subsection 88(1)

The consideration received by Legrand would be a $100,000 note.


Land:
The land is transferred under the provisions of subsection 85(1). Under paragraph 85(1)(c.1) and to
avoid any immediate consequences, the agreed amount would be set at $50,000 and the consideration
paid by Invermore would consist of a $50,000 note and 75,000 Class B shares.

Continued...
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Building:
The building is transferred under the provisions of subsection 85(1). Under paragraph 85(1)(e) and to
avoid any immediate consequences, the agreed amount would be set at $215,000 and the consideration
paid by Invermore would consist of a $215,000 note and 385,000 Class B shares.
Description
of Transferred
Properties

Cost
or
ACB

UCC

FMV

Agreed
Amount

Non-share
Consideration

Shares

Total
FMV

Land
Building

$ 50,000
285,000

$ 215,000

$ 125,000
600,000
$ 725,000

$ 50,000
215,000
$ 265,000

$ 50,000
215,000
$ 265,000

$ 75,000
385,000
$ 460,000

$ 125,000
600,000
$ 725,000

The tax consequences for Legrand if the rollover form is filed in accordance with the above table are:
Land:
Proceeds of disposition [85(1)(a)]
Adjusted cost base
Capital gain
Taxable capital gain (1/2)

50,000
(50,000)
$
0
$
0

Building:
The lesser of:
Capital cost
Proceeds of disposition [85(1)(a)]
Undepreciated capital cost
Capital cost allowance recapture

$ 285,000
$ 215,000

$ 215,000
(215,000)
$
0

The cost of the investment for Invermore is:


Shares of public corporations
Land [85(1)(a)]
Building [85(5)]
Deemed capital cost
Capital cost allowance deduction deemed to have been taken

$ 100,000
$ 50,000
$ 285,000
(70,000)
$ 215,000

Continued...
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b. Adjusted cost base of the 460,000 Class B shares


Under paragraph 85(1)(g), the adjusted cost base of the 460,000 Class B shares is zero.
The lesser of:
Fair market value of the shares
Agreed amount less fair market value of the non-share consideration
($265,000 $265,000 = $0)

$ 460,000
$

Paid-up capital of the 460,000 Class B shares


Under paragraph 85(2.1)(a), there is a PUC reduction equal to:

A B

C
A

where
A = Increase in the paid-up capital of all the shares following the transfer = $460,000
B = Agreed amount less fair market value of the non-share consideration
= $265,000 $265,000 = $0
C = Increase in the paid-up capital of the class of shares received in consideration of the rollover
= $460,000
($460,000 $0)

$ 460,000

Legal paid-up capital


Reduction under subsection 85(2.1)
Paid-up capital for tax purposes

$ 460,000
(460,000)
$
0

Redemption of the 460,000 Class B shares


Deemed dividend subsection 84(3)
Amount paid
Paid-up capital of the 100,000 shares
Deemed dividend

$ 460,000
(0)
$ 460,000

This is an inter-corporate dividend. This dividend will be deductible under subsection 112(1). Since
Invermore and Legrand are connected corporations, the dividend may be subject to Part IV tax only if
Invermore has a dividend refund.
Capital gain
Proceeds of disposition [54]
Amount received
Dividend [84(3)]
Adjusted cost base
Capital gain

$ 460,000
(460,000)

$
$

0
(0)
0

Continued...
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14
2

c.

The conditions to be met for the shares to be qualified small business corporation shares are:

The shares must not be owned by anyone other than the individual or a person or partnership related
to him or her throughout the 24-month period preceding the disposition. This condition is met, since
Alex has owned the shares since 2003.

At the time of the disposition, the shares must be shares of a small business corporation (SBC), that
is, a Canadian-controlled private corporation of which all or substantially all (90% or more,
according to Canada Revenue Agency) of the fair market value of the assets consists of assets used
in an active business in Canada or debts or shares of connected SBCs. This criterion is not met,
since on the transfer of the investments, Legrand owns notes and shares of Invermore that are not
eligible assets since Invermore is not an SBC.

Throughout the 24 months preceding the disposition, the shares must be shares of a Canadiancontrolled private corporation of which more than 50% of the fair market value of the assets consists
of assets used in an active business carried on in Canada or shares or debts of connected business
corporations according to certain tests. This criterion is not met, because at the beginning of
January 2010, only 45% of the assets were eligible.

Question 4
a. The income attribution rules apply only for attributing property income or capital gains when there is
a loan to a spouse [subsection 74.1(1) and section 74.2]. Since the income from operating the shop
will be business income, Myriam will have to include the income or loss from the womens clothing
shop in her income.

b. Subsection 74.4(2) would likely apply, since:

There is a loan to a corporation that is not a small business corporation.


It is reasonable to consider that one of the main purposes of the loan is to reduce Ottos income and
benefit someone who is a designated person.
Ottos daughter, through the trust, is a specified shareholder of the corporation within the meaning
of subsection 248(1).

Otto must report annually the deemed interest calculated according to the prescribed rate on the
unpaid amount of the loan, less the taxable dividends included in Udines income, if it is reasonable to
consider that these dividends are part of the benefit that Otto wants to confer and these dividends are
included in Udines split income.
The attribution rule will cease to apply when Udine reaches age 18.
3

c.

The trust created by Otto is an inter vivos trust whose income is taxed at the maximum rate for
individuals [subsection 122(1)]. If the income is not payable to Udine, the trust must pay tax on the
income, since no deduction under paragraph 104(6)(b) may be claimed. Since the trust is considered
an individual, the non-eligible dividend will be grossed up by 1/4 under paragraph 82(1)(b), and under
section 121 the trust will be able to claim the dividend tax credit equal to 2/3 of the gross-up.

Continued...
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d. If the income is payable to Udine, the trust has the option of deducting the amount payable to Udine
from its income under paragraph 104(6)(b), in which case Udine will be liable for tax on the dividend.
Since she is a minor and this is a dividend on shares not listed on a designated stock exchange, the tax
on split income would apply to the dividend under subsection 120.4(2). Thus, the dividend would be
taxed at the maximum rate for individuals. The gross-up and the dividend tax credit would apply.
There would be no attribution of income to Otto, since the tax on split income applies [74.5(13)].

e.

15
2

The planned liquidation of the trust when Udine reaches the age of 30 means that the trust will have
existed for more than 21 years. Under subsection 104(4), there is a deemed disposition of the property
of the trust at its fair market value every 21 years. Thus, if the trustee finds that there are major
increases in value that would result in high taxes because of the deemed disposition, he may choose to
avoid taxation by distributing the appreciated property to Udine before this deemed disposition.
Where the property of a personal trust is to be distributed to the capital beneficiaries as settlement of
their interest, this is generally done by means of a rollover under section 107.

Question 5
a. Agree. While the income-producing property is no longer owned by Cispadane, subsection 20.1(1)
allows interest to continue to be deducted on a portion of the loan money that was lost, calculated as
follows:
Unpaid balance
Less: $30,000

$ 30,000
$
$

,
,

(3,000)
$ 27,000

As to the interest on the $3,000, since the money from the sale of the shares was used to earn income
from the business carried on by Cispadane, the interest is deductible under paragraph 20(1)(c).
6

b. Disagree. A partnership is not a person and is not deemed to be a person, but it computes its income
as if it were a person. The portion of the partnership income or loss from each source is allocated to
the partners while retaining its characteristics, source, and nature [subsection 96(1)].
Thus, Cispadane must report business income of $80,000 (20% of $400,000). The capital cost
allowance deduction must be claimed at the partnership level and not individually by each member,
because for purposes of computing the partnership income, the partnership is treated as if it were a
separate person. Since the partners agreed not to claim capital cost allowance within the partnership,
this cannot be done on a partners income tax return.
Also, Cispadane must include in its income a dividend of $16,000 (20% of $80,000). The dividend
retains its nature. Since this is a dividend of a Canadian corporation, a deduction under
subsection 112(1) may be claimed. Part IV tax applies unless the dividend is from a connected
corporation, in which case the Part IV tax payable is determined on the basis of the dividend refund of
the payor corporation.

Continued...
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c.

Agree.
Effect of section 86:
Section 86 applies, since this is a reorganization of capital, Cispadane receives an amount of money,
and no election is made under subsection 85(1).
Cost of the note [86(1)(a)]

$ 100,000

Cost of new preferred shares [86(1)(b)]


Adjusted cost base of the old common shares
Fair market value of the note

$ 10,000
(100,000)

POD of the old common shares [86(1)(c)]


Cost of the note
Cost of the new preferred shares

$ 100,000

$ 100,000

PUC of the new preferred shares


Legal paid-up capital

$ 10,000

$10,000
PUC reduction [86(2.1)(a)] $10,000 $0
$10,000
Deemed dividend [84(3)]:
Amount paid
Note
Paid-up capital of the new preferred shares [84(5)(b)]
Paid-up capital of the cancelled common shares
Deemed dividend [84(3)]

(10,000)

