ca_exm_tx1_2009-03

CGA-CANADAPERSONAL & CORPORATE TAXATION [TX1] EXAMINATIONMarch 2009Time: 3 HoursNotes:1. This examination is based on the Canadian Income Tax Act (ITA) with Regulations (CCH 86th Edition).2. Round all calculations to the nearest dollar, except price per share.3. The following items, applicable to the 2008 taxation year, are provided for reference:Federal Income Tax Rates — 20082008 Taxable Income Federal Marginal Tax Rate$37,88515%toUp$75,769 22%–$37,886$123,184 26%$75,770–over 29%$123,185andPersonal Tax Credits 20081. Single status taxpayer (paragraph 118(1)(c)) ............................................................................................................. $ 1,4402. Married status taxpayer (paragraph 118(1)(a))Same as for single status taxpayer under (1) above,with an additional spousal credit of .................................................................................................................... 1,440 118(1)(b.1)) (306)Child(paragraph3.4. Eligible dependant status taxpayer (paragraph 118(1)(b))Same as for married status taxpayer in (2) above.5. Infirm dependants 18 years of age or older (paragraph 118(1)(d)) (614)The credit is reduced if dependant’s net income exceeds ......................................................................................... 5,8116. Taxpayer is 65 years of age or over (subsection 118(2)) (791)The credit is reduced if net income exceeds .............................................................................................................. 31,5247. Medical expenses credit (subsection 118.2(1))The maximum reduction for purposes of the credit ........................................................................................... 1,9628. Caregiver — parent/grandparent (maximum) (paragraph 118(1)(c.1)) (614)The credit is reduced if dependant’s net income exceeds ......................................................................................... 13,9869. Education credit for each qualifying month (paragraph 118.6(2)(a)) (70)10. Education credit for each qualifying month (paragraph 118.6(2)(b)) (21)credit (subsection 118(10)) (153)Employment11.Marks130 QuestionSelect the best answer for each of the following unrelated items. Answer each of these items in yourexamination booklet by giving the number of your choice. For example, if the best answer for item (a)is (1), write (a)(1) in your examination booklet. If more than one answer is given for an item, that item willnot be marked. Incorrect answers will be marked as zero. Marks will not be awarded for explanations.Note:2 marks eacha. Which of the following will result in an individual being taxable in Canada on his or her worldwideincome?1) The individual is a citizen of Canada.2) The individual is domiciled in Canada.3) The individual is a resident of Canada.4) The individual sojourns in Canada for at least 150 days in a year.b. Mary is a self-employed consultant. Her husband Jacob is employed as a school teacher. Which of thefollowing correctly states the number of days after December 31, 2008 that Mary and Jacob have tofile their 2008 income tax returns?1) Mary 166 days; Jacob 166 days2) Mary 166 days; Jacob 120 days3) Mary 120 days; Jacob 120 days4) Mary 181 days; Jacob 181 daysc. Which of the following correctly describes the minimum penalty imposed on a taxpayer who evadesincome tax?1) 20% of the unpaid tax2) 30% of the tax sought to be evaded3) 40% of the unpaid tax4) 50% of the tax sought to be evadedd. When establishing if an individual is employed or self-employed, it is necessary to determine whetherthe individual is directed by someone who is in a position to order not only what is to be done but howit is to be done. This test is part of which of the following tests?1) Economic reality testtest2) Integration3) Specific result testtest4) Organizatione. Diane is employed as a science professor at a university. In 2008 she purchased a patent for ascientific process. She