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CHAPTER 11

Computation of Taxable Income and Tax after


General Reductions for Corporations
Problem 1
[ITA: 3; 110.1112]
The following data summarizes the operations of Red Pocket Limited for the years of 2002 to 2005 ended
September 30.
2002
2003
2004
2005
Income (loss) from business...... $ 54,000 $ 32,000 $ (75,000) $ 62,500
Dividend income Taxable
42,500
22,500
18,000
10,500
Canadian corporations............
Taxable capital gains..................
11,000
2,500
5,000
9,000
Allowable capital losses.............
2,000
4,500
3,500

Allowable business investment


3,750

loss..........................................
Charitable donations..................
23,000
9,000
3,000
13,000
The corporation has a net capital loss balance of $13,500 which arose in 1998.
REQUIRED
Compute the taxable income for Red Pocket Limited for the years indicated and show the amounts that are
available for carryforward to 2006. (Deal with each item line-by-line across the years, rather than computing
income one year at a time.)

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Introduction to Federal Income Taxation in Canada

230
Solution 1
Par. 3(a)

Income from business.......................


Income from property.......................

Par. 3(b)

Taxable capital gains.........................


Allowable capital losses....................

2002
54,000
42,500
$ 96,500
11,000
(2,000)
$

2003
32,000
22,500
$ 54,500
2,500
(2,500)

2004

$
$

2005
62,500
10,500
$ 73,000
9,000
Nil

Nil
18,000
18,000
5,000
(3,500)

19,500
n/a
(75,000)
Nil

Nil

Par. 3(c)
Par. 3(d)

ABIL.................................................
Business loss.....................................
Income from Division B....................
Inter-company dividends...................

Par. 3 (e)
Sec. 112
Sec. 110.1

Par. 111(1)(b)

Charitable donations2:
Carryover....................................
Current........................................
Net capital losses3..............................

Par. 111(1)(a)
Non-capital losses4............................
Taxable income................................................................

$ 105,500
(3,750)
n/a
$ 101,750
(42,500)
$ 59,250

54,500
n/a
n/a
$ 54,500
(22,500)
$ 32,000

n/a
(23,000)
$ 36,250
(9,000)
$ 27,250
(27,250)
Nil

(9,000)
$ 23,000

$ 23,000
(23,000)
Nil

Nil
(1,500)
Nil

Nil

82,000
n/a
n/a
$ 82,000
(10,500)
$ 71,500
(3,000)
(13,000)
$ 55,500
(500)
$ 55,000
(24,750)
$ 30,250

NOTES TO SOLUTION
(1) A maximum of $2,500 can be deducted in 2003.
(2) Charitable donations:
2002: Lesser of:
(a) 75% of $101,750 = $76,313
(b) $23,000
Carryforward: Nil
2003: Lesser of:
(a) 75% of $54,500 = $40,875
(b) $9,000
Carryforward: Nil
2004: Lesser of:
(a) 75% of Nil = Nil
(b) $3,000
Carryforward: $3,000
2005: Lesser of:
(a) 75% of $82,000 = $61,500
(b) $3,000 + $13,000 = $16,000
Carryforward: Nil
(3) Net capital losses
1998 net capital loss converted to 2002 rates: $13,500 1/2/3/4...........................................
Net capital loss deducted in 2002 to the extent of net taxable capital gains.........................
2003 net capital loss not utilized..........................................................................................
2004 net capital loss deducted to the extent of net taxable capital gains..............................
2005 remaining net capital loss deducted in 2005 to the extent of net taxable capital gains
Available for carryforward...................................................................................................

9,000
(9,000)
Nil
$ 2,000
(1,500)
$
500
(500)
Nil

Solutions to Chapter 11 Assignment Problems

231

(4) Non-capital losses


Par. 3(d) Loss from business in 2004........................................................... $ 75,000
Dividends deducted under sec. 112...............................................
18,000
Add: net capital loss deducted............................................................................................
Less: sec 3(c): par. 3(a) dividends.................................................................
par. 3(b) taxable capital gain.................................................

$ 18,000
1,500

Losses utilized: 2002..................................................................................... $ 27,250


2003.....................................................................................
23,000
2005.....................................................................................
24,750
Closing balance..................................................................................................................

$ 93,000
1,500
$ 94,500
19,500
$ 75,000
75,000
Nil

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232
Problem 2

[ITA: 111(4), (5), (5.1); 249(4)]


On November 1, 2005, Chris purchased all the issued shares of Transtek Inc. from an acquaintance, Tom.
Transtek carries on a transmission repair business and has done so since its incorporation on January 1, 2004. In
addition to the transmission repair business, Transtek rents out a small building it owns. Neither the transmission
repair business nor the rental endeavour has been successful.
When Chris purchased Transtek, his financial projections indicated that Transtek would have significant
income within two years. Chris credited Transteks failure to Toms brash personality and laziness. Chris, on the
other hand, has a strong work ethic and has many contacts in the automotive industry to refer work to him.
The values of the capital assets owned by Transtek at the time of purchase by Chris are as follows:
Repair shop
Rental property
Land
Building
Land
Building
F.M.V...................... $ 140,000 $ 230,000 $ 70,000 $ 120,000
Cost/A.C.B..............
80,000
150,000
90,000
120,000
U.C.C......................

147,000

120,000
Chris selected June 30, 2006, as the first fiscal year-end for Transtek after his purchase. The following is a
schedule of Transteks income (and losses) from its inception, January 1, 2004, through June 30, 2007.
Period
Jan. 1/2004Dec.
31/2004....................
Jan. 1/2005Oct.
31/2005....................
Nov. 1/2005June
30/2006....................
July 1/2006June
30/2007....................

Transmission
repair business

Rental
income (loss)

Capital
Loss

$ (40,000)

$ (2,000)

$ (10,000)

(60,000)

(5,000)

(25,000)

6,000

54,000

11,000

REQUIRED
(A) Discuss the tax implications of the acquisition of Transtek Inc. on November 1, 2005, ignoring all
possible elections/options.
(B) Determine the tax consequences of the acquisition of Transtek Inc. under the assumption that:
(i) the maximum amount of all elections/options is utilized; and
(ii) the partial amount of all elections/options is utilized so that only enough income is generated to offset
most or all of the losses which would otherwise expire on the acquisition of control.

Solutions to Chapter 11 Assignment Problems

233

Solution 2
The data given in the problem statement can be summarized as follows:

Note that if no election is made, there is no income to offset the current business loss of $60,000 or the noncapital loss carryforward of $40,000. Therefore the non-capital loss available to carry forward from October 31,
2005 is $100,000 (i.e., $60,000 + $40,000). Note that the $2,000 of non-capital loss carryforward from a property
loss expires.
If the maximum election is made, the $3,000 of recapture offsets the business loss, leaving $57,000 (i.e.,
$60,000 $3,000) of net business loss. The $70,000 of taxable capital gain offsets the $22,000 of expiring losses,
leaving $48,000 (i.e., $70,000 $22,000) to offset the remaining $57,000 of business loss. There is no remaining
taxable capital gain to offset some of the $40,000 non-capital loss carryforward. As a result, the non-capital loss
available for carry forward from October 31, 2005 is $40,000.
If only a partial election is made, it should be enough to offset only $20,000 of the $22,000 of expiring
losses. The other $2,000 of expiring loss is the property loss carryforward which can only be utilized if enough
Division B income is elected, resulting in the elimination of the current business loss, as was the case with the
maximum election. If a partial election of only $20,000 of taxable capital gain is made, the current business loss
of $60,000 is not offset and, hence, is available to carry forward, along with the $40,000 of business non-capital
losses, from October 31, 2005 for a total of $100,000.
Part A (Ignoring all possible elections)
An acquisition of control occurred when Chris acquired more than 50% of the voting shares of Transtek Inc.
from an unrelated person, Tom.
The taxation year of Transtek is deemed to end immediately before the acquisition of control, October 31,
2005 [ssec. 249(4)].
Tax returns are required to be filed for this short year (i.e., 10 months) and amounts, such as C.C.A. (if
claimed), will have to be prorated.
It is assumed that any accrued losses in inventory and accounts receivable have been recognized in
calculating the business loss of $60,000.

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234

There are no accrued losses on the depreciable property. Therefore, there is no adjustment required [ssec.
111(5.1)].
There is a $20,000 accrued loss on the rental property land that must be recognized. The A.C.B. of the land
is reduced from $90,000 to $70,000 [par. 111(4)(c)]. The $20,000 reduction is deemed to be a capital loss
[par. 111(4)(d)].
The income (loss) for the taxation year ended October 31, 2005 is computed below.
Par. 3(a)
Par. 3(b)

Business income.......................................................................................................

