UNIVERSITY OF TORONTO

FACULTY OF LAW
PAGE 1 OF 4

DATE: Wednesday, April 9, 2014

TIME: 9:30 am – 12:30 pm

ANNUAL EXAMINATIONS, 2013-14, APRIL 9, 2014

CANADIAN INCOME TAX LAW

Examiner: Jeffrey Shafer

NOTE: 1. You may use any kind of material you wish during the examination, for example, notes,
the casebook, and texts, except books owned by the library. Subject to note 4 below,
calculators are permitted.

2. The exam is composed of two questions, which are of equal value.

3. If there are facts missing that you consider necessary to your analysis, make reasonable
assumptions regarding the missing facts, and identify clearly in your answer where
you have made such assumptions.

4. Cell phones, pagers and other communication devices are prohibited in exams. Cell
phones are not permitted as a time keeping device, therefore should not be visible on the
desk during an examination. Communication devices left on the desk during an exam
may be removed by the invigilator.

5. Before you begin, ensure that you have written your pseudoname, course name, and
the number of the booklet on each examination booklet and the name of the instructor on
the first booklet. If you request an additional booklet(s) during the examination, write the
required information on the booklet at the time you receive it. No time will be permitted
for this at the end of the examination.

6. During the examination, only one student at a time is permitted to leave the examination
room. No student may leave within fifteen minutes of the conclusion of the examination.

7. At the end of this examination, the invigilator will ask you to stop writing, count the total
number of booklets used, record this on the front of the first booklet, and insert all
booklets into the first booklet. For students who are typing their examination, the
invigilator will ask you to stop typing and exit Examsoft. You will then return the exam
questions and all exam booklets to the invigilator and have your TCard returned to
you. Once you have received your TCard you can leave the examination room.

8. Time limits will be strictly enforced. Students who continue to write or type after the
examination has ended will have their answer booklets/examination envelope collected
separately and may be subject to a penalty.

...continued page 2
Annual Examinations, 2013-2014
Canadian Income Tax Law – Jeffrey Shafer Page 2 of 4

Question1

Bunsen was tired of the hard work he was doing at his job as a research chemist at the University of
Toronto. So, he decided to quit his position as a researcher and move to Australia to get a job as a scuba
diving instructor. Bunsen quit his job and moved with his wife and kids to Australia. Bunsen closed his bank
accounts, cancelled his Ontario drivers’ license, cancelled his Canadian credit cards, and sold all of his
investments. Bunsen and his family left Canada at the end of 2011 after the sale of their home described
below.

In order to make the move, Bunsen had to sell the family’s house in Toronto. The family had just moved in
2 years ago and Bunsen and his wife had sunk a lot of money into the home on the advice of a professional
decorator regarding certain renovations that were popular at the time (this was the family’s third house, both
others having been sold after renovation as well). In fact, Bunsen was sad to sell the house, as with all the
disruption from the renovations the family had only lived in the house for 8 months in the past two years.
Bunsen paid $400,000 for the house, and had spent an additional $100,000 on renovations, so he was
hopeful that he could get at least $600,000 for the house. Despite aggressive advertising and many visits,
nobody was ready to offer that price. Eventually Bunsen’s real estate agent conceded that the house was
not worth more than $550,000 in the current market. One interested buyer eventually offered $550,000 in
December of 2011. Bunsen didn’t really need the money immediately, and so asked the buyer if they would
be willing to pay $600,000 for the house with no down payment and all the cash being paid in the following
year. The buyer agreed and the house was sold on those terms in December of 2011, with the $600,000
being paid in December of 2012.

In February 2012 Bunsen and the family settled (after some travel) in Australia where he took a job as an
employee of a local scuba dive company (“ScubaPro”) starting February 1. Bunsen’s salary was
AUS$5,000 a month, which translated to CDN$6,000. Bunsen spent $500 on a new wetsuit for his new job.

