‘Annual Examinations, 2013-2014 Page 1 of 8 Canadian Income Tax Law, Professor Alario Note: UNIVERSITY OF TORONTO FACULTY OF LAW “Thursday, December 5.2019 445— 7:15pm (CANADIAN INCOME TAX LAW Examiner: Professor Alarie 4. You may use any kind of hard-copy material you wish during the examination, ‘except for books owned by the library. You may not use any electronic reference ‘materials, Calculators are permited 2. The exam has two “perspective” questions (worth 10% each, fora total of 20%) ‘and 16 “soenaria™ questions (worth 5% each, total of 80%). The two “perspective” {questions have a word limit of 150 words each. The ethers have no word int, 3. Cell phones, pagers and other communication devices are prohibited in exams. Cel phones are not permitted as a time keeping device and should not be visible on the desk during an examination. Communication devices left on the desk during an ‘examn may be removed by the ivigliator. 4, Before you begin, ensure that you have writen your pseudoname, course name, and the number of the booklet on each examination booklet and the name of the instructor on the fist booklet If you request an additonal booklets) during the examination, wie the required information an the booklet at the ime you recive it. No {ime wil be permited for this atthe end of the examination, 5, During the examination, only one student at a time is permited to leave the examination room, No student may leave within fifteen minutes ofthe conclusion ofthe examination, 6, _ At the end of this examination, the invglator will ask you to stop ving, count the total number of bookiets used, record this onthe front ofthe fist booklet, and insert al booklets into the frst booklet, For students who are typing ther examination, the invgitetor wil ask you fo stop typing and exit Exameof. You will then remain seated fand quiet ‘until ell the examination paporefonvelopes are collected, The inviltate(s) wil let you know when you can leave the examination room, 7. Time limits vill be strictly enforced, Students who continue to wie oF type after the examination has ended will have their answer bookets/examination envelope collected separately and may be subject to a penalty.‘Annual Examinations, 2013-2014 Page 2 068 ‘Cenadian Income Tax Law, Professor Alario. Perspective Questions - 10% each (~ 18 minutes each) 4. For what reasons might a reasonable person aaree with the following statement (limit of 180 words)? ‘Canadian courts interpreting the income Tax Act should do more to accommodate economic reality and deemphasize legal substance.” In your answer refer to atleast one case to support your reasoning. 2. For what reasons might a reasonable person sisagree with the folowing statement limit of 150 words)? “On balance, the GAAR has been a useful addition to the Canadian income Tax hot” In your answer refer to atleast one case to support your reasoning. ‘Scenario Questions Scenario One ‘Jack Palmer ("JP") was employed by Amold Limited (”Amold"), a general building contractor in the City of Toronto, from 1983 to 2010. From 1995 to 2010 he took on a more senior roe at ‘Arnold 8 ils treasurer and general office manager. In is capacity as weasurer and general ‘office manager, JP was in charge of all the financial operations ofthe business and supervised the keeping of the books of financial record, His duties included the approval of invoices for payment, including invoices received by Amol from its sub-contractors, and JP was personaly Fesponsible forthe preparation of bils and invoices sent oul on behalf of Amold. Shortly after the CRA started investigating Arnold atthe beginning of 2010, JP resigned. Beginning in early 2004, unknown to the directors of Arnold, JP arranged with a Mr. Steven Howard SH") for SH to submit invoices to sub-contractors employed on certain jobs in which ‘Ammold was the general coniractor. SH was an unemployed nelghbour of JP. SH used various shell companies wih different names that sounded legitimate (e.g, Canadian Electrical Supply Ine, Weber Plimbing Lie, ete) te efeate and iasue tious Invoices, It wae not conlomplated thal SH or any ofthese shell companies established by SH would actually do any work at al for the sub-contractors, and they had no employees or means of carrying out any work a al. The invoices were to be entirely fictious, Upon payment of the ficitious invoices by the sub- ‘contractore, SH would cash the cheques. Pursuant to the arrangement, SH kept 40% of the ‘amounts fr himself and gave the remaining 60% ofthe money to JP. Te beauty of the plan was tha, as expected, the sub-contractors did not carefully scrutinize the invoices, About haf of the time the sub-contractors would simply pay the invoices and add the ‘cost of paying the invoices to their own invoices. as disbursements to the general contractor.ols ‘Annual Examinations, 2013-2014 Pag ‘Canadian Income Tax Law, Professor Alarie “The other half ofthe time, the sub-contractors just forwarded the invoicgs to Arnold for payment lect. Since JP was in charge of monitoring all the invoices and payments for Arnold and the ‘amounts skimmed through this pracass were never very large, the scheme was dificult for outsiders to see. During a routine audit in ate 2008, several eld auditors forthe CRA attempted to reconcile the Invoice chain