CHAPTER FIFTEEN SOLUTIONS

Solution to Assignment Problem Fifteen - 1

Part A The adjustments for Part A would be:
• Add amortization expense of $28,000.
• Deduct CCA of $22,500.

Part B The adjustments for Part B would be:

• Add the $4,800 in estimated warranty costs deducted.
• Deduct the $5,100 in actual warranty costs incurred.

Part C The adjustment for Part C would be:

• Deduct the $2,400 in premium amortization.

Part D The adjustments for Part D would be:

• Add the accounting loss of $31,000 ($87,000 - $56,000).
• Deduct the $6,000 terminal loss ($62,000 - $56,000).

Part E The adjustment for Part E would be:

• Add the $3,700 in charitable donations.

Part F The adjustment for Part F would be:

• Add the $2,000 accounting loss.
• Do not deduct the allowable capital loss, as there are no taxable capital gains.
Solution to Assignment Problem Fifteen - 2
The required calculation of Net Income For Tax Purposes and Taxable Income is as follows:

ITA 3(a) Dividends $ 33,500

ITA 3(b) Taxable Capital Gains $9,600
Allowable Capital Losses ( 4,425) 5,175
ITA 3(c) $ 38,675
ITA 3(d) Business Loss ( 141,800)
Net Income For Tax Purposes Nil
Dividends Received ($ 33,500)
Net Capital Loss Carry Forward
(Limited To Net Taxable Capital Gains) ( 5,175)
Charitable Donations Nil
Taxable Income $ Nil

The carry forward balances available at the end of the year are as follows:

Net Capital Loss Carry Forward From 2005

Beginning Balance $10,500
Used During Year ( 5,175)
Net Capital Loss Carry Forward $ 5,325

Charitable Donations
Beginning Balance $1,350
Added During Year 5,400
Used During Year Nil
Unused Charitable Donations $6,750

Non-Capital Loss
Balance Under E
Dividends $ 33,500
Business Loss 141,800
Net Capital Loss Carry Forward Deducted 5,175
Subtotal $180,475
Balance Under F - Income Under ITA 3(c) ( 38,675)
Non-Capital Loss Carry Forward $141,800
Solution to Assignment Problem Fifteen - 3
The Taxable Income of Dunway Ltd. would be calculated as follows:

Operating Income ($725,000 - $533,000) $192,000

Dividends Received ($37,500 + $15,000) 52,500
Taxable Capital Gain [(1/2)($222,000)] 111,000
Net Income For Tax Purposes $355,500
Deductions:
Dividends Received ($ 52,500)
Donation To Government (Note 1) ( 26,000)
Donations To Registered Charities (Note 1) ( 141,000)
Net Capital Loss Carry Forward (Note 2) ( 111,000) ( 330,500)
Taxable Income Before Non-Capital Loss Carry Forward $ 25,000
Non-Capital Loss Carry Forward (Note 3) ( 25,000)
Taxable Income Nil

Note 1 There is no addition to Net Income For Tax Purposes with respect to the donations as this
calculation does not start with accounting Net Income. The donations to registered Canadian charities
total less than 75 percent of Net Income For Tax Purposes and are therefore fully deductible in the
calculation of Taxable Income.

Note 2 The net capital loss carry forward can only be deducted to the extent of the $111,000 taxable
capital gain. At the end of the current year, Dunway will have a net capital loss balance of $111,000
($222,000 - $111,000). Since the problem states that no future capital gains are anticipated, the
maximum amount of the net capital loss carry forward was claimed first.

