Problem Set

LECTURE 7 PROBLEM SET         

Updated April 29, 2014

Question 1

You, CPA, have just finished meeting with your client, Mrs. Howe, a Canadian resident for tax purposes, and Patricia Yu, a partner at your accounting firm. Mrs. Howe’s business is currently a sole proprietorship and she would like to transfer all of her business assets to a newly incorporated company HS Inc. while minimizing personal tax on the transfer.  

Mrs. Howe has provided you with additional information in Exhibit I and Patricia has provided you with an extract of a blank copy of a s. 85(1) election form that you may need to fill out. Patricia wants you to draft a memo to her describing and calculating any tax consequences to Mrs. Howe and to HS Inc. if all of the assets are transferred using subsection 85(1) of the Act.

Patricia reminds you to give specific section, subsection and paragraph (where applicable) references from the Income Tax Act to support your answer. Patricia also wants you to answer a question asked by Mrs. Howe during the meeting: will GST/HST apply to Mrs. Howe upon the sale of all her business assets to HS Inc.?

Exhibit I

Mrs. Howe

Additional Information

• Mrs. Howe runs an active business in Toronto and it is profitable. She wants to incorporate in order to get the small business deduction and pay less income tax
• Mrs. Howe wants to receive preferred shares and the maximum amount of debt receivable (rounded to the nearest $1,000) as consideration
• Mrs. Howe has the following business assets that she wants to transfer to HS Inc., if possible, using subsection 85(1):

FMV                ACB                        UCC

Tools and equipment                   $30,000        $25,000                $5,000        

• In addition to the above assets, Mrs. Howe has estimated that the value of her business’ internally generated goodwill is $50,000. Mrs. Howe’s cumulative eligible capital (CEC) account balance is nil  

Exhibit II

Extract of s. 85(1) Election Form

               Tax                        Elected              Non-share                   Share

Asset                FMV            Value      _        Amount     Consideration    Consideration     Income

Solution

Memo

To: Patricia

From: CPA

Re: Mrs. Howe (s.85)

The tools and equipment and the goodwill can be transferred using s. 85(1) of the Act since they are eligible property [s. 85(1.1)]. In order to minimize the income tax consequences an elected amount equal to tax value should be chosen, as can be seen in the chart below, since the elected amount will become the proceeds of disposition to Mrs. Howe [s. 85(1)(a)]: