Chapter 3

Problem One
Jay Day and Charlotte Knight conduct similar financial activities. Each is employed
and has a portfolio of investments, and during the current year, each started a
separate small business. Their financial results for the year ended December 31,
2023, are identical, as follows.
Employment income $ 40,000
Interest income from investment portfolio 15,000
Loss from new small business operation (20,000)
The only difference between Jay and Charlotte is that Jay operated his business as a
proprietorship, whereas Charlotte operated her business from a wholly owned
corporation.
Required: 1. (a) Assuming that individual tax rates are 40%, compare the tax
liability of Jay with that of Charlotte for 2023. (For purposes of these calculations,
ignore “other deductions.”)
2. (b) How and when may Charlotte use her business loss to reduce her tax liability?
3. (c) What impact may the difference in tax treatment have on Jay’s and
Charlotte’s wealth accumulation and on their long-term returns on investment?
Answer:
A) CALCULATION OF Tax Liability for Jay and Charlotte for 2023.

Particulars Jay Charlotte

3(a) Employment Income (JAY) 40,000 40,000
Business Income 0 0
Property Income (Interest) 15,000 15000
Other items of Income 0 0
Subtotal 1 55000 55000
3(b) Taxable Capital gains
00
Net gains rom personal property
00
Allowable Capital losses 00 00
( 00)
Subtotal 2 00 00
3(c) Other Deductions 00 00
Subtotal 3 00 00
3(d) Employment Losses
00
Business Losses
00
Property losses
00
Allowable business investment (20000) 00
losses
00
Total Net Income for Tax 35000 55000
Purposes

Tax Liability (40%) 14000 22000

Since, Jay is sole proprietor, so his business loss can be deducted from his income
under 3(d), where Charlotte, having corporation does not have the option to reduce
it from her personal income, because under this type of structure , person and
corporation are taxed separately.
2. (b) How and when may Charlotte use her business loss to reduce her tax liability?
Charlotte can offset her business loss only from corporation’s future earnings not
from her personal income.
Charlotte can carry forward loss of $ 20,000 and offset from future income, this will
reduce her future corporation tax liability.
3. (c) What impact may the difference in tax treatment have on Jay’s and
Charlotte’s wealth accumulation and on their long-term returns on investment?
The impact of tax on Jay and Charlotte’s wealth can be as follows:
1) Jay have to ay $ 8000 less than charlotte in taxes, which he can use for
investment or reinvestment in his business. ( Jay have more disposable
income)
2) Jay used immediate tax relief by offsetting business loss from his personal
income where as Charlotte have to wait and rely on corporation for tax relief.
3) Charlotte’s corporation will be in advantage in long term with access to low
tax rates and with reinvestment of profits back into corporation, would be
beneficial in long term.
4) Charlotte can benefit from tax deferral, as she can invest in tax efficient way,
generate income without paying taxes until funds are distributed as dividends
or capital gains. This would lead to wealth accumulation over time.
Problem Two To what extent, if any, are the following individuals or corporations
liable for tax in Canada?
1. An individual who lives and works in Canada receives an inheritance from an
uncle in France. The inheritance consists of shares, bonds, and French real estate.
During the year, the investments generate interest, dividends, and rents, which are
retained in France and reinvested.
2. A large corporation based in Alabama, U.S., operates a branch in Winnipeg that
employs Canadian staff, holds a supply of inventory, and sells to the Canadian
market.
3. An American citizen, who normally resides in New York and has extensive
American income, for health reasons takes an extended vacation of six-and a-half
months in Banff, Alberta, in the current calendar year.
4. A Manitoba corporation is controlled and managed by its British parent
corporation.
5. A Canadian individual, who is a student at the University of Saskatchewan, earns
income during the summer by operating a street-vending unit in Boulder, Colorado.
6. An individual has been employed in Canada by a large Canadian corporation.
They accept a transfer to manage, on a permanent basis, the corporation’s
operations in Denver, Colorado. They leave Canada with their family on March 31,
2023.
7. An individual who resides in England receives annual dividend income from an
investment in a Canadian corporation.
Answer:
1 : As this individual lives and works in Canada, this person is a resident.

So, resident is taxed on world-wide income for the year including the inheritance
from an uncle in France.

Taxable Worldwide Income In this case:

 Shares: The inherited shares are not taxable, but dividends generated from
Shares are taxable as Income from property.
 Bonds: The bonds are not taxable. The interest from Bonds is taxable as
Income from property.
 French Real Estate: The property is not taxable in case. The rent generated
from real estate is taxable as Income from property.
2 : Winnipeg branch(Canadian Branch) of US based corporation is subject to tax on
Canadian income. US. Corporation (foreign corporation) has a branch in
Canada(Permanent Establishment), with Canadian Staff, supply of inventory and
sell in Canadian market, so it is resident of Canada and is liable to report and pay
tax on the income earned in Can

3: American citizen is “Sojourner”, as he spent more than 182 days in Canada and
considered as deemed resident and liable to pay tax on world wide income in
Canada. However, due to treaty between US and Canada, that American Citizen
would be saved from double taxation.