Note 3 The non-capital loss carry forward has only been deducted to the extent of the amount required
to reduce Taxable Income to nil, leaving a non-capital loss carry forward of $112,000 ($137,000 -
$25,000). It would have been possible to carry forward the donations instead, but the non-capital loss
carry forward period is greater than the five year donation carry forward.
Solution to Assignment Problem Fifteen - 4
The Net Income For Tax Purposes and Taxable Income of Fortan Ltd. for the eight month period ending
December 31, 2007 is as follows:

Accounting Income Before Taxes $59,835

Add:
Golf Club Membership Fees $ 1,080
Non-Deductible Portion Of Meals
And Entertainment [(50%)($820)] 410
Warranty Reserve 4,440
Amortization Expense 12,384
Charitable Donations 2,160
Reserve For Self-Insurance 2,322 22,796

Deduct: CCA (Note One) ( 6,309)

Net Income For Tax Purposes $76,322
Deduct:
Charitable Donations (Note Two) ($ 1,680)
Non-Capital Loss Carry Forward ( 10,800) ( 12,480)
Taxable Income $63,842

Note One The CCA for the eight month period ending December 31, 2007, can be calculated as
follows:

Furniture And Equipment

Opening UCC $ 32,500
One-Half Net Additions [(1/2)($2,000)] 1,000
CCA Base $ 33,500
Rate (Class 8) 20%
Full Year Amount $ 6,700
Proration For Short Fiscal Year 245/365
Class 8 CCA $ 4,497

Delivery Van
Addition $ 18,000
One-Half Net Additions ( 9,000)
CCA Base $ 9,000
Rate (Class 10) 30%
Full Year Amount $ 2,700
Proration For Short Fiscal Year 245/365
Class 10 CCA $ 1,812

Class 8 CCA $ 4,497

Class 10 CCA 1,812
Total CCA $ 6,309
 Note Two Since Fortan has no U.S. source income, and the Canadian government has never made
a gift to the United States Organ Transplant Association, the $480 donation to a U.S. charity is not
deductible. This leaves an amount of $1,680 ($2,160 - $480).

Other Notes The following additional points are relevant to the solution:
• There are no restrictions against deducting the sales convention expenses or the bad debt loss related to
the bankrupt customer.
• Where a foreign exchange loss arises in the normal course of business operations, it is fully deductible.
• Dividends declared are not deducted in the calculation of either accounting Net Income or Taxable
Income.
Solution to Assignment Problem Fifteen - 5
Part A The non-capital loss for the period to March 31, 2007 would be as follows:

Loss As Per March 31, 2007 Income Statement ($23,000)

Required Accounts Receivable Adjustment ($45,000 - $33,000) ( 12,000)
Building Election - Recaptured CCA ($285,000 - $270,000) 15,000
Fixtures And Equipment - Deemed CCA ( 5,000)
Vehicles Election - Recaptured CCA ($87,000 - $80,000) 7,000
Non-Capital Loss For Period Ending March 31, 2007 ($18,000)

Net Income For Tax Purposes and Taxable Income for the period ending March 31, 2007, calculated as per
the ITA 3 rules, would be as follows:

ITA 3(a) - Non-Capital Income (Positive Amounts Only) Nil

ITA 3(b) - Net Taxable Capital Gains (Losses):

Elections Under ITA 111(4)(e):
Gain On Land [(1/2)($420,000 - $275,000)] $ 72,500
Gain On Building [(1/2)($320,000 - $285,000)] 17,500
Required Write-Down - ITA 111(4)(c) And (d)
Loss On Temporary Investments - [(1/2)($53,000 - $23,000)] ( 15,000)
ITA 3(c) - Total $ 75,000
ITA 3(d) - Non-Capital Loss For The Period ( 18,000)
Net Income For Tax Purposes $ 57,000
Net Capital Loss Carry Forward (See Following Explanation) ( 75,000)
Taxable Income Nil

On January 1, 2007, the net capital loss balance would be as follows:

From 2005 [(1/2)($68,000)] $34,000
From 2006 [(1/2)($85,000)] 42,500
Total Available $76,500

The net capital loss carry forward that can be deducted is limited to the $75,000 in net taxable capital gains
for the period, leaving an unused amount of $1,500. This amount would be lost forever as a result of the
acquisition of control.
As we have used the optional conversion of a net capital loss carry forward balance into part of the non-
capital loss carry forward balance, the current period’s non-capital loss of $18,000 will be added to the non-
capital loss carry forward balance. The resulting non-capital loss carry forward would be $160,000
($63,500 + $78,500 + $18,000).