Despite what seemed like an ideal life in Australia, Bunsen’s family quickly became homesick. At the end of
May, 2012, Bunsen was forced to quit his new job and return with his family back to Toronto. On Bunsen’s
last day, his boss, who had become a good friend, gave Bunsen a ScubaPro branded wetsuit (which
retailed for $500) as a token of gratitude for Bunsen’s hard work; Bunsen was flattered at the generosity of
the gesture, even though he knew that the wetsuit only cost ScubaPro $100 to buy from its supplier. When
ScubaPro learned that Bunsen was quitting, they were very concerned that Bunsen might be going over to
the local competition and didn’t want him revealing ScubaPro’s secret dive locations. Bunsen had no
intention of revealing that information, but the issue was very important to ScubaPro. ScubaPro offered to
pay Bunsen $1,000 if he would sign an agreement (exchanging signature pages by email from Toronto) in
early June of 2012, pursuant to which Bunsen agreed that he was not permitted to reveal to anyone the
location of ScubaPro’s secret dive spots. Bunsen was quite happy to accept what he viewed as free
money, and quickly signed the agreement. ScubaPro promptly honoured its obligation and mailed Bunsen
a cheque for $1,000, but due to the vagaries of international mail, the cheque did not arrive in Toronto until
January of 2013.

The family moved back to Toronto in June of 2012. Bunsen and his family rented a home in Toronto while
Bunsen looked for scuba-related work in Toronto during the rest of the year, but he was unsuccessful.

Bunsen and his wife found a new house they wanted to buy in Toronto, at a price of $700,000. Bunsen
approached a local bank in January of 2013 to see if he could borrow $50,000, being the amount needed in
addition to the family’s savings to allow them to buy the new house. The bank agreed to lend the money
towards the purchase of the new house. At the last minute, on the advice of a friend who had taken a tax
course in law school, Bunsen asked the bank if instead of the borrowed money being paid to the seller of
the new house, the bank would agree to allow Bunsen to sell some shares that he owned in Bell Canada for
Annual Examinations, 2013-2014
Canadian Income Tax Law – Jeffrey Shafer Page 3 of 4

$50,000 to raise the additional money for the house, with the bank then lending him the $50,000 to buy
shares of Bell Canada in the market to replace the ones he sold. Bunsen agreed that the bank loan still
would be secured by a mortgage on the new house. The bank reviewed this proposal and decided that this
was economically the same as lending to buy the new house, so it agreed to the revised arrangement and
signed a loan agreement with Bunsen. In January of 2013 Bunsen sold the shares of Bell Canada for
$50,000 (he realized no gain or loss), bought the new house, borrowed $50,000 from the bank and bought
new shares of Bell Canada for $50,000. Under the loan agreement with the bank, Bunsen agreed to repay
the $50,000 in 5 years’ time, and to pay to the bank in each year an amount equal to 20% of the income
generated in each such year from the Bell Canada shares bought with the loan proceeds. The Bell Canada
shares owned by Bunsen in 2013 only paid $1,000 in dividends, so Bunsen paid $200 to the bank.

Unable to find scuba-related work, Bunsen approached the University of Toronto in early 2013 to see if
there were any chemistry positions available. The University wanted to hire Bunsen back to his old position,
but Bunsen wanted the flexibility to do other things as well. Bunsen arranged with the University to work as
a “contract researcher”. The contract he negotiated with the University gave Bunsen flexibility in his hours,
and permitted Bunsen to do other chemistry research work if he wanted to do so, although the actual work
he would be doing was nearly identical to what he used to do and he would still have to report to the head of
the lab he was working in. The contract provided for a flat fee of $60,000 per year, payable in monthly
instalments. Space was at a premium at the University, so the contract also required that Bunsen maintain
a home office where he could do online research, writing of reports and other administrative tasks that did
not require lab space. Bunsen spent $5,000 on his home office in 2013. Bunsen also spent $500 on
protective gear (lab coat, goggles, etc.) that he used while working in the lab. Despite the non-exclusive
nature of the contract, Bunsen’s research work at the University took so much of his time that he did not
even look for other opportunities.

Please advise Bunsen on the Canadian income tax consequences of the above facts. Please assume that
the only classes of depreciable property listed in the regulations to the Income Tax Act (Canada)
are: Class 1: Recordaks (40% rate); Class 2 – Computer equipment (20% rate); and Class 3 –
wetsuits (50% rate).

Question 2

Fozzie had always loved magic. As a kid he would perform for friends and family at every opportunity, and
he always loved watching his extensive collection of recorded performances of the “masters”. One
weekend, Fozzie happened to pass by a garage sale and noticed an old magician’s table (used for sawing
assistants in half) for sale. On further inspection it turned out that the props for an entire magic show were
being sold by an old magician. His immediate impulse was to buy the old stage props – the cost seemed
reasonable – but his cautious side prevented him from making the purchase on the spot. As much as
Fozzie was interested in the props, he was reluctant to spend a few hundred dollars for a collection of old
magic tricks if they weren’t really worth it. So, Fozzie went home and used the Internet to research the
market for old magic tricks. He discovered that some of these old props were very valuable, while some
were practically worthless.

