SEVEN CHAPTER SOLUTIONS
Solution to Assignment Problem Seven - 1
As the equipment purchased in 2006 is for manufacturing and processing, it would be allocated to Class 43. This declining balance class is subject to a 30 percent rate. The maximum CCA would be calculated as follows: Capital Cost Of Assets Previous Year's CCA (Less Than Maximum Of $75,000) Balance - Beginning Of Current Year Capital Grant Proceeds Of Disposition (Note) Balance Before CCA Maximum CCA At 30% January 1, 2008 UCC Balance $500,000 ( 50,000) $450,000 ( 40,000) ( 230,000) $180,000 ( 54,000) $126,000
Note The capital cost of the equipment sold is $230,000 [(1/2)($500,000 - $40,000)]. The $45,000 ($275,000 $230,000) amount of proceeds in excess of the capital cost would be treated as a capital gain, rather than as a deduction from the UCC of the class.
Solution to Assignment Problem Seven - 2
Part A The maximum CCA for each of the three years would be calculated as follows: 2005 Additions One-Half Net Additions CCA Base Maximum CCA: [(4%)($127,500)] [(20%)($1,400)] Add: One-Half Net Additions January 1, 2006 UCC Opening 2006 UCC Disposition - Lesser Of: Proceeds Of $3,200 Cost Of $2,800 Maximum CCA At 4 Percent Recapture Of CCA January 1, 2007 UCC Opening 2007 UCC Dispositions - Lesser Of: Deemed Proceeds Of $105,000 [(1/3)($315,000)] Cost Of $85,000 [(1/3)($255,000)] Balance For CCA Determination Maximum CCA is Lesser Of: $6,196 [(4%)($154,904)] Net Rental Income Before CCA Of $5,300 January 1, 2008 UCC Class 1 $255,000 ( 127,500) $127,500 ( 5,100) 127,500 $249,900 $249,900 ( 280) 1,400 $2,520 $2,520 Class 8 $2,800 ( 1,400) $1,400
( 2,800) ( 9,996) $239,904 $239,904 280 Nil
( 85,000) $154,904
( 5,300) $149,604
The disposition of the Class 8 assets for more than their capital cost would create recapture and a taxable capital gain of $200 [(1/2)($3,200 - $2,800)]. In 2005 and 2006, his rental income before CCA is greater than his maximum CCA and, as a consequence, he can deduct maximum CCA for these years. In 2007, his rental income of $5,300 limits the amount of CCA that can be deducted, as the deduction of CCA cannot be used to create or increase a loss on a rental property. Part B Mr. Taylor's decision to occupy one-third of his rental property represents a change in use that will be considered a deemed disposition of one-third of the property at fair market value. This will result in a taxable capital gain that can be calculated as follows: Deemed Proceeds (One-Third Of Market Values) Adjusted Cost Base (One-Third Of The Original Cost Of Building And Land) Capital Gain Inclusion Rate Taxable Capital Gain Building $105,000 ( 85,000) $ 20,000 1/2 $ 10,000 Land $40,000 ( 30,000) $10,000 1/2 $ 5,000
There is an election to defer recognition of gains on the conversion of a principal residence to a rental property, provided no CCA is claimed. However, as Mr. Taylor claimed CCA on the unit he has moved into, he cannot make this election. This election is covered in Chapter 10 .