Nil

Property income........................................................................................................

Nil

Net capital gains:


Taxable capital gains......................................................................

Nil

Allowable capital loss: rental property ($20,000 1/2)..................

$ (10,000)

Par. 3(c)
Par. 3(d)

Nil
Nil

Business loss......................................................................................

$ (60,000)

Property loss.......................................................................................

(5,000)

$ (65,000)

Division B income....................................................................................................

Nil

The net capital losses (($10,000 1/2) + $10,000 = $15,000) expire immediately following the October 31,
2005 year-end [par. 111(4)(a)].
The non-capital loss balance at November 1, 2005 is computed as follows:
Balance, Jan. 1, 2005................................................................................................................... $ 42,000
Loss for taxation year ended Oct. 31, 2005:
from business.................................................................................................

from property.................................................................................................

5,000
$

Less Par. 3(c) amount determined above..............................................................

60,000
65,000
0

65,000

Balance, Oct. 31, 2005................................................................................................................

$ 107,000

Less: unutilized losses about to expire:


non-capital property losses..........................................................

$ 2,000

current property loss....................................................................

5,000

Balance, Nov. 1, 2005.................................................................................................................

7,000
$ 100,000

Only the portion of the non-capital loss that may reasonably be regarded as a loss from carrying on a
business ($40,000 + $60,000 = $100,000) is deductible after October 31, 2005. Thus, the rental losses ($2,000 +
$5,000 = $7,000) expire immediately following the October 31, 2005 year-end [par. 111(5)(a)].
The $100,000 non-capital loss will be deductible only if the following condition is met the transmission
repair business is carried on for profit or with a reasonable expectation of profit throughout the taxation year in
which the losses are to be claimed [spar. 111(5)(a)(i)]. The condition appears to be met for the June 30, 2006 and
the June 30, 2007 taxation years. The transmission repair business was carried on throughout each of the years. It
was carried on for profit for the taxation year ended June 30, 2007. Due to Chriss work ethic and contacts in the
industry, it is reasonable to assume that it was carried on with a reasonable expectation of profit for the taxation
year ended June 30, 2006, despite the loss that was actually realized.
The $100,000 non-capital loss is deductible only to the extent of income from the transmission repair
business and income from a business selling similar products or providing similar services [spar. 111(5)(a)(ii)].
Thus, $54,000 of the non-capital loss incurred prior to November 1, 2005 is deductible for the June 30, 2007
taxation year. None of it is deductible for the June 30, 2006 taxation year due to the loss in that year. The
remainder ($100,000 $54,000 = $46,000) can be carried forward to 2008 subject to these same restrictions.

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235

These restrictions do not apply to the non-capital loss ($25,000 $6,000 = $19,000) incurred in the taxation
year ended June 30, 2006. Thus $11,000 of the 2006 non-capital loss is deductible in 2007, in addition to the
$54,000 mentioned above.
Part B (i) (Maximum election)
Paragraph 111(4)(e) allows Transtek to elect to be deemed to have disposed of the repair shop land for
proceeds of $140,000 (maximum) and the repair shop building for proceeds of $230,000 (maximum). If Transtek
makes this election, the A.C.B. of the land on November 1, 2005 will be $140,000 and the A.C.B. of the building
will be $230,000. The new undepreciated capital cost for the building will be limited by paragraph 13(7)(1) to
$150,000 + 1/2 ($230,000 150,000) = $190,000.
The income for the taxation year ended October 31, 2005 will be as follows:
Par. 3(a): Business income........................................................................................................
Property income........................................................................................................
Par. 3(b): Net capital gains:
Taxable capital gains:
Repair shop land ($140,000 $80,000) 1/2................................. $ 30,000
40,000
Repair shop building ($230,000 $150,000) 1/2.........................
$ 70,000
(10,000)
Allowable capital loss ($20,000 1/2)................................................
Par. 3(c)
Par. 3(d)

............................................................................................................
Business loss.......................................................................................
Less: recapture building ($147,000 $150,000)...........................

Nil
Nil

60,000

60,000

$ (60,000)
3,000
$ (57,000)
Property loss.......................................................................................
(5,000)
Division B income.......................................................................................................................
Division C deductions:
Par. 111(1)(a) Net capital loss from 2004..................................................... $ (5,000)
Par. 111(1)(b) Non-capital loss:
Business.......................................................... $(
Nil)
Property...........................................................
(Nil)
(Nil)
Taxable income...........................................................................................................................
Non-capital loss balance, Nov. 1, 2005:
Balance, Jan. 1, 2005...............................................................
Added in taxation year ended Oct. 31/05
($60K $5K $5K $57K....................................................
Utilized in taxation year ended Oct. 31, 2005 or expired........
Remaining...............................................................................

Business
$ 40,000

Property
$
2,000

7,000
(Nil)
47,000

Nil
(2,000)
Nil

(62,000)
Nil

(5,000)
Nil
$

Total
42,000

7,000
(2,000)
47,000

The $47,000 remaining may reasonably be regarded as a loss from carrying on business and thus is
deductible in a taxation year after October 31, 2005, subject to the restrictions discussed in Part A.
By making the maximum elections possible, the non-capital loss balance of Transtek at November 1, 2005
has been significantly reduced.
Part B (ii) (Minimum election to utilize expiring losses)
The following losses will expire October 31, 2005, if not utilized:
The 2004 net capital loss..............................................................................................
The Oct. 31, 2005 allowable capital loss......................................................................
The rental loss portion of the 2004 non-capital loss.....................................................
The Oct. 31, 2005 rental loss........................................................................................

5,000
10,000
2,000
5,000
$ 22,000

It is impossible to utilize the rental loss portion of the 2004 non-capital loss of $2,000 without triggering
sufficient income under paragraph 3(c) to utilize the entire October 31, 2005 business loss. This would not be
beneficial. Therefore, only $20,000 of the expiring losses will be used.

Introduction to Federal Income Taxation in Canada

236

To utilize these losses in the taxation year ending October 31, 2005, a capital gain of 2 $20,000 = $40,000
is needed. To avoid recapture, the election should be made on the land, not the building.* Thus, Transtek will
elect under paragraph 111(4)(e) to be deemed to have disposed of the repair shop land for proceeds of $120,000,
i.e., (2 $20,000) + 80,000. The A.C.B. of the land at November 1, 2005 will be $120,000.
* An alternative is considered below.
The income for the taxation year ended October 31, 2005 will be as follows:
Par. 3(a)

Business income........................................................................................................
Property income........................................................................................................
Par. 3(b) Net capital gains:
Taxable capital gain:
Repair shop land ($120,000 $80,000) 1/2..................................... $ 20,000
(10,000)
Allowable capital loss ($20,000 1/2)................................................
Par. 3(c).......................................................................................................................................
Par. 3(d) Business loss....................................................................................... $ (60,000)
Property loss.......................................................................................
(5,000)
Division B income.......................................................................................................................

Nil
Nil

$ 10,000
$ 10,000
(65,000)
Nil

Division C deductions:
Par. 111(1)(a) Net capital loss from 2004............................................................................
Taxable income............................................................................................................................

$ (5,000)
Nil

The net capital loss claimed has no effect on taxable income, but it will increase the non-capital loss balance.
The non-capital loss balance at November 1, 2005 is computed as follows:
Balance, Jan. 1, 2005...................................................................................................................
Par. 3(d) Loss for taxation year ended Oct. 31, 2005:
from business........................................................................................ $ 60,000
from property........................................................................................
5,000
$ 65,000
Add: Net capital loss deducted..............................................................................
5,000
$ 70,000
Less: Par. 3 (c) amount determined above............................................................
10,000
Balance, Oct. 31, 2005................................................................................................................
Less: the unutilized non-capital property loss.............................................................................
Balance, Nov. 1, 2005.................................................................................................................

$ 42,000

60,000
*
$ 102,000
2,000
$ 100,000

* Exactly equal to the business loss above.

Only the portion of the non-capital loss that may reasonably be regarded as a loss from carrying on a
business ($40,000 + $60,000 = $100,000) is deductible after October 31, 2005. It is subject to the restrictions
discussed in Part A.
Summary:
The three alternatives presented above are summarized as follows for comparative purposes:
Taxable Income for the Deemed Taxation Year Ended October 31, 2005:
No election
Par. 3(a) Income from non-capital sources ( 0).......................
Par. 3(b) Net taxable capital gains ( 0):
Deemed taxable capital gains (elective):
land.....................................................
Nil
building..............................................
Nil
Accrued allowable capital loss
(automatic):
rental land........................................... $ (10,000)
Par. 3(c) Par. 3(a) + par. 3(b).....................................................

Maximum election
Nil

Nil
$

Nil
Nil

30,000
40,000

(10,000)

Partial election
Nil
$ 20,000
Nil

$ 60,000
$ 60,000

(10,000)

$ 10,000
$ 10,000

Solutions to Chapter 11 Assignment Problems


Par. 3(d) Losses from non-capital sources and
ABILs:
Loss from business operations....................
Recapture (elective): building.....................
Loss from property......................................

$ (60,000)
Nil
(5,000)

237

(65,000)

Division B income......................................................................
Optional net capital loss deducted........................
Nil
Non-capital loss deducted:
From property..............................................
Nil
From business..............................................
Nil

Nil

Taxable income..........................................................................

Nil

$ (60,000)
3,000
(5,000)

(62,000)

(65,000)

Nil
(5,000)

Nil

$(60,000)
Nil
(5,000)

Nil
Nil

Nil
(5,000)

(Nil)

Nil
Nil

Nil

Nil

Nil

Non-Capital Losses Available for Carryforward at Deemed Taxation Year Ended Oct. 31, 2005:
No election
Balance from Jan. 1, 2005.......................................................... $ 42,000
Non-capital loss Oct. 31, 2005:
Par. 3(d) losses see above........................ $ 65,000
Add: net capital losses deducted...................
Nil
Less: par. 3(c) income see above.............

$ 65,000
Nil

65,000

Maximum election
$ 42,000
$ 62,000
5,000
$ 67,000
60,000

$ 107,000
Less: losses utilized at Oct. 31, 2005.....................
losses not utilized but expired:
Current property loss............................
Carryforward property loss..................

Nil

Partial election
$ 42,000
$ 65,000
5,000

7,000

$ 70,000
10,000

$ 49,000
Nil
Nil
2,000

60,000
$ 102,000

Nil

$ 5,000
2,000

7,000

Available for carryforward from Nov. 1, 2005..........................

$ 100,000

$ 47,000

$ 100,000

Net Capital Losses available for Carryforward..........................

Nil

Nil

Nil

2,000

Nil
2,000

2,000

The results of the above comparison of the three alternatives are further summarized as follows:
Alternatives
(A)
(B)(i)
(B)(ii)
Taxable income.................................................................
Nil
Nil
Nil
Net capital loss deducted...................................................
Nil $
5,000 $
5,000
Non-capital loss balance, Nov. 1, 2005............................. $ 100,000
47,000
100,000
A.C.B. of repair shop land.................................................
80,000
140,000
120,000
A.C.B. of repair shop building..........................................
150,000
230,000
150,000
U.C.C. of repair shop building..........................................
147,000
190,000
147,000
*
* $147,000 + $3,000 + 1/2 ($230,000 $150,000)

Alternative B (ii) is better if the non-capital loss can be offset by income generated in the next seven years.
The resultant lower A.C.B. of the land and building under this option is only relevant on a disposition. The lower
U.C.C. on the building only represents an opportunity loss of C.C.A. at a 4% declining balance rate.
Consider the alternative of electing deemed proceeds of disposition of $190,000 (i.e., (2 $20,000) +
$150,000) on the repair shop building. Income under paragraph 3(b) would be the same as for Part B (ii).
However, the business loss under paragraph 3(d) would be only $57,000 (i.e., $60,000 $3,000 recapture), since
recapture would be triggered. This would reduce the non-capital loss balance at November 1, 2005 by $3,000 to
$97,000. However, the UCC of the repair shop building could be increased from $147,000 to $170,000 (i.e., +
$3,000 of recapture + $20,000 of taxable capital gain). The increased CCA base would begin to shelter income
from tax, in this case, in the year ended June 30, 2006, when the corporation earns a profit. If, for example, the
corporation uses a discount rate of 10% and faces a tax rate of 20%, the present value of the tax shield on the
incremental UCC base of $23,000 (i.e., $170,000 $147,000) is:
$23,000 .04 .20
= $1,314
.04 + .10
The value of the extra $3,000 in the non-capital loss balance in the same year and at the same assumed tax
rate of 20% is $600 (i.e., 20% of $3,000).

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Introduction to Federal Income Taxation in Canada

Problem 3
[ITA: 111(4), (5), (5.1); 249(4)]
In 2002, a chain of bakeries, called Buscat Ltd., commenced operation. The industry is highly competitive
and because of Mr. Buscats lack of marketing skills, the corporation incurred losses in the first three taxation
years of operations as follows:
Taxation year-end
Dec. 31, 2002..................................................
Dec. 31, 2003..................................................
Dec. 31, 2004..................................................

Non-capital
losses
$ 60,000
45,000
25,000

Capital
losses
$ 12,000
8,000
4,000

On July 1, 2005, Mr. Buscat decided to sell 75% of his common shares to Mr. Bran, owner of Buns Plus
Ltd. Mr. Bran has been in the business of supplying bread dough, pastry dough and bun bags for ten years and
has been very successful. Buns Plus Ltd. has two divisions: a bakery and a coffee shop, which it intends to
transfer to Buscat Ltd.
The following income tax data relates to Buscat Limiteds operations from January 1, 2005 to June 30,
2005:
(a) Business loss (before inventory valuation).. $ 10,000
(b) Allowable capital loss.................................
2,000
(c) Property loss................................................
5,500
(d) Assets at June 30, 2005:
Inventory.............................
Land....................................
Building..............................
Bakery equipment...............

Cost/A.C.B.
$ 85,000
155,000
65,000
100,000

U.C.C.

$ 45,000
86,000

F.M.V.
$ 65,000
195,000
75,000
70,000

During the later part of the 2005 calendar year, the bakery/coffee shop of Buns Plus Ltd. was transferred to
Buscat Ltd. For the six-month period ending on December 31, 2005, Buscat Limited had net income of $90,000
from all its businesses.
The net income earned was as follows:
Buscat bakery..................................................... $ (55,000)
Buns Plus bakery................................................
130,000
Coffee shop........................................................
15,000
$ 90,000
In the 2006 taxation year, Buscat Ltd. expects to earn $250,000, of which $65,000 will be from the original
Buscat bakery business and $20,000 from the coffee shop business.
REQUIRED
Prepare an analysis of the income tax implications of the acquisition of shares. In your analysis, consider the
two election options from which an election choice is most likely to be made.

Solutions to Chapter 11 Assignment Problems

239

Solution 3
The data given in the problem statement can be summarized as follows:

The two election options to consider are the maximum election and the partial election.
If the maximum election is made, the $20,000 of recapture offsets the business loss, leaving $26,000 (i.e.,
$46,000 $20,000) of net business loss. The $25,000 of taxable capital gain offsets the $19,500 of expiring
losses, leaving $5,500 (i.e., $25,000 $19,500) to offset the remaining $26,000 of business loss, leaving $20,500
of that business loss. As a result, the non-capital loss available for carry forward from June 30, 2005 is $150,500
(i.e., $20,500 + $130,000).
If only a partial election is made to offset the $19,500 of expiring losses, the current business loss of
$46,000 is not offset and, hence, is available to carry forward, along with the $130,000 of non-capital losses,
from June 30, 2005 for a total of $176,000. If the election is made on the land, the ACB of the land can be
increased without a tax cost.
Note that if no election is made there is no income to offset the current business loss of $46,000 or the noncapital loss carryforward of $130,000. Therefore, the non-capital loss available to carry forward from June 30,
2005 is $176,000 (i.e., $46,000 + $130,000), which is the same as in the partial election, but there is no increase
in any cost value..
Deemed Year-end
Buscat Ltd. is deemed to have a taxation year ending June 30, 2005, immediately before the acquisition of
control by Buns Plus Ltd. on July 1, 2005 [ssec. 249(4)]. Tax returns will have to be filed for this short taxation
year (i.e., 6 months) and amounts such as C.C.A. will have to be prorated. In addition, the short taxation year will
cause the counting of a carryforward year for the non-capital losses from 2002, 2003 and 2004.

240

Introduction to Federal Income Taxation in Canada

Loss from Non-capital Sources


Losses from non-capital sources for the deemed taxation year ended June 30, 2005, before any elections and
options are computed as follows:
Loss from business....................................................................................................... $ 10,000
Add: Inventory loss [ssec. 10(1)] ($85,000 $65,000)..............................................
20,000
Bakery equipment Deemed CCA ($86,000 $70,000)................................
16,000
Total business losses..................................................................................................... $ 46,000
Add: Property loss (will expire unless utilized by June 30, 2005)..............................
5,500
Total losses from non-capital sources........................................................................... $ 51,500
Maximum Election
Division B income and taxable income
Par. 3(a) Income from non-capital sources................................................................................
Par. 3(b) Net taxable capital gains:............................................................................................
Election on land [($195,000 $155,000) 1/2]..................................................
Election on building [($75,000 $65,000) 1/2]................................................
Less: Allowable capital loss................................................................................
Par. 3(c) Sum of par. 3(a) plus par. 3(b) less any Subdivision e deductions (nil)......................
Par. 3(d) Property loss........................................................................................... $ 5,500
Business losses.......................................................................................
46,000
$ 51,500
Less: Building recapture.........................................................................
20,000
Sec. 3 income................................................................................................................................
Division C deductions:
Net capital losses: 2002..................................................................................... $ 6,000
2003.....................................................................................
4,000
2004.....................................................................................
2,000
Taxable income.............................................................................................................................

Nil
$ 20,000
5,000
$ 25,000
2,000
$ 23,000

31,500
Nil

$ 12,000
Nil

Non-capital losses available for carryforward after acquisition of control:


Balance July 1, 2005
2002 non-C.L.....................................................................................................
2003 non-C.L.....................................................................................................
2004 non-C.L.....................................................................................................
Non-C.L. from deemed taxation year before acquisition of control:
Total par. 3(d) loss (see above calculation).......................................................
Add: Net capital loss deducted..........................................................................

$ 60,000
45,000
25,000

$ 130,000

$ 31,500
12,000
$ 43,500
Less: Par. 3(c) income above.............................................................................
23,000
Total non-capital losses.................................................................................................................

20,500
$ 150,500

The $150,500 loss carryforward balance must reasonably be regarded as its loss from carrying on a
business.
2002, 2003 and 2004 loss carryforwards from a business as stated in the question............... $ 130,000
June 30, 2004 business loss net of recapture..................................................... $ 26,000
Less portion of this loss used against par. 3(c) income*...................................
5,500
20,500
$ 150,500
* Par. 3(c) income........................................................................................................
Less:
Property losses....................................................................... $ 5,500
Net capital losses restored as business losses.......................
12,000

$ 23,000
17,500
$

5,500

Solutions to Chapter 11 Assignment Problems

241

The non-capital losses will expire as follows, assuming that Buscat Ltd.s fiscal year-end after the
acquisition of control returns to December 31.
2002 non-C.L. on December 31, 2008
2003 non-C.L. on December 31, 2009
2004 non-C.L. on December 31, 2013
2005 deemed taxation year on December 31, 2014
The adjusted cost base/capital cost of the properties which were deemed to be sold at their fair market values
would be:
Capital
U.C.C.
Adjusted
cost
cost base
Bakery equipment................................................................... $ 100,000
$ 70,000
$ 100,000
Land........................................................................................
n/a
n/a
195,000
Building*................................................................................
70,000
70,000
75,000
* $65,000 + 1/2 ($75,000 $65,000).

In order for these non-capital losses to be deductible in subsequent fiscal periods, two conditions in
subparagraph 111(5)(a)(i) must be met:
(a) the bakery business which generated the loss must be carried on throughout the taxation year in which
the non-capital loss is deducted; and
(b) the bakery business must be carried on for profit or with a reasonable expectation of profit.
It would appear that both conditions will be met, since the Buscat business is being carried on and Buns Plus
expects that the Buscat bakery business will earn a profit of $65,000 in 2006.
If the conditions of subparagraph 111(5)(a)(i) are met, then the non-capital losses may be deducted from
income of the bakery business that generated the loss plus the income from the sale of similar products or
services. If it can be assumed that the bakery business, transferred to Buscat Ltd., sells similar products and/or
services as the Buscat bakery business, then the maximum $90,000 of non-capital losses can be deducted on
December 31, 2005 as follows:
Lesser of:
(a) Net income for year...................................................................................................... $ 90,000
(b) Income from: the loss business...............................................................
Nil
the sale of similar products.............................................. $ 130,000
$ 130,000
The remaining $60,500 ($150,500 $90,000) of non-capital losses can be carried forward to 2006 subject to
the deductibility tests discussed above.
Partial election
The minimum amount to be elected upon under paragraph 111(4)(e) (i.e., proceeds of disposition) should be
an amount equal to 2 times the sum of:
(a) the allowable capital loss of $2,000 which is about to expire,
(b) the net capital losses of $12,000 which would otherwise expire, and
(c) the property loss of $5,500 which otherwise expires plus the adjusted cost base of the property to be
elected upon.
If the land was chosen as the asset to trigger all of the taxable capital gain, then the deemed proceeds would
be determined as:
[2 ($2,000 + $5,500 + $12,000) + $155,000] or $194,000
The resulting taxable income computation would be:
Par. 3(a)
Par. 3(b)

Par. 3(c)

Non-capital sources of income


Net taxable capital gain:
Land, 1/2 ($194,000 $155,000)......................................................... $ 19,500
Allowable capital loss.........................................................................
(2,000)
Sum of par. 3(a) plus par. 3(b) less any Subdivision e deductions (nil)....................

Nil
$ 17,500
$ 17,500

Introduction to Federal Income Taxation in Canada

242
Par. 3(d)

Property loss.......................................................................................
Business loss.......................................................................................

5,500
46,000
$ 51,500
Less: Building recapture.....................................................................
Nil
Sec. 3 income..............................................................................................................................
Division C
Net capital loss............................................................................................................................
Taxable income...........................................................................................................................
Non-capital losses available for carryforward after the acquisition of control:
Balance, July 1, 2005...................................................................................................................
Non-capital losses from the deemed taxation year ended June 30, 2004.............. $ 51,500
Add: Net capital losses deducted above................................................................
12,000
$ 63,500
Less: Par. 3(c) income above................................................................................
17,500
Total non-capital losses...............................................................................................................

51,500
Nil
$ 12,000
Nil
$ 130,000

46,000
*
$ 176,000

* Exactly equal to the business loss above.

Summary
The two alternatives presented above are summarized as follows for comparative purposes:
Taxable Income for the Deemed Taxation Year Ended June 30, 2005:
Maximum
Partial
election
election
Par. 3(a) Income from non-capital sources ( 0)................................
Nil
Nil
Par. 3(b) Net taxable capital gains ( 0):
Deemed taxable capital gains (elective):
land.................................................... $ 20,000
$ 19,500
building..............................................
5,000
Nil
Allowable capital loss...............................
(2,000) $ 23,000
(2,000) $ 17,500
Par. 3(c) Par. 3(a) + par. 3(b)............................................................. $ 23,000
$ 17,500
Par. 3(d) Losses from non-capital sources and ABILs:
Loss from business.................................... $ (46,000)
$ (46,000)
Recapture (elective): building...................
20,000
Nil
Loss from property....................................
(5,500)
(31,500)
(5,500)
(51,500)
Division B income...............................................................................
Nil
Nil
Optional net capital loss deducted........................................................
(12,000)
(12,000)
Non-capital loss deducted....................................................................
Nil
Nil
Taxable income....................................................................................
Nil
Nil
Non-Capital Losses available for Carryforward at Deemed Taxation Year ended June 30, 2005:
Maximum election
Partial election
Balance, Jan. 1, 2005............................................................................ $ 130,000
$ 130,000
Non-capital loss June. 30, 2005:
Par. 3(d) losses see above.................................... $ 31,500
$ 51,500
Add: net capital losses deducted...............................
12,000
12,000
$ 43,500
$ 63,500
Less: par. 3(c) income see above.........................
23,000
20,500
17,500
46,000
$ 150,500
$ 176,000
Less: losses utilized at June 30, 2005.............................
Nil
Nil
losses not utilized but expired...............................
Nil
Nil
Nil
Nil
Available for carryforward from June. 30, 2005.................................. $ 150,500
$ 176,000
Net Capital Losses available for Carryforward...................................
Nil
Nil

Solutions to Chapter 11 Assignment Problems

243

The results of the above comparison of the two alternatives are further summarized as follows:
Alternatives
Taxable income.........................................................................
Net capital loss deducted..........................................................
Total non-capital losses available for carryforward..................
A.C.B. of land...........................................................................
U.C.C. of building.....................................................................
A.C.B. of building.....................................................................

(a)
0
$ 12,000
150,500
195,000
70,000
75,000

(b)
0
$ 12,000
176,000
194,000
45,000
65,000

Difference
0
0
$ 25,500
(1,000)
(25,000)
(10,000)

Alternative (b) is better if the additional $25,500 of non-capital loss can be offset by income generated in the
next 10 years. The resultant lower A.C.B. of the land under this option is only relevant on a disposition. The
lower U.C.C. on the building only represents a loss of C.C.A. at a 4% declining balance rate. On the other hand,
if an additional $25,500 of income cannot be generated in the next seven years (i.e., business losses continue),
Alternative (a) is better.

244

Introduction to Federal Income Taxation in Canada

Problem 4
[ITA: 920; 3855; 110.1112]
The controller of Video Madness Inc. has prepared the accounting income statement for the year ended
April 30, 2005:
VIDEO MADNESS INC.
INCOME STATEMENT
FOR THE YEAR ENDED APRIL 30, 2005
Sales..................................................................
Cost of sales...................................................... $ 523,000
Administrative expenses...................................
185,000
Operating income..............................................
Other income and expenses..............................
Provision for income taxes................................
Net income........................................................

$ 995,000
708,000
$ 287,000
55,000
$ 342,000
102,000
$ 240,000

Other Information
(1) Included in the calculation of Administrative expenses:
(a) Interest on late income tax payments.............................
(b) Depreciation and amortization (maximum capital cost
allowance of $149,500)..................................................
(c) Club dues for the local Country Club.............................
(d) Federal political contributions........................................
(e) Donations to registered charities....................................
(f) Property tax with respect to vacant land not being used
in the course of the business...........................................
(g) Life insurance premium with respect to the president
(the company is the beneficiary; not required for
financing).......................................................................
(2) Included in the calculation of Other income and
expenses:
(a) Landscaping of ground around new premise.................
(b) Fees paid with respect to the investigation of a suitable
site for the companys manufacturing plant...................
(c) Dividends received from taxable Canadian corporation
of $42,800 and foreign corporation dividends received
(not from a foreign affiliate) of $5,500 (Cdn.)...............
(d) Gain from the sale of another piece of land, used in the
business, sold for $200,000 in March (purchased for
$73,800).........................................................................
(e) Loss on sale of investments held as capital property
purchased for $85,000 and sold for $75,000..................
(3) Loss carryforwards from 2004 are:
(a) Non-capital losses..........................................................
(b) Net capital losses (realized in 1999)..............................

435
104,900
1,750
2,500
22,500
3,000
1,950
4,800
5,500
48,300
126,200
10,000
73,800
75,000

REQUIRED
Prepare a schedule reconciling the accounting net income to income for tax purposes and taxable income.
Indicate the appropriate statutory reference for your inclusions or exclusions.

Solutions to Chapter 11 Assignment Problems

245

Solution 4
Net income before income taxes..................................................................................................
Add: Loss on the sale of investment [ssec. 9(3)]................................................. $ 10,000
Depreciation and amortization [par. 18(1)(b)]...........................................
104,900
Interest on income tax payments [par. 18(1)(t)].........................................
435
Club dues [par. 18(1)(l)]............................................................................
1,750
Political contributions [par. 18(1)(n)]........................................................
2,500
Charitable donations [par. 18(1)(a)]...........................................................
22,500
Property tax on vacant land [ssec. 18(2)]...................................................
3,000
Life insurance premium [pars. 18(1)(a), (b), (c)].......................................
1,950
Subtotal......................................................................................................
Deduct: Capital cost allowance [par. 20(1)(a)].................................................... $ 149,500
Gain on sale of land [ssec. 9(3)].............................................................
126,200
Add: Taxable capital gain on business land [sec. 38]: 1/2 ($200,000
$73,800).................................................................................................
Allowable capital loss on investments [sec. 38]: 1/2 ($75,000
$85,000):................................................................................................
Net income under Division B................................................................................
Less Division C deductions:
Charitable donations [sec. 110.1]...................................................................
Dividends [sec. 112]......................................................................................
Non-capital loss [par. 111(1)(b)]...................................................................
Net capital loss [par. 111(1)(a)]: $75,000 4/3 1/2.....................................
Taxable income.....................................................................................................
The following items were correctly included on the accounting income statement:
(a) Landscaping costs [par. 20(1)(aa)];
(b) Site investigation fees [par. 20(1)(dd)];
(c) Dividends from taxable Canadian corporations [par. 12(1)(j)]; and
(d) Dividends from foreign corporations [par. 12(1)(k)].

147,035
$ 489,035
275,700
$ 213,335

63,100
(5,000)

$ 342,000

22,500
42,800
73,800
50,000

58,100
$ 271,435

189,100
$ 82,335

246

Introduction to Federal Income Taxation in Canada

Problem 5
[ITA: 124; ITR: 400]
The taxpayer, whose head office was in Manitoba, manufactured and sold various fans. Local sales agencies
were maintained in Ontario and in Quebec. At the Ontario agency, two qualified representatives handled business
under the company name. They were authorized to sign quotations. Contracts could be made, terms of payment
arranged and credit given without reference to the head office in Winnipeg. The company name was displayed
for public visibility, was used on calling cards, and was listed in the telephone directory. The Ontario agency,
occupying one-half of a building with warehouse facilities, maintained an inventory worth about $6,000. Orders
for standard-sized fans were filled from stock-in-trade. Orders for large fans were filled from the head office in
Winnipeg. The Quebec agency was substantially similar to that in Ontario.
REQUIRED
Determine whether or not the company has a permanent establishment in the provinces of Ontario and
Quebec. In reaching a conclusion, compare this situation with the case of M.N.R. v. Sunbeam discussed in this
chapter.

Solutions to Chapter 11 Assignment Problems

247

Solution 5
[Reference: Chicago Blower (Canada) Ltd. v. M.N.R., (T.A.B.) 66 DTC 471]
(A) Facts fall within Regulation 400(2)(b)
(i) the company carried on business in each province through an agent,
the agent was established in a particular place, clearly identified to the public,
occupied building with various warehouse facilities,
the agent had general authority to contract,
the agent had a stock of merchandise from which he filled orders,
the exception to this was on orders for larger fans,
thus, the condition was met at least in part,
(ii) therefore, the company does have a permanent establishment in the provinces indicated.
(B) This conclusion differs from that in the Sunbeam case which can be distinguished on its facts,
(i) in the Sunbeam case, the taxpayers representatives in Quebec did not have authority to make contracts
on the companys behalf,
(ii) there was no telephone listing in the companys name and that name did not appear on any business
signs.

248

Introduction to Federal Income Taxation in Canada

Problem 6
[ITA: Part I.3]
Larger Than Life Inc., a public corporation in the service industry, had the following balance sheet as at
December 31, 2005:
Cash..........................................................................................
Accounts receivable (net) ........................................................
Inventory ..................................................................................
Investment in Canadian subsidiary ..........................................
Unsecured demand loan to Mr. Filth E. Rich ...........................
Future income taxes (debit) .....................................................
Total assets ...............................................................................
Accounts payable .....................................................................
Bank indebtedness (due on demand) ........................................
Mortgage due to Mrs. Low N. Shark .......................................
Common shares ........................................................................
Retained earnings .....................................................................
Total liabilities and equity .......................................................

($ 000s)
40,000
50,000
60,000
120,000
60,000
20,000
350,000
55,000
75,000
35,000
65,000
120,000
350,000

The investment has been accounted for using the equity basis with the carrying value being computed as
follows:
Original cost of shares..............................................................
Accumulated share of subsidiarys earnings.............................
Accumulated dividends received..............................................
Carrying value..........................................................................

$ 110,000
20,000
(10,000)
$ 120,000

Larger Than Lifes taxable income for its taxation year ended December 31, 2005, was $9,000,000 with
82% of its income being earned in a province. Larger Than Life grew significantly during 2005. In 2004, the
corporation was not even subject to Part I.3 tax and its taxable income was only $800,000 (all earned in the
province of Ontario). The corporation had no taxable income in the prior six years.
REQUIRED
Determine Larger Than Lifes Part I.3 tax liability for its 2005 tax year. Assume that Larger Than Life is
allocated $40,000,000 of the capital deduction in its related group of corporations.