Armed with this new knowledge, Fozzie went back to the garage sale. The little boy in him still wanted to
buy everything, but he just couldn’t justify to himself buying the “worthless” stuff, so he picked through the
magic tricks/props being sold to identify the valuable ones. The cost for what he picked out totalled $700,
which he thought was a great bargain. Fozzie didn’t have $700 on him (that was more than he had planned
on spending), and rather than risk going to an ATM to withdraw cash, he borrowed $200 from his brother
who came with him to the garage sale. Fozzie was so pleased with his purchase that when he paid his
brother back the $200 the next day, he insisted on adding an extra $20 to say “thank you”.
Annual Examinations, 2013-2014
Canadian Income Tax Law – Jeffrey Shafer Page 4 of 4

Fozzie set up the magic equipment in his basement, and thoroughly enjoyed owning those pieces of magic
history. He even performed a trick or two for friends on occasion using the new props. He was so pleased
with his purchases that he began actively searching for other magic equipment on the used market. Over
time, Fozzie built up an extensive network of contacts in the magic industry, as well as a good deal of
expertise in the area, but continued to buy magic equipment only for his own personal collection. As his
knowledge increased in the area, he became interested in ever more exotic magic equipment. In 2011 he
finally sold the original equipment he bought at the garage sale; he hated to see it go, but he needed the
room in his basement for new purchases, and one of his contacts made him an offer he couldn’t refuse at
$1,500 for the lot. That was a great deal for Fozzie, even though he had to pay $50 to ship the equipment
to the buyer as part of the deal.

Later in 2011, Fozzie learned that a local high-end magic equipment supplier was going out of business and
was liquidating its entire inventory. Fozzie understood that the asking prices for this bulk of equipment were
far lower than he could obtain reselling the equipment to private magicians and collectors such as himself.
So, although it was a large financial commitment, Fozzie bought 200 cases of “trick” decks of cards for
$20,000. By devoting significant time on the weekends (he still had a “day job”) Fozzie was able to arrange
to sell all 200 cases within a few months, for total sale proceeds of $30,000.

Fozzie was pleased with this result, and began buying large quantities of magic supplies from struggling
dealers around the country, selling the goods through an online web-store he set up for the purpose. In
2011 Fozzie spent $1,000 to hire a programmer to design and implement his custom web store, and bought
computer servers for $500 to support the web store. In 2012 Fozzie bought various magic equipment for a
total of $50,000, which he then sold through his web store for an aggregate of $75,000. Without even
entering the contest, Fozzie’s web store won an award for best new online magic equipment retail site for
2012, which great honour was accompanied by a prize of $50. In late 2012 Fozzie was sued by one of his
customers for breach of privacy when some personal information was accidentally made available on the
public part of Fozzie’s web store because of a cyber-attack on his web store; Fozzie settled the law suit for
$1,000.

In 2013, despite his success, Fozzie decided that he wanted to get rid of the web store. He wanted to get
back to focussing on his own personal love of magic, without the hassle of dealing with customers. One of
his many contacts expressed an interest in buying the web store, and was willing to pay $40,000 for it, but
was concerned that without Fozzie’s expertise the store would not continue to be successful. Fozzie agreed
that he would sell the web store, and would also provide “transitional” consulting services to the buyer for
two years to help ensure the store would be successful. The buyer was willing to pay Fozzie $8,000, on top
of the $40,000, in consideration for the services. The buyer was also willing to allow Fozzie a pretty free
hand in drafting the legal agreement governing the transaction; Fozzie, thinking it was a good idea, drafted
the agreement to provide for the sale of the web store for a price of $48,000, and agreed to provide the
transitional services for two years at no extra cost. Fozzie sold the store in 2013 for the $48,000, which he
received immediately, and provided the transitional services in 2013 and 2014. Fozzie sold his computer
servers separately in 2013 for $100. Fozzie used some of the proceeds from the sale of the business to buy
himself a new home computer for entertainment purposes.

Please advise Fozzie on the Canadian income tax consequences of the above facts. Please assume that
the only classes of depreciable property listed in the regulations to the Income Tax Act (Canada)
are: Class 1: Recordaks (40% rate); Class 2 – Computer equipment (20% rate); and Class 3 –
wetsuits (50% rate).

*** THE END ***