1

LECTURE 6 PROBLEM SET

Updated April 28, 2014

It is now early July 2014 and your client, Walter, has just finished meeting with Ralph
Macho a partner at your accounting firm. Walter owns 100% of the shares of W Ltd. a
Canadian controlled private corporation (CCPC). Ralph has called you, CPA, into his
office.
Ralph has informed you that Walter wants to sell his business and retire and he will either
sell all his shares or have W Ltd. sell all its assets, pay all its liabilities and wind-up.
Walters shares are qualified small business corporation (QSBC) shares and he has never
used any of his capital gains exemption.
Ralph wants you to draft a memo to file calculating the after-tax proceeds of each option.
Ralph has provided you with the following information (see Exhibit I)

Exhibit I
W Ltd.
Additional Information

Walter has received an offer to purchase all of his shares of W Ltd. for $200,000.
The purchaser has also offered to instead buy all the assets of W Ltd. for FMV
and is flexible about either buying the shares or the assets (depending upon what
Walter wants)
The purchaser will continue on the business of W Ltd.
The PUC and ACB of Walters shares of W Ltd. is $100 in aggregate
Ralph says to assume: W Ltd. is taxable at a combined corporate rate (i.e., federal
and provincial) of: 18% on active business income eligible for the small business
deduction; and 40% on all other income. These rates exclude the 6 2/3%
additional refundable tax (ART). Ralph says that Walter has other income and has
a combined (federal and provincial) personal income tax rate of 45% on ordinary
income; and that Walter can get a provincial dividend tax credit equal to: 4.5%
times the taxable dividends received for non-eligible dividends; and 10% times
the taxable dividends received for eligible dividends
Ralph also says to assume that W Ltd.s taxable income is zero, its capital
dividend account has been correctly computed as $20,000, and its RDTOH is
$30,000 immediately before the sale of W Ltd. assets takes place

Copyright Joanne Magee/Jason Fleming

The following is a projected balance sheet showing assets and liabilities at tax
costs with estimated fair market values (FMV) at todays date:

Assets
Marketable securities, at cost (FMV: $15,000)
Accounts receivable (face value is $83,000, a reserve of $3,000 was
claimed in the prior year; FMV: $80,000)
Equipment, at UCC (FMV: $13,000, cost $25,000)
Intangibles, at CEC a/c balance (FMV: $200,000, cost 0)
Liabilities (Bank loan and Accounts payable)
Net Assets

Tax Cost
5,000
80,000
16,000
0
$ 101,000
(70,000)
$31,000

SOLUTION

Memo
To: File
From: CPA
Re: W Ltd.
Sale of Shares
If Walter sells his W Ltd. shares he will have the following income tax consequences:
P of D
$200,000
Less: ACB
($100)
Capital gain
$199,900
Since Walters W Ltd. shares are QSBC shares and he has never used any of his $800,000
capital gains exemption, this gain will be tax-free.
Hence Walter will receive after-tax cash of $200,000 if he sells his shares.
W Ltd. sells assets, pays liabilities and winds-up
If W Ltd. sells its assets it will pay tax on any income/gains and the after-tax proceeds
will be used to pay liabilities and then distributed to Walter as part of the wind-up.

Copyright Joanne Magee/Jason Fleming

Asset

Note

Open bal.
Mkt Sec.
A/R
Equipment
CEC
Liabilities

1
2
3
4

Income tax
(17,460 +2,333)
Div.ref.
5
=RDTOH

1.

2.

3.

4.

5.

Proceeds
15,000
80,000
13,000
200,000
(70,000)
(19,793)

ABI

0
(3,000)
100,000
97,000
@ 18%
17,460

Investment
Income

CDA

RDTOH

20,000
5,000

30,000

5,000

5,000
@ 46 2/3%
2,333

31,333

@ 26 2/3%

249,540

1,333

Marketable securities
Proceeds
Less: cost
Capital gain
taxable capital gain
CDA
Accounts receivable
- add back reserve
- loss on A/R = $80K FMV cost
$83K cost = $80K (which is net of $3K reserve) plus $3K reserve
Vender and purchaser should jointly elect using section 22

100,000
125,000

1,333
31,333

15,000
(5,000)
10,000
5,000
5,000

3,000
(3,000)

Equipment
Lesser of: cost ($25k) and proceeds ($13k)
Less: UCC
Terminal loss

13,000
(16,000)
(3,000)

Intangibles
Proceeds
Less: cost
Economic gain
ABI (1/2)
CDA (1/2)

200,000
(0)
200,000
100,000
100,000

RDTOH
AII = $5,000 x 26 and 2/3% = $1,333

Since the taxable dividend to Walter (see below) is more than $94,000 (i.e., more than 3 x
the RDTOH balance of $31,333) the company can get a dividend refund equal to W
Ltd.s RDTOH balance.
Copyright Joanne Magee/Jason Fleming

As can be seen in the chart above, the after-tax proceeds remaining after paying the
liabilities is $249,540. First the company can (and should) file an election to pay a taxfree capital dividend to Walter equal to the capital dividend account balance of $125,000.
Then the company will redeem all its shares for FMV of $124,540 (i.e., $249,540 $125,000).
Step 1
Redemption proceeds
Less: PUC (received tax-free)
Deemed dividend

$124,540
(100)
$124,440

Step 2
Adjusted P of D ([$124,540 - $124,440 (i.e., deemed div.)]
Less: ACB
CG (= TCG)

100
(100)
Nil

Walter will pay tax on the grossed up deemed dividend. This is a non-eligible dividend
since all of W Ltd.s income is either active business income and/or AII.
Grossed up dividend 1.18 x $124,440
$146,839
Federal tax (45% x $146,839)
$66,078
Federal DTC [13/18 x $22,399 (i.e., $146,839 - $124,440)]
($16,177)
Provincial DTC (4.5% x $146,839)
($6,608)
Personal tax on dividend
$43,293
Hence after the wind-up, Walter will receive:
Capital dividend (tax-free)
Redemption proceeds
Less personal tax on dividend

$125,000
$124,540
$249,540
($43,293)
$206,247

Conclusion
Walter should have W Ltd. sell its assets for FMV, pay its liabilities and wind-up since
this way Walter will end up with $206,247 which is $6,247 more than he would receive if
he sold his shares for $200,000.

Copyright Joanne Magee/Jason Fleming