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Assessment: Income Tax Planning Web - Academic Partners Unit 3 Post-Assessment (C115V20U3L0A25Q20)
Date Submitted: 07/10/2022 07:35:00 PM
Total Correct Answers: 20
Total Incorrect Answers: 0

Your Mark (total correct percentage): 100%

1 Jeremy and Rita plan to incorporate their small business. What statement is true?

Correct

The correct answer:

Once the business is set up, Jeremy can set up a competing business as a sole proprietor.

Your answer:

Once the business is set up, Jeremy can set up a competing business as a sole proprietor.

Solution:

Once the business is set up, Jeremy can set up a competing business as a sole proprietor. Under a partnership, partners
have a duty of loyalty towards each other meaning they cannot set up a competing business. With a corporation a duty
of loyalty does not exist.

Unlike a partnership, a corporation is a separate legal entity from its owners so, it would continue to exist even if Jeremy
and Rita died. While a partnership must carry on business activities and have a profit motive, there is no such
requirement for a corporation. Shareholders of a corporation may be involved in the management of the company
however, they are not required to do so.

2 Tony and Armando currently operate a partnership, but they are thinking about incorporating their
business. Tony is unsure about some of the differences between corporations and partnerships. Which
of the following statements are FALSE?

1. If Armando dies, the corporation would cease to exist.

2. The corporation must carry on business activities.
3. Once the corporation is established, Tony would be free to set up a competing business as a sole
proprietor.
4. Both Tony and Armando would have limited liability for the debts and obligations of the
corporation.

Correct

The correct answer: 1 and 2

Your answer: 1 and 2
Solution:

Unlike a partnership, a corporation is a separate legal entity from its owners, so it would continue to exist even if the
owners died. While a partnership must carry on business activities, there is no requirement for a corporation to do so.
Partners have a duty of loyalty towards each other and they cannot set up competing businesses, but there is no such
duty of loyalty in the case of corporations. One of the major attractions of the corporate form of business is that it offers
the owners limited liability for the debts and obligations of the business.

(Statement 1 is false.) Unlike a partnership, a corporation is a separate legal entity from its owners. So, the corporation
would continue to exist even if Armando died.

(Statement 2 is false.) While a partnership must carry on business activities, there is no requirement for a corporation to
do so.

3 Solomon has heard that there may be advantages to investing in a Canadian-controlled private
corporation (CCPC), but he is unsure what that means. Which of the following companies would qualify
as a CCPC?

1. Brewmans, a brewery started by John Brewman in Guelph, Ontario using his grandfather's
recipes, where the shares are listed on the TSVX Stock Exchange.
2. The New Attitude Value Fund, a closed-end investment fund that trades on the Toronto Stock
Exchange that only holds shares in small Canadian corporations. Currently the shares of the Fund
are held by 120 different investors with holdings ranging from $300 to $80,000 each.
3. Balloons Away, an incorporated company that offers hot air balloon rides to Canadian corporate
executives. The shares of Balloons Away are held by Solomon's brother Sam, Sam's wife Jeanette,
and their two children, each of whom is a Canadian citizen.
4. Reuse-it Inc., a recycling company that was started as a worker's cooperative and that is now
incorporated with each one of the 200 Canadian employees owning 0.5% of the outstanding
shares. The total value of all of the outstanding shares is $800,000.

Correct

The correct answer: 3 only

Your answer: 3 only
Solution:

A public corporation is one that:

has one or more classes of its shares listed on a prescribed stock exchange in Canada
has elected, or has been designated by CRA, to be a public corporation and, among other conditions, its shares
are held by at least 150 shareholders, each of whom holds at least $500 worth of shares (ITA 89(1)).

A private corporation is one that is resident in Canada, is not a public corporation, and is not controlled directly or
indirectly by one or more public corporations (ITA 89(1)). Special income tax rules apply to private corporations.

A Canadian-controlled private corporation (CCPC) is a Canadian private corporation that is not controlled directly or
indirectly by one or more non-residents or public corporations (ITA 125(7)).

(Statement 3) The shares of Balloons Away are held by Solomon's brother Sam, Sam's wife Jeanette, and their two
children, each of whom is a Canadian citizen. The shares do not trade on a stock exchange, and they are not held by at
least 150 shareholders, so Balloons Away is not a public corporation. All of the shareholders are Canadian residents. So,
Balloons away is a Canadian-controlled private corporation because it is not a public corporation and it is controlled only
by Canadian residents.

4 Henry has used his family's secret recipes to start up a very successful fast food noodle shop, Oodles of
Noodles, in Vancouver. He originally started the business as a sole proprietor, but now he wants to
incorporate the business and possibly set up outlets in Toronto, Montreal and other major urban centres
across the country. Which of the following statements are FALSE?

1. Henry can obtain either a federal or a BC charter.

 2. Once he receives his corporate charter but before the first shareholders' meeting, he will have to
decide on how many directors the corporation should have.
3. Once Henry incorporates his company, he can raise capital for expansion of the business by
selling shares of the business to friends, relatives or even strangers.
4. He will have to perform a name search first if he wants to incorporate under the name "Oodles of
Noodles Ltd".

Correct

The correct answer: 2 only

Your answer: 2 only
Solution:

An entrepreneur can incorporate his or her business either under the Canada Business Corporations Act or under his or
her province's corporate legislation. The federal charter would allow the entrepreneur to do business in any province
without having to get the permission of the province first. However, if his or her business was incorporated under
provincial laws, he or she could still do business in the other provinces by registering his or her business there and
obtaining the province's permission, which usually is not a problem. An entrepreneur has to specify the number of
directors in the articles of incorporation, which must accompany his or her application for incorporation.

If an entrepreneur wants to incorporate his or her business under a specific name, instead of a numbered company, then
he or she will first have to perform a name search to ensure that the name is not being used elsewhere.

Once an entrepreneur incorporates the business, he or she can raise capital by selling shares to anyone, including both
arms' length and non-arms' length parties.

(Statement 2 is false.) Henry must specify the number of directors in the articles of incorporation, which must
accompany his application for incorporation. So, Harry cannot wait until after he receives his corporate charter to decide
on how many directors the corporation should have.

5 When Treetop Housing was first incorporated, it raised capital by issuing 100,000 shares at $10 per
share. Over the course of its first five years of business, Treetop had retained earnings of $1.4 million.
Unfortunately, the real estate market in that area is in a state of decline and the current value of
Treetop's net assets is only $1.6 million. As a result of the poor prospects for this market, shares in
Treetop are currently trading at $13.50 per share. What is the amount of Treetop's shareholders' equity?

Correct

The correct answer: $2,400,000

Your answer: $2,400,000
Solution:

The shareholders' equity is equal to the amount of cash or capital that the shareholders originally contributed to acquire
their interest in the corporation, plus any retained earnings.

(Choice D) Treetop raised capital by issuing 100,000 shares at $10 per share. It also had retained earnings over the last
five years of $1.4 million. So, Treetop's shareholders' equity is $2,400,000, calculated as ((number of shares issued x
issue price) + retained earnings) or ((100,000 x $10) + ($1,400,000)).

6 Gord holds shares in several corporations. Which of the following statements is FALSE?

Correct

The correct answer: Gord can receive capital dividends from his shares in Nortel, a public corporation.
Your answer: Gord can receive capital dividends from his shares in Nortel, a public corporation.
Solution:

Capital dividends result from certain types of income that were not taxable to the corporation, such as the tax-free
portion of capital gains, or the death benefit of life insurance policies. Only private corporations can pay capital
dividends.

If an open-end investment corporation or mutual fund realizes a capital gain by selling one of its portfolio investments, it
will distribute that gain to investors as a capital gains dividend, where only 50% is subject to tax.

A regular dividend is simply a dividend that has been paid periodically, usually quarterly, for a number of years. Regular
dividends can be paid by both public and private corporations. To the extent that a holding company has after-tax
income, it can pay regular dividends to its shareholders.

A stock dividend is a dividend that is paid by a corporation in the form of additional stock in the payer corporation,
accompanied by an increase in the paid-up capital of the corporation. Both public and private corporations can issue
stock dividends.

(Choice C is false.) Only private corporations can issue capital dividends. Nortel is a public corporation. So, Gord cannot
receive capital dividends from his Nortel shares.

7 Veronica holds shares in several corporations, including:

Privco, a Canadian controlled private corporation.

Pubco, a public corporation.
Investco, an open-end investment corporation.

Her investment advisor told her that from this portfolio, she might receive a combination of regular
dividends, capital dividends, capital gains dividends and stock dividends. However, Veronica has no idea
what the differences are between these types of dividends. Which of the following statements is FALSE?

Correct

The correct answer: She may receive a capital dividend from Investco.
Your answer: She may receive a capital dividend from Investco.
Solution:

Regular dividends represent a portion of a corporation's after-tax profits that is distributed to shareholders. Any after-tax
profits that are not distributed to shareholders are referred to as retained earnings. Public corporations, private
corporations and investment corporations can all issue regular dividends.

Only private corporations can pay capital dividends. These dividends result from certain types of income that were not
taxable to the corporation, such as the tax-free 50% of capital gains or the death benefit of certain life insurance
policies.

If an open-end investment corporation or mutual fund realizes a capital gain by selling one of its portfolio investments, it
will distribute that gain to investors as a capital gains dividend, where only 50% is subject to tax.

(Choice B is false.) Investco is an investment corporation, not a private corporation. So, Veronica cannot receive a
capital dividend from Investco.

8 Cecil is in the process of incorporating a business with three friends and he is drawing up a
shareholders' agreement with the assistance of a lawyer. Which of the following should the agreement
address?

1. The extent of each shareholder's liability for the debts of the corporation.
 2. The corporation's policy for hiring members of the shareholders' families.
3. The corporation's policy for lending money to its officers or shareholders.
4. The manner in which profits will be allocated to the individual shareholders.

Correct

The correct answer: 2 and 3

Your answer: 2 and 3
Solution:

Shareholders' agreements usually address the following issues:

issuing more shares

lending money to officers or shareholders
determining the payment and amounts of dividends
taking on new debt
using any corporation assets as collateral for debts
hiring family members
transferring shares
changing the nature or purpose of the business in any substantial way
signing any major contracts or leases

Unlike partnership agreements, shareholders' agreements cannot be used to specify how each shareholder will share in
the profits of the corporation. This is because the entitlement is already fixed according to the relative number of shares
that each shareholder owns. Also, the shareholders of the corporation have limited liability for the debts of the
corporation unless they have personally guaranteed a loan to the corporation, so there is no need to address this matter
in the shareholders' agreement either.

(Statement 2 and 3 are true.) So, Cecil's shareholders' agreement should address the corporation's policy for hiring
members of the shareholders' families and the corporation's policy for lending money to its officers or shareholders.

9 Perennial Passions Inc., a grower and distributor of exotic perennial plants, recorded net income of
$620,000 on its financial statements. When determining its net income for tax purposes, Perennial
Passions must do all of the following, EXCEPT:

Correct

The correct answer: deduct any depreciation expense and add capital cost allowance
Your answer: deduct any depreciation expense and add capital cost allowance
Solution:

The way that a corporation records income for accounting purposes and for tax purposes is different. In order to
determine net income for tax purposes, several adjustments must be made. For example:

Depreciation is an accounting concept, while capital cost allowance is the corresponding tax concept. Because a
company originally deducts depreciation expense when calculating net income for financial purposes, it must add
this back to its income and deduct capital cost allowance instead.
Interest and penalties on unpaid taxes are deductible for accounting purposes, but not for tax purposes, so a
company must add back any interest or penalties on income taxes when determining net income for tax
purposes.
The full amount of a gain realized upon the sale of a capital property is included in income for accounting
purposes, but only 50% of such a gain is taxable. So, a company must deduct any gains on the sale of assets and
add back the taxable capital gains.
Capital dividends received from another taxable Canadian corporation are not taxable, but they are included in
accounting income. So, a company must deduct any capital gains received from another taxable Canadian
 corporation when determining net income for tax purposes.

(Choice A) So, Perennial Passions will have to add back any depreciation expense and deduct capital cost allowance.

10 Steve and Barney are the only two shareholders of Near North Products Inc., a private Canadian corporation. Steve
owns 49% of the shares. The federal tax rate of the corporation after applying the general rate reduction is 25%.
Adding 10% provincial corporate tax would result in a combined corproate tax rate of 35%. Steve is a resident of
Canada; Barney lives in the United States and is not a Canadian resident. This year, the corporation had $60,000 in
taxable business income and Steve and Barney are considering the possibility of paying the after-tax amount
out either as dividends or as bonuses. Steve is in a 29% federal tax bracket and a 19.7% provincial tax bracket.

Non-Eligible (CCPC) DTC Enhanced DTC

Federal 9.0301% 15.02%

Provincial 5.13% 6.70%

What course of action would likely be MOST beneficial for Steve and why?

Correct

The correct answer:

Steve should take the bonus because he will have more left after-tax.

Your answer:

Steve should take the bonus because he will have more left after-tax.

Solution:

A Canadian-controlled private corporation (CCPC) is a Canadian corporation that is not controlled directly or indirectly by
one or more non-residents or public corporations. Subject to certain limits, active business income earned specifcially by
a CCPC may receive tax relief by way of the small businees deduction. The small business deduction (SMABUD) is
calculated at a rate of 19% of eligible income, where eligible income is the lesser of active business income, taxable
income and the small business deduction limit. This deduction effectively reduces the net federal tax rate to 9%,
calculated as (general corporate tax rate – SMABUD rate – federal abatement) or (38% – 19% – 10%). Provincial taxes
then increase this tax rate typically by 10%, resulting in a total combined provincial and federal corporate tax rate of
19%, calculated as (9% + 10%).

As Barney is a non-resident, Near North Products Inc. will not satisfy the definition of a Canadian-controlled private
corporation and therefore, it will not qualify for the small business deduction. As a result, the taxable income of the
company will be taxed at a federal corporate rate of 25%, calculated as (general corporate tax rate – general rate
reduction) or (38% – 13%) plus, 10% for provincial corporate tax. This leaves retained earnings of $39,000 calculated
as [taxable corporate income x (1 - (federal tax rate + provincial tax rate))] or [$60,000 x (1 – (25% + 10%))]. Of this
amount, $19,110 could be paid as a dividend to Stave calculated as (retained earnings x Steve's ownership interest) or
($39,000 x 49%).

Since Near North Products Inc. is not a CCPC its dividends will be eligible for the enhanced dividend tax credit. Steve's
taxable income would be $26,371.80 calculated as (dividend x enhanced gross-up rate) or ($19,110 X 138%). His
federal tax would be $3,686.78, calculated as [taxable dividend x (federal marginal tax rate – federal dividend tax
credit)] or [$26,371.80 x (29% – 15.02%)]. His provincial tax would be $3,428.33 calculated as [taxable dividend x
(provincial marginal tax rate – provincial dividend tax credit)] or [$26,371.80 x (19.70% – 6.70%)]. Therefore, if Steve
choses to receive a dividend, he would have $11,994.89 after tax, calculated as [dividend – (federal tax + provincial
tax)] or [$19,110 – ($3,686.78 + $3,428.33)].

If the money were paid as a bonus, it would be deductible from the income of the corporation and would not be subject
to corporate tax. Steve's bonus would be $29,400, calculated as (bonus x Steve's ownership interest) or ($60,000 x
49%) and it would be fully taxable to Steve. He would have $15,082.20 after tax, calculated as [bonus x (1 – (federal
marginal tax rate + provincial marginal tax rate))] or [$29,400 x (1 – (29% + 19.7%))].

So, Steve should take the bonus because he will have $3,087.31 more left after-tax compared to receiving dividends,
calculated as (after-tax amount of bonus – after-tax amount of dividends) or ($15,082.20 – $11,994.89).

11 John is the sole shareholder of a Canadian-controlled private corporation (CCPC), which is expecting net
income for this fiscal year to be $500,000. Which of the following methods can NOT be used to reduce
this net income to within the small business deduction limit?

Correct

The correct answer: repayment of the shareholder's loans

Your answer: repayment of the shareholder's loans
Solution:

The small business deduction (SMABUD) is only available on net income up to the SMABUD limit for the year. As long as
net income remains below this limit, the integration of the corporate and personal tax systems is such that there is not a
significant difference if corporate earnings are paid out as salary to an employee/shareholder, or as dividends. Once net
income is over this limit, however, the combined corporate/personal taxes increase significantly. So, CCPCs can try to
keep their net income below the SMABUD limit by:

declaring bonuses or increasing salaries

making deferred profit sharing plan (DPSP) contributions
making registered pension plan (RPP) contributions
making corporate-paid RRSP contributions
establishing deductible employee benefit programs

A loan repayment would not reduce active business income. So, the repayment of shareholder loans cannot be used to
reduce net income to optimize use of the small business deduction.

12 Barb has managed to establish a very successful placement agency for temporary secretarial support workers and
she is thinking about incorporating the business before she expands her services to include other service areas such
as data processing, graphic illustration and technical writing. She is attracted by the limited liability of the corporate
form of business, but she is also intrigued by the tax advantages, especially if the business qualifies for the small
business deduction. Which of the following statements are TRUE?

1. Barb would be able to reinvest more of her business earnings in the business using the corporate
form of business.
2. By allowing her husband, Richard, to purchase an interest in the business she can achieve some
income splitting within the family.
3. By allowing Richard to become a shareholder, collectively, they could shelter up to $1,766,768 in
taxable capital gains when they eventually sell the business.
4. Any income earned by the corporation would not be subject to tax until after it was paid out to
Barb as dividends. At that time, it would be eligible for the federal dividend gross-up and tax
credit scheme.

Correct

The correct answer:

1 and 2

Your answer:

1 and 2

Solution:

If Barb incorporates her business, she would be able to reinvest more of her business earnings in the business using the
corporate form of business. By allowing her husband, Richard, to purchase an interest in the business she could also
achieve some income splitting within the family.

There are several tax advantages to incorporating a business. If a business operates as a sole proprietorship, the net
income of the business would be subject to tax at the owner's marginal rate, which could mean that significantly less is
left to reinvest in the business. If the business is structured as a corporation that qualifies for the small business
deduction, the business would be taxed at a lower corporate rate of about 19% calculated as (general corporate tax rate
- SMABUD rate) or (38% - 19%). This would leave approximately 81% of its net income left to invest.

If a sole proprietor incorporates his or her business and, at the time of incorporation, his or her spouse acquires some of
the common shares of that corporation, any resulting dividend income would be split between the two spouses in
proportion to their ownership interests. If both spouses were shareholders, they could both make use of the lifetime
capital gains exemption. Cumulatively, this means they could shelter $1,766,768 in capital gains, calculated as (lifetime
capital gains exemption × # of shareholders) or ($883,384 x 2) and $883,384 in taxable capital gains, calculated as
(total capital gains sheltered x capital gains inclusion rate) or ($1,766,768 x 50%).

Income earned by the corporation is first taxed within the corporation. Dividends represent a distribution of after-tax
income to shareholders.

13 What is the purpose of the scheme referred to as Part IV tax?

Correct

The correct answer: discourage the shareholders of private corporations from deferring personal tax by leaving
dividend income from portfolio investments in a corporation
Your answer: discourage the shareholders of private corporations from deferring personal tax by leaving dividend
income from portfolio investments in a corporation
Solution:

Part IV tax is a refundable tax that is imposed on dividends that a corporation receives from its investment portfolio. As
a result, there is no advantage in leaving dividends received from the corporation's portfolio of investments in the
corporation.

(Choice A) So, the purpose of Part IV tax is to discourage the shareholders of private corporations from deferring
personal tax by leaving dividend income from portfolio investments in a corporation.

14 Susan is considering incorporating her business, Susco, and reinvesting the business income in a portfolio of
investments. If she does so, what statements are true?

1. The taxable investment income of the corporation would be taxed at approximately 19%, up to
the small business deduction limit.
2. If Susco invests its after-tax profits in shares of other unconnected taxable Canadian
corporations, any dividend income that Susco earns on those investments would not be subject to
Part 1 tax but, it would be subject to Part IV tax.
3. Susco would receive a tax refund of approximately $0.38 for every $1 of taxable dividends it paid
to Susan, up to the amount in its RDTOH account.
 4. If Susco earns interest income on its portfolio investments, it will be subject to a refundable Part
1 tax of 331/3%.

Correct

The correct answer:

2 and 3

Your answer:

2 and 3

Solution:

Only the taxable active business income—which typically excludes investment income—is eligible for the small business
deduction, which results in an approximate corporate tax rate of 19%. Investment income, other than dividend income,
is taxed at the full corporate rate of 38%. Normally, dividends flow tax-free from one taxable Canadian corporation to
another. However, to discourage owners of private corporations from leaving that dividend income in the corporation, the
Income Tax Act imposes a special refundable Part IV tax of 38.33% of the dividend income. This same amount is
credited to the corporation's RDTOH (refundable dividend tax on hand) account. When the corporation pays out taxable
dividends to its shareholders, it can claim a refund of $0.38 for every $1 in dividends paid, up to the balance in the
RDTOH account.

Other investment income, such as interest, is also subject to special treatment. It is subject to a refundable Part 1 tax of
30.67% which is credited to the RDTOH account.

15 Aiden is one of 10 shareholders in Privco, a Canadian-controlled private corporation. Each shareholder acquired 10%
of the outstanding 10,000 shares by contributing capital of $160,000. At the end of its first fiscal year, Privco had
retained earnings of $880,000. It decided to pay out a regular dividend of $480,000 and to capitalize $400,000 of its
retained earnings while issuing a stock dividend of 25%. What statement is FALSE?

Correct

The correct answer:

As a result of issuing the stock dividend, the total fair market value of Privco's shares will likely drop.

Your answer:

As a result of issuing the stock dividend, the total fair market value of Privco's shares will likely drop.

Solution:

A stock dividend is a dividend that is paid by a corporation in the form of additional stock in the payer corporation,
accompanied by an increase in the paid-up capital of the corporation (ITA 248(1)). Stock dividends are taxed just like
any other dividend and they are eligible for the dividend gross-up and tax credit scheme. The amount of this deemed
dividend is equal to the shareholder's portion of the increase in the paid-up capital associated with the stock dividend.

In contrast, in the case of a stock split, there is an increase in the number of shares accompanied by a proportional
decrease in the legal paid-up capital per share, so that neither the total amount of legal paid-up capital nor the amount
of surplus available for distribution as a dividend is altered. The fair market value of the shares usually decreases after a
stock split because there is an increase in the number of shares without an increase in the paid-up capital of the
corporation. However, in the case of a true stock dividend, the increase in the number of shares is accompanied by a
capitalization of retained earnings, so the value of the shares should not drop.

A stock dividend is treated just like a regular dividend for tax purposes so, it is subject to a gross up of 115% in the case
of a CCPC (in most instances) and 138% for public corporations. The value of a stock dividend is equal to the increase in
the paid up capital that accompanied it.

Privco capitalized retained earnings of $400,000 when it issued a stock dividend of 25%. So, the total fair market value
of Privco's shares should not drop as a result of issuing the stock dividend.

16 Peter is one of six shareholders, but not an employee, of a Canadian-controlled private corporation that
manufactures windows. The corporation has a large amount of cash on hand and the other shareholders
have agreed that the corporation can lend him $50,000 for a few years. To avoid having the principal
included in his taxable income, which of the following conditions must the loan meet?

Correct

The correct answer: It must be repaid within one year of the end of the fiscal year in which it was made.
Your answer: It must be repaid within one year of the end of the fiscal year in which it was made.
Solution:

A loan can be made to a shareholder who is not an employee for any purpose without being included in that
shareholder's income, as long as the loan is repaid within one year of the end of the corporation's taxation year in which
the loan was made, and provided that the loan is not part of a series of loans. If the interest rate charged is less than
the rate prescribed by ITR 4300, the shareholder is considered to be receiving a taxable benefit equivalent to interest at
the prescribed rate less any interest charged.

(Choice C) Peter is a shareholder, but not an employee. So, he is permitted to receive a loan for any purpose without
having it included in his income as long as the loan is repaid within one year of the end of the fiscal year in which it was
made.

17 Scott is the sole owner of Operco, a Canadian controlled private corporation that manufactures optical
lenses. He decided to create a holding company, HOLDCO, to hold his shares in Operco. He bought 50%
of the non-voting common shares of HOLDCO, while his wife Allison bought 30% and each of their 4
children acquired 5% each. He then transferred his shares in Operco into HOLDCO in exchange for all of
the preferred voting shares of the HOLDCO. All of the following statements are true, EXCEPT:

Correct

The correct answer: Any dividends paid by Operco to HOLDCO will be subject to a refundable Part IV tax.
Your answer: Any dividends paid by Operco to HOLDCO will be subject to a refundable Part IV tax.
Solution:

To split income with family members, the owner of an operating company can set up a holding company as an empty
shell. As long as the holding company has no assets, the family members can acquire non-voting common shares of that
HOLDCO for a small amount, say $1 per share. Once the family members have their common shares, the owner of the
operating company rolls over his or her shares in that operating company to HOLDCO in exchange for voting preferred
shares. This allows the original business owner to keep control over the business, while giving him or her an income in
the form of dividends from the preferred shares. It also passes any future growth in the operating company to the
common shareholders, by establishing an estate freeze. If the original owner of the operating company elects to hold
some of the common-shares in HOLDCO, he or she will have established only a partial estate freeze, because some of
the future growth will be taxable to the owner.

The after-tax profits from the operating company are paid into HOLDCO tax free, because they are both taxable
Canadian corporations. This removes assets from the reach of the creditors of the operating company, without having
the dividend income immediately taxable to the shareholders, leaving more to invest within HOLDCO. HOLDCO will not
have to pay Part IV tax on these dividends because the two companies are connected and the income is not considered
to be income from portfolio investments.

(Choice B) HOLDCO and Operco are both taxable Canadian corporations, so any dividends paid by Operco to HOLDCO
will not be subject to a refundable Part IV tax.

18 Ted is considering incorporating his professional practice. Which of the following is NOT an advantage of
professional incorporation?

Correct

The correct answer: Ted will be able to reduce the taxes on his professional income by paying himself dividends that
are eligible for the dividend tax credit.
Your answer: Ted will be able to reduce the taxes on his professional income by paying himself dividends that are
eligible for the dividend tax credit.
Solution:

Owners of small business corporations have the choice of receiving their compensation in the form of salary, which is
fully deductible to the corporation and fully taxable to the owner, or as dividends. In the case of dividends, business
income is first taxable to the corporation, and the after-tax profits are paid to the owner in the form of dividends, which
in turn are subject to the dividend gross-up and tax credit scheme, resulting in personal tax. The dividend gross-up and
tax credit scheme is designed to integrate the personal and corporate tax systems. As long as the corporation's income
is less than the small business limit, the dividend tax credit scheme should result in almost the same combined
corporate/personal tax as would be paid if the entire amount was paid out as salary.

19 Stephanie is an accountant in a province that permits incorporation of a professional practice. If Stephanie

incorporates her accounting practice, what statement is FALSE?

Correct

The correct answer:

If the practice loses money, both Stephanie and her husband would be able to deduct the loss from their other sources
of income.

Your answer:

If the practice loses money, both Stephanie and her husband would be able to deduct the loss from their other sources
of income.

Solution:

The greatest advantage of a professional corporation is tax reduction. The professional corporation does not offer its
shareholders any tax advantages that are not available to the shareholders of any other corporation. It simply enables
some professionals to incorporate their practices so they can benefit from those tax advantages, while preventing them
from benefiting from the limited liability that is otherwise available to corporate shareholders. So, once a professional
practice is incorporated, it can take advantage of the small business deduction on net active business income up to the
SMABUD limit. Spouses and other family members can acquire an interest in the corporation so that income splitting can
be achieved and all shareholders can make use of the lifetime capital gains exemption.

In the case of corporations, business losses cannot flow through to shareholders to be applied against other income.
However, the losses can be deducted from past or future profits of the corporation, with some restrictions.

Once Stephanie incorporates her practice, business losses will no longer flow through to her. So, if the practice loses
 money, neither Stephanie nor her husband would be able to deduct the loss from their other sources of income.

20 Georgia is an entrepreneur who enjoys the challenge of raising new capital, getting a new business up
and running and then letting someone else take over. This allows her to reap the financial benefits
before moving on to the next new venture. In most cases the businesses have been successful, but a
couple have failed dramatically. Georgia favours the corporate form of business and retains a controlling
interest in each business. Which of the following statements are TRUE?

1. By structuring each new business as a separate corporation, Georgia protects the successful
businesses from the ones that are financial failures.
2. Georgia can use the business losses that result from the unsuccessful businesses to offset the
taxable profits that result from the successful businesses.
3. If Georgia maintains an active role each business, she is in danger of losing her limited liability
status.
4. If one of Georgia's incorporated businesses is a direct mail advertising business, she can start a
similar business as a sole proprietor.

Correct

The correct answer: 1 and 4

Your answer: 1 and 4
Solution:

Each corporation is a distinct legal entity and the shareholders are not personally liable for the debts of the corporation.
Shareholders of a corporation always have limited liability regardless of whether or not they take an active role in the
business, unless they have personally guaranteed a business loan. Shareholders do not have a duty of loyalty to their
corporations. Corporations do not flow through losses to the shareholders in the same manner as partnerships or
proprietorships flow through their losses to the partners or proprietors.

(Statement 1 is true.) Each corporation is a distinct legal entity and the shareholders are not personally liable for the
debts of the corporation. So, even though Georgia maintains a controlling interest in each corporation, if one business
fails it will not affect the finances of the other businesses.

(Statement 4 is true.) Shareholders do not have a duty of loyalty to their corporations. So, if one of Georgia's
incorporated businesses is a direct mail advertising business, she can start a similar business as a sole proprietor.

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