ca_exm_tx1_2007-03

CGA-CANADATAXATION 1 EXAMINATIONMarch 2007Time: 3 HoursNotes:1. This examination is based on the Canadian Income Tax Act (ITA) with Regulations (CCH 82nd Edition).2. Round all calculations to the nearest dollar, except price per share.3. The following items, applicable to the 2006 taxation year, are provided for reference:Federal Income Tax Rates — 20062006 Taxable Income Federal Marginal Tax Rate15.25%$36,378Upto–$72,756 22%$36,379$118,285 26%–$72,757andover 29%$118,286Personal Tax Credits 20061. Single status taxpayer (paragraph 118(1)(c))............................................................................................................. $ 1,3482. Married status taxpayer (paragraph 118(1)(a))Same as for single status taxpayer under (1) above,creditspousalof.................................................................................................................... 1,145 withanadditionalThe additional spousal credit is reduced if spouse’s net income exceeds (768)3. Eligible dependant status taxpayer (paragraph 118(1)(b))Same as for married status taxpayer in (2) above.4. Infirm dependants 18 years of age or older (paragraph 118(1)(d)) (600)The credit is reduced if dependant’s net income exceeds......................................................................................... 5,5805. Taxpayer is 65 years of age or over (subsection 118(2)) (620)6. Medical expenses credit (subsection 118.2(1))The maximum reduction for purposes of the credit........................................................................................... 1,8847. Caregiver — parent/grandparent (maximum) (paragraph 118(1)(c.1)) (600)The credit is reduced if dependant’s net income exceeds.........................................................................................13,4308. Education credit for each qualifying month (paragraph 118.6(2)(a)) (61)9. Education credit for each qualifying month (paragraph 118.6(2)(b)) (18)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 statements is true regarding corporate income tax returns?1) A Canadian controlled private corporation (CCPC) must file an income tax return within 6months of its taxation year end only if it has taxable income.2) A CCPC must file an income tax return within 6 months of its taxation year end even if it has notaxable income.3) A public corporation must file an income tax return within 4 months of its taxation year end evenif its taxable income is nil and it has a loss for the year.4) A CCPC must file an income tax return within 4 months of its taxation year end if it has notaxable income and has no financial transactions during the year.b. Which of the following statements is correct regarding the penalty for failing to file a required incometax return?1) The person is subject to a penalty of 10% of the unpaid tax plus 2% of the unpaid tax per month toa maximum of 24 months.2) The person is subject to a penalty of 5% of the unpaid tax plus 1% of the unpaid tax per month toa maximum of 24 months.3) The person is subject to a penalty of 10% of the unpaid tax plus 1% of the unpaid tax per month toa maximum of 12 months.4) The person is subject to a penalty of 5% of the unpaid tax plus 1% of the unpaid tax per month toa maximum of 12 months.c. Which of the following statements is true regarding an individual’s status as a resident of Canada fortax purposes?1) An individual can only be a resident of Canada if he or she is present in the country for more than183 days.2) An individual can only be a resident of Canada if he or she is a citizen of Canada.3) An individual is deemed to be a resident of Canada if he or she maintains a dwelling place inCanada.4) An individual can be considered a resident throughout the year if he or she has a continuing stateof relationship with the country.d. There are several general objectives that are considered essential to a good tax system. The statement“individuals with income of $100,000 should proportionally pay more tax than those earning $40,000”is an example of which of the following general objectives?1) Neutrality2) Simplicity3) Competitiveness4) FairnessContinued...e. Chen moved to Canada from the United States in June 2006 and became a