FNCE-2005 M2 Solutions to Selected Problems

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Red River College *

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2005

Subject

Accounting

Date

Apr 3, 2024

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docx

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Uploaded by franklin_a

Solution to P 11-1 Part 1 (a) Net income for tax purposes: Profits from operations Head office $1,200,000 Alberta branch 10,000 1,210,000 Dividend income 80,000 Taxable capital gains 70,000 Net income for tax purposes $1,360,000 (b) Taxable income: Net income for tax purposes $1,360,000 Deduct: Net capital losses (limited to capital gains, above) [ITA 111(1)(b)] (70,000) Non-capital losses [ITA 111(1)(a)] (120,000) Dividends [ITA 112(1)] (80,000 ) Taxable income $1,090,000 (c) Federal and provincial taxes: Before calculating the provincial tax liability, it is necessary to determine the allocation of business income to Nova Scotia and Alberta [Reg. 402(3)]. Provincial allocation - Because the Alberta activity is conducted from a permanent establishment in that province, a portion of the taxable income is subject to Alberta provincial tax. The percentage of taxable income allocated to Alberta is 14.36% calculated as follows [Reg 402(3)]: Sales in Alberta $1,300,000 = 14.44% Total sales $9,000,000 Wages in Alberta $200,000 = 14.28% Total wages $1,400,000 Average sales % and wages % 14.44% + 14.28% = 28.72 = 14.36% 2 Taxable Income - Alberta: $1,090,000 x 14.36% = $ 156,525 Taxable Income - Nova Scotia: 100% - 14.36% = 85.64% x $1,090,000 933,475

Total $1,090,000 Federal: Basic rate 38% x $1,090,000 [ITA 123(1)] $414,200 Abatement 10% x $1,090,000 [ITA 124(1)] (109,000 ) 305,200 General tax reduction 13% x $1,090,000 [ITA 123.4] (141,700 ) Federal Tax 163,500 Provincial Nova Scotia 16% x $933,475 149,356 Alberta 12% x $156,525 18,783 Total Tax $331,639 Part 2 Operating the Alberta operation as a branch of the main corporation resulted in two tax benefits:  The arbitrary provincial allocation formula caused $156,525 of taxable income to be taxed in Alberta at the lower provincial rate of 12% (versus 16% in Nova Scotia) when the actual Alberta profit was only $10,000. If a separate corporation had been used, total provincial taxes would increase because only $10,000 of the total taxable income of $1,090,000 would be taxed in Alberta. Therefore, if the Alberta branch had been incorporated from the outset, the taxes for the year would have increased by $5,861 calculated as follows: Provincial profits: Branch $156,525 Corporation (10,000 ) $146,525 Tax cost 16% - 12% = 4% x $146,525 = $5,861 Solution to P 11-5 Part 1 In order to reduce the risk of the $650,000 loss carry-forward from expiring, the company can take a number of discretionary steps that will increase income currently in exchange for deductions at a later time. This action will reduce the loss carry-forward but preserve the discretionary items to reduce income at some future time. Some of or all of the following can be done:

(a) Capital cost allowance : CCA is discretionary and if it is not claimed in the current year, the UCC of the class will be higher allowing greater CCA to be claimed in future years. Based on the current year's financial statement, this could increase income by $40,000. (b) Salary to owner : The sole shareholder of the company receives a salary of $60,000. By not paying this salary to the owner, income can increase by $60,000 annually. This step will also reduce the tax payable by the shareholder. If the shareholder needs funds for personal living expenses, the corporation can repay a portion of the shareholder's loan of $400,000 which results in no tax to the shareholder. The amount of the annual shareholder debt repayment required (to meet the owner's personal needs) is equal to the after-tax salary previously received, which is considerably less than $60,000. As less cash is being paid out of the company, its financial strength is enhanced. (c) Allowance for Doubtful Accounts : The company has claimed a reserve of $310,000 for doubtful accounts receivable. Deducting this reserve is discretionary. The current year's reserve is first added to next year's income and a new reserve is claimed. If no reserve is claimed next year, income will increase by $310,000. A new reserve can be deducted in any future year provided that it is reasonable. (d) Interest on shareholder's loan : The amount owing to the shareholder bears interest at 9% which reduces the corporate income and increases the shareholder's taxable income. This amounts to $36,000 annually ($400,000 x 9%). If the demand loan is renegotiated without interest, corporate income will increase and the shareholder's personal tax cost will decrease. If the shareholder needs the funds for personal reasons, annual repayments of the loan can be made similar to the salary adjustment above. If the current year's tax return has not been filed, some of the above items can be implemented in the current year. The potential adjustments total $446,000 as follows: CCA $ 40,000 Salary to owner 60,000 Reserve for bad debts 310,000 Interest on shareholder loan 36,000 $446,000 Therefore, the potential adjustments are sufficient to use up a large portion of the loss carry-over of $650,000 and preserve the deductions for future years. Solution to P 11-6 In computing federal tax for a public corporation there is no tax benefit to be obtained by claiming the M&P deduction (13) since other income receives the general tax reduction (13%). However, there is a provincial benefit in some provinces, Saskatchewan, being one of them.

If the manufacturing business is operated as a division of Vertex, the M & P profits will be $1,542,375 as follows: [Reg. 5200 – 5202] Business profits: Manufacturing operations $ 240,000 NDI existing operations 4,730,000 4,970,000 Less interest on bonds (130,000 ) Adjusted business income $4,840,000 Manufacturing capital (MC) Cost of depreciable manufacturing property Building (80% x $300,000) $240,000 Manufacturing equipment 600,000 $840,000 MC - $840,000 x 10% x 100/85 $98,824 Total capital (TC) Owned assets: Building acquired $ 300,000 Manufacturing equipment 600,000 Cost of VDI's existing depreciable assets 1,890,000 2,790,000 Leased assets - rent of trucks 80,000 TC - ($2,790,000 x 10%) + $80,000 $359,000 Manufacturing labour (ML) Direct labour $320,000 ML - $320,000 x 100/75 $426,667 Total labour (TL) Direct labour - manufacturing $ 320,000 Administrative salaries 630,000 Warehouse and sales salaries 340,000 TL $1,290,000

M & P Profits: MC + ML -------------- x ABI TC + TL $98,824 + $426,667 ------------------------------ x $4,840,000 = $1,542,375 $359,000 + 1,290,000 The Saskatchewan provincial tax reduction – 2% x $1,542,375 = $30,848 If the manufacturing plant is structured as a separate corporation, the maximum M & P profits could not exceed $240,000 (the profits for the corporation). The maximum Saskatchewan tax reduction would be $4,800 (2% x $240,000). Therefore, the division structure increases the provincial M&P tax reduction by $26,048 ($30,848 - $4,800). Assuming profit levels are maintained, this is an annual amount. Dividend Refund - Private company (A) + (B) + (C) (A) Lessor of: (i) 38 1/3% x eligible dividends paid 3,833 (ii) Eligible RDTOH balance 5,750 3,833 Plus (B) Lessor of: (i) 38 1/3% x non-eligible dividends paid 28,748 (ii) Non-eligible RDTOH balance 6,000 6,000 Plus (C) Lessor of: (i) 38 1/3% x non-eligible dividends paid 28,748 less: Non-eligible RDTOH balance (6,000) 22,748 and (ii) Eligible RDTOH balance 5,750 less: Dividend refund for eligible dividends (3,833) 1,917 1,917 11,750

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