Solution to Assignment Problem Three-1

Cheeco Marques
As the bonus is not paid within three years of the end of the year in which the services were rendered,
this is a salary deferral arrangement. The company will deduct the bonus in the taxation year ending
November 30, 2020. As it was earned in 2020, Cheeco will have to include the bonus in the calendar
year ending December 31, 2020.

Zeppo Marques
In this case, the bonus is paid within 180 days of the company’s November 30, 2020, year end. Given
this, the company will be able to deduct the bonus in that year. However, Zeppo will not have to
include it in income until the calendar year ending December 31, 2021.

Groucho Marques
The company will deduct the bonus in the year ending November 30, 2020. Groucho will include it in
income in the calendar year ending December 31, 2020.

Harpo Marques
In this case, the bonus is not paid within 180 days of the company’s November 30, 2020, year end.
This means that the company will not be able to deduct the bonus until the taxation year ending
November 30, 2021. Harpo will include the bonus in income in the calendar year ending December
31, 2021.
Solution to Assignment Problem Three-3
Part A - Jordan Chooses The Lexus ES
If Jordan chooses the Lexus ES and selects Option 1, the taxable benefit will be calculated as
follows:
Standby Charge [(2%)(12)($60,000)] $14,400
Operating Cost Benefit (Jordan Pays His Own Costs) Nil
Total Taxable Benefit $14,400
Number Of Years 2
Total Taxable Benefit - Option 1 $28,800

Given this, the after tax cash flow associated with Option 1 would be calculated as follows:
Signing Bonus ($150,000 - $60,000) $90,000
Tax Consequences:
Signing Bonus ($ 90,000)
Taxable Benefit ( 28,800)
Increase In Taxable Income ($118,800)
Jordan’ Marginal Tax Rate 51% ( 60,588)
Net Cash Inflow (Outflow) $29,412

Alternatively, the after tax cash flow associated with Option 2 would be as follows:
Signing Bonus $150,000
Purchase Price Of Vehicle ( 60,000)
Tax Consequences:
Signing Bonus ($150,000)
Jordan’ Marginal Tax Rate 51% ( 76,500)
Trade In Proceeds 30,000
Net Cash Inflow (Outflow) $ 43,500

With respect to the Lexus ES alternative, selecting Option 2, is the better alternative. Note that, as
Jordan pays his own operating expenses in both Option 1 and Option 2, this factor can be ignored
in our calculations.

Part B - Jordan Chooses the Audi S8

If Jordan chooses the Audi S8 and selects Option 1, the taxable benefit will be calculated as follows:
Standby Charge [(2%)(12)($150,000)] $36,000
Operating Cost Benefit (Jordan Pays His Own Costs) Nil
Total Taxable Benefit $36,000
Number Of Years 2
Total Taxable Benefit - Option 1 $72,000

Given this, the after tax cash flow associated with Option 1 would be calculated as follows:

Signing Bonus Nil

Tax Consequences:
Taxable Benefit ($72,000)
Signing Bonus Nil
Increase In Taxable Income ( 72,000)
Jordan’ Marginal Tax Rate 51% ($36,720)
Net Cash Inflow (Outflow) ($36,720)
Alternatively, the after tax cash flow associated with Option 2 would be as follows:
Signing Bonus $150,000
Purchase Price Of Vehicle ( 150,000)
Tax Consequences:
Signing Bonus ($150,000)
Jordan’ Marginal Tax Rate 51% ( 76,500)
Trade In Proceeds 70,000
Net Cash Inflow (Outflow) $ 6,500

Once again, operating costs are ignored in that Jordan pays his own operating costs in both Option
1 and Option 2. In this case, Option 2 is the better alternative. As was the case with the Lexus ES,
Option 2 is the better alternative. These results largely reflect the fact that, in Option 2, Jordan
benefits from the trade-in value of the vehicle.
Although the requirements of the problem ask that only the cash flows be considered, we would
note that the alternative of purchasing the car carries more uncertainty. Both the resale value and
the actual operating costs are estimates. If there was a large variation from the estimate for either
or both of these amounts, it could substantially affect the total cash outflow of the purchase
alternative.
Solution to Assignment Problem Three-9
Case 1
The required information under the assumption that Salter Inc. is a Canadian controlled private
corporation is as follows:
• Year of granting and year of exercise - No tax effect.
• Year of sale - The tax effects would be as follows:
Fair Market Value Of Acquired Shares [($37.80)(410)] $15,498.00
Cost Of Acquired Shares [($32.00)(410)] ( 13,120.00)
Employment Income $ 2,378.00
Taxable Capital Gain [(410)($45.80 - $37.80)(1/2)] 1,640.00
Increase In Net Income For Tax Purposes $ 4,018.00
Deduction Under ITA 110(1)(d) [(1/2)($2,378)] ( 1,189.00)
Increase In Taxable Income $ 2,829.00

As the option price was greater than the fair market value of the shares at the time the options were
issued, the ITA 110(1)(d) deduction can be taken.