Canadian resident for taxpurposes. At the date of his arrival, he owned shares of YY Inc. (a U.S. public corporation) that had a market value of $30,000. The shares of YY were acquired in 2004 for $40,000. In August 2006, Chen acquired shares of CC Ltd. (a Canadian public corporation) for $10,000. In December 2006, he sold all of the YY shares for $38,000 and all of the CC shares for $4,000. Which of the following correctly describes the change to Chen’s net income for tax purposes in 2006 resulting from the sales of shares?1) Chen’s net income for tax purposes will not increase or decrease.2) Chen’s net income for tax purposes will increase by $1,000.3) Chen’s net income for tax purposes will decrease by $3,000.4) Chen’s net income for tax purposes will decrease by $4,000.f. Which of the following types of income is not taxable in Canada under Part I of the Income Tax Actwhen earned by a non-resident?1) Income from exercising a stock option2) Income from a grant or scholarship3) Taxable capital gain from the sale of real estate4) Dividends from a Canadian private corporationg. Gibb Inc. operates a large insurance company. It receives funds from clients who deposit money toearn interest to purchase life insurance. Gibb earns interest income from reinvesting the customer deposits in either bonds or loans to businesses. It also earns interest from customers who are late paying their premiums. Which of the following correctly describes the classification of the interest income earned by Gibb for tax purposes?1) All interest is classified as property income.2) The interest from overdue premiums is business income and all other interest is property income.3) The interest from overdue premiums and the interest from the business loan are business income,but the bond interest is property income.4) All interest is classified as business income.h. Which of the following sources of income is not subject to a withholding tax under Part XIII of theIncome Tax Act when earned by a non-resident?1) Taxable dividends from a Canadian public corporation2) Interest from a government of Canada bond3) Capital dividends from a CCPC4) Royaltiesi. HPO Inc. is a CCPC earning business and investment income. HPO owned shares in TT Ltd., also aCCPC. The TT shares cost $10,000 in 2001 and have a fair market value of $22,000. On December 31, 2006, HPO transferred the shares of TT to its sole shareholder, an individual, and treated the distribution as a dividend. Which of the following statements is correct regarding the transfer of the TT shares?1) HPO’s taxable income is increased by zero amount and the shareholder’s taxable income isincreased by $12,500.2) HPO’s taxable income is increased by $6,000 and the shareholder’s taxable income is increasedby $27,500.3) HPO’s taxable income is increased by $12,000 and the shareholder’s taxable income is increasedby $15,000.4) HPO’s taxable income is increased by zero amount and the shareholder’s taxable income isincreased by $10,000.Continued...j. Which of the following correctly describes the tax treatment of a net capital loss incurred by an individual?1) The loss can be carried back 3 years and forward 10 years and deducted against any source ofincome.2) The loss can be carried back 5 years and forward 20 years and deducted against taxable capitalgains.3) The loss can be carried back 3 years and forward indefinitely and deducted against taxable capitalgains.4) The loss can be carried back 5 years and forward 10 years and deducted against any source ofincome.k. Which of the following statements is true regarding salary/bonus versus dividend distributions from a CCPC to a shareholder/manager in the highest tax bracket?1) If the corporation earns active business income over $300,000, it is always better to pay adividend to take advantage of the dividend tax credit.2) If the corporation earns active business income over $300,000, a bonus should always be paid toreduce income to $300,000 whether or not the shareholder/manager needs the funds.3) If the corporation earns active business income over $300,000, and the shareholder/manager is notin need of additional funds, a bonus should only be paid if the avoidance of double taxationoutweighs the returns