for @ number of Arnold's larger construction contracts. They were principal inlorested in the GST/HST issues arising out of the projects, but soon began to sense that Something deeper wes amiss. As forensie audtore wore brought on board! by the CRA and JP fait thatthe gig was up. he resigned from Arnold cng “health Issues" and a desire to “spend ‘more time with family.” In his resignation letter, he acknowledged that athough there may be ‘some inadvertent anomalies in the paperwork, he was confident that everything was in order {and staled that he would “cooperate uly withthe investigation” since "he has nothing to hide.” It turns out that over the course of the scheme, JP and SH nad jointly been able to extract §2 millon through fetious invoices ($1.2 milion to JP and $0.8 milion to SH). Nether of them had {declared any of these amounls as income for Canadian income tax purposes. Suppose that the ‘CRA now has conclusive evidence of the above scheme and can prove all ofthe facts above with evidence admissible in court Questions re: Scenario One (no word limit) ~ 6% each (~ 26 minutes) 3, On what bases might JP and SH be found to have the amounts they extracted treated as taxable income? Rank the plausibilty ofthe different bases, 4, Naturally Ameld had deducted the $2 millon pald pursuant tothe fictitious invoices in determining ts income from business. What are the appropriate tax consequences for ‘Arnold as a result of the scheme for the relevant taxation years? Should the CRA reassess Arnold? 5, if Ammold sues JP and SH to recover the $2 milion it lost pursuant to the scheme and settles out of court withthe defendants for $1.2 millon, what are the tax consequences Fely to be forthe company (ignore the legal expenses)? 6. FAP and SH settle with Amold for $1.2 milion in damages, what isthe appropriate tax treatment to them of the satlement they pay? Is it different for JP than it is for SH? yny or wy not?‘Annual Examinations, 2013-2014 Page 4.of8 Canagian Income Tax Law, Professor Alarie Scenario Two Mr. Michael Wilson received a gold watch from his employer, a Canadian clothing retailer, in 2012. A similar walch was given to all employees who had achieved 25 years of employment ‘with that employer and did not opt instead for tne alternative git—a $1,000 ait certificate. Those ‘employees who exercised the option to accept instead the gift certificate for $7,000 were stil ‘entitled to use the usual employee discount of 40%, mearing that they could really buy clothes ‘with 2 retail vakio of about $1400. The omployer preferred employees to choose the git ‘oriicate because the cost of the watch fo the employer ranged from $6,500 to $7,500. It was ‘only out ofa desire to maintain ils traditions thatthe employer continued to offer the gold watch. Also, every year about 90% of the employees chose the watch over the gilt certifieate. There ‘would be a deep sense of disappointment and unfaimess if the watch offer were discontinued, Mr. Wilson is no ordinary Canaan clothing reall employee. At the time that he was given the ‘option of either the gold watch or the $1,000 gift cetitcate, Mr. Wilson was convinced that he ‘would be better off with the gold watch, A significant reason was that he knew thatthe value of ‘gold had inereased significantly in the past few years and so he expected that setting forthe git Certificate was unlikely to be @ good deal relative tothe watch, ‘As ittumed out, Mr. Wilson's assessment was not entirely accurate. An evaluation of the wateh prepared by a fcensed appraiser suggested that because the company logo and other features fon the watch were not of a nature to be of any valve toa third party, the market price of the watch was equal to the watch’s scrap value, which was estimated at $961. A similar valuation ‘was given by a jeweler in the community where Mr, Wilson resided, wito concluded that the walch had no retail value due to the presence of the corporate logo and estimated its scrap value at $937 based on the market price of god ‘Although the employer had not included any taxable beneft on Mr. Wilson's income tax return in 2012 on the basis thatthe gold watch wae “primarily for the employers business purposes," the CRA objected to ths treatment, The CRA Included amounts on each employee's income forthe cost of walches to the employer. Pursuant to this, the CRA included an amount of $7,471, the ‘aclual cost of the watch to the employer, in Mr. Wison’s income from employment for the 2012 taxation year as a beneft under paragraph 6(1)@) ofthe Income Tax Act In order to pay the increased tax, Mr. Wilson was forced to sell the watch on an online auction site turns out that despite the views of the appraisers, the watches have some nostalgic value as collectors items. Lucky for Mr. Wilson, he was able to recover $4,500 for the watch through the online auction, which was enough to pay the additonal tax demanded by the CRA, ‘Questions re: Scenario Two (no word limit) 5% each (~ 26 minutes) 7. In,your view, does Mr. Wilson need to include an amount in his income in respect of his receipt ofthe gold watch as the CRA demands? Why or why not? If so, what fs the appropriate valuation ofthe taxable benofi?‘Annual Examinations, 2013-2014 Paue 5 of Canaglan Income Tax Law, Professor Alario 8, What are the appropriate tax consequences to the employer of providing the watches to employees? More specifically, how much should the company be permitted 10 deduct with respect to the gold watches given to employees? 9. What, if any, are the appropriate income tax consequences for Mr. Wison from the sale of the gol watch onthe online auction ste for $4,500? 10. What are the approprate tax consequences 10 the 10% of employees who opt 10 receive the $1,000 gift certiicates instead of the gold watch? ‘Scenatio Three ‘Company A and Company 8 operate at arm's langth fiom each other. For some time, Company B has been jnlerested in purchasing a particular parcel of real property from Company A, The property of interest is vacant land that is adjacent to the recenlly completed head office premises of Company 8, Company B is interested in acquiring the land to preserve the ability to ‘expand is corporate headquarters complex in future years. Company A purchased the vacant lot several years ago. Al the time of the property's ‘acquisition, the area was all farm land, Although Company A is in the land development business, it orginal purchased tho propery for long-erm investment purposes, believing that the development of the area would take at least a further 15 or 20 years. Company A had originally acquired the vacant land at a cost of $200,000. Before Company B built its headquarters on the neighbouring land, Company A had the propery appraised by a neutral third-party ata value of $350,000. For both specific reasons linked to the area and more general ‘market reasons, afler the construction of Company 8's headquarters the appraised value of ‘Company A's land increased to $500,000. Even before commencing the construction ofthe new headquarters, Company B had expressed soma intarest in buying the properly. Company A had resistad, on the basis that they were holding the propery for the long-term and did not have other attractive places to invest the proceeds from the sale if they were fo sell to Company B, ‘After several months of negotiations, Company A and Company B entered into an agreement for the sale of a proparty at a price of $750,000 payable in six instalments over the course of five years. The fst installment of $150,000 was due on the execution of the agreement. The remaining five installments were due in the amount of $120,000 before the end of each of the Subsequent five years. There was interest payable only n the event of default on any of the Payments, and no discount was to be provided for early payment. The interest rate payable on default was 25% per year, ‘Assume that it can be established atthe time of the agreement that Company A and Company 8 are equally credt worthy and are able to borrow from reputable lenders (eg., Canadian chartered banks) at interest rates of 5% per year.‘Annual Examinations, 2013-2014 Page Sof 8 cian Income Tax Law, Professor Arie Questions re: Scenario Throo (no word limit) 5% each (~ 26 minutes) “11. What would be Company A's argument in support of characterizing the gain on the sale ofthe property as a capital gain for tax purposes? 42, Along the same lines, what would be Company A's argument in support of characterizing the deferred payments as entiely consisting of proceeds of disposition fon the sala ofthe property? 49, Based on the case law and the provisions ofthe Income Tax At, what in your view is the most appropriate tax treatment to Company A on the amounts that it receives on the sale of the property to Company 87 Why? 414. Suppose that Company A succeeds in defending its positions thatthe sale should be treated as giving rise to a capital gain (question 11) and that the deferred payments should be regarded as consisting entirely as proceeds of dispostion on the sale ofthe property (question 12). What are the proper tax consequences to each company if ‘Company B is late in making the payments on the purchase of the property to Company A. in responding, assume that Company B does eventually make the payments along with interest at 25% Scenario Four Peter has an amazingly fortunate year in 2005, followed by a spectacularly unfortunate 2006. ‘Ashley ie a clever con artist who takes advantage of Peter, On January 1, 2005, Peter finds $525,000 in cash in a brown paper bag on the Toronto subway. There is no marking on the bag {nd no obvious way to go about finding the tue owner. A constable atthe police station advises Peter that given the circumstances, the cash probably consists of proveeds of crime, but since there Is no evidence of the rue owner or the origin ofthe cash its his to keep. Peter quis his parttime job and starts looking fora better job. Peter decides fo enler a poker tournament at the Fallsview Casino in Niagara Falls, Ontario, with $10,000 of the money found on the subway. Peter reads up on the poker strategy for ‘several weeks before the tournament begins. Peter proves to have both beginner's luck and a ‘Quick mind. At the poker tournament, Peter not only makes ito the final table, bul fishes tst ‘out of 2000 entrants. His prize for winning is $1,000,000. His two-part fairytale win is nationwide news, especialy the fact that he tumed a potion ofthe found money into a milion Peter invests his $1,000,000 from the poker tournament in shares of BabbleOnPoker.com, He buys 