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Question

Problem 5

Heather is excited about the future but she has come to you concerned that her corporate

structure

is not what it should be for her situation. She would like you to propose a structure that you think will

work for her.

Background

Heather lives in Saskatoon and she started her operating company, Heath Inc., sixteen years ago

and it is performing very well. On incorporation she paid $100 for 100 common shares. Heath Inc. is

currently generating an after-tax operating profit of $300,000 and Heather expects the business to

continue to grow over the foreseeable future. Out of the after-tax profit, $100,000 is needed for

reinvestment in the business and the remaining $200,000 is available to be reinvested elsewhere. She

would like to get this $200,000 out of the company to provide some creditor protection. Her advisors

have estimated the current value of the company at $2.0 million.

Last year she had an opportunity she could not refuse. Land and building offered for sale at $1.2

million were perfect for her business, so she incorporated a company, Real Inc., to buy the property. She

did this to protect the real estate from any creditor issues that may arise in the future in Heath Inc.

Heather paid $100 for 100 common shares. She then loaned Real Inc. $400,000 of personal capital, at an

interest rate of 5%, and Real Inc. took out a mortgage for a further $800,000 to buy the property. Real

Inc. is charging Heath Inc. market rent to cover the interest and operating expenses, although Real Inc.

is still operating at a loss. The value of the real estate has not increased since it was purchased.

This year she had an idea for a new business that she thinks is a sure winner. Again, Heather

incorporated a company, New Inc., with her investment of $100 for 100 common shares. This new

business will need capital to get started. Her problem is that she does not have any free capital

personally but there is extra cash flow in Heath Inc. that she could use.

Also, she is the President of all three companies and is being paid from each. This results in Canada

Pension Plan premiums being paid in all three companies and general confusion for her controller.

Heather would like to simplify this and, if possible, only be paid from one company.

Heather is in the top personal tax bracket and has never used her capital gains exemption.

Before your next meeting with Heather you want to:

(A) Assess the situation.

(B) Identify the issues:

(a) Propose an efficient structure for the corporations.

(C) Analyze the issues:

(a) Develop the details needed to support the steps taken to implement the proposed structure.

(D) Advise/recommend.

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