4: Manitoba corporation is incorporated in Canada, so it is a resident of Canada for

tax purposes, regardless parent corporation is based in Britain. So Manitoba
corporation will be subject to Canadian income tax on its worldwide income.

5: Canadian Resident, tax on worldwide income.

A Canadian individual who still has permanent ties in Canada should be considered
resident for Canadian tax purposes and should report all worldwide income on
Canadian personal tax return. This individual is studying in Canada and stayed in
US only in summer to operate a street vending unit to earn income.

So, this individual should report income earned in Boulder, Colorado (US) on
Canadian tax returns.

6: Individual is part time resident, as they leave permanently on March 31, 2024.
Non-resident after March 31.

It means this individual should be considered resident for 3 months in 2023 and
should report worldwide income earned until March 2023 on Canadian tax returns.

7: Individual earning dividend from investment in Canadian Corporation is non-

resident, and the tax on the dividend amount originated in Canada is called
“Withholding tax”. As the payer must withhold tax on the payment and pay to
Canadian tax authorities.
The Canadian corporation should withhold 25% tax from the dividend income
before making payment to non resident.
Problem THREE
Indicate the category of income under the Income Tax Act into which each of the
following items falls:
1. (a)annual stipend received by an individual for serving as a director of a public
corporation – Employment Income
2. (b) receipt of alimony (spousal support) payments - Other items of Income
3. (c) receipts from an employer’s registered pension plan – Other items of Income
4. (d) dividends received from a foreign corporation – Property Income
5. (e) proceeds from the sale of land acquired for resale – Business Income
6. (f) loss from a loan to a small business corporation – Capital Loss/Business Loss
7. (g) moving expenses – other deductions
8. (h) gain from the sale of shares of a public corporation – Capital Gain Income
9. (i) fees received for providing legal services – Business Income
10. (j) alimony (spousal support) paid – Other items of Income
11. (k) gain on the sale of an automobile purchased for resale – Business Income
12. (l) bonus from an employer – Employment Income

Answer:

Problem Four
A taxpayer has the following financial results for a particular year.
Employment Income 30,000
Business profit: A Enterprise $10,000
Business loss: B Enterprise 3,000
Other sources of income: pension 12000
Property income: interest 5000
Allowable capital losses on sale of land 20000
Allowable business investment loss 2000
Taxable capital gains on sale of securities 15000
Other deductions (includes CPP enhanced contributions) 3,000
Required:
Determine the taxpayer’s net income for tax purposes in accordance with the
statutory scheme formula.

Answer:

Particulars $
3(a) Employment Income (JAY) 30,000
Business Income: A Enterprise 10,000
Property Income (Interest) 5,000
Other items of Income(pension) 12,000
Subtotal 1 57,000
3(b) Taxable Capital gains (sale of securities) 15,000

Net gains from personal property

15000
Allowable Capital losses 00
(20,000)
Subtotal 2 00
3(c) Other Deductions (includes CPP enhanced (3000)
contributions)
Subtotal 3 00
3(d) Employment Losses
00
Business Losses : (B Enterprise) (3000)
Property losses
00
Allowable business investment losses (2000) (5000)
Total Net Income for Tax Purposes 49,000

