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BUS 345 – Chapter 6 – In Class Exercise and Answer

Exam Exercise Six - 1(Automobile Ownership Costs)


Mr. Alex Roddle acquires an automobile to be used 100 percent of the time in his unincorporated business. This
business has been in operation for several years. The purchase occurs on October 1, 2017 at a cost of $83,000. He
finances $70,000 of the car purchase through his bank at an annual rate of 9 percent. Interest charges for the period
October 1, 2017 through December 31, 2017 amount to $1,575. What amounts can Mr. Roddle deduct in his 2017
tax return with respect to this acquisition? Ignore GST and PST considerations.

Exam Exercise Solution Six - 1 (Automobile Ownership Costs)


The base amount for the CCA calculation is limited to the Class 10.1 maximum of $30,000. As a result, the
amounts that can be deducted by Mr. Roddle in his tax return are as follows:
Capital Cost Allowance [(30%)(1/2)($30,000)] $4,500
Interest Costs - Lesser Of:
 Amount Paid = $1,575
 [($10)(92 Days)] = $920 920
Total Deduction $5,420

Exam Exercise Six - 2 (Leases: Tax Vs. GAAP)


Sharp Ltd. signs an 8 year lease for an asset with an economic life of 9 years. The lease payments are $32,500 per
year. Compare the tax treatment of the lease with its treatment under GAAP.

Exam Exercise Solution Six - 2 (Leases: Tax Vs. GAAP)


For tax purposes, the lease would be treated as an operating lease, with the deduction being based only on the lease
payments. Under GAAP, the lease would have to be treated as a purchase and capitalized. This is because during
the lease term the lease transfers “substantially all of the benefits and risks of ownership related to the leased
property from the lessor to the lessee”. This means that the accounting deductions would be for amortization on the
capitalized asset and interest costs on the associated liability.
BUS 345 – Chapter 6 – In Class Exercise and Answer

EXERCISE SIX – 3 AUTOMOBILE COSTS AND BENEFITS


Maxine’s Cleaning Services is a Canadian controlled private corporation with a December 31 year end. Maxine
Brott is the sole shareholder of the corporation and actively participates in the operation of the business as an
employee.
Because of the extensive travel required in supervising her employees, the Company provides Ms. Brott with a
car. During the first 6 months of 2017, the provided car was a Honda Accord that had been purchased in 2016 for
$29,000. During this 6 month period, she drove the car a total of 23,000 kilometers, of which 15,000 were related to
her employment activities. The Class 10 UCC balance at the beginning of 2017 was $24,650.
On July 1, 2017, the Honda Accord was sold for $25,000. It was replaced with a BMW 7 Series sedan at a cost of
$105,000. During the period July 1, 2017 through December 31, 2017, she drove this vehicle a total of 37,000
kilometers, of which 18,000 were related to her employment activities.
Throughout 2017, the Company paid for all of the operating costs of both vehicles, a total of $12,300.
Other than the Honda Accord and the BMW sedan, the Company did not own any other vehicles during
2017. During the period January 1, 2017 through December 31, 2017, an automobile was always available to Ms.
Brott.
Required: Determine the following:
The tax consequences to Maxine’s Cleaning Services that result from owning and selling the Honda Accord and
owning the BMW sedan during 2017.

Ignore GST and PST considerations in both parts of this question.

Exercise Six – 3 Solution


Part A
The tax consequences resulting from the sale of the Honda can be calculated as follows:

January 1, 2017 UCC $24,650


Disposition - Lesser Of:
Capital Cost = $29,000
Proceeds Of Disposition = $25,000 ( 25,000)
Negative Ending Balance ($ 350)
Recapture Of CCA 350
UCC - December 31, 2017 Nil

The $350 of recapture would be included in Maxine’s net business income for 2017. No CCA would be deducted
for Class 10. Note that, because the BMW cost more than $30,000, it would be allocated to a separate Class
10.1. This means that its acquisition would not eliminate the recapture in Class 10.
The maximum CCA deduction on the BMW would be calculated as follows:

Capital Cost (Limited To $30,000) $30,000


One-Half Net Additions ( 15,000)
Balance For CCA Purposes $15,000
Rate 30%
Maximum CCA $ 4,500

The net effect on income due to the two automobiles would be as follows:
Recapture Inclusion $ 350
CCA ( 4,500)
Operating Costs (Fully Deductible) ( 12,300)
Decrease In Net Income For Tax Purposes ($16,450)
BUS 345 – Chapter 6 – In Class Exercise and Answer

Exercise Six – 4 Work Space In Home Costs And CCA


In order to supplement his income working in a Calgary bookstore, Mr. Victor Larson has decided to start a home
based business that will specialize in selling used textbooks to university and college students.
The business will be run out of space that he has set aside in his residence. This space involves 18 percent of the
total floor space in the residence.
The residence was acquired on January 1, 2017 at a total cost of $426,000. It is estimated that $150,000 of this total
value can be attributed to the land on which the residence is situated. For the year ending December 31, 2017, Mr.
Larson has the following costs that can be associated with this residence:

Utilities For Home (Heat, Light, And Water) $ 3,200


Mortgage Interest Paid 10,100
House Insurance 500
Property Taxes 4,300
Repairs And Maintenance For Home 2,600
Total $20,700

The business begins operations on January 31, 2017. On that date, Mr. Larson acquires the following assets to be
used in his new business:

Office Furniture And Storage Racks $18,500


Computer 1,430
Business Software 570
In addition, he has a separate telephone line installed for dealing exclusively with the mail order business. The
telephone charge includes charges for a toll-free number and a long distance package.
During the period January 31, 2017 through December 31, 2017, his mail order sales total $182,000. Costs
associated with these sales are as follows:

Cost Of Merchandise Sold $98,000


Unsold Merchandise (Lower Of Cost And Market) 23,500
Packaging Materials 2,400
Shipping Costs 4,600
Miscellaneous Office Supplies 560
Telephone (Total Charge For The Period) 1,100
Printing Of Posters And Brochures Distributed 420

Required:
A. Can Mr. Larson deduct work space in the home costs? Briefly explain your conclusion.
B. Compute the minimum net business income or loss that Mr. Larson must report in his 2017 personal income tax
return.
C. Briefly describe any issues that should be discussed with Mr. Larson concerning the work space in his home
and business costs.
BUS 345 – Chapter 6 – In Class Exercise and Answer

Exercise Six – 4 Solution


Part A
Under ITA 18(12), the following conditions must be satisfied in order for expenses related to work space in a self-
contained domestic establishment to be deductible:
 the work space is either the individual’s principal place of business; or
 the work space is used exclusively for the purpose of earning income from business and is used on a regular
and continuous basis for meeting clients, customers, or patients of the individual in respect of the business.
With respect to Mr. Larson’s mail order business, the allocated space in his home would appear to be his principal
place of business. This means that he would be able to deduct work space in home costs in determining his net
business income.

Part B
The calculation of the minimum net business income to be reported in Mr. Larson’s personal tax return is as follows:
Revenues $182,000
Expenses Other Than Home Work Space Costs:
Cost Of Merchandise Sold ($98,000)
Packaging Materials ( 2,400)
Shipping Costs ( 4,600)
Miscellaneous Office Supplies ( 560)
Telephone ( 1,100)
Printing Of Posters And Brochures ( 420)
CCA (Note 1) ( 2,321) ( 109,401)
Income Before Home Work Space Costs $ 72,599
Less: Home Work Space Costs (Note 2) ( 4,332)
Net Business Income $ 68,267

Note 1 Maximum CCA amounts on the assets of the business (not including CCA on the house) for the
short fiscal year would be calculated as follows (alternative calculations shown in the two columns):
Short Fiscal Year
100% (335/365)
Class 8 [($18,500)(1/2)(20%)] $1,850 $1,698
Class 50 [($1,430)(1/2)(55%)] 393 361
Class 12 [($570)(1/2)(100%)] 285 262
Total $2,528
Short Fiscal Year Factor 335/365
Maximum CCA* $2,320 $2,321

*The $1 difference in the two amounts is due to rounding difference in the calculations.
BUS 345 – Chapter 6 – In Class Exercise and Answer

Note 2 The work space in home costs would be calculated as follows:

Utilities For Home (Heat, Light, And Water) $ 3,200


Mortgage Interest Paid 10,100
House Insurance 500
Property Taxes 4,300
Repairs And Maintenance For Home 2,600
Total $20,700
Class 1 CCA [($426,000 - $150,000)(1/2)(4%)] 5,520
Total Costs For The Home $26,220
Percentage Of Floor Space 18%
Subtotal $ 4,720
Short Fiscal Year Factor 335/365
Deductible Home Work Space Costs $ 4,332

Part C
There are two issues that should be discussed with Mr. Larson.
 As this problem asks for “minimum” net business income, CCA must be deducted on Mr. Larson’s home. The
problem with this is that, if he takes CCA, it could jeopardize the principal residence exemption on this
property, resulting in the payment of taxes on a portion of the taxable capital gain that might arise on any future
sale of the property, assuming real estate prices are increasing. This is discussed in more detail in Chapter 8.
 Although it is not relevant for this year, Mr. Larson should be aware that the deduction of work space in home
costs cannot be used to create a loss in the future. However, any amount not deductible because it is greater
than his income can be deducted in any subsequent year provided there is sufficient income from the same
business in that year. This provides for an unlimited carry forward of unused work space in home costs (see IT-
514, Work Space in Home Expenses).