knew at the time it would take many years for the process to be commerciallyviable but anticipated it would grow in value. Six months after the purchase, Diane listed the patentfor sale and sold it at a loss in 2009. Which of the following best describes the tax status of the loss?loss1) Capitalloss2) Businessloss3) Property4) Allowable business investment lossContinued...f. Which of the following types of income received by a non-resident is not subject to tax in Canadaunder Part I of the Income Tax Act?1) Income earned from a business carried on in Canada at a Canadian permanent establishment2) Capital gain from the sale of taxable Canadian property3) Income earned while temporarily employed in Canada4) Interest earned on a business loan to a resident of Canadag. Which of the following types of income is subject to a withholding tax under Part XIII of the IncomeTax Act when paid to a non-resident?1) Royalty paid on copyright to a musical work2) Interest paid to an arm’s-length party3) Management fee to an arm’s-length business4) Building rent to an arm’s-length landlordh. On September 30, 2008, Sabrina left Canada to permanently reside in the U.S. At the date of departureshe owned shares of a Canadian public corporation that had a market value of $40,000 and originally cost $10,000. Her salary up to the date of departure was $70,000. In December 2008, Sabrina sold the shares of the Canadian public corporation for $30,000. She earned a salary of $20,000 in the U.S.Which of the following correctly describes Sabrina’s 2008 income for tax purposes in Canada?1) Employment income — $90,000; taxable capital gain — $10,0002) Employment income — $70,000; taxable capital gain — $15,0003) Employment income — $70,000; taxable capital gain — $10,0004) Employment income — $90,000; taxable capital gain — $15,000i. AA Inc. is a Canadian-controlled private corporation (CCPC) whose voting common shares are owned80% by Delia and 20% by BB Inc., a CCPC. BB Inc. is owned 100% by Karen. Delia and Karen are sisters. Which of the following statements is true regarding AA and BB?1) AA and BB are not associated but are connected and related.2) AA and BB are associated, connected, and related.3) AA and BB are not associated and not connected, but are related.4) AA and BB are not associated and not related, but are connected.j. Samir operates a business as a sole proprietorship. The business earns $120,000 annually. Normally, Samir requires all of the after-tax business earnings to pay for personal family expenses. If Samir were to incorporate the business, which of the following best describes the resulting tax benefits?1) Incorporation will create permanent tax savings resulting from the use of the small businessdeduction.2) Incorporation will create a tax deferral resulting from the use of the small business deduction.3) Incorporation will create permanent tax savings because the corporation is entitled to moredeductions in arriving at taxable income.4) Incorporation will create an insignificant tax advantage.Continued...k. MM Ltd., a CCPC, will earn $600,000 of active business income in its 2008 taxation year. MM’s combined tax rate is 20% on income subject to the small business deduction and 31% on other active business income. MM has no refundable dividend tax on hand (RDTOH) balance. The president and sole shareholder of MM receives an annual salary, but requires additional funds for personal use.Which of the following statements is correct regarding the distribution of additional funds by MM?1) MM should pay a salary to avoid significant double taxation.2) MM should pay a dividend to reduce overall taxes from the dividend tax credit on an eligibledividend.3) MM can pay either an eligible dividend or a salary, as the overall tax will be approximately thesame.4) MM should pay a dividend to avoid significant double taxation.l. Which of the following statements is true regarding the carry-over period available for a restricted farm loss?1) 3 