Part B The loss carry forward that is available for the nine month period ending December 31, 2007 is the
$160,000 non-capital loss carry forward that resulted from bread operations in 2005, 2006, and the first
three months of 2007 ($63,500 + $78,500 +$18,000). As these losses can only be applied against profits in
the bread operations, they cannot be used during the period ending December 31, 2007. Note, however,
that there is no restriction against using the current year’s loss on bread operations against the income from
the figurines to reduce the 2007 Net Income For Tax Purposes to $78,000 ($123,000 - $45,000). This
means that the non-capital loss carry forward at December 31, 2007 is unchanged at $160,000.
Part C The $40,000 loss on the figurines must be deducted from the profits of the bread operations, to
produce a Net Income For Tax Purposes of $171,000 ($211,000 - $40,000). As this income is entirely from
bread operations, all of the $160,000 non-capital loss carry forward can be deducted, leaving a Taxable
Income of $11,000. There is no remaining non-capital loss carry forward at December 31, 2008.
Solution to Assignment Problem Fifteen - 6
Part A As the fair market value of the equipment is less than its UCC, Fortunato Ltd. would be required to
write it down to its fair market value of $100,000 [ITA 111(5.1)]. The $20,000 write-down would be
considered deemed CCA. While the UCC of the equipment would be reduced from $120,000 to $100,000,
its cost would remain at $250,000.
This write-down would bring the business loss, before elections, for the January 1, 2007 through March 31,
2007 period to $46,000 ($26,000 + $20,000).
Elections on the other three assets would have the following results:

Long-Term Investments The election here would be at $90,000, and this would be the new
adjusted cost base of these investments. This election would result in a taxable capital gain of
$29,000 [($90,000 - $32,000)(1/2)].
Land The election here would be at $225,000, and this would be the new adjusted cost base for
this asset. This election would result in a taxable capital gain of $42,500 [($225,000 -
$140,000)(1/2)].
Building The election here would be at $426,000, and this would be the new capital cost for this
asset. The UCC would increase to $426,000, and there would be recaptured CCA of $106,000
($426,000 - $320,000).

Fortunato Ltd.’s Net Income For Tax Purposes for the period January 1, 2007 through March 31, 2007
would be calculated as follows:

ITA 3(a) Business Income

Loss Before Elections ($ 46,000)
Recaptured CCA 106,000 $ 60,000
ITA 3(b) Taxable Capital Gains
Long-Term Investments $ 29,000
Land 42,500 71,500
Net Income For Tax Purposes $131,500
Net Capital Loss Carry Forward ( 26,000)
Taxable Income Before Non-Capital Loss Carry Over $105,500
Non-Capital Loss Carry Forward ( 225,000)
Taxable Income* ($119,500)

*While you cannot have a negative Taxable Income (the correct amount is nil), in this simple case,
the negative number is the non-capital loss carry forward balance.

These results would leave a net capital loss carry forward of nil and a non-capital loss carry forward,
calculated as follows:

December 31, 2006 Balance $225,000

Net Capital Losses Deducted 26,000
Subtotal $251,000
Income Under ITA 3(c) ( 131,500)
Non-Capital Loss Carry Forward $119,500
Part B The only loss that will expire on March 31, 2007 is the $26,000 net capital loss carry forward. To
be able to use this carry forward, a capital gain of $52,000 ($26,000 ÷ 1/2) is required. This could be
achieved by electing a deemed proceeds of disposition of $84,000 ($32,000 + $52,000) on the Long-Term
Investments or, alternatively, electing a deemed proceeds of disposition of $192,000 ($140,000 + $52,000)
on the Land. As the Long-Term Investments are about to be sold, this would be the better choice, as the
increased adjusted cost base on this asset would serve to reduce the taxable capital gain that will result from
their sale.