Solution to Assignment Problem Seven - 3
Class 1 - Building The maximum CCA amount is $5,160 [($258,000)(1/2)(4%)], leaving a January 1, 2008 UCC balance of $252,840 ($258,000 - $5,160). Class 3 - Building There were no additions or dispositions in this class. As a consequence, the maximum CCA would be $78,100 [(5%)($1,562,000)], leaving a January 1, 2008 UCC balance of $1,483,900 ($1,562,000 $78,100). Class 8 - Office Furniture And Equipment The required calculations for this class would be as follows: Opening Balance Additions During Fiscal Year Dispositions During Fiscal Year ($38,000 + $11,000) One-Half Net Additions CCA Base CCA At 20 Percent One-Half Net Additions January 1, 2008 UCC Balance $278,000 72,000 ( 49,000) ( 11,500) $289,500 ( 57,900) 11,500 $243,100
With respect to the sale that occurred during the year, there would be a capital gain of $4,000 ($42,000 - $38,000), one-half, or $2,000, of which would be included in the Company's Net Income For Tax Purposes. Class 10 - Vehicles The required calculations for this class would be as follows: Opening Balance Additions During Fiscal Year Dispositions During Fiscal Year One-Half Net Additions CCA Base CCA At 30 Percent One-Half Net Additions January 1, 2008 UCC Balance $204,000 63,000 ( 12,000) ( 25,500) $229,500 ( 68,850) 25,500 $186,150
Class 13 - Leasehold Improvements In general, leasehold improvements will be written off over the term of the lease on a straight line basis. For purposes of applying this calculation, the term of the lease includes the first renewal option beginning in a period after the improvements were made. In the case of the original improvements, the period to be used is 10 years. With respect to the improvements during the current period, the write-off period will be 8 years. Also note that Class 13 assets are subject to the first year rules on net additions. The required calculation is as follows:
Opening Balance Additions CCA Base Capital Cost Allowance: First Improvements ($125,000 10) Current Improvements [($58,000 8)(1/2)] January 1, 2008 UCC Balance
$106,250 58,000 $164,250 ( 12,500) ( 3,625) $148,125
Class 43 - Manufacturing Equipment The required calculations are as follows: Opening Balance Dispositions (Proceeds) Terminal Loss $126,000 ( 89,000) $ 37,000
At this point, all of the assets in Class 43 have been retired and there is still a $37,000 UCC balance. This results in a terminal loss that will be deducted in full from the Net Income of Burton Steel Ltd. The terminal loss will also be deducted from the UCC balance leaving a January 1, 2008 balance of nil. Class 45 - Computers The rate for Class 45 is 45 percent and the class is subject to the first year rules. The required calculations for this class would be as follows: Opening Balance Additions During Fiscal Year One-Half Net Additions CCA Base Capital Cost Allowance (45%) One-Half Net Additions January 1, 2008 UCC Balance $11,000 17,000 ( 8,500) $19,500 ( 8,775) 8,500 $19,225
Summary Of The Results The maximum CCA for the year ending December 31, 2007 and the January 1, 2008 UCC balances can be summarized as follows: Maximum CCA $ 5,160 78,100 57,900 68,850 16,125 Terminal Loss 8,775 UCC $ 252,840 1,483,900 243,100 186,150 148,125 Nil 19,225
Class 1 Class 3 Class 8 Class 10 Class 13 Class 43 Class 45
In addition, the following income effects resulted from the information provided in the problem: Taxable Capital Gain On Class 8 Assets [(1/2)($4,000)]$ 2,000 Terminal Loss On Class 43 Assets Total Deduction ( 37,000) ($35,000)
Solution to Assignment Problem Seven - 4
2002 Solution The required calculations are as follows: Additions To Class [(10 Cars)($10,000)] One-Half Net Additions [(1/2)($100,000)] CCA Base CCA [($50,000)(30%)(185/365)] One-Half Net Additions UCC For January 1, 2003 $100,000 ( 50,000) $ 50,000 ( 7,603) 50,000 $ 92,397
Note that one-half of the net additions for the year is deducted to provide the basis for calculating the 2002 CCA, and then added back to establish the opening UCC for the next period. The other point that is illustrated in this first year is application of the short fiscal period rules. As the business was established on June 30, 2002, its operations were carried out for 185 days in 2002, and only a proportionate share of the annual CCA charge may be taken. We would call your attention to the fact that it is length of the taxation year, not the period of ownership of the assets, that establishes the fraction of the year for which CCA is to be recorded.
2003 Solution The required calculations are as follows: Opening Balance For The Class Additions [(10 Cars)($10,500)] Dispositions (Proceeds) One-Half Net Additions [(1/2)($105,000 - $21,500)] CCA Base CCA At 30 Percent One-Half Net Additions UCC For January 1, 2004 $ 92,397 105,000 ( 21,500) ( 41,750) $134,147 ( 40,244) 41,750 $135,653
Here again, one-half of the net additions for the year are deducted in establishing the base for calculating CCA, with the same amount being added back to determine the opening UCC for the next period.
2004 Solution The required calculations are as follows: Opening Balance For The Class Dispositions (Proceeds) CCA Base CCA At 30 Percent UCC For January 1, 2005 $135,653 ( 30,000) $105,653 ( 31,696) $ 73,957
The calculations are simplified by the absence of additions to the delivery car fleet. To establish the CCA base, it is only necessary to deduct the proceeds of the dispositions. The new UCC is the CCA base, less the CCA for the period.
2005 Solution The required calculations are as follows: Opening Balance For The Class Dispositions (Proceeds) Negative Balance Recapture UCC For January 1, 2006 $73,957 ( 84,000) ($10,043) 10,043 Nil
The inability to replace the fleet cars in a timely fashion results in additional income in the amount of $10,043. In a more realistic situation, it is likely that actions would have been taken to delay the retirement of the older cars and, thereby, avoid the tax implications of recapture. There is no election available to defer the recapture as the election would only apply if the voluntarily replaced property was real property. Note also that when recapture occurs, the balance in the class for the next period is reduced to zero.
2006 Solution The required calculations are as follows: Opening Balance For The Class Acquisitions [(20 Cars)($14,000)] One-Half Net Additions [(1/2)($280,000)] CCA Base CCA At 30 Percent One-Half Net Additions UCC For January 1, 2007 Nil $280,000 ( 140,000) $140,000 ( 42,000) 140,000 $238,000
As was the case in 2002 and 2003, one-half of the net additions must be deducted in establishing the base for CCA and then added back to determine the opening UCC for the next period.
2007 Solution The required calculations are as follows: Opening Balance For The Class Dispositions (Proceeds) Terminal Loss $238,000 ( 174,000) $ 64,000
At this point, all of the assets in Class 10 have been retired and there is still a $64,000 balance in the UCC. This results in a terminal loss that will be deducted in full from the other income of Sorrento Pizza. The terminal loss will also be deducted from the UCC balance leaving a January 1, 2008 balance of nil.
Solution to Assignment Problem Seven - 5
Part A The required of calculation the maximum CCA is as follows: Class 3 $263,000 Nil Nil Nil $263,000 5% $ 13,150 Class 8 $72,000 Nil Nil Nil $72,000 20% $14,400 Class 10 $52,000 38,000 ( 23,000) ( 7,500) $59,500 30% $17,850
Opening Balance Additions Proceeds Of Disposition One-Half Net Additions CCA Base CCA Rate Maximum CCA
This gives a maximum amount for CCA of $45,400 for the taxation year.
Part B Since the Company only has Net and Taxable Income before CCA of $23,500 and the problem states that loss carry overs should not be considered, maximum CCA would not be deducted as this would produce a loss. Only $23,500 in CCA should be taken in order to reduce the Taxable Income to nil. With respect to the classes from which it should be taken, the usual procedure is to deduct the required amount from the classes with the lowest rates. By leaving the classes with higher rates untouched, larger amounts of CCA can be deducted in later periods as required. In this example, the recommended CCA deductions would be as follows: Class 3 (Maximum Available) Class 8 (Required Balance) Total CCA $13,150 10,350 $23,500
The deduction of this amount of CCA would serve to reduce Taxable Income to nil.
CHAPTER EIGHT SOLUTIONS
Solution to Assignment Problem Eight - 1
The current year's deduction for bad debts in the calculation of business income would be calculated as follows: End Of Previous Year's Allowance For Bad Debts Bad Debt Write Offs During Current Year ($8,800 - $700) Bad Debt Recoveries During Current Year End Of Current Year's Allowance For Bad Debts ($15,900 + $700) Total Reduction In Business Income $11,500 ( 8,100) 1,500 ( 16,600) ($11,700)
Note that the $700 that was due from Dr. Allworth's personal friend has been treated as part of the allowance for bad debts, rather than as part of the write-offs for the period. The $190 recovery in the preceding year would have been included in income in that year.
Solution to Assignment Problem Eight - 2
In the valuation of inventories, tax rules follow closely the procedures that would be used under generally accepted accounting principles. This means that the Company can use either fair market value or lower of cost and market. In the determination of cost, taxpayers are permitted to use either a First In, First Out or an Average Cost basis. In general, whatever cost basis is chosen should be consistently applied each year and be the same method used for financial statement purposes. Using the First In, First Out method, the appropriate value for the ending inventory would be determined as follows: 17,000 Units At $12.50 5,000 Units At $12.00 22,000 Units At FIFO Cost $212,500 60,000 $272,500
To determine average cost per unit, we would divide the $1,554,500 total cost of goods available for sale by the 136,000 units available during the year, to arrive at an average cost of $11.43 per unit. Multiplying this average cost per unit times the 22,000 units on hand on December 31 would give a total cost of $251,460. If the Company were to choose the use of lower of cost or market, the market figure would be $258,500 [(22,000)($11.75)]. If cost were determined on a First In, First Out basis, this market figure would be lower and would be used. In contrast, if the Company determines cost on an Average Cost basis, the average cost of $251,460 would be less than the market of $258,500 and cost would be used. While it is not an acceptable practice under GAAP, the CRA will accept the use of market values, without regard to their relationship to cost. If this approach is taken, the value of the December 31 inventory would be $258,500 [(22,000)($11.75)]. Note that IT-473R indicates that the Department will not accept the use of a Last In, First Out assumption for determining the cost of inventories. This then, is the one approach that would be permitted under generally accepted accounting principles but not under the current policies of the CRA (as noted in the text, there is an Exposure Draft outstanding that, when incorporated into the CICA Handbook, will prohibit the use of LIFO for accounting purposes).
Solution to Assignment Problem Eight - 3
As the lease was entered into in 2006, the 2006 limits on deductibility apply for the life of the lease. Part A For 2006, the maximum deduction for automobile lease payments would be the least of:
The least of the three figures is $202 and this will be the maximum 2006 deduction for Borris Industries. For 2007, the maximum deduction for automobile costs would be the least of:
The least of the three figures is $2,429 and this will be the maximum 2007 deduction for Borris Industries. Part B The taxable benefit that will be included in the 2006 Net Income For Tax Purposes of Mr. Borris is calculated as follows: Standby Charge [(2/3)(1)($1,800)(1/1)] Operating Cost Benefit [($0.22)(2,500)] Repayment Total Benefit $1,200 550 ( 500) $1,250
The taxable benefit that will be included in the 2007 Net Income For Tax Purposes of Mr. Borris is calculated as follows: Standby Charge [(2/3)(12)($1,800)(12/12)] Operating Cost Benefit [($0.22)(22,000)] Repayment Total Benefit $14,400 4,840 ( 6,000) $ 13,240
As his 2007 employment related kilometers were more than 50 percent of total kilometers, Mr. Borris could have used the alternative calculation of the operating cost benefit (i.e., 50 percent of the standby charge). However, he would not do so as this would result in a higher total benefit. Also note that as Mr. Borris' personal usage exceeds 20,004 kilometers during the year, he is not eligible for a reduction in the standby charge.
Part C The impact of the costs of the Mercedes on the Taxable Income of Borris Industries would depend on whether the benefit is taxable as an employee benefit under ITA 6(1)(e)/(k) or as a shareholder benefit under ITA 15(5). If ITA 15(5) applies, then no amounts related to the personal use would be deductible by the corporation, nor would the Company be able to claim much with respect to CCA, as an automobile provided to a shareholder would not be a depreciable property for ITA purposes [at least that part that relates to personal use - See ITR 1102(1)(c)]. If the benefit is taxable as an employee benefit, the operating costs would be deductible and the lease costs would be as calculated in Part A.