years previous and 10 years forward2) 3 years previous and 20 years forward3) 5 years previous and 15 years forward4) 2 years previous and 5 years forwardm. In 2008, a parent gifted shares of a public company to her 16-year-old son. In the same year, the son received a dividend of $500 from the shares and then sold the shares for $2,000 more than their fair market value on the date of the gift. Which of the following correctly describes the 2008 taximplications relating to the shares?1) The son includes the dividend and taxable capital gain in his income for tax purposes.2) The parent includes the dividend and taxable capital gain in her income for tax purposes.3) The parent includes the dividend in her income for tax purposes and the son includes the taxablecapital gain.4) The parent includes the taxable capital gain in her income for tax purposes and the son includesthe dividend in his.n. Which of the following is correct in describing the last year in which an individual can contribute to an RRSP?1) Before the year in which the individual turns 712) Before the year in which the individual turns 693) Any time during the year in which the individual turns 714) Any time during the year in which the individual turns 69o. Which of the following statements is true regarding the calculation of net income for tax purposes from a rental property owned by a corporation?1) A loss from a rental property can only be deducted from other property income.2) Rental income must be recorded when earned and not only when received.3) Capital cost allowance can always be deducted when calculating net rental income for taxpurposes.4) A rental property cannot deduct a reserve for uncollected rents.45 Question 2Step Ltd., a CCPC, operates a retail business. Financial statements for the year ended December 31, 2008report a net income before tax of $451,000.You have been retained to determine the corporation’s tax liability and provide advice on other taxmatters. You have gathered the information outlined in Exhibit 2-1.Required26 a. Under Part I of the Income Tax Act, calculate Step’s minimum net income for tax purposes andminimum taxable income for the 2008 taxation year.15 b. Based on your answer to part (a), calculate the minimum Part I and Part IV federal income tax,refundable dividend tax on hand (RDTOH), and dividend refund (if any) for the 2008 taxation year(ignore the general rate reduction).4 c. Briefly describe the tax implications for shareholders A and B with regard to their sale of shares in2009 (see Exhibit 2-1, item 7).EXHIBIT 2-1STEP LTD.2008 Financial Information1. Step’s income for accounting purposes for 2008:operations $446,000retailIncomefromLoss on sale of assets (14,000) Interestincome 6,000income 13,000 Dividend$ 451,0002. Dividend income consists of $3,000 from shares of public corporations and $10,000 from KK Inc., aCCPC. Step owns 40% of KK’s shares. In 2008, KK earned active business income of $100,000. In2008, KK received a dividend refund of $5,000 from its RDTOH account.The interest income of $6,000 was received on October 31, 2008 and represents the semi-annualinterest on a $200,000 GIC investment with a 6% per annum interest. The GIC was acquired onMay 1, 2008.3. A review of Step’s 2007 corporate tax return provides the following information:Non-capital loss carry forward balance $ 9,000account NIL dividendCapitalCumulative eligible capital 12,000General rate income pool (GRIP) 8,000 RDTOH NIL Undepreciated capital cost:Class1 630,0008 120,000ClassClass10 22,00017 30,000ClassContinued...EXHIBIT 2-1 (Continued)4. On July 1, 2008, Step purchased a warehouse for $500,000 (land 100,000; building 400,000). Thebuilding was originally constructed in 2001.On September 1, 2008, Step sold its only delivery truck for $28,000. The truck originally cost$42,000. On the same day, it purchased a new automobile for $37,000 to be used by the company’s sales manager.On December 1, 2008, Step returned its leased computers and purchased several new ones at a cost of $20,000.5. The following items are included in various expense accounts:Golf club membership dues for the vice president to entertain suppliers $ 2,000 fees:LegalDrafting and registering a mortgage on the new building 1,500Drafting purchase agreement for the new building 3,000Filing a lawsuit against a supplier for breach of contract 3,500Amortization 50,000 Painting the interior of two retail buildings (one owned, one leased) 12,000 Paving the parking lot of the newly acquired warehouse property 18,000 Annual audit fee 9,000 Bonus to a store manager, payable in two equal instalments on April 30 andSeptember 30, 2009 22,000 Reserve for unredeemed gift certificate sold in 2008 17,000 Lease on vice president’s automobile (ignore GST and PST) 10,200 Life insurance on the company president 800 Site investigation for new building 2,4006. On December 15, 2008, Step declared and paid a dividend of $12,000.7. There are three shareholders of Step Ltd.: one controlling shareholder and two minority shareholders.Minority shareholder A acquired 40 shares at $1,000 per share in 1999 and another 60 shares at$1,500 per share in 2001. Minority shareholder B acquired all of her shares in 2003 at $2,500 pershare.At the request of the president, shareholders A and B will each sell, for cash, 20 shares to the sales manager for $1,800 per share. This transaction will occur in 2009. Of Step’s assets, 90% are used in an active business and have been for several years.25 Question 3Emilio is employed by XT Inc., a Canadian public corporation. He has requested your assistance inpreparing his 2008 income tax return.Information regarding Emilio’s financial activities for 2008 is outlined in Exhibit 3-1. Selectedinformation from his 2007 tax return is provided in Exhibit 3-2.Required17 a. Calculate Emilio’s minimum net income for tax purposes in accordance with the format of Section 3of the Income Tax Act, and his minimum taxable income for the 2008 taxation year.8 b. Based on your answer to part (a), calculate Emilio’s minimum federal income tax for the 2008taxation year. Show all calculations.EXHIBIT 3-1EMILIO2008 Financial Information1. Emilio received a salary of $110,000. From this amount, XT deducted income tax of $27,000, CPPand EI of $2,760, donations to a registered charity of $1,000, and Emilio’s share of the premium to aprivate group health insurance plan of $400. In addition to his salary, XT paid the following:XT’s share of the premium to the private group health plan $ 600Group term life insurance premium 500Supplementary unemployment insurance plan premium 900A portion of Emilio’s dues to a professional accounting association (total dues $1,500) 1,000Emilio used a vehicle owned by XT to carry out his employment duties and for personal use. Thevehicle originally cost $34,000 and has an undepreciated capital cost of $16,000. In 2008, Emiliodrove the vehicle 30,000 km, of which 18,000 km was for employment purposes and 12,000 km wasfor personal use. XT paid all of the operating costs of $4,000.In September, Emilio purchased a cell phone for $400 and used it all of the time for employmentpurposes.On February 28, 2008, XT offered Emilio a stock option plan allowing him to purchase 1,000 XTshares at a cost of $10 per share. On that date, the shares were valued at $14 per share. Emiliopurchased the 1,000 shares in June when they were valued at $13 per share. After receiving a dividendof $400, Emilio sold the shares on December 20, 2008 for $20 per share. Upon the sale of the shares,Emilio repaid the $10,000 loan used to acquire the shares plus interest of $300.2. In June 2008, Emilio sold shares of a CCPC for $72,000. The shares were purchased in 1989 for$20,000. Emilio paid $2,000 to a lawyer who negotiated the sale price with the purchaser and draftedthe sale agreement. The agreement required a payment of $7,200 on closing, with the balance payablein four annual instalments beginning in 2009.In 2008, Emilio