chapter sixteen solutions

CHAPTER SIXTEEN SOLUTIONS

Solution to Assignment Problem Sixteen - 1

The required calculations would be as follows:

Corporate Taxes

Income For The Year $50,000 Corporate Taxes (20%) ( 10,000)Income Available For Dividends $40,000

Personal Taxes On Dividends

Dividend Income $40,000 Gross Up (25%) 10,000 Taxable Dividends $50,000

Tax Payable Before Dividend Tax Credit [(29% + 14.5%)($50,000)] $21,750

Dividend Tax Credit [(2/3 + 1/3)($10,000)] ( 10,000)Personal Tax Payable $11,750

Total Taxes On Corporate Flow Through

Corporate Taxes $10,000 Personal Taxes 11,750 Total Taxes $21,750

Total Taxes On Income Earned Directly

Income For The Year $50,000 Combined Federal/Provincial Tax Rate (29% + 14.5%) 43.5% Personal Tax Payable $21,750

As shown in the preceding calculations, using the given information, the total federal and provincial taxes paid is the same whether the $50,000 of income is flowed through a corporation or, alternatively, received directly by the individual.


Part A Assuming Hemingway Industries is a CCPC, the changes in the capital dividend account during the year are as follows:

Adjusted Selling Gain Property Proceeds Cost Base Costs (Loss)

1 $ 8,100 ($ 4,200) ($ 200) $3,700 2 7,900 ( 3,950) ( 375) 3,575 3 2,200 ( 4,300) ( 700) ( 2,800)4 1,900 ( 3,450) ( 260) ( 1,810)

Totals $20,100 ($15,900) ($1,535) $2,665

The net capital gain for the year is $2,665. One-half of this amount, or $1,333, would be added to the capital dividend account.

Part B Assuming Hemingway Industries is a private corporation, but not a CCPC, the changes in the capital dividend account during the year would be the same as in Part A.


Case A The tax consequences in this Case would be calculated as follows:

Redemption Proceeds $78,000 PUC [(1/2)($150,000)] ( 75,000)ITA 84(3) Deemed Dividend $ 3,000 Gross Up Of 25 Percent 750 Taxable Dividend $ 3,750

Redemption Proceeds $78,000 ITA 84(3) Deemed Dividend ( 3,000)Proceeds Of Disposition $75,000 Adjusted Cost Base ( 72,000)Capital Gain $ 3,000 Inclusion Rate 1/2 Taxable Capital Gain $ 1,500

The total increase in Taxable Income would be $5,250 ($3,750 + $1,500). As all of this individual’s shares have been redeemed, information on changes in the adjusted cost base is not relevant.

Case B The total dividend would be $92,500 [($0.50)(185,000)]. However, as it is a capital dividend, it would have no tax consequences for the individuals holding the Common Shares. The adjusted cost base of the shares held would not be changed. While this has no immediate tax consequences for the shareholders, this transaction would reduce Deemit’s Capital Dividend Account by $92,500.

Case C The tax consequences in this Case would be calculated as follows:

Liquidating Dividend [(185,000)($2.10)] $388,500 PUC Of Common Shares ( 370,000)ITA 84(4) Deemed Dividend $ 18,500 Gross Up Of 25 Percent 4,625 Taxable Dividend And Increase In Taxable Income $ 23,125

The adjusted cost base of the shares would be reduced by the PUC amount of $370,000. This amounts to $2.00 per share for each of the 185,000 outstanding shares.

Case D The tax consequences in this Case would be calculated as follows:

Increase In PUC $60,000 Decrease (Increase) In Net Assets ( 50,000)ITA 84(1) Deemed Dividend $10,000

The deemed dividend would be allocated over all 28,000 shares outstanding at a rate of $0.36 per share ($10,000 ÷ 28,000) and subject to the 25 percent gross up and tax credit procedures. This means that only $2,880 [(8,000)($0.36)] of the dividend would be allocated to the shareholder whose debt was converted to Preferred Shares. This amount would also be added to the adjusted cost base of his shares, resulting in the following capital gains calculation:

Proceeds Of Disposition $60,000 Adjusted Cost Base:

Cost Of Debt $50,000 Deemed Dividend [(8,000)($.36)] 2,880 ( 52,880)

Capital Gain $ 7,120 Inclusion Rate 1/2 Taxable Capital Gain $ 3,560

This amount would be added to the taxable dividend of $3,600 [($2,880)(125%)], resulting in an increase in Taxable Income of $7,160 ($3,600 + $3,560).