Solution to Assignment Problem Eight - 10
The Net Income For Tax Purposes of Voxit Inc., would be calculated as follows: Accounting Income Before Taxes Additions: Current Income Tax Expense Bond Discount Amortization Interest On Tax Instalments Reserve For Inventory Declines Amortization Expense Charitable Donations (Note One) Loss On The Sale Of Vehicles Appraisal Fees (Note Two) Deduction: Future Income Tax Benefit CCA (Note Three) Terminal Loss On Class 10 CEC (Note Four) Net Income For Tax Purposes $565,000 $210,000 3,500 1,250 12,600 51,500 14,500 36,200 2,600
332,150 $897,150
($ 23,000) ( 68,302) ( 30,968) ( 630)
( 122,900) $774,250
Note One The corporate charitable donations can be deducted in the calculation of Taxable Income, but are not deductible in the calculation of Net Income For Tax Purposes. Note Two While the problem states that this item was deducted in the calculation of accounting income, this would not be in compliance with generally accepted accounting principles. Generally accepted accounting principles would require that the appraisal costs on the property to be sold be added to the cost of the relevant property. Regardless of the treatment accorded to this item in the accounting records of Voxit, it is clear that it could not be deducted for tax purposes. Note Three The required CCA calculations would be as follows: Class 1 [($325,236)(4%)] Class 8 Opening Balance Additions Disposal Proceeds One-Half Net Addition CCA Base Rate Class 8 CCA Class 13 ($36,400 14) $ 13,009 $226,964 $262,000 ( 189,000) 73,000 ( 36,500) $263,464 20% $ 52,693 $ 2,600
Total CCA ($13,009 + $52,693 + $2,600)
$68,302
Note that the January 1 Class 13 balance shows that less than the maximum CCA for this class has been claimed in the past. Class 10 - Terminal Loss ($56,500 - $87,468) ($30,968)
Note Five The required CEC calculation would be as follows: CEC Deduction [(3/4)($55,000 - $43,000)(7%)] $630
Notes On Excluded Items The GST paid would not be included in the sales figures and the input tax credits would not be included in the expenses. As a consequence, no adjustment to the accounting figures is required. The cost of sponsoring the local soccer team is deductible for both tax and accounting purposes. The cost of theft by employees who are not officers of the Company is deductible.
Solution to Assignment Problem Eight - 11
Part A If the ITA 22 election is not made, the tax consequences for Ms. Close would be as follows: Add: 2006 Reserve For Bad Debts Deduct Capital Loss: Proceeds Of Disposition Adjusted Cost Base Capital Loss Non-Deductible One-Half 2007 Income Inclusion $8,000 $107,000 ( 120,000) ($ 13,000) 6,500
( 6,500) $1,500
If the ITA 22 election is not made, the tax consequences to Mr. Phar would be as follows: Proceeds Of Disposition Adjusted Cost Base Capital Loss Non-Deductible One-Half 2007 Deduction From Income $100,000 ( 107,000) ($ 7,000) 3,500 ($ 3,500)
Note that, in the case of both Ms. Close and Mr. Phar, the allowable capital losses included in the preceding calculations could only be deducted against taxable capital gains. If they did not have taxable capital gains sufficient to absorb their allowable capital losses, Ms. Close would have an inclusion of $8,000, and Mr. Phar would have no deduction or inclusion. Part B If the ITA 22 election is made, the tax consequences for Ms. Close would be as follows: Add: 2006 Reserve For Bad Debts Deduct: Business Loss ($120,000 - $107,000) 2007 Deduction From Income $ 8,000 ( 13,000) ($ 5,000)
If the ITA 22 election is made, the tax consequences to Mr. Phar would be as follows: Add: Face Value - Price Paid ($120,000 - $107,000) Deduct: Actual Write-Offs ($120,000 - $100,000) 2007 Deduction From Income $13,000 ( 20,000) ($ 7,000)
Note that, as the actual amount collected ($100,000) was less than the estimated fair value at the time of transfer ($107,000), both Ms. Close and Mr. Phar are better off using the ITA 22 election.