Part C If Foodland Inc. either does not intend to continue the same business in which the loss occurred, or
does not expect to have sufficient profits in that business to absorb the non-capital losses within the
relevant carry forward period, the Company should make all elections as per Part A. Alternatively, if they
expect to have sufficient profits in continuing the bakery business to absorb the losses, they should use the
Part B approach that maximizes the non-capital loss carry forward. The reason for this is that the tax
benefit of the non-capital loss carry forward will be realized as soon as profits are available in the post-
acquisition period. Alternatively, the higher asset costs that result from the Part A elections will only be
realized if the assets are sold or, in the case of the building, as CCA is taken.
Solution to Assignment Problem Fifteen - 7
2004 The calculations are as follows:
Accounting Income $110,000
Accounting Gain On Disposition Of Land ( 18,000)
Taxable Capital Gains [(1/2)($18,000)] 9,000
Charitable Donations 3,200
Net Income (Loss) For Tax Purposes $104,200
Charitable Donations ( 3,200)
Dividends ( 11,000)
Taxable Income $ 90,000

There are no loss carry overs at the end of 2004.

2005 The calculations are as follows:

Accounting Loss ($180,000)
Accounting Loss On Disposition Of Land 9,000
Charitable Donations 5,800
Net Income (Loss) For Tax Purposes (See Note) ($165,200)
Dividends ( 19,000)
Taxable Income (Loss) ($184,200)

Note Neither Net Income For Tax Purposes nor Taxable Income can be negative. They are either
positive or, where we have shown negative amounts, nil. However, showing these negative
balances can be useful in the calculations that follow.

Non-Capital Losses Carry Back There will be a non-capital loss carry back to 2004 of $90,000,
leaving a non-capital loss carry forward of $94,200 ($184,200 - $90,000). This carry over was
deducted first, in keeping with the policy of minimizing non-capital loss carry overs.

Alternative Solution As all of last year’s income has been eliminated by the non-capital loss carry
back, a net capital loss balance of $4,500 [(1/2)($9,000)] will have to be carried forward. As there
were taxable capital gains in 2004, an alternative solution would have been to carry this amount
back to 2004. This would have resulted in a corresponding reduction in the amount of the non-
capital loss carried back to that year.

Charitable Contributions All of the charitable donations of $5,800 will have to be carried
forward. There is no provision for a carry back of such contributions.
2006 The calculations are as follows:
Accounting Income $85,000
Accounting Gain On Disposition Of Land ( 12,000)
Taxable Capital Gain [(1/2)($12,000)] 6,000
Charitable Donations 4,100
Net Income (Loss) For Tax Purposes $83,100
Charitable Donations ( 4,100)
Dividends ( 18,000)
Taxable Income Before Carry Forwards $61,000
Charitable Donations Carry Forward (All) ( 5,800)
Non-Capital Loss Carry Forward (Maximum Needed) ( 55,200)
Taxable Income Nil

Charitable Donations As per the Company’s policies, charitable donations were deducted prior to
any loss carry overs. Subsequent to this deduction, there is no carry forward of charitable
donations at the end of 2006.

Non-Capital Loss Carry Forward The carry forward of $55,200 will leave a non-capital loss
carry forward of $39,000 ($94,200 - $55,200) at the end of 2006.

Net Capital Loss The $4,500 net capital loss balance from 2005 remains at the end of 2006. As
was the case in 2005, an alternative solution would have been to deduct this carry forward with a
corresponding reduction in the amount of the non-capital loss carry forward deducted.

2007 The calculations are as follows:

Accounting Loss ($42,000)

Accounting Gain On Disposition Of Land ( 2,000)
Taxable Capital Gain [(1/2)($2,000)] 1,000
Charitable Donations 2,900
Net Income (Loss) For Tax Purposes ($40,100)
Dividends ( 12,000)
Taxable Income (Loss) ($52,100)

Non-Capital Loss Carry Forward There is a non-capital loss carry forward of $91,100 ($39,000
+ $52,100) at the end of 2007.

Net Capital Loss The $4,500 net capital loss balance from 2005 remains.