The Part IV Tax Payable for Conrod Holdings Ltd. would be calculated as follows:

Dividend Refund Received By Morsal Inc. $7,000 Conrod’s Percentage Of Ownership 70% Part IV Payable On Morsal Inc. Dividends $4,900 Part IV Tax On Imperial Oil Dividends [(1/3)($500)] 167 Part IV Tax Payable $5,067

The refundable portion of the Part I tax would be the least of the following amounts:

Aggregate Investment Income [(1/2)($9,200)] $ 4,600 Rate 26-2/3%ITA 129(3)(a)(i) $ 1,227

Taxable Income $44,000 Amount Eligible For Small Business Deduction ( 10,000)Total $34,000 Rate 26-2/3% ITA 129(3)(a)(ii) $ 9,067

ITA 129(3)(a)(iii) Adjusted Part I Tax Payable ($9,250 - $501) $ 8,749

The refundable portion of Part I tax is equal to $1,227, which is the least of the preceding three amounts.

The end of year balance in the Refundable Dividend Tax On Hand account and refundable Part I tax can be calculated as follows:

RDTOH Balance - End Of The Preceding Year $ 8,950 Dividend Refund For The Preceding Year ( 4,000)Opening Balance $ 4,950 Part IV Tax Payable 5,067 Refundable Part I Tax 1,227 RDTOH Balance - End Of The Year $11,244

As the interest received appears to be related to temporary balances resulting from the Company’s normal business activities, it would be viewed as active business income and would not influence the preceding calculations.

The taxable dividends paid of $10,000 will generate a $3,333 [(1/3)($10,000)] dividend refund, as this is less than the ending balance in the Refundable Dividend Tax On Hand account.


Part A The required calculations to determine Part I federal Tax Payable are as follows:

Net Income For Tax Purposes $473,900 Dividends ($108,000 + $56,000) ( 164,000)Taxable Income $309,900

Base Amount Of Part I Tax [(38%)($309,900)] $117,762 Federal Surtax [(4%)(28%)($309,900)] 3,471 Refundable Tax On Investment Income (Note Two) 6,240 Federal Tax Abatement [(10%)($309,900)] ( 30,990)Small Business Deduction (Note One) ( 34,608)General Rate Reduction For CCPCs (Note Three) Nil Part I Federal Tax Payable $ 61,875

Note One The small business deduction is 16 percent of the least of the following three amounts:

1. Active Business Income $216,300

2. Taxable Income (no foreign tax credit adjustment) $309,900

3. Allocated Annual Business Limit ($400,000 - $100,000) $300,000

The lowest of these figures is the active business income of $216,300 and this gives a small business deduction of $34,608 [(16%)($216,300)].

Note Two The aggregate investment income of $93,600 is calculated as follows:

Interest On Government Bonds $ 36,300 Taxable Capital Gains 57,300 Aggregate Investment Income $ 93,600

The ITA 123.3 refundable tax (ART) is 6-2/3 percent of the lesser of:

1. Aggregate Investment Income $93,600

2. Taxable Income $309,900 Deduct: Amount Eligible For The SBD ( 216,300 ) $93,600

The ITA 123.3 tax on aggregate investment income is $6,240 [(6-2/3%)($93,600)].

Note Three The general rate reduction would be calculated as follows:

Taxable Income $309,900 Amount Eligible For The Small Business Deduction ( 216,300)Aggregate Investment Income (Note Two) ( 93,600)Full Rate Taxable Income Nil Rate 7% General Rate Reduction Nil

Part B The required calculation of the Part IV Tax Payable on the portfolio investment dividends is as follows:

Part IV Tax [($56,000)(1/3)] $18,667

Part C The calculation of the ending balance in the Refundable Dividend Tax On Hand account is as follows:

RDTOH, End Of The Preceding Year Nil Dividend Refund For The Preceding Year Nil Opening Balance Nil Refundable Portion Of Part I Tax (Note Four) $24,960 Part IV Tax (See Part B) 18,667 RDTOH Balance - December 31, 2007 $43,627

Note Four Using amounts calculated in Part A, the amount of refundable Part I tax is $24,960, the least of three amounts, calculated as follows:

Amount Under ITA 129(3)(a)(i) [(26-2/3%)($93,600)] $24,960 Amount Under ITA 129(3)(a)(ii) [(26-2/3%)($309,900 - $216,300)] $24,960 Amount Under ITA 129(3)(a)(iii) ($61,875 - $3,471) $58,404

Part D The dividend refund for the year would be $10,800, the lesser of:

One-third of taxable dividends paid [($32,400)(1/3)] = $10,800

RDTOH Balance - December 31, 2007 (Part C) = $43,627

Part E The capital dividend account contains the non-taxable portion of net capital gains. As Vader Ltd. has not previously reported any capital gains, the opening balance of this account is nil. The taxable capital gains of $57,300 represent one-half of a $114,600 capital gain. As a result, the balance in the capital dividend account is $57,300 [(1/2)($114,600)].

Part F The required calculation to determine federal Tax Payable is as follows:

Part I Tax $61,875 Part IV Tax (See Part B) 18,667 Dividend Refund (See Part D) ( 10,800)Federal Tax Payable $69,742


The required calculation of Part I Tax Payable would be as follows:

Taxable Income (Given) $95,000

Base Amount Of Part I Tax [(38%)($95,000)] $36,100 Federal Surtax [(4%)(28%)($95,000)] 1,064 Additional Refundable Tax On Investment Income (Note Two) 267 Federal Tax Abatement [(10%)($95,000)] ( 9,500)Small Business Deduction (Note One) ( 14,560)Foreign Non-Business Income Tax Credit (Equal To Withholding) ( 1,200)Manufacturing And Processing Profits Deduction (Note Three) Nil General Rate Reduction (Note Four) Nil Part I Tax Payable $12,171

Note One There is a circular calculation involved in the calculation of foreign tax credits, the small business deduction, and the ART. This adds considerable complexity to the calculation of Tax Payable and, in most situations, the additional calculations do not influence the outcome (that would, in fact, be the case in this problem). To avoid these additional calculations, we have stated that the foreign tax credit is equal to the amount withheld.Given the preceding assumption with respect to the foreign tax credit, the small business deduction would be equal to 16 percent of the least of:

1. Active Business Income $133,000

2. Taxable Income $95,000 Deduct: [(10/3)($1,200)] Foreign Non-Business Tax Credit ( 4,000 ) $ 91,000

3. Annual Business Limit $400,000

The least of the three figures is $91,000, resulting in a small business deduction of $14,560 [(16%)($91,000)].

Note Two The aggregate investment income is equal to the gross foreign investment income of $8,000. The ITA 123.3 refundable tax (ART) is 6-2/3 percent of the lesser of:

1. Aggregate Investment Income $8,000


The ITA 123.3 tax on aggregate investment income of $267 [(6-2/3%)($4,000)].

Note Three The manufacturing and processing deduction would be 7 percent of the lesser of:

1. Canadian M & P Profits (Given) $99,000 Deduct: Amount Eligible For SBD ( 91,000 ) $8,000

2. Taxable Income $95,000 Deduct: Amount Eligible For The SBD ( 91,000)Aggregate Investment Income (Note Two) ( 8,000 ) Nil

Given these calculations, the M& P deduction would be nil.