that can be made by retaining the funds in the corporation for reinvestment.4) If the corporation earns active business income over $300,000 and the shareholder/managerrequires additional funds, either a bonus or a dividend can be paid because corporate and personal income tax is integrated.l. Which of the following properties is not a listed personal property?necklace1) A2) An antique phonograph machine3) A rare coinmanuscriptantique4) Anm. Which of the following is not a traditional test to determine if an individual is an employee or an independent contractor?test1) Service2) Economic reality testtest3) Integrationtest4) Controln. Which of the following statements is true regarding an RRSP?1) A withdrawal to pay for medical expenses can be made on a tax-free basis.2) An individual’s net rental income will increase the contribution limit.3) An individual is not eligible to contribute to an RRSP after the age of 65.4) An individual’s unused contribution limit can be carried for a maximum of 5 years.o. The common voting shares of Reo Ltd., a CCPC, are owned 20% by Carl, 55% by Sheila, and 25% by Bear Ltd., a CCPC. Sheila also owns 40% of the voting shares of Bear. The remaining shares of Bear are owned 20% each by Henry, George, and Peter, who are not related to Carl or Sheila. Which of the following correctly describes the tax relationship between Reo and Bear?1) Reo and Bear are connected and related but not associated.2) Reo and Bear are associated, connected, and related.3) Reo and Bear are connected but not associated or related.4) Reo and Bear are not associated, related, or connected.245 QuestionTable Inc., a CCPC, operates a manufacturing and wholesale business. Financial statements for the yearended December 31, 2006 report a net income before tax of $524,000.You have been retained to determine the corporation’s income 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 Table’s minimum net income for tax purposes andminimum taxable income for the 2006 taxation year.16 b. Based on your answer to part (a), calculate the minimum Part I, Part IV federal income tax, andRDTOH account for the 2006 taxation year (ignore surtaxes and do not calculate the general ratereduction).3 c. Briefly explain how tax can be minimized for the proposed dividend distribution in 2007 (Exhibit 2-1,item 7).EXHIBIT 2-1TABLE INC.2006 Financial Information1. Table’s net income for tax purposes is summarized as follows:Wholesale division income $ 190,000Manufacturing division income 222,000Net loss on sale of assets (20,000)Dividend income — Public companies 12,000Share of income of ZZ Ltd. 120,000$ 524,0002. Table owns 60% of the shares of ZZ Ltd. For ZZ’s year ended December 31, 2006, it reported netincome before tax of $200,000 and claimed the small business deduction on $160,000. ZZ paid adividend of $15,000 in 2006, of which $9,000 was received by Table. The dividend was not includedin income but was credited to the ZZ investment account on the balance sheet. At the time of thedividend, ZZ had RDTOH of $7,000.3. A review of Table’s 2005 corporate tax return provides the following information:Capitalaccount $ 8,000 dividendCumulative eligible capital 40,000 RDTOH 3,000 Undepreciated capital costClass10.1 17,00010 30,000Class12 10,000Class13 60,000Class43 180,000ClassContinued...4. On July 1, 2006, Table purchased a competitor’s business for $400,000, which included the following: Goodwill $ 100,000 equipment 20,000 ComputerInventory 240,000 Manufacturingequipment 40,000On September 1, 2006, Table purchased a new delivery truck for $60,000 and traded in an older truck valued at $20,000 that was originally purchased for $36,000. Table also sold a passenger vehicle for $12,000 that originally cost $32,000. A replacement vehicle was leased.Table occupies leased premises under a 10-year lease agreement with one renewable option of 5 years.The lease began on January 1, 2000 when leasehold improvements costing $80,000 were added.In August 2006, Table sold a parcel of land it had acquired to build a new warehouse when a new and more suitable site became available. Consequently, it sold the original parcel of land for $100,000(original cost $80,000) and leased the new property.5. Table’s