$ 100,000

$ 100,000
(10,000)
$ 90,000

A deduction under subsection 112(1) can be claimed. Part IV tax may be payable if Republic receives
a dividend refund.
Subsection 55(2) would also apply unless the safe income is sufficient, subject to Part IV tax applying
to the dividend.
Capital gain on disposition of the old common shares:
POD [54]
POD [86(1)(c)]
Deemed dividend [84(3)]
ACB
Capital gain

$ 100,000
(90,000)

END OF SOLUTIONS

100

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$ 10,000
(10,000)
$

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CGA-CANADA
ADVANCED PERSONAL & CORPORATE TAXATION [TX2]
December 2010
EXAMINERS COMMENTS

General comments
The pass rate for this examination was unsatisfactory.
Candidates have a good understanding of several topics. For example, most candidates applied the
provisions on transferring property under a subsection 85(1) rollover correctly.
However, some basic concepts have not been mastered, which impedes the ability of some candidates to
pass the examination. For example, several candidates grossed up a taxable intercorporate dividend when
it was included in income, whereas a dividend of that nature received from a taxable Canadian corporation
gives rise instead to a deduction in computing taxable income. Also, some candidates included 100% of
the capital gain in income, rather than 50%.

Specific Comments
Question 1 Multiple choice (Level 1 for all topics)
Performance on this question was satisfactory.
Candidates had the most difficulty with parts (e) and (h). These questions dealt with the following topics:
1(e) Module 6, Topic 6.4, acquisition of control; ITA, subsection 111(4)
1(h) Module 3, Topic 3.1, non-arms length transfer of shares; ITA, subsections 84.1(1) and (2)
Question 2 Taxes at death, winding up a corporation, and ethics (Level 1)
Performance was satisfactory on parts (a) and (c) of this question, which dealt with taxes at death and
ethics. Overall, candidates have a good understanding of these topics. Regarding taxes at death, some
candidates did not clearly understand the concept of rights or things. In addition, when property is
transferred to a spouse resident in Canada, the general rule is that there is a rollover to the spouse. The
possible election is not to take the rollover and to dispose of all or some of the property at fair market
value.
Performance was unsatisfactory on part (b), which dealt with the winding up of a corporation. Several
candidates applied the rules for winding up a wholly-owned subsidiary even though the corporation in
this case was held by an individual.
Question 3 Transferring property to a corporation under subsection 85(1), share redemption, and capital gains
deduction (Level 1)
Overall, candidates did well on part (a), which dealt with a section 85 rollover. Candidates have a good
understanding of why one uses a transfer of property to a corporation without immediate tax
consequences.
Candidates did fairly well on part (b), which dealt with share redemption. However, some candidates did
not mention that while this type of transaction results in a deemed dividend, there is also a disposition of
the shares.
In part (c), often the answers provided were only theoretical in nature, without any reference to the case at
hand, which meant that full marks could not be awarded.
Continued...

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Question 4 Attribution rules and taxation of a trust and of its beneficiaries (Level 1)
Performance on parts (a), (b), and (d), which dealt with the income attribution rules, was poor. In most
cases, the candidates identified that there was a problem related to the attribution rules, but they applied
the wrong rules and exceptions. Attribution rules do not apply to business income. Also, candidates do not
have a good understanding of the concept of tax on split income. When this tax applies, attribution rules
do not apply.
Performance on parts (c) and (e) was satisfactory. Candidates seemed to have a better understanding of
the basic rules on the taxation of trusts and of their beneficiaries. Several candidates need to review the
concept of income payable to a beneficiary and the deduction allowed under paragraph 106(4)(b).
Question 5 Interest deductibility, computation of the income of a partnership, and reorganization of capital
under section 86 (Level 1)
This question dealt with three unrelated topics.
Part (a) dealt with the disposition of property without repayment of the loan that was used to acquire that
property. Few candidates mentioned that subsection 20.1(1) applied in order to deduct the interest payable
if certain conditions were met.
Candidates did poorly on part (b), which dealt with partnerships. Several candidates did not indicate that
CCA must be deducted when computing the income of the partnership rather than individually. The
taxable dividend received by the partnership and attributed to the partner, Cispadane, must not be grossed
up and does not entitle the partner to a tax credit. Several candidates mentioned that this was a good thing;
however, the partner was a corporation and this rule only applies to individuals.
The answers provided for the last part of the question were often incomplete, with few explanations of the
application of section 86, which refers to a reorganization of capital. Several candidates identified that the
transaction resulted in a deemed dividend, but once again the consequences of the disposition of the shares
were omitted.

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