Problem Five
Meadows Enterprises Ltd. is a Canadian corporation located in Regina. The company
operates a retail business that has shown consistent profits for several years. Cash
generated from those profits has been used to acquire investments. The company
prefers two types of investments: real estate and shares in other corporations.
Unfortunately, in 2023, the investments resulted in some losses.
The following chart provides a summary of the corporation’s 2023 financial results.
Table Summary: The table has three columns. Column one, rows three, five, seven,
and eight are indented to a second level; row nine is indented to a third level.
Column two, rows one to six, and nine are blank. Column three, rows six and seven
are blank.
Retail sales 1240000
Cost of sales 868000
Gross profit 372000
Retail administrative expenses 191000
Income from operations 181000
Other income (losses): (22000)
Net loss from real estate rentals (170000) (192000)
Net loss on the sale of shares of other (11000)
corporations
The real estate investments include several small commercial buildings that are
rented to retail tenants. In 2023, one of those tenants ceased operations, and a
replacement tenant could not be found. That is the main reason for the $22,000 loss
in real estate rentals.
The net loss of $170,000 on shares of other corporations arose from two sale
transactions, as summarized in the following chart.
Table Summary: The table has three columns with headers in row one. Column one,
row four is indented; row one is blank.
Sale 1 Sale 2
Selling price $72,000 $10,000
Original cost of shares 65,000 187,000
Gain (loss) $ 7,000 $(177,000)
Both investments, which were in public corporations, had been owned for several
years.
An accountant has just completed Meadows’ 2023 tax return and has informed the
president that Meadows owes $20,670 in income taxes. The president is upset by
this and exclaims, “That’s impossible! Our company lost $11,000, so it can’t owe
$20,670 in income taxes! I know that the corporate tax rate for my company is
13%, and 13% of nothing is nothing.”
Required: Briefly explain why the company owes $20,670 in income tax for 2023.
Show your calculations.
Answer:
Cases
CASE ONE Bendana Corporation
Bendana Corporation is a Canadian company that specializes in the construction of
sports facilities. Although its head office is in Edmonton, final approval of all major
construction projects is given by the executive officers of Bendana’s parent
company, Holdings Limited. Holdings Limited is incorporated in the United Kingdom,
and all of its shares are owned by British residents. Holdings owns 100% of
Bendana’s shares.
The president of Bendana has called for a meeting next week to discuss the
company’s expansion to the United States. The executives are considering two basic
options for the American organization. One is to open an administrative office in
Chicago. The office would bid on all American contracts and service those contracts
by hiring American staff and leasing all equipment from American companies.
Alternatively, Bendana has an opportunity to acquire the shares of a small
construction company that already has an experienced staff and good basic
equipment. The president is hopeful that the meeting will settle the issue so that a
plan of action can be set in motion.
Whichever option is chosen, Landry Peters, a senior vice-president, will move to
Chicago to head the American operation. Landry intends to leave Edmonton in
October 2023 and rent an apartment in Chicago. His spouse and two children will
follow in late December when the school break begins. A third child, Darla, will
remain in Edmonton to complete her remaining two years at university. Darla will
reside at their house near the university until she graduates, at which time the
house will be put up for sale. The house is owned by Landry’s spouse. Darla intends
to have two boarders staying at the house, who will pay rent monthly to the spouse.
Landry holds 10% of the shares of a Canadian private corporation. The majority
shareholder of that corporation is his sibling, Jason. The company pays regular
quarterly dividends. Landry has agreed to sell the shares to Jason early in 2024. The
sale will result in a small profit for Landry. Jason will pay 40% of the purchase price
in cash and the balance over two years, with interest at 7%.
Bendana has recently been awarded a contract to build a soccer stadium in Regina.
The company has asked the British parent company to send its soccer field expert
to Regina to consult on the project. Eliana Thompson will arrive in Regina on
November 1, 2023, and remain there until August 2024, by which time the project
will be substantially finished. Eliana will be paid a salary by Bendana while in
Canada. Eliana’s spouse will remain in the United Kingdom to manage their large
investment portfolio.
Remi Watkins, Bendana’s financial expert, works out of the company’s Toronto
office. Remi left last month for Sudan, where she will arrange the financing for a
large project of the Sudanese government. Basically, Remi is on loan to that
government. She is excited about taking a break from her normal duties and
pleased to hear that Sudan does not levy any income tax. Remi has kept her
apartment in Toronto, as she plans to be away only until November 2024. While she
is away, her sister will occupy the apartment.
Required: Describe briefly how each of the above activities will be affected by
Canadian tax laws.
CASE TWO Samuel and MET Ltd.
Samuel Tamm is the sole shareholder of MET, a Canadian-controlled private
corporation carrying on an active business, with a December 31 fiscal year-end.
Samuel met with you on January 6, 2024, about a number of issues.
On August 1, 2023, Samuel received a demand to file a tax return for the 2021
taxation year. Samuel did not file a tax return for 2021 because salary from MET
was his only income for the year. The payroll clerk at MET was careful to ensure that
the correct amount of tax was withheld from Samuel’s pay and remitted to the CRA
monthly. Thus, Samuel is looking for confirmation that he is not required to file a tax
return for 2021.
In 2022, Samuel won $500,000 in a lottery, which he invested wisely. Because of
the investment income, he prepared a tax return for 2022. He personally delivered
the tax return, together with a cheque for $9,200, the balance of tax owing, to the
CRA on September 30, 2023. According to Samuel’s calculations, he will owe
$12,000 in tax on his investment income earned in 2023, so he plans to file his
2023 tax return on time. He did not make any tax instalments in 2023 as he did not
receive an instalment notice from the CRA. Samuel wonders whether he should
make instalments for 2024. He estimates that the tax on his 2024 investment
income will be $16,000.
MET’s total federal tax liability was $18,000 in each of 2021 and 2022. It increased
to $26,200 for 2023. MET made monthly federal tax instalments of $1,500 on the
last day of each month in 2023. Samuel wants to ensure that the corporate tax
return for 2023 is filed on time and that all taxes owing are paid by the due date to
avoid paying interest.
MET received a Notice of Reassessment for the 2019 taxation year, dated December
6, 2023, stating that the corporation was assessed additional tax for the 2019 year
in the amount of $42,000. Samuel is convinced that the reassessment is in error.
Samuel has the original Notice of Assessment for 2019, issued February 21, 2021,
which indicated that the return was assessed as filed.
Samuel is married and has three children. His spouse is a self-employed computer
consultant.
Required:
Prepare a memo to Samuel providing advice on the issues. Assume the prescribed
rates of interest under Reg. 4301 for computing taxable benefits are 3% for the first,
third, and fourth quarters, and 2% for the second quarter of 2023.