Charitable Donations ‘There is a $2,900 carry forward of charitable donations at the end of 2007.
Solution to Assignment Problem Fifteen - 8
Net Income For Tax Purposes And Taxable Income Before Carry Overs The income calculations for
the four years, before any consideration of loss carry overs, would be as follows:

2004 2005 2006 2007

Business Income (Loss) ($22,000) $78,000 $ 95,000 ($176,000)
Taxable Capital Gains Nil Nil 12,000 11,000
Dividends 4,000 6,000 6,000 5,000
Net Income (Loss) For Tax Purposes* ($18,000) $84,000 $113,000 ($160,000)
Dividends ( 4,000) ( 6,000) ( 6,000) ( 5,000)
Charitable Donations Nil ( 12,000) ( 23,800) Nil
Taxable Income (Loss)
Before Carry Overs* ($22,000) $66,000 $ 83,200 ($165,000)

*Neither Net Income For Tax Purposes nor Taxable Income can be negative. They are either positive or, in
those cases where we have shown negative amounts, nil. However, showing these negative balances can be
useful in the calculations that follow.

2004 Analysis Both Net Income For Tax Purposes and Taxable Income will be reported as nil. At the end
of this year, the following loss carry forwards will be present:
• Non-Capital Loss $22,000
• Net Capital Loss [($66,000)(1/2)] $33,000

2005 Analysis The $22,000 non-capital loss from 2004 can be carried forward and deducted in this year,
resulting in the following Taxable Income calculation:

Taxable Income Before Carry Overs (See Schedule) $66,000

2004 Non-Capital Loss Carry Forward (All) ( 22,000)
2005 Taxable Income $44,000

As there are no taxable capital gains realized in 2005, none of the 2004 net capital loss carry forward can be
deducted. As a result, the net capital loss carry forward will remain unchanged at $33,000.

2006 Analysis During 2006, Lockwood has taxable capital gains of $12,000 [($24,000)(1/2)] and, as a
consequence, a part of the net capital loss carry forward can be used. This results in the following Taxable
Income calculation for 2006:

2006 Taxable Income Before Carry Overs (See Schedule) $83,200

Net Capital Loss Carry Forward (Limited To Taxable Capital Gains) ( 12,000)
2006 Taxable Income $71,200

After using $12,000 of this balance during 2006, the following net capital loss balance would remain:
• Net Capital Loss ($33,000 - $12,000) $21,000
2007 Analysis As management seems confident of profitability in future years and it is the policy of the
Company to minimize its net capital loss balance, it would seem appropriate to deduct the maximum net
capital loss during this year. This amount would be limited to the current taxable capital gains of $11,000.
This would leave the following balance at the end of 2007:

• Net Capital Loss ($21,000 - $11,000) $10,000

This leaves a non-capital loss carry over of $176,000 [($176,000 + $5,000 + $11,000) - ($5,000 +
$11,000)]. A portion of this can be carried back to 2005 to reduce the Taxable Income of that year to nil.
The amended figures for that year would be as follows:

2005 Taxable Income As Reported In 2005 $44,000

Non-Capital Loss Carry Back From 2007 ( 44,000)
Amended 2005 Taxable Income $ Nil

A further carry back can be made to 2006, resulting in amended figures as follows:

2006 Taxable Income As Reported In 2006 $71,200

Non-Capital Loss Carry Back From 2007 ( 71,200)
Amended 2006 Taxable Income $ Nil

At the end of 2007, the non-capital loss carry forward is calculated as follows:

2007 Non-Capital Loss $176,000

Carried Back To 2005 ( 44,000)
Carried Back To 2006 ( 71,200)
Non-Capital Loss Carry Forward $ 60,800

The $1,200 in unused charitable donations can be carried forward for five years.
Solution to Assignment Problem Fifteen - 9
From the descriptions in the problem, it would appear that each of the provincial offices of Borodin Ltd.
would qualify as a permanent establishment. As a consequence, the allocation to each of these provinces
would be based on the following calculations:

Salaries And Wages Gross Revenues

Province Amount Percent Amount Percent
Alberta $ 928,000 16% $ 3,338,400 16%
British Columbia 1,160,000 20% 4,798,950 23%
Nova Scotia 754,000 13% 2,921,100 14%
Saskatchewan 464,000 8% 2,503,800 12%
Ontario 2,494,000 43% 7,302,750 35%
Total $5,800,000 100% $20,865,000 100%