1000 shares at the equivalent of $40 CON per share and another 1000 shares at the ‘equivalent of $60 CON per share. BabbleOnPoker com is not based in Canada and trades on @ foreign stock exchange. Peter thinks that BabbleOnPoker com is going to experience explosive ‘ov, He sees nothing but blue skies inthe future for online gambiing,Page 708 tn another unusual development, largely on the basis of his fairytale win In poker tournament, Peter is subsequenlly approached by BabbleOnPoker.com to appear in a series of ads for the site in 2005, Peter agrees and is paid $100,000 for doing so. Peter incurs expenses {acoommodation, fight, taxis, meals) out of his own packet of $1,800 to travel to Vancouver where the ads are fed, So ends Peter's fiytalo 2005 taxation year. In 2006, Peter has plans to parlay his great luck in 2006 into something even bigger and better. To this end, he plays poker on BabbleOnPoker.com throughout 2006, He is ahead by $500,000, by the ond of June 2606 and eantinuee to add to hie gaine for most of the your. However, is ‘December 2006 his ego got him caught up ina three-week, heacl-o-head "grudge match with @ ‘well-known poker personality. He was oulplayed and lost $800,000 in the month of December 2006 alone. As a result, Peter was down $15,000 overall from poker playing for the 2006 ‘taxation year, Including beth ive tournaments and online action, he played @ otal of 3,000 hours (an average of 60 hours per week) forthe year In November 2006, @ woman named Ashley approaches Peter. Ashley claims that the money Peter found on the TTC was hers. Ashley to's Peter that she read about his amazing story in a ‘magazine. In the magazine story, Peter descrived the brown paper bag, disclosed the amount ‘of money In the bag, the denominations of the bils, and even reported the station at which he boarded the train and discovered the bag (Bathurst Station, on the eastbound tran). When ‘Ashley explains that she left the bag accidentally on the eastbound tran atthe Bathurst Station ‘on New Year's Day, 2005, Peter thinks Ashley's claim is transparently bogus. ‘Ashley then, to Peter’s surprise, proves to his complete satisfaction that the money really is hers by having the Toronto Transit Commission (TTC) fax to him a copy of a report allegedly made interally by the TTC showing thal Ashley reported losing a brown paper bag ofthe exact same description as the one he found on the eastbound train at the Bathurst Station. Peter is ‘overcome by gui for having doubted Ashley and sends her a letter of apology and a cheque for $527,500. Peter explains thal the extra $2,500 represents interest on the money. Peter i vid at the TTC for not having linked the missing property report with his widely publicized discovery. The apparent incompetence of the TOC Is ht al that surprising to Peter, but he is nonetheless Lpset about it ‘As ittumns out, Peter was right to doubt the veracity of Ashley's story. The TCC had not been incompetent after all. Ashlay had indeed leamed of her find by reading the magazine story. Her mind immediately started working out a way to con Peter. It was fay easy to find some discarded TTC letterhead in a garbage bin outside of TTC headquarters. Ashley then scanned the letterhead into her computer, cleaned up the smudges and wrinkles using a digtal photo- edting program, wrote up a suitably blunt and bureaucratic description of her alleged “report of missing money’ ant had printer cut in calor ata capy shop for $10, “The tricky part for Ashley was to get the document faxed directly from TTC headquarters to Peter. To make this happen, as a pretext she drossed up as a bike courier, raced into the TTC. Public Communications Office with a package addressed to the head of the TTC (a box with 500 blank sheets of paper in t), and asked the staff f they would be able to do her a huge favour and fax “this confidential document” right away to a specific Toronto fax number. The ‘staff of course didat bother read the lelter and faxed it immediately, which had the effect of ‘securing Ashlay her payoff of $27,500 from PeterAnnwal Examinations, 2013-2014 Canacian Income Tax Law, Professor Alar Shares in BabbleOnPoker.com doubled in value in the frst half of 2006 to the equivalent of $100 CON per share, Although the share price continued to increase in the second half of 2008, it never went higher than the equivalent of $140 CDN, When the United States enacted federal legislation resalving the fagal uncertainty around online gambling by making it clearly legal, Peter's shares in BabbleOnPoker.com, slumped to be worth the equivalent of $20,000 CON. On December 30, 2006, Peter sells 1000 of the shares thal day for proceeds equal to $10,000 CDN, On December 31, Peter sels the remaining 1000 shares for proceeds equal to $8,000 CON. ‘Quostions re: Scenario Four (no word limit)~ 5% each (~ 25 minutes) 15. What are the tax consequences for Peter from the discovery ofthe cash in 2005 anc {rom his interactions with Ashley in 2008? 16, What are the tax consequences for Peter from his poker playing and endorsement activites in 2005 and 20062 417, What aro the tax consequences for Ashley from scamming Peter in 2006? 18, What are the tax consequences for Peter from his transactions in BabbleOnPoker.com ‘stock in 2005 and 20087 “THE END “*