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Twenty-five years ago, Angelo and Fred started their own consulting...

Twenty-five years ago, Angelo and Fred started their own consulting company, XYZ Co. Angelo, who is 55, retired from the business on December 31, 2019. He and his wife plan to travel throughout Canada during retirement.


It is now January 5, 2020. Fred would like to purchase Angelo's 50% share of XYZ.


Earnings have been stable over the past 10 years, and Fred and Angelo have agreed to a purchase price of three times the prior year's earnings after tax. Since Angelo's wife already has a trip booked for early February, both Fred and Angelo would like to have the transaction wrapped up as quickly as possible. They have asked you, CPA, to review the attached income statement and notes and provide an estimate of XYZ's federal income tax expense for 2019 and let them know if they need to pay any further instalments to the Canada Revenue Agency (CRA).


Fred does not anticipate having the cash resources to complete the purchase and is concerned about his ability to pay the debt service costs if he has to borrow money to purchase Angelo's shares. As the two men are friends, Fred would like to structure the purchase so that it provides the optimal tax advantage to Angelo.


Fred has heard about the capital gains exemption and wonders whether it could be applied to this transaction. Neither Angelo nor Fred has disposed of any capital properties in the past. XYZ only holds assets that are essential to the operation of the business.

Appendix I

XYZ Co. draft financial statements

Draft unaudited statement of earnings

For the year ending December 31


                                                                                 2019


Revenue                                                            $  449,000

                                                                          

Expenses

  Salaries and wages                                             120,478

  Utilities                                                                 13,325

   Insurance                                                               4,666

   Travel and conferences                                        18,270

   Repairs and maintenance                                     19,565

   Miscellaneous                                                       29,114

   Professional fees                                                  24,387

   Amortization                                                         11,500

   Interest expense                                                     1,687

   Meals and entertainment                                        6,859

   Golf membership                                                    3,478

Total expenses                                                       253,329


Income before taxes                                          $  195,671


Notes:


1.   XYZ had made investments in equipment to support their business. At December 31, 2018, the equipment had an undepreciated capital cost of $78,000 in Class 8.


2.   Interest was incurred in 2019 because XYZ didn't file its 2018 tax return until August 2019. As there was a small balance owing, the CRA assessed interest and penalties of $1,687.


3.   XYZ qualifies for the small business deduction and has a tax rate of 9%.


4.   During the year, XYZ made tax instalments of $28,000 to the CRA.


Required:

 Calculate the cost of purchase price.

Life time capital gain deduction

Conclusion - recommendation

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