The province by province average of the two percentages, calculated above, would be used to allocate total
Taxable Income of $2,983,000 as follows:

Taxable
Province Wages Revenues Average Income
Alberta 16% 16% 16.0% $ 477,280
British Columbia 20% 23% 21.5% 641,345
Nova Scotia 13% 14% 13.5% 402,705
Saskatchewan 8% 12% 10.0% 298,300
Ontario 43% 35% 39.0% 1,163,370
Total 100% 100% 100.0% $2,983,000
Solution to Assignment Problem Fifteen - 10
Case 1 As a group, Mr. Jones and Mr. Twitty control both Jones Ltd. and Twitty Inc. As a consequence,
these two Companies would be associated under ITA 256(1)(b).

Case 2 Ms. Wynette controls Wynette Enterprises Ltd., and is related to each member of the group that
controls Lynn Inc. In addition, Ms. Wynette has the necessary 25 percent plus cross-ownership in Lynn
Inc. As a consequence, Wynette Enterprises Ltd. and Lynn Inc. are associated under ITA 256(1)(d).

Case 3 A group, consisting of Mr. Travis and Mr. Cash, have control of both Cowboys Ltd. and Horses Inc.
Therefore, Cowboys Ltd. and Horses Inc. are associated under ITA 256(1)(b).

Case 4 Mr. Nelson controls Willie’s Hits Ltd. and a related person, his brother, controls Randy’s Boots Inc.
In addition, Mr. Nelson has the necessary 25 percent plus cross-ownership in Randy’s Boots Inc. This
means that Willie’s Hits Ltd. and Randy’s Boots Inc. are associated under ITA 256(1)(c).

Case 5 Ms. Parton controls Alpha Company, is related to each member of the group (Ms. Parton and her
spouse) that control Beta Company, and has cross-ownership of Beta Company in excess of 25 percent.
This means that these two Companies are associated under ITA 256(1)(d). Her spouse controls Centra
Company, is related to each member of the group (the spouse and Ms. Parton) that controls Beta Company,
and has the necessary cross-ownership of at least 25 percent of Beta Company shares. This means that
these two Companies are also associated under ITA 256(1)(d). As they are not controlled by the same
individual or group, Alpha Company and Centra Company are not associated under ITA 256(1). However,
as they are both associated with the same third corporation (Beta Company), Alpha and Centra would be
associated under ITA 256(2). Note that ITA 256(2) allows Alpha and Centra to avoid association, provided
Beta elects not to be associated with either Company. This will mean, however, that Beta will have a
business limit for the period of nil.

Case 6 For the purposes of determining associated companies, Ms. Gale is deemed to own the 30 percent
interest in Norton Music Inc. that is held by her minor child [ITA 256(1.3)] and the 20 percent interest in
Norton Music Inc. for which she holds an option [ITA 256(1.4)]. When this is combined with her own
interest of 10 percent, she would be considered to control Norton Music Inc. As she controls both Kristal
Enterprises Ltd. and Norton Music Inc., these Companies are associated under ITA 256(1)(b).
Solution to Assignment Problem Fifteen - 11
Part A As Barton Ltd. controls Norton Inc., the two Companies are associated under ITA 256(1)(a).

Part B As both Boulding Ltd. and Boulding Inc. are controlled by the same individual (Thomas Boulding),
they are associated under ITA 256(1)(b).

Part C As Elm Ltd. and Maple Inc. are controlled by the same group of persons (Mary Cunningham and
Brenda Parton), they are associated under ITA 256(1)(b).