Solutions to Chapter 11 Assignment Problems

249

Solution 6
Capital
Capital stock [par. 181.2(3)(a)]...............................................................................
Retained earnings [par. 181.2(3)(a)].......................................................................
Bank debt [par. 181.2(3)(c)]....................................................................................
Mortgage payable [par. 181.2(3)(d)].......................................................................
Future income taxes (debit) [par. 181.2(3)(h)]........................................................
Total capital....................................................................................................................
Investment allowance2
Investment in subsidiary [par. 181.2(4)(a)].............................................................
Taxable capital ($265,000,000 $110,000,000)............................................................
Taxable capital employed in Canada (82% of $155,000,000)........................................
Capital deduction (as allocated in related group)...........................................................
Amount subject to Part I.3 tax........................................................................................
Part I.3 tax @ 0.175%....................................................................................................
2005 surtax (4% of 28% of $9,000,000).........................................................................
2005 Canadian surtax payable (82% of $100,800).........................................................
2005 Part I.3 tax liability (A) minus (B)....................................................................
2004 surtax (4% 28% 100% $800,000).............................................................
Part I.3 tax payable ($69,769 $8,960) ([sec. 181.1(4)]................................................

65,000,000
110,000,000
75,000,000
35,000,000
(20,000,000)
$ 265,000,000

$ 110,000,000 1
$ 155,000,000
$ 127,100,000
40,000,000
$ 87,100,000
$
152,425 (A)
$
100,800
$
82,656 (B)
$
69,769
$
8,960
$

60,8093

NOTES TO SOLUTION
(1) Subsection 181(3) requires that the equity method not be used in determining amounts to be included in
capital and the investment allowance. Therefore, $10,000,000 has been subtracted from both the carrying value
of the investment and retained earnings in order to remove the effect of the equity method of accounting.
(2) The demand loan receivable does not qualify for the investment allowance since it is neither owing
from a corporation [par. 181.2(4)(b)] nor a bond, debenture, note, mortgage, hypothec, or similar obligation of
another corporation [par. 181.2(4)(c)].
(3) This amount can be offset by Canadian surtax payable in the following three years. No further unused
surtax credits exist from the preceding seven years.

250

Introduction to Federal Income Taxation in Canada

Problem 7
[ITA: 125.1]
One of your manufacturing clients, Mano-Pac Limited, a public company, provides you with the following
information in order to calculate their manufacturing and processing profit deduction:
(a) Salary expenses are represented by:
Accounting staff........................................................... $ 200,000
Quality control staff.....................................................
150,000
Plant staff.....................................................................
800,000
Plant supervisors and maintenance...............................
90,000
Distribution staff (responsible for distribution of
finished products).................................................
65,000
Receiving department staff (responsible for receiving
and storing raw materials)....................................
45,000
Clerk responsible for purchasing raw materials...........
35,000
$ 1,385,000
(b) Fixed assets of Mano-Pac Ltd.:
Data processing equipment........................................... $
50,000
Manufacturing equipment............................................
900,000
Office equipment..........................................................
100,000
Vending machines etc. in employee cafeteria..............
10,000
$ 1,060,000
(c) Taxable income is comprised of:
Manufacturing income................................................. $ 375,000
Investment income.......................................................
65,000
Division B income....................................................... $ 440,000
Less: charitable donations............................................
15,000
Taxable income............................................................ $ 425,000
REQUIRED
Calculate the manufacturing and processing profit deduction Mano-Pac Ltd. can claim.

Solutions to Chapter 11 Assignment Problems

251

Solution 7
Calculation of manufacturing and processing profits deduction from tax:
7% of lesser of:
(a) Canadian manufacturing and processing profits..................................................
(b) Taxable income...................................................................................................
7% of $374,970 = $26,248

$ 374,970 1
$ 425,000

NOTE TO SOLUTION
(1) Calculation of Canadian manufacturing and processing profits:
MP =
=
=

MC + ML
ADJUBI
C+L
$105,882 + $1,385,000
$375,000
$106,000 + $1,385,000
$374,970

(a) ADJUBI (Adjusted Business Income):


Division B income......................................................................................................
Less: Investment income.............................................................................................
(b) C (Cost of Capital):
10% of gross capital cost of assets ($1,060,000) =.....................................................
(c) MC (Cost of Manufacturing and Processing Capital):
10% of manufacturing assets ($900,000)....................................................................
100/85 of total (100/85 $90,000) =.........................................................................
Lesser of: (i) cost of capital (C)..................................................................................
(ii) cost of manufacturing and processing capital (MC).............................
(d) L (Cost of Labour):
Total salary expenses..................................................................................................
(e) ML (Cost of Manufacturing and Processing Labour):
Portion of total salary expenses used in qualified activities:
Total salary expenses...........................................................................................
Less*: Accounting......................................................................... $ 200,000
Distribution........................................................................
65,000
Raw materials clerk...........................................................
35,000
100/75 of $1,085,000...........................................................................................
Lesser of: (i) cost of labour (1)...................................................................................
(ii) cost of manufacturing and processing labour (ML)..............................
* Regulation 5202: definition of qualified activities.

$
$

440,000
65,000
375,000

106,000

$
$

90,000
105,882

$
$

106,000
105,882

$ 1,385,000

$ 1,385,000

$
$
$
$

(300,000)
1,085,000
1,446,667
1,385,000
1,446,667

252

Introduction to Federal Income Taxation in Canada

Problem 8
[ITA: 123; 124; 126]
Barltrop Limited is a Canadian public company involved in the software consulting business. Its controller
provided you with the following information related to its 2005 taxation year ended December 31:
Income under Division B from consulting business including
$100,000 earned in U.S. operations (before deducting
$16,000 U.S. tax paid).......................................................
Canadian investment royalty income........................................
U.K. non-foreign affiliate income (before $3,000 tax
withheld)............................................................................
Taxable dividend received from non-connected Canadian
corporations.......................................................................
Taxable capital gains................................................................
Charitable donations.................................................................
Unused foreign tax credit in respect of U.S..............................
Net capital losses carried forward arising in 1999....................

$ 264,000
10,000
20,000
5,000
6,000
100,000
3,000
12,000

Barltrop Limited has permanent establishments in the U.S., B.C. and Alberta. Its gross revenues and salaries
and wages data have been allocated as follows:

Gross revenues.....................
Salaries and wages................

British
Columbia
$ 3,000,000
500,000

Alberta
$ 3,000,000
300,000

U.S.
$ 4,000,000
200,000

Assume that the British Columbia corporation tax rate is 13.5% and the Alberta rate is 11.5%. Also, assume
that taxable income for Alberta is computed on the same basis as federal taxable income.
Gross revenues exclude income from property not used in connection with the principal business operation
of the corporation.
REQUIRED
Compute the total tax payable by the company for the 2005 taxation year, including provincial tax. Show all
calculations.

Solutions to Chapter 11 Assignment Problems

253

Solution 8
Income under Division B from consulting business....................................................................
Canadian investment royalty income...........................................................................................
U.K. non-foreign affiliate income...............................................................................................
Taxable dividend received from non-connected Canadian corporations.....................................
Taxable capital gains...................................................................................................................
Income under Division B.............................................................................................................
Deduct:
Charitable donations (not exceeding 75% $305,000 = $228,750)....................................
Canadian dividends received................................................................................................
1999 net capital loss ($12,000 1/2 / 3/4; limited to taxable capital gains of $6,000)...........
Taxable income...........................................................................................................................
Basic federal tax at 38% of $194,000..........................................................................................
Deduct: Abatement from federal tax (see Schedule 1)................................................................
Net...............................................................................................................................................
Add: Federal surtax @ 4% of 28% $194,000..........................................................................
Deduct:
Non-business foreign tax credit (see Schedule 2).................................................................
Business foreign tax credit (see Schedule 3)........................................................................
Tax reduction (7% of $194,000)...........................................................................................
Part I tax payable (federal)..........................................................................................................
Provincial tax:
British Columbia 13.5% of $77,600.....................................................................................
Alberta rate 11.5% of $58,200.............................................................................................
Total tax.......................................................................................................................................

$ 264,000
10,000
20,000
5,000
6,000
$ 305,000
(100,000)
(5,000)
(6,000)
$ 194,000
$ 73,720
(13,580)
$ 60,140
2,173
(3,000)
(19,000)
(13,580)
$ 26,733

10,476
6,693
43,902

Schedule 1: Abatement from federal tax


B.C.
Gross revenues......................................
% gr. revenues (1).................................
Salaries and wages................................
% S&W (2)............................................
(1) + (2)
................................................
2

Alberta

$3,000K
30%
$500K
50%

$3,000K
30%
$300K
30%

Total
Cdn.
$6,000K
60%
$800K
80%

40%

30%

70%

U.S.

Total

$4,000K
40%
$200K
20%

$10,000K
100%
$1,000K
100%

30%

100%

Abatement: 10% of 70% of $194,000 = $13,580


Allocation of income to: B.C. 40% $194,000 = $77,600
Alberta 30% $194,000 = $58,200
Schedule 2: Non-business foreign tax credit (U.K. income)
Lesser of:
(i) tax paid

$ 3,000

income from U.K.


tax otherwise payable after
(ii) income less dividends and abatement plus surtax minus
net capital loss carryover
general tax reduction
$20,000
$305,000 $5,000 $6,000

($60,140 + $2,173 $13,580)

$20,000
$294,000

$48,733 =.....................................................................

Lesser amount is $3,000.

$ 3,315

Introduction to Federal Income Taxation in Canada

254

Schedule 3: Business foreign tax credit (U.S. income)


Least of:
(i) tax paid ($16,000 + $3,000)..............................................................................................
tax otherwise payable
income from U.S.
(ii) income less dividends and plus surtax minus
general tax reduction
net capital loss carryover

$ 19,000

$100,000
$305,000 $5,000 $6,000

($73,720 + $2,173 $13,580)

$100,000
$294,000

$62,313 =.....................................................................

$ 21,195

(iii) tax otherwise payable before any reduction or credits plus surtax less non-business tax
credit ($73,720 + $2,173 $13,580 $3,000)..................................................................
Lesser amount is $19,000.

$ 59,313

Solutions to Chapter 11 Assignment Problems

255

Problem 9
[ITA: 12(1)(t); 37; 127(5)(11); ITR:2900]
Infotech is a public company in its first year of business in the information technology industry. It operates
out of a plant in Ottawa, Ontario. In 2005, it incurred $2,200,000 of scientific research and experimental
development expenditures (SR&ED) which qualify for deduction under subsection 37(1) of the Act. The breakdown of these expenses is as follows:
Current SR&ED expenditures [par. 37(1)(a)]...............................
Capital SR&ED expenditures [spar. 37(1)(b)(i)]
new equipment.............................................. $ 300,000
200,000
used equipment.............................................

$ 1,700,000

Total SR&ED expenditures...........................................................

$ 2,200,000

500,000

Infotechs federal income tax rate after abatement is 22.12%. Its taxable income before deducting the
$2,200,000 claim under section 37 is $3,200,000.
REQUIRED
(A) Compute the maximum investment tax credit available to Infotech in 2005.
(B) Compute the companys net federal Part I tax payable after the investment tax credit, assuming a
maximum section 37 deduction is claimed.
(C) What is the amount, if any, of the investment tax credit carryover?
(D) Compute the companys deduction or income inclusion in the following year if no further SR&ED
expenditures are made.

Introduction to Federal Income Taxation in Canada

256
Solution 9

(A) The maximum investment tax credit is


20% [$1,700,000 + $300,000] = $400,000
Note that the used equipment is not a qualified expenditure for the purposes of sec. 127(9)
because it is not new property [Reg. 2902(2)(iii)].
(B) Taxable income before sec. 37 deduction................................................................. $ 3,200,000
Sec. 37 deduction......................................................................................................
(2,200,000)
Taxable income......................................................................................................... $ 1,000,000
Net tax 22.12%.......................................................................................................... $
221,200
Investment tax credit.................................................................................................
(221,200)
Net federal tax payable under Part I..........................................................................
Nil
(C) The remaining investment tax credit of $178,800 (ie., $400,000 $221,200) may be carried back
three and forward ten years.
(D) Sec. 37 SR&ED expenditures in first year................................................................ $ 2,200,000
Sec. 37 deduction in first year...................................................................................
(2,200,000)
Balance at the beginning of the second year.............................................................
Nil
Less: ITC claim for first year....................................................................................
(221,200)
Recapture in second year [sec. 12(1)(t)]....................................................................
221,200
Balance after recapture..............................................................................................
Nil
If no further SR&ED expenditures are made in the following year, the income inclusion would be
$221,200 [sec. 12(1)(t)].

Solutions to Chapter 11 Assignment Problems

257

Problem 10
[ITA: 123; 124; 125.1; 126; 127(5)]
Up, Up and Away Limited is a public corporation that manufactures hot air balloons in the province of New
Brunswick. For the year ended September 30, 2005, its accounting income statement was as follows:
Sales......................................................................................
Cost of sales and other expenses including C.C.A................
Operating profit.....................................................................
Other net income...................................................................
Net income before taxes........................................................
Provision for taxes................................................................
Net income............................................................................

$ 1,225,000
(725,000)
$ 500,000
198,500
$ 698,500
(200,725)
$ 497,775

Selected Additional Information


(1) Other income includes:
Dividends from taxable Canadian corporation.................... $ 85,000
Canadian interest income.....................................................
52,500
Foreign interest income, net of withholding taxes of
61,000
$10,000................................................................................
(2) Up, Up and Away Limited has a non-capital loss carryforward of
$255,545.
(3) Up, Up and Away Limited purchased qualified equipment costing
$250,000 which is eligible for the investment tax credit.
(4) The M&P profits calculation under Regulation 5200 yielded $435,000.
(5) Donations to registered charities were $9,755 (deducted from
accounting income).
REQUIRED
Calculate the total taxes payable for 2005 using a 13% provincial rate of tax. (For the calculation of the
foreign tax credit, assume that there is no general tax reduction. Then, calculate the general tax reduction to show
that this assumption is accurate.)

Introduction to Federal Income Taxation in Canada

258
Solution 10

Income under Division B:


Operating profits..........................................................................................................................
Dividends from taxable Canadian corporations...........................................................................
Canadian investment income (i.e., interest income)....................................................................
Foreign investment income ($61,000 + $10,000)........................................................................
Add: donations..........................................................................................................................
Division B income.......................................................................................................................
Less: Division C deductions:
Taxable dividends deductible under sec. 112.......................................................... $ 85,000
Donations (max. 75% of $718,255 = $538,691).....................................................
9,755
Non-capital losses...................................................................................................
255,545
Taxable income...................................................................................................................................
Federal tax (38% of $367,955)............................................................................................................
Federal abatement (10% of $367,955)................................................................................................
Federal tax after abatement.................................................................................................................
Add: surtax (4% of $103,027).............................................................................................................

$ 500,000
85,000
52,500
71,000
$ 708,500
9,755
$ 718,255

$
$
$
$

Less: M & P profits deduction(1)................................................................................... $ 25,757


Foreign non-business tax credit(2)........................................................................
10,000
Tax rate reduction(3).............................................................................................
Nil
Federal tax before investment tax credit..............................................................................................
Investment tax credit (10% of $250,000)............................................................................................
Part I federal tax payable.....................................................................................................................
New Brunswick tax @ 13% of $367,955............................................................................................
Total tax liability.................................................................................................................................
NOTES TO SOLUTION
(1) Manufacturing and processing profits deduction
Lesser of:
(i) M. & P. profits.......................................................................................................
(ii) Taxable income.....................................................................................................
7% of $367,955 =..................................................................................................
(2) Foreign non-business tax credit
Lesser of:
(i) Amount paid..........................................................................................................
(ii)

$71,000
$107,148 ...........................................................................
$718,255 $85,000

(3) Tax reduction


Taxable income..................................................................................................................
Less: 100/7 M&P profits deduction (100/7 $25,757).....................................................
Net......................................................................................................................................

350,300
367,955
139,823
(36,796)
103,027
4,121
107,148

35,757
$ 71,391
(25,000)
$ 46,391
47,834
$ 94,225

$ 435,000
$ 367,955
$ 25,757

10,000

12,013

$ 367,955
367,955
Nil

Therefore, there is no tax rate reduction, since all taxable income is eligible for the M&P profits deduction.