Note Four The general rate reduction is nil, calculated as follows:

Taxable Income $95,000 Amount Eligible For The SBD ( 91,000)Amount Eligible For The M&P Deduction Nil Aggregate Investment Income (Note Two) ( 8,000)Full Rate Taxable Income Nil Rate 7% General Rate Reduction Nil


Part A The Taxable Income of the Gardner Distributing Company would be calculated as follows:

Pre-Tax Accounting Income $598,000 Additions:

Amortization Expense $ 47,000 Charitable Donations 15,000 Loss On Sale Of Truck 19,000 Taxable Capital Gain (Note One) 3,500 84,500

$682,500 Deductions:

Accounting Gain On Investment Sale ($ 7,000)Capital Cost Allowance (Note Two) ( 138,900)Terminal Loss (Note Three) ( 12,000) ( 157,900)

Net Income For Tax Purposes $524,600 Charitable Donations ( 15,000)Dividends From Taxable Canadian Companies ( 27,000)Taxable Income $482,600

Note One The taxable capital gain on the investment would be calculated as follows:

Proceeds Of Disposition $100,000 Adjusted Cost Base ( 93,000)Capital Gain $ 7,000 Inclusion Rate 1/2 Taxable Capital Gain $ 3,500

Note Two The CCA can be calculated as follows:

Class 3 [(5%)($726,000)] $ 36,300 Class 8 {[20%][$472,000 + ($82,000)(1/2)]} 102,600 Total CCA $138,900

Note Three The only remaining asset in Class 10 was sold for $10,000. As this was $12,000 less than the UCC balance ($22,000 - $10,000), this amount becomes a terminal loss for the year.

Part B The Part I federal Tax Payable can be calculated as follows:

Base Amount Of Part I Tax [(38%)($482,600)] $183,388 Federal Surtax [(4%)(28%)($482,600)] 5,405 Federal Tax Abatement [(10%)($482,600)] ( 48,260)Small Business Deduction (Note Four) ( 64,000)Additional Refundable Tax On Investment Income (Note Five) 233 General Rate Reduction For CCPCs (Note Six) ( 5,537)Part I Tax Payable $ 71,229

Note Four The small business deduction would be equal to 16 percent of the least of:

1. Active Business Income ($524,600 - $3,500 - $27,000) $494,100

2. Taxable Income (no foreign tax credit adjustments)$482,600


The least of the three figures is $400,000 and 16 percent of this amount is $64,000.

Note Five The aggregate investment income is equal to the taxable capital gain of $3,500. The ITA 123.3 tax on aggregate investment income (ART) is 6-2/3 percent of the lesser of:

1. Aggregate Investment Income (Taxable Capital Gain) $ 3,500


The lesser of these amounts is $3,500 and 6-2/3 percent of this amount is $233.

Note Six The general rate reduction is calculated as follows:

Taxable Income $482,600 Amount Eligible For The SBD ( 400,000)Aggregate Investment Income (Note Five) ( 3,500)Full Rate Taxable Income $ 79,100 Rate 7% General Rate Reduction $ 5,537

Part C The calculation of the ending balance in the Refundable Dividend Tax On Hand account is as follows:

RDTOH, End Of The Preceding Year $19,000 Dividend Refund For The Preceding Year ( 5,000 ) $14,000

Refundable Portion Of Part I Tax (Note Seven) $ 933 Part IV Tax On Dividends Received [(1/3)($27,000)] 9,000 9,933 RDTOH Balance - December 31, 2007 $23,933

Note Seven Using amounts calculated in Part B, the amount of refundable Part I tax is $933, the least of three amounts, calculated as follows:

Amount Under ITA 129(3)(a)(i) [(26-2/3%)($3,500)] $ 933 Amount Under ITA 129(3)(a)(ii) [(26-2/3%)($482,600 - $400,000)]

$22,027 Amount Under ITA 129(3)(a)(iii) ($71,229 - $5,405) $65,824

Part D The minimum federal Tax Payable can be calculated as follows:

Part I Tax (Part B) $71,229 Part IV Tax On Dividends Received [(1/3)($27,000)] 9,000 Dividend Refund (Note Eight) ( 5,667)Federal Tax Payable $74,562

Note Eight The dividend refund for the year would be $5,667, the lesser of:

One-third of taxable dividends paid [(1/3)($17,000)] = $5,667

RDTOH Balance - December 31, 2007 = $23,933

Part E The balance in the capital dividend account can be calculated as follows:

Opening Balance $27,200 Non-Taxable Half Of Current Year’s Capital Gain [(1/2)($7,000)] 3,500 Capital Dividends Declared ( 10,000)Capital Dividend Account Balance - December 31, 2007 $20,700


Part A The Part I Tax Payable is calculated as follows:

Base Amount Of Part I Tax [(38%)($245,000)] $93,100 Surtax [(4%)(28%)($245,000)] 2,744 Federal Tax Abatement [(10%)($245,000)(91%)] ( 22,295)Small Business Deduction (Note One) ( 16,000)Additional Refundable Tax On Investment Income (Note Two) 2,400 Foreign Non-Business Income Tax Credit (Equal To Amount Withheld) ( 3,000)Foreign Business Income Tax Credit (Equal To Amount Withheld) ( 6,000)Manufacturing And Processing Profits Deduction (Note Three) ( 1,610)General Rate Reduction (Note Four) ( 6,020)Part I Tax Payable $43,319

Note One There is a circular calculation involved in the calculation of foreign tax credits, the small business deduction, and the ART. This adds considerable complexity to the calculation of Tax Payable and, in most situations, the additional calculations do not influence the outcome (that would, in fact, be the case in this problem). To avoid these additional calculations, we have stated that foreign tax credits are equal to the amounts withheld.

Given the assumption with regard to foreign tax credits, the small business deduction would be 16 percent of the least of the following three amounts:

1. Canadian Active Business Income ($123,000 + $78,000) $201,000

2. Taxable Income $245,000 Deduct: [(10/3)($3,000)] Foreign Non-Business Tax Credit ( 10,000) [(3)($6,000)] Foreign Business Tax Credit ( 18,000 ) $217,000

3. Allocated Annual Business Limit (Given) $100,000

The least of these figures is the Company’s $100,000 share of the annual business limit, resulting in a small business deduction of $16,000 [(16%)($100,000)].

Note Two The aggregate investment income of $36,000 is calculated as follows:

Canadian Interest Income $10,000 Canadian Taxable Capital Gains 24,000 Foreign Non-Business Income 20,000 Net Capital Loss Carry Forward Deducted ( 18,000)Aggregate Investment Income $36,000


1. Aggregate Investment Income $ 36,000


The ITA 123.3 tax on aggregate investment income is $2,400 [(6-2/3%)($36,000)].

Note Three The manufacturing and processing profits deduction would be 7 percent of the lesser of:

1. M & P Profits As Per ITR 5200 (Given) $123,000 Deduct: Amount Eligible For The SBD ( 100,000 ) $23,000

2. Taxable Income $245,000Deduct: Amount Eligible For The SBD ( 100,000) [(3)($6,000)] Foreign Business Tax Credit ( 18,000) Aggregate Investment Income (Note Two) ( 36,000 ) $91,000

The lesser of these figures is $23,000, resulting in a manufacturing and processing profits deduction in the amount of $1,610 [(7%)($23,000)].

Note Four The general rate reduction is calculated as follows:

Taxable Income $245,000 Amount Eligible For The SBD ( 100,000)Amount Eligible For The M&P Deduction ( 23,000)Aggregate Investment Income (Note Two) ( 36,000)Full Rate Taxable Income $ 86,000 Rate 7% General Rate Reduction $ 6,020

Part B The balance in the Refundable Dividend Tax On Hand account is calculated as follows:

RDTOH, End Of The Preceding Year $132,000 Dividend Refund For The Preceding Year ( 28,000 ) $104,000

Refundable Portion Of Part I Tax (Note Five) $ 8,467 Part IV Tax Payable [(1/3)($26,000)] 8,667 17,134 RDTOH Balance - December 31, 2007 $121,134

Note Five The refundable portion of the Part I tax would be the least of three amounts:

Aggregate Investment Income (Note Two) $ 36,000 Rate 26-2/3%

$ 9,600 Deduct Excess Of:

Foreign Non-Business Tax Credit $3,000 Over 9-1/3% Of Foreign Non-Business Income [(9-1/3%)($20,000)] ( 1,867) ( 1,133)

Amount Under ITA 129(3)(a)(i) $ 8,467

Taxable Income $245,000 Deduct:

Amount Eligible For The Small Business Deduction ( 100,000)[(25/9)($3,000)] Foreign Non-Business Tax Credit ( 8,333)[(3)($6,000)] Foreign Business Tax Credit ( 18,000)

Total $118,667 Rate 26-2/3% Amount Under ITA 129(3)(a)(ii) $ 31,645

Part I Tax Payable $ 43,319 Deduct: Surtax ( 2,744)Amount Under ITA 129(3)(a)(iii) $ 40,575

The least of these three figures is $8,467, the amount determined under ITA 129(3)(a)(i).

Part C The dividend refund for the year would be $41,333, the lesser of:

One-third of taxable dividends paid [(1/3)($124,000)] = $41,333



Part A Startop’s Taxable Income would be calculated as follows:

Accounting Net Income $462,000

Additions:Amortization Expense $546,000 Recaptured CCA On Sale Of Depreciable Assets ($390,000 - $350,000) 40,000 Taxable Capital Gain On Sale Of Depreciable Assets [(1/2)($450,000 - $390,000)] 30,000 Non-Deductible Meals And Entertainment [(50%)($50,000)] 25,000 Warranty Reserve 20,000 Withholding On Foreign Income 3,000 664,000

Deductions:CCA (Note One) ($730,000)Accounting Gain On Depreciable Assets ($450,000 - $330,000) ( 120,000) ( 850,000)

Net Income For Tax Purposes $276,000 Dividends Received ( 11,000)Non-Capital Loss Carry Forward Deducted ( 205,000)Net Capital Loss Carry Forward Deducted ( 19,000)Taxable Income $ 41,000

Note One As the balance in Class 8 was nil subsequent to the sale of assets, no CCA would be included on Class 8 assets.

Part B The Part IV Tax Payable on the $11,000 in portfolio dividends received would be $3,667 [($11,000)(1/3)].

Part C Assuming the foreign non-business tax credit is equal to the amount withheld, the calculation of Startop’s Part I Tax Payable would be as follows:

Base Amount Of Part I Tax [(38%)($41,000)] $15,580 Surtax [(4%)(28%)($41,000)] 459 Federal Tax Abatement [(10%)($41,000)] ( 4,100)Small Business Deduction (Note Two) ( 4,960)Additional Refundable Tax On Investment Income (Note Three) 667 Foreign Non-Business Tax Credit (Amount Withheld) ( 3,000)Manufacturing And Processing Profits Deduction (Note Four) Nil General Rate Reduction (Note Five) Nil Part I Tax Payable $ 4,646

Note Two The small business deduction is 16 percent of the least of the following three amounts:

1. Active Business Income (Given) $190,000

2. Taxable Income $41,000 Deduct: [(10/3)($3,000)] Foreign Non-Business Tax Credit ( 10,000 ) $ 31,000


The lowest of these figures is the adjusted taxable income of $31,000, and this gives a small business deduction of $4,960 [(16%)($31,000)].

Note Three The aggregate investment income of $56,000 is calculated as follows:

Interest On Long-Term Investments $25,000 Taxable Capital Gains 30,000 Foreign Non-Business Income 20,000 Net Capital Loss Carry Forward Deducted ( 19,000)Aggregate Investment Income $56,000


1. Aggregate Investment Income $ 56,000


The ITA 123.3 tax on aggregate investment income is $667 [(6-2/3%)($10,000)].

Note Four The manufacturing and processing profits deduction is nil. It is equal to 7 percent of the lesser of:

1. Canadian M & P Profits (Given) $150,000 Deduct: Amount Eligible For SBD ( 31,000 ) $119,000

2. Taxable Income $41,000 Deduct: Amount Eligible For The SBD ( 31,000) Aggregate Investment Income (Note Two) ( 56,000 ) Nil

Given these calculations, the M& P deduction would be nil.