Part D Fielding Inc. and Lawson Ltd. are associated under ITA 256(1)(d) because:
• Alice Fielding controls Fielding Inc.
• Alice is related to each member of a group (Alice and Betty Falcon) that controls Lawson Ltd.
Note that under ITA 256(1.5), a person is related to himself.
• Alice owns not less than 25 percent of the shares of Lawson Ltd.
In similar fashion, Falcon Inc. and Lawson Ltd. are associated under ITA 256(1)(d) because:
• Betty Falcon controls Falcon Inc.
• Betty is related to each member of a group (Betty and Alice Fielding) that controls Lawson Ltd.
Again, under ITA 256(1.5), a person is related to himself.
• Betty owns not less than 25 percent of the shares of Lawson Ltd.
Because both Fielding Inc. and Falcon Inc. are associated with Lawson Ltd., Fielding Inc. and Falcon Inc.
are associated under ITA 256(2). If it was desirable, Lawson Ltd. could make the appropriate election
under ITA 256(2) to be deemed not to be associated with Fielding Inc. and Falcon Inc. However, the
annual business limit for Lawson Ltd. would be reduced to nil.

Part E As Michael has direct control over Forbes Ltd. and indirect control of Malcom Inc., the two
Companies are associated under ITA 256(1)(b). Indirect control is provided for under ITA 256(1.2)(d).
The interest of Michael in Malcolm Inc. is 51percent. This is calculated as 30 percent direct control plus
21 percent [(70%)(30%)] indirect control.

Part F Both Rastau Ltd. and Sucrol Inc. are controlled by the group Richard Barnes and Susan Firth.
Therefore, they are associated under ITA 256(1)(b).
Solution to Assignment Problem Fifteen - 12

Part I Tax Payable Kannon’s Part I tax payable for the year would be calculated as follows:

Base Amount Of Part I Tax [(38%)($473,000)] $179,740

Surtax [(4%)(28%)($473,000)] 5,298
Federal Tax Abatement [(10%)(88.6%)($473,000)] (Note One) ( 41,908)
Small Business Deduction (Note Two) ( 32,142)
General Rate Reduction For CCPCs (Note Three) ( 19,048)
Part I Tax Payable $ 91,940

Note One The federal tax abatement must be reduced because of the foreign business income. The
percentage would be calculated as follows:
Canadian Wages And Salaries As Percentage Of Total
($560,000 + $642,000) ÷ $1,298,000 92.6%
Canadian Gross Revenues As Percentage Of Total
($1,200,000 + $1,232,000) ÷ $2,879,000 84.5%

Based on these calculations, the percentage of income on which the federal tax abatement would be
available is 88.6 percent [(92.6% + 84.5%) ÷ 2].

Note Two Since Kannon’s Taxable Capital Employed In Canada during 2006 was greater than $10
million, its small business deduction is reduced. The B component of the ITA 125(5.1) reduction
formula is $5,600 [(.00225)($12,488,890 - $10,000,000)]. Given this, the required reduction would be
calculated as follows:

[($400,000)($5,600 ÷ $11,250)] = $199,111 Reduction

The small business deduction is equal to 16 percent of the least of:

• Canadian Active Business Income $440,000
• Taxable Income 473,000
• Reduced Annual Business Limit ($400,000 - $199,111) 200,889

The small business deduction would be $32,142 [(16%)($200,889)].

Note Three The 7 percent general rate reduction is available on Taxable Income, less the amounts that
benefit from the small business deduction. This amount is $19,048 [(7%)($473,000 - $200,889)].
Solution to Assignment Problem Fifteen - 13
The components required for the calculation of manufacturing and processing profits are as follows:

Adjusted Business Income Adjusted business income would be equal to the manufacturing
income of $523,000.

Cost Of Capital The cost of capital would be equal to 10 percent of the gross capital costs of
$1,499,500, an amount of $149,950.

Cost Of Manufacturing And Processing Capital This amount would be calculated as follows:

Cost Of Manufacturing Capital [(10%)($1,275,000)] $127,500

Multiple 100/85
Total $150,000

As this exceeds the total cost of capital, the cost of manufacturing capital would be $149,950.

Cost Of Labour This would simply be the total wage and salary costs of $1,951,900.

Cost Of Manufacturing And Processing Labour This amount would be calculated as follows:

Plant Employees $1,132,000

Quality Control Employees 211,200
Plant Supervision And Maintenance Employees 127,300
Receiving Employees 62,800
Total $1,533,300
Multiple 100/75
Total $2,044,400

As this exceeds the total cost of labour, the cost of manufacturing and processing labour would be
$1,951,900.