income statement for the year ended December 31, 2006 included the following:68,000 Amortization $ Reserve for bad debts 22,000 Reserve for warranty obligations 8,000 bonuses 440,000 andSalariespromotion 14,000 andAdvertisingRepairs and maintenance 47,000At year end, salaries and bonus included a bonus payable of $40,000, which will be paid in4 installments of $10,000 each on March 15, June 15, September 15, and December 15, 2007.The reserve for warranty obligations relates to the purchase of the competitor’s business in 2006. At December 31, 2006, only $2,000 in warranty claims had been paid.Advertising and promotion include charitable donations of $5,000 and meals and drinks forentertainment purposes of $6,600.Repairs and maintenance include $7,000 for a utility connection for the recently acquired land.6. The company’s manufacturing and processing income for tax purposes in 2006 has been calculated tobe $230,000.7. No dividends were declared in 2006. However, Table intends to pay a dividend in 2007. The presidenthas asked for your advice on this matter as he wants to minimize the overall tax to the company and to the shareholders.25 Question3Susan is employed by J.P. Inc. She has requested your assistance in preparing her 2006 incometax return.Information regarding Susan’s financial activities for 2006 is outlined in Exhibit 3-1. Selected informationfrom her 2005 tax return is provided in Exhibit 3-2.Required19 a. Calculate Susan’s minimum net income for tax purposes in accordance with the format of Section 3 ofthe Income Tax Act, and her minimum taxable income for the 2006 taxation year. (Ignore the universalchild care benefit.)6 b. Based on your answer to part (a), calculate Susan’s minimum federal income tax for the 2006 taxationyear. Show all calculations.EXHIBIT 3-1SUSAN2006 Financial Information1. Susan’s salary in 2006 was $95,000. From this, J.P. deducted income tax of $24,000 and CPP and EIof $2,640. J.P. did not have a company pension plan. However, they contributed $6,000 to Susan’spersonal RRSP and $1,000 to a deferred profit sharing plan. J.P. also pays the premiums for privatemedical insurance ($1,000) and group term life insurance ($700).Susan uses a company car for both business and personal use. In 2006 she drove a total of 22,000 km,of which 16,000 km were for employment duties. J.P. purchased the automobile in 2005 for $44,000and its U.C.C. at the end of 2006 was $18,000. J.P. paid all the automobile operating costs, whichtotalled $2,400.J.P. also pays Susan a monthly travel allowance of $400 ($4,800 per year) for out-of-town travel foremployment purposes. In 2006, Susan spent $5,600 in travel costs for airfare and hotels. All mealswere paid directly by her manager who travelled with her.2. Susan owns shares in a private corporation left to her by her late husband. In 2006, she receiveddividends of $6,000 from the corporation. She also repaid a $20,000 loan to the corporation onDecember 31, 2006. She had borrowed the money from the company in 2004. In 2006, CRA indicatedthe loan period exceeded the permitted time limit and consequently assessed her with income of$20,000, being the amount of the loan. Susan had paid 5% interest annually to the corporation. Theloan had been used to purchase shares on the stock market.In December 2006, Susan sold 1,000 shares of XX Inc., a public company, for $20,000 ($20 pershare). Over the past 2 years her investment records showed the following transactions: Purchases:2004 — XX Inc. — 1,000 shares @ $8 $ 8,0002004 — PP Inc. — 1,000 shares @ $20 20,0002005 — XX Inc. — 1,000 shares @ $14 14,000Sales:2005 — PP Inc. — 1,000 shares @ $26 26,000Continued...3. Susan’s mother died in 2006. Susan received $20,000 from her mother’s life insurance policy and adiamond ring valued at $800. In 2004, her mother had gifted her a summer cottage valued at$120,000. In late 2006, Susan sold the diamond ring for $1,400 and the summer cottage for $110,000.4. Susan has 2 children. The 4-year-old daughter attends daycare. The 2006 daycare fees were $7,200.The 4-year-old earned $800 in interest from her grandmother’s estate. Her 16-year-old son also earned$800 from a summer job. In 2006 Susan paid dental fees of $3,800 for her son.EXHIBIT 3-2SUSANSelected 2005 Cantax SchedulesEND OF EXAMINATION 100TAXATION 1 [TX1]EXAMINATIONBefore starting to write the examination, make sure that it is complete and that there are no printing defects. This examination consists of 8 pages. There are 3 questions for a total of 100 marks.READ THE QUESTIONS CAREFULLY AND ANSWER WHAT IS ASKED.To assist you in answering the examination questions, CGA-Canada includes the following glossary of terms.GlossaryFrom David Palmer, Study Guide: Developing Effective Study Methods (Vancouver: CGA-Canada, 1996). Copyright David Palmer.Compare Examine qualities or characteristics thatresemble each other. Emphasize similarities,although differences may be mentioned. Contrast Comparebyobservingdifferences. Stressthe dissimilarities of qualities orcharacteristics. (Also Distinguish between) Criticize Express your own judgment concerning thetopic or viewpoint in question. Discuss bothpros and cons.Define Clearly state the meaning of the word orterm. Relate the meaning specifically to theway it is used in the subject area underdiscussion. Perhaps also show how the itemdefined differs from items in other classes. Describe Tellthewhole story in narrative form. Diagram Give a drawing, chart, plan or graphicanswer. Usually you should label a diagram.In some cases, add a brief explanation ordescription.Discuss This calls for the most complete and detailed answer. Examine and analyze carefully andpresent both pros and cons. To discussbriefly requires you to state in a fewsentences the critical factors.Evaluate This requires making an informed judgment.Your judgment must be shown to be basedon knowledge and information about thesubject. (Just stating your own ideas is notsufficient.) Cite authorities. Cite advantagesand limitations.Explain In explanatory answers you must clarify the cause(s), or reasons(s). State the "how" and"why" of the subject. Give reasons fordifferences of opinions or of results. Illustrate Make clear by giving an example, e.g., afigure, diagram or concrete example. Indicate Provide a short explanation.Interpret Translate, give examples of, solve, orcomment on a subject, usually making ajudgment on it.Justify Prove or give reasons for decisions orconclusions.List Present an itemized series or tabulation.Be concise. Point form is oftenacceptable. (Also Enumerate or Identify) Outline This is an organized description. Give ageneral overview, stating main andsupporting ideas. Use headings andsub-headings, usually in point form. Omitminor details.Prove Establish that something is true by citingevidence or giving clear logical reasons. Relate Show how things are connected with eachother or how one causes another,correlates with another, or is like another. Review Examine a subject critically, analyzingand commenting on the importantstatements to be made about it.State Present the main points in brief, clearsequence, usually omitting details,illustrations, or examples.Summarize Give the main points or facts in condensedform, like the summary of a chapter,omitting details and illustrations.Trace In narrative form, describe progress,development, or historical events fromsome point of origin.CGA-CANADATAXATION 1 EXAMINATIONMarch 2007SUGGESTED SOLUTIONSMarks Time: 3 Hours 130 QuestionNote:2 marks eachSources/Calculations:a. 2) Topic 1.4 (Level 1)b. 4) Topic 1.4 (Level 1)c. 4) Topic 1.9 (Level 1)d. 4) Topic 1.1 (Level 1)e. 2) Topic 10.1 (Level 1)1/2 (38,000 – 30,000) + 1/2 (4,000 – 10,000) = $1,000f. 4) Topic 10.2 (Level 1)g. 4) Topics 3.2 and 5.1 (Level 1)h. 2) Topic 10.3 (Level 1)i. 2) Topic 9.3 (Level 2)j. 3) Topic 7.2 (Level 1)k. 3) Topic 9.6 (Level 1)l. 2) Topic 6.4 (Level 1)m. 1) Topic 2.1 (Level 1)n. 2) Topic 5.8 (Level 1)o. 3) Topics 8.4 and 9.2 (Level 1)245 Question26 a. Minimum net income for tax purposes and taxable income:Net income per financial statements $ 524,000(Deduct):Add(1) Loss on sale of assets 20,000(1) Share of net income of ZZ Ltd. (120,000)(1) Dividend from ZZ Ltd. 9,000(1) Taxable capital gain on land – 1/2 (100,000 – 80,000) 10,000(2) CEC deduction — 7% (40,000) + 7% (3/4) 100,000 (8,050)(1) CCA — Class 10.1 — 1/2 (30%) 17,000 (2,550)(2) CCA — Class 10 — 30% (30,000) + (1/2 ) (30%) (60,000 – 20,000) (15,000)(1) CCA — Class 12 — 100% (10,000) (10,000)(2) CCA — Class 13 — lesser of (1/5) 80,000 = 16,000; 80,000 / (10 + 5) = 5,333 (5,333)(2) CCA — Class 43 — 30% (180,000) + (1/2) (30%) (40,000) (60,000)(1) CCA — Class 45 — 45% (1/2) (20,000) (4,500)(1) Amortization 68,000(1) Deferred bonus — beyond 180 days 20,000forwarranty obligations 8,000(1) Reservewarranty expense (2,000)(1) Actualdonations 5,000(1) Charitable(1) Entertainment meals — 50% (6,600) 3,300purposes 439,867taxforincome(2) NetDeduct:(2) Taxable dividends (12,000 + 9,000) (21,000)(5,000)donations(1) Charitable413,867income $TaxableNote:The 2 marks for net income for tax purposes are reduced if items that should be excluded from the calculation are incorrectlyincluded, such as capital loss on sale of truck, reserve for bad debts, and the utility connection.Continued...16 b. Federal tax:Part I tax:× $413,867 $ 157,26938%—Basicrate10%× $413,867 (41,387)—Abatement(2) 115,882Small business deduction (SBD) — 16% × least of:408,867income1 $ Activebusinessincome 413,867Taxable160,000) 140,000(300,000–limitBusiness× $140,000 (22,400)(2) 16%Additional refundable tax on investment income 62/3% × lesser of:Aggregate investment income — TCG (10,000) $ 10,000Taxable income less amount on which SBD is computed(413,867–140,000) 273,867(3) 62/3% × $10,000 667M&P deduction — 7% × lesser of:M&P income — Amount qualifying for SBD (230,000 – 140,000) $ 90,000Taxable income less amount on which SBD is computed(2) Minus investment income (413,867 – 140,000 – 10,000) 263,867 (6,300)87,849$1Active business income:Net income for tax purposes $ 439,867Deduct:gain (10,000)capitalTaxable9,000) (21,000)+Dividends(12,000408,867(2) $Parttax:IV3,000 (1) ZZ Ltd. — connected — 60% (5,000)2$331/3% × 12,000 4,000—(1) Other$ 7,0002ZZ’s refund: lesser of 1/3 (15,000) = 5,000 or RDTOH of $7,000RDTOH:Opening $ 3,000tax 7,000IV(1) PartRefundable portion of Part I tax — least of:262/3% × investment income (10,000 above) $ 2,667262/3% × taxable income less amount on which SBD is computed(413,867 – 140,000) 73,024tax 87,849 2,667I(2) Part12,667$3 c. Table should first utilize the capital dividend account to create a tax-free dividend. The balance in thecapital dividend account at December 31, 2006 is $18,000 (opening $8,000 + tax-free portion capitalgain $10,000). Also, the RDTOH balance is $12,667 and a taxable dividend of $38,000 would providea full refund (1/3× 38,000 = $12,667).25 Question319 a. Net income for tax purposes and taxable income:Section 3(a)Employmentincome:(1) Salary $ 95,000(1) RRSP contribution — benefit 6,000benefit 700 insurance(1) Life(1) Auto — standby charge 44,000 × 2% × 12 months = 10,560 × 6,000 / 20,000 km 3,168(1) Auto — operating benefit — 6,000 @ 22¢ 1,320allowance 4,800(1) Travel110,988(1) Less — travel expenses (5,600)105,388 income:Property× 1.25 $ 7,5006,000(1) Dividend—(1) Less interest expense — 20,000 × 5% (1,000) 6,500Section 3(b)Taxable capital gain:(1) Shares of XX Inc. — proceeds 1,000 × $20 $ 20,000(1) Less ACB (8,000 + 14,000) / 2,000 = $11 × 1,000 11,0009,000×1/24,5009,000—(1) TaxableNet gain from LPP1/2 (1,400 – 1,000 deemed) 200NIL 4,500(2) LPP loss — Cantax 200116,388 3(c)SectionOtherdeductions:of $7,000; $7,200 actual; 2/3 (105,388) = $70,258 (7,000)least(1) Childcare—(1) RRSP — limit by Cantax (5,000)104,388 3(d)Sectionloan (20,000)shareholder(1) Repaymentoftaxpurposes 84,388forincome(1) NetDeduct:(1) Net capital loss (limit to net taxable gains) (4,500)79,888income $ TaxableNote:The 1 mark for net income for tax purposes is reduced if items that should be excluded from the calculation are incorrectly includedsuch as DPSP, private health insurance, life insurance proceeds, child’s income, loss on summer cottage (personal use property).Continued...6 b.tax:Federal× 15.25% $ 5,548 $36,378× 22% 8,003 36,3787,132 × 26% 1,85479,888 15,405(1) $credits:Tax$7,500× 131/3% (1,000)—credit(1) Dividendtax(1) Individual (1,348)(1) Equivalent to spouse — (claim daughter) 1,145 – 15.25%* (800 – 768) (1,140)2,640× 15.25%* (403) —(1) CPP/EI× (3,800 – 1,884) (292)15.25%(1) Medical—$ 11,222 * Will accept rate applied to the lowest income bracket in the federal tax calculation.END OF SOLUTIONS 100。