Note Five The general reduction under ITA 123.4(2) would also be nil, as the full rate Taxable Income is nil, calculated as follows:

Taxable Income $41,000 Amount Eligible For The SBD ( 31,000)Aggregate Investment Income (Note Two) ( 56,000)Full Rate Taxable Income Nil

Part D - Dividend Refund Assuming the foreign non-business tax credit is equal to the amount withheld, the ending balance in the RDTOH account would be calculated as follows:

RDTOH Balance - End Of The Preceding Year $17,000 Dividend Refund For The Preceding Year Nil $17,000

Refundable Portion Of Part I Tax (Note Six) $ 445 Part IV Tax (Part B) 3,667 4,112 RDTOH Balance - December 31, 2007 $21,112

The dividend refund for the year would be $21,112, the lesser of:

One-third of taxable dividends paid [($210,000)(1/3)] = $70,000


Note Six The refundable portion of Part I tax would be the least of the following three amounts:

Aggregate Investment Income (Note Three) $ 56,000 Rate 26-2/3%

$ 14,933 Deduct Excess Of:

Foreign Non-Business Tax Credit $3,000 Over 9-1/3% Of Foreign Non-Business Income [(9-1/3%)($20,000)] ( 1,867) ( 1,133)

Amount Under ITA 129(3)(a)(i) $ 13,800

Taxable Income $41,000 Deduct:

Amount Eligible For The Small Business Deduction ( 31,000)[(25/9)($3,000)] Foreign Non-Business Tax Credit ( 8,333)

Total $ 1,667 Rate 26-2/3% Amount Under ITA 129(3)(a)(ii) $ 445

Part I Tax Payable $ 4,646 Deduct: Surtax ( 459)Amount Under ITA 129(3)(a)(iii) $ 4,187

The refundable amount of Part I tax is $445, the amount determined under ITA 129(3)(a)(ii).

Part E If you cannot assume that the foreign tax credit is equal to the amount withheld, determining the actual foreign tax credit is a complex calculation in this situation. The use of foreign taxes paid as credits against Canadian Tax Payable is limited by a formula that includes the “tax otherwise payable”. In the case of foreign taxes paid on non-business income, the “tax otherwise payable” in the formula includes the ART that is assessed under ITA 123.3. This creates a problem in that the calculation of the ART includes the amount eligible for the small business deduction [ITA 123.3(b)]. In turn, the determination of the amount eligible for the small business deduction requires the use of the foreign tax credits for foreign taxes paid on non-business and business income [ITA 125(1)(b)(i) and (ii)].

To solve this circular calculation, for the purpose of calculating the small business deduction, the foreign tax credit for taxes paid on non-business income is calculated using a “tax otherwise payable” figure that does not include the ART under ITA 123.3. This means that in situations where foreign non-business income, the small business deduction, and the ART are involved, the following procedures should be used:

1. Calculate the foreign non-business tax credit using a “tax otherwise payable” that excludes the ART. This initial version of the foreign non-business tax credit will be used only for determining the small business deduction, with the actual credit to be applied calculated after the ART has been determined.

2. Calculate the amount eligible for the small business deduction using the numbers determined in Step 1.

3. Calculate the ART, using the amount eligible for the small business deduction determined in Step 2.

4. Calculate the actual foreign non-business tax credit using a “tax otherwise payable” figure that includes the ART.

The initial foreign non-business income tax credit would be the lesser of:

Foreign Non-Business Tax Paid $3,000

An Amount Calculated As Follows:

For the purposes of the following calculation of the small business deduction, the foreign non-business income tax credit is calculated using a tax otherwise payable figure that excludes the additional refundable tax on investment income. This alternative calculation is only necessary when the foreign non-business tax credit is based on the formula, rather than the actual amounts withheld at the foreign source. Note also that this alternative calculation does not alter the actual foreign non-business tax credit that will be claimed.