also sold a painting for $2,800, which originally cost $800. In addition, he sold hispersonal piano for $2,000, which had originally cost $3,000 in 2001.3. Emilio is single and supports his 14-year-old daughter who lives with him. In 2008, his daughterearned $1,800 of interest from a bond left to her by her deceased grandparent.Continued...EXHIBIT 3-2Selected 2007 Cantax Schedules100END OF EXAMINATIONCGA-CANADAPERSONAL & CORPORATE TAXATION [TX1] EXAMINATIONMarch 2009SUGGESTED SOLUTIONSMarks Time: 3 Hours 130 QuestionNote:2 marks eachSources/Calculations:a. 3) Topic 1.9 (Level 1)b. 1) Topic 1.4 (Level 1)c. 4) Topic 1.4 (Level 1)d. 1) Topic 2.1 (Level 1)e. 2) Topic 3.1 (Level 1)f. 4) Topic 10.2 (Level 1)g. 4) Topic 10.3 (Level 1)h. 2) Topic 10.1 (Level 1)Salary to departure $70,000; taxable capital gain 1/2 (40,000 – 10,000) = $15,000i. 1) Topics 4.1, 8.4, and 9.2 (Levels 1 and 2)j. 4) Topic 9.5 (Level 1)k. 3) Topic 9.6 (Level 1)l. 2) Topic 7.2 (Level 1)m. 3) Topic 5.9 (Level 2)n. 3) Topic 5.8 (Level 1)o. 2) Topic 5.4 (Level 1)45 Question 2Minimum net income for tax purposes and taxable income26 a.Net income per financial statements $451,000Add(Deduct):assets 14,000of(1) Lossonsale(1) Accrued interest on GIC — $200,000 × 6% × 2/12 (or 61/365) 2,000($12,000) (840)—7%(1) CECdeduction(2) CCA — Class 1 — 4% ($630,000) + (1/2) (4%) ($400,000 + $3,000) (see note) (33,260)(1) CCA — Class 8 — 20% ($120,000) (24,000)(2) CCA — Class 17 — 8% ($30,000) + (1/2) (8%) ($18,000)(3,120)(2) CCA — Class 10.1 — 30% (1/2) ($30,000 limit) (4,500)(2) CCA — Class 50 — 55% (1/2) $20,000 (5,500)(1) Recapture — Class 10 — ($28,000 – $22,000) 6,000clubdues 2,000(1) Golf(1) Legal — cost of financing — $1,500 – 1/5 ($1,500) 1,200—agreementcapital 3,000(1) Legal—purchase(1) Amortization 50,000—capital 18,000lot(1) Pavingparking(1) Bonus unpaid over 180 days — 1/2 ($22,000) 11,000(2) Excessive auto lease — $10,200 – ($800 × 12) 600insurance on president 800(1) Life(2) Net income for tax purposes (see note) 488,380Deduct:loss (9,000) Non-capitaldividends (13,000)Taxableincome $466,380(2) TaxableNote:The 3 marks for net income for tax purposes are reduced if items that should be excluded from the calculation are incorrectlyincluded, such as land, capital loss on depreciable property, earnings of KK, legal for lawsuit, painting, audit fee, reserve for giftcertificates, and site investigation.Continued...15 b.Federal taxPart I taxBasic rate — 38% × $466,380 $ 177,224Abatement — 10% × $466,380 (46,638)(2) 130,586Small business deduction (SBD) — 17% × least of:467,380income1 $ Activebusinessincome 466,380Taxable(2) Business limit — 17% × $400,000 400,000 (68,000)Additional refundable tax on investment income — 62/3% × lesser of:Aggregate investment income — Interest ($6,000 + $2,000) $ 8,000Taxable income less amount on which SBD is computed–$400,000) 66,380($466,380(3) 62/3% × $8,000 53463,120$1Active business income:Net income for tax purposes $ 488,380Deduct:+$2,000) (8,000)($6,000InterestDividends (13,000)467,380(2) $Part IV tax(2) KK — connected –— 40% ($5,000 refund) $ 2,000Public corporations — 331/3% ($3,000) 1,000$ 3,000RDTOHOpening $ 0tax 3,000IV(1) PartRefundable portion of Part I tax — least of:262/3% × investment income ($8,000) $ 2,134262/3% × taxable income less amount on which SBD is computed$400,000) 17,704–($466,380tax 63,120 2,134(2) PartI$ 5,134(1) Dividend refundLesserof:331/3% × $12,000 $ 4,000RDTOH 5,134 $ 4,0004 c. The ACB of shareholder A’s shares is the weighted average of the two acquisitions; that is, $1,300 pershare — [(40 × $1,000) + (60 × $1,500)] divided by (40 + 60) = $1,300. Shareholder A has a taxablecapital gain of $5,000 — (1/2) [(20 × $1,800) – (20 × $1,300)]. Shareholder B has an allowable capitalloss of $7,000 — (1/2) [20 × ($1,800 – $2,500)]The shares are qualified small business shares and shareholder A is eligible for the capital gainexemption and shareholder B’s loss is an allowable business investment loss (ABIL) deductibleagainst any source of income.25 Question 3Net income for tax purposes and taxable income17 a.Paragraph 3 (a)income:Employment110,000(1) Salary $(1) Benefit — group term life insurance 500(1) Benefit — professional accounting dues 1,000(2) Auto — standby charge — $34,000 × 2% × 12 months = $8,160 × 12,000 km / (1,667 × 12) 4,895(1) Operating benefit — lesser of:24¢ × 12,000 km = $2,880 or 1/2 of $4,895 = $2,448 2,448(1) Stock option — $1,000 × (13 – 10) 3,000121,843dues 1,500professional—(1) Deduct120,343 income:Property(1) Eligible dividends (XT) — $400 × 1.45 $ 580interestexpense (300) 280(1) Deduct—Paragraph 3 (b)gains:capitalTaxable(1) XT shares — 1/2 [1,000 × ($20 – $13)] $ 3,500(1) CCPC shares — (1/2) ($72,000 – $20,000 – $2,000) $ 25,000Deduct reserve — lesser of:=$20,000;($25,000)4/55,000(1) or 64,800/72,000 × $25,000 = $22,500 (20,000)(1) L.P.P. — painting — $2,800 – $1,000 deemed 1,800(1) Less L.P.P. loss forward (500)1,3009,150(1) Inclusion50% 650rate(1) Net income for tax purposes and taxable income $ 129,773Note:The 2 marks for net income for tax purposes is reduced if items that should be excluded from the calculation are incorrectlyincluded, such as private health premiums, supplementary unemployment insurance premium, cost or CCA on cell phone, capitalloss on P.U.P. (piano), or daughter’s income. Marks are also lost if items are misclassified within Section 3 of the Income Tax Act.Continued...8 b.Federal tax15% $ 5,683×37,885$22% 8,334 37,884×26% 12,328×47,4156,589 × 29% 1,911129,773 28,256(1) $credits:Tax(1) Dividend tax credit, eligible — $580 × 18.97% (110)(1) Individual ($9,600 × 15%) (1,440)(1) Equivalent to spouse — $1,440 – (15% × $1,800) (1,170)(1) Child credit — $2,038 × 15% (306)(1) CPP/EI — $2,760 × 15% (414)(1) Employment — $1,019 × 15% (153)(1) Donation — (15% × $200) + (29% × $800) (262)$ 24,401100END OF SOLUTIONSCGA-CANADAPERSONAL & CORPORATE TAXATION [TX1] EXAMINATIONMarch 2009EXAMINER’S COMMENTSGeneral CommentsThe overall examination result was satisfactory. Most candidates were able to complete the examinationwithin the designated time permitted. The multiple-choice questions presented the most difficulty.Students also had difficulty with certain elements of employment income, business income, and capitalgains.Specific CommentsQuestion 1 Multiple choice (Level 1)Performance on this question was unsatisfactory.Candidates had the most difficulty with parts (d) tax policy, (e) capital gain versus business income, (g)international tax (withholding tax), (j) benefits of incorporation, and (k) salary versus dividend.Question 2 Corporate tax, including the calculation of business income, capital cost allowance, property income, Part I tax, Part IV tax, and RDTOH (Level 1)Performance on this question was excellent.The most common errors in part (a) were calculating CCA for class 10.1 and class 50, not recognizing thatthe reserve for gift certificates, legal cost for the lawsuit, and the cost of site investigations are alldeductible expenses for tax, and incorrectly calculating the allowable deduction for the auto lease. Part (b)was well answered. The most common error was the calculation of Part IV tax on dividend from theconnected corporation. Part (c) was poorly answered. Most candidates correctly calculated the gain andloss, but did not include a reference to the capital gain deduction and the allowable business investmentloss status.Question 3 Employment income, property income, capital gains/losses, and the calculation of personal tax and tax credits (Level 1)Performance on this question was satisfactory.The most common errors in part (a ) were calculating the standby charge, not including the professional feespaid by the employer as a taxable benefit, calculating the reserve for deferred proceeds on the capital gain, andincorrectly including the private health insurance as a taxable benefit. Part (b) was well answered except forthe calculation of the spousal equivalent tax credit.。