Based on the preceding amounts, the manufacturing and processing profits for the current year are
calculated as follows:

Given the preceding calculations, the manufacturing and processing profits deduction for the current year is
equal to 7 percent of the lesser of:

• Manufacturing And Processing Profits $523,000

• Taxable Income $595,800

The deduction would be $36,610 [(7%)($523,000)].

Solution to Assignment Problem Fifteen - 14
Part A Net Income For Tax Purposes for Industrial Tools Ltd. would be calculated as follows:

Accounting Income Before Taxes $2,305,000

Additions:
Taxable Capital Gain [(1/2)($950,000 - $875,000)] $ 37,500
Recaptured CCA ($875,000 - $625,000) 250,000
Charitable Donations 28,000
Interest And Penalties 2,500
Warranty Reserve 20,000
Amortization Expense 478,000 816,000
$3,121,000
Deductions:
CEC Amount [(7%)($115,000)] ($ 8,050)
Accounting Gain On Building ( 225,000)
CCA ( 523,000) ( 756,050)
Net Income For Tax Purposes $2,364,950

Part B Taxable Income for Industrial Tools Ltd. would be calculated as follows:

Net Income For Tax Purposes $2,364,950

Dividends Received ( 42,000)
Charitable Donations ( 23,000)
Net Capital Loss Carry Over (Note) ( 37,500)
Taxable Income $2,262,450

Note The net capital loss carry forward can be used only to the extent of the taxable capital gain
for the year, resulting in a deduction of $37,500. This leaves a remaining net capital loss carry
forward of $52,500 ($90,000 - $37,500).

Part C Federal Tax Payable for Industrial Tools Ltd. would be calculated as follows:

Base Amount Of Part I Tax [(38%)($2,262,450)] $859,731

Corporate Surtax [(4%)(28%)($2,262,450)] 25,339
Federal Tax Abatement [(10%)($2,262,450)] ( 226,245)
General Rate Reduction [(7%)($2,262,450)] ( 158,372)
Federal Tax Payable $500,453
Solution to Assignment Problem Fifteen - 15
The calculation of federal Part I Tax Payable would be as follows:

Canadian Active Business Income $187,000

Foreign Income (U.S. Branches) 32,000
Net Income For Tax Purposes And Taxable Income $219,000

Base Amount of Part I Tax [(38%)($219,000)] $ 83,220

Corporate Surtax [(4%)(28%)($219,000)] 2,453
Federal Tax Abatement [(10%)($187,000)] - Note One ( 18,700)
Foreign Business Income Tax Credit - Note Two ( 9,600)
Small Business Deduction [(16%)($187,000)] - Note Three ( 29,920)
General Rate Reduction [(7%)($219,000 - $187,000)] ( 2,240)
Part I Tax Payable $ 25,213

Note One The U.S. business income is not earned in a province and, as a consequence, is not eligible for
the federal tax abatement. In addition, such foreign business income is not eligible for the small business
deduction.

Note Two The foreign business income tax credit is $9,600, the least of the following three amounts:

• Actual Foreign Taxes Withheld ($6,200 + $3,400) $9,600

• An amount calculated as follows:

[Foreign Business Income ÷ Adjusted Net Income][Tax Otherwise Payable]
= [($32,000 ÷ $219,000)($83,220 + $2,453 - $2,240)] $12,191

• Tax Otherwise Payable, Less Non-Business

Foreign Tax Credits Deducted [($83,220 + $2,453 - $2,240) - Nil] $83,433

Note that the tests of the foreign tax credit amounts include the effect of the general rate reduction.

Note Three Given the preceding foreign tax credit, the small business deduction would be equal to 16
percent of the least of:
1. Canadian Active Business Income $187,000
2. Taxable Income $219,000
Less [(3)($9,600)] ( 28,800) $190,200
3. Annual Business Limit $400,000 $187,000

The least of the three figures is $187,000, and 16 percent of this amount is $29,920.