The small business deduction is 16 percent of the least of the following three amounts:

1. Active Business Income (Given) $190,000

2. Taxable Income $41,000 Deduct: [(10/3)($971)] Foreign Non-Business Tax Credit ( 3,237 ) $ 37,763


The lowest of these figures is the adjusted taxable income of $37,763, and this gives a small business deduction of $6,042 [(16%)($37,763)].


1. Aggregate Investment Income (Note Three) $56,000

2. Taxable Income $41,000 Deduct: Amount Eligible For The SBD (Part E)( 37,763 ) $ 3,237

The ITA 123.3 tax on aggregate investment income is $216 [(6-2/3%)($3,237)].

The actual foreign non-business tax credit that takes into consideration the ART will be the lesser of the following:

Foreign Non-Business Tax Paid $3,000

An Amount Calculated As Follows:

The lesser figure is $988, and is the actual foreign non-business tax credit. Note that this is greater than the initial calculation of the foreign non-business tax credit, used in the calculation of the small business deduction in this Part E.

A comparison of the results in Part C and Part E calculations is as follows:

Part C Part EBase Amount of Part I Tax [(38%)($41,000)] $15,580 $15,580 Surtax [(4%)(28%)($41,000)] 459 459 Additional Refundable Tax On Investment Income 667 216 Federal Tax Abatement [(10%)($41,000)] ( 4,100) ( 4,100)Small Business Deduction ( 4,960) ( 6,042)Foreign Non-Business Tax Credit ( 3,000) ( 988)Part I Tax Payable $ 4,646 $5,125

Part F - Tax Planning Issues The Company could have made an election to pay a tax free capital dividend. With the opening capital dividend account balance of $20,000, and the $30,000 addition from the asset sale in the current year, a $50,000 capital dividend could have been declared.

This solution assumes deduction, in full, of the non-capital loss carry forward. This is necessary to obtain the required minimum Taxable Income. An alternative for tax planning purposes would be to deduct less of this carry forward, an approach that would provide for taking more of the small business deduction and the federal foreign non-business tax credit in the current year. If the Company is confident that it will have more active business income than is eligible for the $400,000 small business deduction, this might be a preferable solution, since there is no carry forward of the small business deduction if it is not used in the current period. However, this approach would involve paying taxes on the additional income during the current year.

Part E states that any excess of foreign tax withheld over the federal foreign tax credit would be eligible for a provincial foreign tax credit. If this was not the case, the excess could be deductible for federal purposes under ITA 20(12), and would decrease Taxable Income. If the excess cannot be claimed as a provincial foreign tax credit, it could be advantageous to increase Taxable Income so that more of the foreign taxes withheld could be claimed as part of the federal foreign non-business tax credit, rather than as a less valuable deduction from Net Income For Tax Purposes. This approach would also involve paying taxes on the additional income during the current year.

Solution to Assignment Case Sixteen - 1

The PDF version of this Solutions Manual includes selected schedules and worksheets from the ProFile T2 return. Note that the program can only be used to calculate 2006 (not 2007) tax returns and the problem and solution reflect this fact.

The complete tax return is available on the Instructor’s Resource CD-ROM under the heading “Case Tax Solutions” in two forms, a ProFile version and a .PDF version.

To view the .PDF file that contains the complete tax return, select the file “Case 16-1” from the PDF Format drop-down list.

To view the ProFile file of the complete tax return, select the file “Case 16-1” from the ProFile Format drop-down list.

For more information on how to use the ProFile tax program, please refer to the sample tax returns in the Study Guide.

Notes To The Tax Return

The accounting figures would include a deduction for amortization of the landscaping costs in the amount of $2,000 [(10%)($20,000)]. For tax purposes, the entire $20,000 can be deducted. As the $2,000 amortization was part of the Amortization Expense figure, it was added back with the $122,000 addition on Schedule 1. This means that the full $20,000 cost must be deducted on Schedule 1.

On Schedule 7, it is necessary to input the foreign interest in both the “Foreign” and the “Aggregate” column. The long-term bond interest is input in the “Aggregate” column only.

Information concerning Reid Inc., including the allocation of the annual business limit, is input on form RACDetails, “Related And Associated Corporations Details”.

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