Solutions to Chapter 11 Assignment Problems

259

Problem 11
[ITA: 123; 124; 125.1; 126; 127(5)]
Tecniquip Limited is a public corporation whose head office is located in Toronto, Ontario. The activities of
the corporation are carried on through permanent establishments in the provinces of Ontario and Alberta, and in
the United States.
The following is an allocation of selected items for the fiscal year ended December 31, 2005.
Ontario
Alberta
U.S.
Total
($ 000) ($ 000) ($ 000) ($ 000)
Sales............................................. $ 6,000 $
400 $ 4,600 $ 11,000
Salaries:
Production employees............. $
900 $
300 $ 1,000 $ 2,200
Payroll benefits for
production employees.........
10
0
0
10
Office employees....................
320
170
410
900
Purchasing agents...................
120
90
180
390
Raw material receiving
& storing employees...
200
220
280
700
Finished goods warehouse
employees...........................
500
0
0
500
Plant maintenance staff...........
80
20
60
160
Finished product inspectors....
110
60
130
300
Sales staff...............................
300
100
300
700
$ 2,540 $
960 $ 2,360 $ 5,860
Assets owned (capital cost):
Office buildings...................... $
300 $
0 $
250 $
550
Office equipment....................
90
0
70
160
Equipment used in SR&ED....
250
0
0
250
Manufacturing plants..............
1,750
40
900
2,690
Warehouses for finished
goods...................................
800
40
1,220
2,060
Land........................................
1,000
10
600
1,610
$ 4,190 $
90 $ 3,040 $ 7,320
Assets leased (annual rental
cost):
Production machinery............. $
540 $
10 $
80 $
630
Automobiles for sales staff.....
2
0
2
4
$
542 $
10 $
82 $
634
For the year ended December 31, 2005, Tecniquip Limited
obtained the following results:
Income from manufacturing operations in Ontario.....................
Income from manufacturing operations in Alberta.....................
Income from manufacturing operations in the United States
(before $200,000 Cdn. of US taxes paid)................................
Canadian-source interest income (investment)...........................
Foreign-source investment income (before $3,000 in foreign
tax withheld)............................................................................
Taxable capital gain....................................................................
Taxable dividends from taxable Canadian corporations.............
Net income under Division B......................................................

$ 1,000,000
240,000
800,000
$ 2,040,000
12,000
20,000
10,000
15,000
$ 2,097,000

260

Introduction to Federal Income Taxation in Canada

In computing income from manufacturing, the corporation claimed a deduction of $150,000 under
subsection 37(1) of the Act for scientific research and experimental development (SR&ED). $100,000 of the
deduction related to expenditures of a current nature and $50,000 was the cost of equipment purchased during the
year for use by it in scientific research and experimental development carried on in Canada.
During the year, the corporation made charitable donations totalling $50,000 and claimed non-capital losses
of $60,000 and the net capital losses carried forward from 1999 of $9,000.
REQUIRED
Compute the federal Part I tax payable and provincial tax at 12% for Ontario and 11.5% for Alberta,
assuming that taxable income allocated to those provinces is the appropriate provincial tax base. Show all
calculations, whether or not necessary to your final answer. (For the calculation of the manufacturing and
processing profits deduction, assume that the foreign tax credit is equal to the foreign tax paid. However, show
the full calculation of the foreign tax credits, including the effect of the general tax reduction.)

Solutions to Chapter 11 Assignment Problems

261

Solution 11
Net income under Division B....................................................................................................
Division C deductions: Dividends from taxable Canadian corporations..................................
Charitable donations (max. 75% $2,097,000)................................
Net capital losses ($9,000 1/2 / 3/4)...................................................
Non-capital losses...............................................................................
Taxable income.........................................................................................................................
Tax @ 38%................................................................................................................................
Federal abatement1.....................................................................................................................
Surtax2.......................................................................................................................................
Non-business foreign tax deductions3........................................................................................
Business foreign tax deductions4...............................................................................................
Manufacturing and processing profits deduction5......................................................................
Tax reduction6............................................................................................................................
Federal tax before investment tax credit....................................................................................
Investment tax credit7................................................................................................................
Federal Part I tax payable..........................................................................................................
Provincial tax payable: Ontario @ 12% $963,340...............................................................
Alberta @ 11.5% $196,600............................................................

$ 2,097,000
(15,000)
(50,000)
(6,000)
(60,000)
$ 1,966,000
$ 747,080
(115,994)
$ 631,086
22,019
$ 653,105
(3,000)
(200,000)
(67,529)
(70,091)
$ 312,485
(30,000)
$ 282,485
$ 115,601
22,609
$

138,210

NOTES TO SOLUTION
(1) Federal abatement:

Ontario...........
Alberta...........
U.S.................
Total...............

Gross revenue
Amount
%
$ 6,000,000
54.6%
400,000
3.6
$ 6,400,000
58.2
4,600,000
41.8
$ 11,000,000
100.0%

Salaries & wages


Amount
%
$ 2,540,000
43.3%
960,000
16.4
$ 3,500,000
59.7
2,360,000
40.3
$ 5,860,000
100.0%

Allocation of taxable income to each province:


Ontario.................................................................................
Alberta.................................................................................

Average percentage
/2 (54.6% + 43.3%) = 49.0%
1
/2 (3.6% + 16.4%) = 10.0%
1
/2 (58.2% + 59.7%) = 59.0%
1

49% $1,966,000 =
10% $1,966,000 =

Taxable income earned in a province or territory................

963,340
196,600

$ 1,159,940

Abatement is 10% $1,159,940 = $115,994.


(2) Surtax: (28% $1,966,000) 4% = $22,019
(3) Non-business foreign tax deduction:
lesser of:
(a) tax paid
foreign non - business income
(b)
Div. B income - par.111(1)(b) - sec.112

3,000

5,617

tax otherwise payable


(basic abatement + surtax
general reduction)

$20,000
($653,105 $70,091) ..............................................
$2,097,000 $6,000 $15,000

Introduction to Federal Income Taxation in Canada

262

(4) Business foreign tax deduction:


least of:
(a) tax paid........................................................................................................................
tax otherwise payable
foreign non - business income
(b)
(basic + surtax
Div. B income - par.111(1)(b) - sec.112
general reduction)
$800,000
($747,080 + $22,019 $70,091) ....................................
$2,097,000 $6,000 $15,000

200,000

269,367

(c) tax otherwise payable minus non-business foreign tax deduction ($747,080 +
$22,019 $70,091 $3,000)......................................................................................

696,008

(5) Manufacturing and processing profits deduction:


7% of the lesser of:
(i) Canadian manufacturing and processing profits..........................................

964,697

(ii) Taxable income (3 ssec. 126(2))


($1,966,000 (3 $200,000)).....................................................................

$ 1,366,000

7% $964,697 = $67,529
MP =
=

MC + ML
ADJUBI
C+L
$879,000 + $2,520,000
$1,240,000
$879,000 + $3,490,000

= $964,697
Adjusted business income (ADJUBI):
Income from an active business carried on in Canada ($1,000,000 +
$240,000) = $1,240,000
Cost of capital (C):
10% capital cost of depreciable property owned that is used to
earn business income in Canada:
Ontario ($4,190,000 $1,000,000).................................................................
Alberta ($90,000 $10,000)...........................................................................

$ 3,190,000
80,000
$ 3,270,000
10%
$ 327,000

plus the rental cost for the year of such assets that are leased instead of purchased:
($542,000 + $10,000)
$
Cost of manufacturing and processing capital (MC):
Portion of cost of capital used in qualified M&P activities:
Cost of manufacturing plants in Ontario and Alberta ($1,750,000 + $40,000)...........
Cost of equipment used in SR&ED.............................................................................

Plus the rental cost of the production machinery ($540,000 + $10,000).....................


/85 $754,000 = $887,059
Cannot exceed the cost of capital, $879,000.
100

552,000
879,000

$ 1,790,000
250,000
$ 2,040,000
10%
$ 204,000
550,000
$ 754,000

Solutions to Chapter 11 Assignment Problems


Cost of Labour (L):
Salaries and wages related to carrying on business in Canada:
Ontario salaries, net of payroll benefits......................................................................
Alberta salaries, net of payroll benefits.......................................................................
Cost of manufacturing and processing labour (ML):
Portion of cost of labour used in qualified M&P activities:
Production employees ($900,000 + $300,000)....................................................
Raw material receiving & storing ($200,000 + $220,000)..................................
Plant maintenance staff ($80,000 + $20,000)......................................................
Finished product inspectors ($110,000 + $60,000).............................................

263

$ 2,530,000
960,000
$ 3,490,000

$ 1,200,000
420,000
100,000
170,000
$ 1,890,000

/75 $1,890,000 = $2,520,000


Cannot exceed the cost of labour, $3,490,000.
100

(6) Tax reduction


Taxable income
Less: 100/7 M&P profits deduction (100/7 $67,529).....................................................
Net......................................................................................................................................
7% of $1,001,300...............................................................................................................

$ 1,966,000
964,700
$ 1,001,300
$
70,091

(7) Investment tax credit: 20% $150,000 = $30,000


Since all $150,000 of the expenditure was deducted in 2005, all $30,000 of the ITC claimed in 2005 will be
included in income in 2006 [par. 12(1)(t)].