Case 2
The required information under the assumption that Salter Inc. is a Canadian controlled private
corporation is as follows:
• Year of granting and year of exercise - No tax effect.
• Year of sale - As the option price was less than the fair market value of the shares at the time
the options were granted, no deduction is available under ITA 110(1)(d). However, Sharon held
the shares for more than two years after their acquisition and, as a consequence, she can claim
a deduction against employment income under ITA 110(1)(d.1). The tax effects would be as
follows:

Fair Market Value Of Acquired Shares [($37.80)(410)] $15,498.00

Cost Of Acquired Shares [($32.00)(410)] ( 13,120.00)
Employment Income $ 2,378.00
Taxable Capital Gain [(410)($43.20 - $37.80)(1/2)] 1,107.00
Increase In Net Income For Tax Purposes $ 3,485.00
Deduction Under ITA 110(1)(d) Nil
Deduction Under ITA 110(1)(d.1) [(1/2)($2,378)] ( 1,189.00)
Increase In Taxable Income $ 2,296.00

Case 3
The required information under the assumption that Salter Inc. is a Canadian public company is as
follows:
• Year of granting - No tax effect.
• Year of exercise - The results for this year would be as follows:
Fair Market Value Of Acquired Shares [($37.80)(410)] $15,498.00
Cost Of Acquired Shares [($32.00)(410)] ( 13,120.00)
Employment Income And
Increase In Net Income For Tax Purposes $ 2,378.00
Deduction Under ITA 110(1)(d) [(1/2)($2,378)] ( 1,189.00)
Increase In Taxable Income $ 1,189.00
 As the option price was greater than the fair market value of the shares at the time the
options were issued, the ITA 110(1)(d) deduction can be taken.
• Year of sale - There would a taxable capital gain calculated as follows:
Proceeds Of Disposition [(410)($42.10)] $17,261.00
Adjusted Cost Base [(410)($37.80)] ( 15,498.00)
Capital Gain $ 1,763.00
Inclusion Rate 1/2
Taxable Capital Gain $ 881.50

This would be both the increase in Net Income For Tax Purposes and the increase in
Taxable Income for the year.

Case 4
The required information under the assumption that Salter Inc. is a Canadian public company
is as follows:
• Year of granting - No tax effect.
• Year of exercise - As the option price was less than the fair market value of the shares at
the time the options were issued, the ITA 110(1)(d) deduction from Taxable Income is not
available. As Salter is a public company, no deduction is available under ITA 110(1)(d.1).
The tax effects would be as follows:
Fair Market Value Of Acquired Shares [($37.80)(410)] $15,498.00
Cost Of Acquired Shares [($32.00)(410)] ( 13,120.00)
Employment Income And
Increase In Net Income For Tax Purposes $ 2,378.00
Deduction Under ITA 110(1)(d) Nil
Increase In Net Income And Taxable Income $ 2,378.00

• Year of sale - There would an allowable capital loss calculated as follows:

Proceeds Of Disposition [(410)($31.00)] $12,710.00
Adjusted Cost Base [(410)($37.80)] ( 15,498.00)
Capital Loss ($ 2,788.00)
Inclusion Rate 1/2
Allowable Capital Loss ($ 1,394.00)

The effect on Net Income For Tax Purposes and Taxable Income would be nil unless
Sharon had taxable capital gains during the year.

Note to Instructor: Depending on what has been covered in your course, students may or
may not be expected to comment on the ability to carry the capital loss back or forward as
follows:
If she has taxable capital gains in the previous three years or any year in the future, the
loss could be carried back or carried forward and deducted in the determination of Taxable
Income.
Solution to Assignment Problem Three-11
For an employee who earns commissions, motor vehicle costs (other than CCA and financing costs)
and other travel costs can be deducted under either ITA 8(1)(f) or, alternatively a combination of ITA
8(1)(h) and 8(1)(h.1). A potential problem arises in that:
• The total deducted under ITA 8(1)(f) is limited to commission income.
• A commission salesperson cannot use ITA 8(1)(f) for some costs (e.g., entertainment and
advertising costs) and use ITA 8(1)(h) and 8(1)(h.1) for his travel costs. If he uses ITA
8(1)(f), he cannot use ITA 8(1)(h) and 8(1)(h.1).
This means that if he is deducting items like entertainment and advertising, which can only be
deducted under ITA 8(1)(f), he will have to deduct travel costs under that provision as well. This
procedure may result in exceeding the commission income limit.
In order to deal with this problem, separate calculations must be made for ITA 8(1)(f) including motor
vehicle and travel costs, and for the total of motor vehicle and travel costs under ITA 8(1)(h) and ITA
8(1)(h.1). Note that the deductions available under ITA 8(1)(i) and ITA 8(1)(j) are not affected by the
choice of ITA 8(1)(f) vs. ITA 8(1)(h) and 8(1)(h.1).
The relevant expense deduction calculations are as follows:
ITA 8(1)(f) ITA 8(1) ITA 8(1)
(Limited to (h) and (h.1) (i) and (j)
$21,460)
Automobile Costs:
Operating Costs
[(43,000/52,000)($10,920)] $ 9,030 $ 9,030 -
Financing Costs
[(43,000/52,000)($2,750)] - - $2,274
CCA [(43,000/52,000)($4,500)] - - 3,721

Professional Dues - - 422

Work Space In The Home Costs:

Interest On Mortgage - - -
Property Taxes [(25%)($3,750)] 938 - -
Utilities [(25%)($1,925)] - - 481
Insurance [(25%)($1,060)] 265 - -
Repairs [(25%)($4,200)] - - 1,050

Travel Costs 26,900 26,900 -

Non-Deductible Meals
[(50%)($11,300)] (Note 1) ( 5,650) ( 5,650) -

Entertainment [$1,920 + $864

+ ($10,500 - $2,850)] 10,434 - -
Non-Deductible Entertainment
[(50%)($10,434)] (Note 2) ( 5,217) - -
Total $36,700 $30,280 $ 7,948

Note 1 Jerald can deduct 50 percent of his meals while traveling for his employer. Whether
the meals are with clients or not does not affect the deductibility.
Note 2 The hockey tickets as well as the cost of the golf club meals would be considered to be
entertainment costs. As such, only 50 percent of these amounts would be deductible. Note,
however, the golf club membership fees are not deductible.
The required calculation of minimum Net Employment Income would be as follows:
Salary $175,000
Commissions 21,460
Expenses ($30,280 + $7,948 - Note 3) ( 38,228)
RPP Contributions (Note 4) ( 4,100)
Awards And Gifts ($425 + $225 - $500 + $400) (Note 5) 550
Stock Option Benefit (Note 6) 1,125
Net Employment Income $155,807

Note 3 The deduction of dues and other expenses under ITA 8(1)(i) and automobile capital
costs (CCA and financing costs) under ITA 8(1)(j) is permitted without regard to other
provisions used.
The deduction for work space in the home costs has been split between ITA 8(1)(i) and (f).
Since the utilities and maintenance portions can be deducted under ITA 8(1)(i) by any
employee, it is not limited by the commission income. The insurance and property tax
components are limited as they are deducted under ITA 8(1)(f). A limitation, which is not
illustrated in this problem, prevents the deduction of work space in the home costs from
creating an employment loss.
As the ITA 8(1)(f) amount is limited to the $21,460 in commission income, the total deduction
using ITA 8(1)(f), (i), and (j), is $29,408 ($21,460 + $7,948).
Using the combination of ITA 8(1)(h), (h.1), (i), and (j) produces a deduction of $38,228 ($30,280
+ $7,948). Note that when this approach is used, work space in the home costs are limited
to utilities and maintenance. Further, there is no deduction for entertainment costs. However,
this approach results in deductions totaling $8,820 ($38,228 - $29,408) more than the
amount available using ITA 8(1)(f), (i), and (j) due to the effect of the commission income
limit.
Note 4 The employer’s contributions to the RPP are not considered to be a taxable benefit.
Note 5 An employee can receive any number of non-cash, non-performance awards and,
as long as the total is less than $500 for the year, there is no taxable benefit. In this case,
Jerald receives non-cash awards of $650 ($425 + $225). The extra $150 ($650 - $500) will
have to be included in income. In addition, he will have to include the gift certificate for $400
as it would be considered a near cash award. Note that he could also have received a long-
service award of up to $500 on a tax free basis. However, it does not appear that such an
award was given.
Note 6 There is an employment income inclusion on the exercise of the stock options of $1,125
[(500)($19.75 - $17.50)]. While there is a deduction equal to one-half of this amount available,
it is a deduction from Taxable Income and does not enter into the calculation of net
employment income. There is also a taxable capital gain on the sale of the 100 shares, but
that too does not enter into the calculation of net employment income.