Carla Armitage owns 100% of the common shares of Extra Ltd., a Canadian-controlled private corporation operating a wholesale business in eastern Canada. Extra’s fiscal year-end is May 31, 2022. It is now April 15, 2022, and Carla has just signed a letter of intent to sell the wholesale business to Q Ltd.
The initial discussions involved the sale of specific assets of Extra, but a sale of the shares of the company may also be considered. Carla has requested your assistance in estimating the tax liability to Extra if the business assets are sold. Information relating to the sale and to the current year’s operating income is provided below.
- The balance sheet of Extra at May 31, 2022, is estimated as follows:
| Accounts receivable | $ | 124,000 | |
| Inventory, at cost | 404,000 | ||
| Land, at cost | 34,000 | ||
| Building, at book value | 284,000 | ||
| Equipment, at book value | 174,000 | ||
| Licence, at book value | 44,000 | ||
| $ | 1,064,000 | ||
| Liabilities | $ | 512,000 | |
| Share capital | 1,000 | ||
| Retained earnings | 551,000 | ||
| $ | 1,064,000 | ||
- Net income before income tax and net gains from the sale of assets for the year ended May 31, 2022, are estimated as follows:
| Income from wholesale operations | $ | 494,000 | |
| Dividend income | 1,400 | ||
| Net income before tax | $ | 495,400 | |
The following additional information relates to the net income:
- The dividend income is eligible dividends received from a Canadian public corporation, the shares of which were sold during the year for proceeds equal to their original cost.
- Expenses deducted from revenues included the following items:
| Legal fees for collection of bad debts | $ | 2,400 | |
| Donations to registered charities | 3,400 | ||
| Meals and beverages to entertain customers | 4,400 | ||
| Non-eligible dividend paid to Carla on March 31, 2022 | 20,400 | ||
| Replacing a broken window in the building | 2,800 | ||
- The 2021 income tax return indicates the following tax account balances:
| NERDTOH | NIL | ||
| Capital dividend account | NIL | ||
| GRIP | NIL | ||
| Undepreciated capital cost | |||
| Class 1 | $ | 290,000 | |
| Class 8 | 140,000 | ||
| Class 14 | 42,000 | ||
| Class 14.1 | 0 | ||
- The letter of intent regarding the sale of the business indicates that the closing date will be May 31, 2022. The letter included the following list of assets to be sold, together with each asset’s estimated market value. For information, the original cost of each asset is provided in the chart below.
| Market value | Cost | |||||
| Accounts receivable | $ | 124,000 | $ | 124,000 | ||
| Inventory | 514,000 | 404,000 | ||||
| Land | 44,000 | 34,000 | ||||
| Building | 604,000 | 324,000 | ||||
| Equipment | 109,000 | 204,000 | ||||
| Licence | 49,000 | 54,000 | ||||
| Goodwill | 104,000 | 0 | ||||
| $ | 1,548,000 | $ | 1,144,000 | |||
Payment for the above assets would consist of cash plus the assumption of Extra’s liabilities.
- You have suggested to Carla that she consider selling the common shares of Extra, rather than the specific assets. You have estimated the market value of the shares to be $910,000. The shares were acquired in 2014 for a cost of $104,000. In previous years, Carla had used the capital gain deduction to exempt from tax $124,000 of gains. Her cumulative net investment loss (CNIL) at the end of 2021 is estimated to be $42,000.
Required:
1. Determine the active business income, aggregate investment income, increase to the capital dividend account, and increase to the non-eligible refundable dividend tax on hand resulting from the sale of the assets. (If an item is not relevant, leave it blank.)
2. Disregard the amounts calculated in Part 1 and assume new information has come to light and that you have correctly updated your calculations to the following:
| The total active business income created on the asset sale is | 123,000 |
| The total aggregate investment created on the asset sale | 204,000 |
| The increase to the capital dividend account resulting from the asset sale is | 204,000 |
| The increase to the non-eligible refundable dividend tax on hand from the asset sale is | 62,567 |
All other information is unchanged. Determine the net income for tax purposes and taxable income. (Enter reductions as negative amounts with a minus (-) sign.)
3. Disregard the amounts you calculated in Part 2 and assume that the net income for tax purposes was 850,000 and the taxable income was 845,200. The amounts listed in Part 2 resulting from the asset sale are unchanged. Determine the total active business income from all sources. (Enter reductions as negative amounts with a minus (-) sign.)
4. Disregard the active business income calculated in Part 3 and assume it was actually 645,000. Also assume that the net income for tax purposes is still 850,000 and the taxable income is still 845,200. Determine the Part I tax, Part IV tax, and dividend refund. Enter reductions as negative amounts with a minus (-) sign. If an amount is zero, enter “0”. Use 0.3833 when multiplying to represent 38 1/3%. Use 0.3067 when multiplying to represent 30 2/3%. (Do not multiply by more than 4 decimal places and round your final answer to the nearest dollar.)
5. If Carla decides to sell the shares of Extra, what amount will be added to her net income for tax purposes in her 2022 taxation year?
Requirements:
