CHAPTER 11

Computation of Taxable Income and Tax after

General Reductions for Corporations
Problem 1
[ITA: 3; 110.1–112]
The following data summarizes the operations of Red Pocket Limited for the years of 2002 to 2005 ended
September 30.
2002 2003 2004 2005
Income (loss) from business...... $ 54,000 $ 32,000 $ (75,000) $ 62,500
Dividend income — Taxable 42,500 22,500 18,000 10,500
Canadian corporations............
Taxable capital gains.................. 11,000 2,500 5,000 9,000
Allowable capital losses............. 2,000 4,500 3,500 —
Allowable business investment 3,750 — — —
loss..........................................
Charitable donations.................. 23,000 9,000 3,000 13,000
The corporation has a net capital loss balance of $13,500 which arose in 1998.
— REQUIRED
Compute the taxable income for Red Pocket Limited for the years indicated and show the amounts that are
available for carryforward to 2006. (Deal with each item line-by-line across the years, rather than computing
income one year at a time.)

229
230 Introduction to Federal Income Taxation in Canada
Solution 1
2002 2003 2004 2005
Par. 3(a) Income from business....................... $ 54,000 $ 32,000 Nil $ 62,500
Income from property....................... 42,500 22,500 $ 18,000 10,500
$ 96,500 $ 54,500 $ 18,000 $ 73,000
Par. 3(b) Taxable capital gains......................... 11,000 2,500 5,000 9,000
Allowable capital losses.................... (2,000) (2,500) (3,500) Nil
1

Par. 3(c) $ 105,500 $ 54,500 $ 19,500 $ 82,000

Par. 3(d) ABIL................................................. (3,750) n/a n/a n/a
Business loss..................................... n/a n/a (75,000) n/a
Par. 3 (e) Income from Division B.................... $ 101,750 $ 54,500 Nil $ 82,000
Sec. 112 Inter-company dividends................... (42,500) (22,500) — (10,500)
$ 59,250 $ 32,000 Nil $ 71,500
Sec. 110.1 Charitable donations2:
Carryover.................................... n/a — — (3,000)
Current........................................ (23,000) (9,000) — (13,000)
$ 36,250 $ 23,000 Nil $ 55,500
Par. 111(1)(b) Net capital losses3.............................. (9,000) — (1,500) (500)
$ 27,250 $ 23,000 Nil $ 55,000
Par. 111(1)(a) Non-capital losses4............................ (27,250) (23,000) — (24,750)
Taxable income................................................................ Nil Nil Nil $ 30,250

— NOTES TO SOLUTION
(1) A maximum of $2,500 can be deducted in 2003.
(2) Charitable donations:
2002: Lesser of: (a) 75% of $101,750 = $76,313
(b) $23,000
Carryforward: Nil
2003: Lesser of: (a) 75% of $54,500 = $40,875
(b) $9,000
Carryforward: Nil
2004: Lesser of: (a) 75% of Nil = Nil
(b) $3,000
Carryforward: $3,000
2005: Lesser of: (a) 75% of $82,000 = $61,500
(b) $3,000 + $13,000 = $16,000
Carryforward: Nil

(3) Net capital losses

1998 net capital loss converted to 2002 rates: $13,500 × 1/2/3/4........................................... $ 9,000
Net capital loss deducted in 2002 to the extent of net taxable capital gains......................... (9,000)
Nil
2003 net capital loss not utilized.......................................................................................... $ 2,000
2004 net capital loss deducted to the extent of net taxable capital gains.............................. (1,500)
$ 500
2005 remaining net capital loss deducted in 2005 to the extent of net taxable capital gains (500)
Available for carryforward................................................................................................... Nil
 Solutions to Chapter 11 Assignment Problems 231
(4) Non-capital losses
Par. 3(d) Loss from business in 2004........................................................... $ 75,000
Dividends deducted under sec. 112............................................... 18,000 $ 93,000
Add: net capital loss deducted............................................................................................ 1,500
$ 94,500
Less: sec 3(c): par. 3(a) dividends................................................................. $ 18,000
par. 3(b) taxable capital gain................................................. 1,500 19,500
$ 75,000
Losses utilized: 2002..................................................................................... $ 27,250
2003..................................................................................... 23,000
2005..................................................................................... 24,750 75,000
Closing balance.................................................................................................................. Nil
232 Introduction to Federal Income Taxation in Canada
Problem 2
[ITA: 111(4), (5), (5.1); 249(4)]
On November 1, 2005, Chris purchased all the issued shares of Transtek Inc. from an acquaintance, Tom.
Transtek carries on a transmission repair business and has done so since its incorporation on January 1, 2004. In
addition to the transmission repair business, Transtek rents out a small building it owns. Neither the transmission
repair business nor the rental endeavour has been successful.
When Chris purchased Transtek, his financial projections indicated that Transtek would have significant
income within two years. Chris credited Transtek’s failure to Tom’s brash personality and laziness. Chris, on the
other hand, has a strong work ethic and has many contacts in the automotive industry to refer work to him.
The values of the capital assets owned by Transtek at the time of purchase by Chris are as follows:
Repair shop Rental property
Land Building Land Building
F.M.V...................... $ 140,000 $ 230,000 $ 70,000 $ 120,000
Cost/A.C.B.............. 80,000 150,000 90,000 120,000
U.C.C...................... — 147,000 — 120,000
Chris selected June 30, 2006, as the first fiscal year-end for Transtek after his purchase. The following is a
schedule of Transtek’s income (and losses) from its inception, January 1, 2004, through June 30, 2007.
Transmission Rental Capital
Period repair business income (loss) Loss
Jan. 1/2004–Dec.
31/2004.................... $ (40,000) $ (2,000) $ (10,000)
Jan. 1/2005–Oct.
31/2005.................... (60,000) (5,000) —
Nov. 1/2005–June
30/2006.................... (25,000) 6,000 —
July 1/2006–June
30/2007.................... 54,000 11,000 —
— REQUIRED
(A) Discuss the tax implications of the acquisition of Transtek Inc. on November 1, 2005, ignoring all
possible elections/options.
(B) Determine the tax consequences of the acquisition of Transtek Inc. under the assumption that:
(i) the maximum amount of all elections/options is utilized; and
(ii) the partial amount of all elections/options is utilized so that only enough income is generated to offset
most or all of the losses which would otherwise expire on the acquisition of control.
 Solutions to Chapter 11 Assignment Problems 233
Solution 2
The data given in the problem statement can be summarized as follows:

Note that if no election is made, there is no income to offset the current business loss of $60,000 or the non-
capital loss carryforward of $40,000. Therefore the non-capital loss available to carry forward from October 31,
2005 is $100,000 (i.e., $60,000 + $40,000). Note that the $2,000 of non-capital loss carryforward from a property
loss expires.
If the maximum election is made, the $3,000 of recapture offsets the business loss, leaving $57,000 (i.e.,
$60,000 – $3,000) of net business loss. The $70,000 of taxable capital gain offsets the $22,000 of expiring losses,
leaving $48,000 (i.e., $70,000 – $22,000) to offset the remaining $57,000 of business loss. There is no remaining
taxable capital gain to offset some of the $40,000 non-capital loss carryforward. As a result, the non-capital loss
available for carry forward from October 31, 2005 is $40,000.
If only a partial election is made, it should be enough to offset only $20,000 of the $22,000 of expiring
losses. The other $2,000 of expiring loss is the property loss carryforward which can only be utilized if enough
Division B income is elected, resulting in the elimination of the current business loss, as was the case with the
maximum election. If a partial election of only $20,000 of taxable capital gain is made, the current business loss
of $60,000 is not offset and, hence, is available to carry forward, along with the $40,000 of business non-capital
losses, from October 31, 2005 for a total of $100,000.
Part A (Ignoring all possible elections)
An acquisition of control occurred when Chris acquired more than 50% of the voting shares of Transtek Inc.
from an unrelated person, Tom.
The taxation year of Transtek is deemed to end immediately before the acquisition of control, October 31,
2005 [ssec. 249(4)].
Tax returns are required to be filed for this short year (i.e., 10 months) and amounts, such as C.C.A. (if
claimed), will have to be prorated.
It is assumed that any accrued losses in inventory and accounts receivable have been recognized in
calculating the business loss of $60,000.
234 Introduction to Federal Income Taxation in Canada
There are no accrued losses on the depreciable property. Therefore, there is no adjustment required [ssec.
111(5.1)].
There is a $20,000 accrued loss on the rental property land that must be recognized. The A.C.B. of the land
is reduced from $90,000 to $70,000 [par. 111(4)(c)]. The $20,000 reduction is deemed to be a capital loss
[par. 111(4)(d)].
The income (loss) for the taxation year ended October 31, 2005 is computed below.
Par. 3(a) Business income....................................................................................................... Nil
Property income........................................................................................................ Nil
Par. 3(b) Net capital gains:
Taxable capital gains...................................................................... Nil
Allowable capital loss: rental property ($20,000 × 1/2).................. $ (10,000) Nil
Par. 3(c) Nil
Par. 3(d) Business loss...................................................................................... $ (60,000)
Property loss....................................................................................... (5,000) $ (65,000)
Division B income.................................................................................................... Nil

The net capital losses (($10,000 × 1/2) + $10,000 = $15,000) expire immediately following the October 31,
2005 year-end [par. 111(4)(a)].
The non-capital loss balance at November 1, 2005 is computed as follows:
Balance, Jan. 1, 2005................................................................................................................... $ 42,000
Loss for taxation year ended Oct. 31, 2005:
from business................................................................................................. $ 60,000
from property................................................................................................. 5,000
$ 65,000
Less Par. 3(c) amount determined above.............................................................. 0 65,000
Balance, Oct. 31, 2005................................................................................................................ $ 107,000
Less: unutilized losses about to expire:
non-capital property losses.......................................................... $ 2,000
current property loss.................................................................... 5,000 7,000
Balance, Nov. 1, 2005................................................................................................................. $ 100,000

Only the portion of the non-capital loss that may reasonably be regarded as a loss from carrying on a
business ($40,000 + $60,000 = $100,000) is deductible after October 31, 2005. Thus, the rental losses ($2,000 +
$5,000 = $7,000) expire immediately following the October 31, 2005 year-end [par. 111(5)(a)].
The $100,000 non-capital loss will be deductible only if the following condition is met — the transmission
repair business is carried on for profit or with a reasonable expectation of profit throughout the taxation year in
which the losses are to be claimed [spar. 111(5)(a)(i)]. The condition appears to be met for the June 30, 2006 and
the June 30, 2007 taxation years. The transmission repair business was carried on throughout each of the years. It
was carried on for profit for the taxation year ended June 30, 2007. Due to Chris’s work ethic and contacts in the
industry, it is reasonable to assume that it was carried on with a reasonable expectation of profit for the taxation
year ended June 30, 2006, despite the loss that was actually realized.
The $100,000 non-capital loss is deductible only to the extent of income from the transmission repair
business and income from a business selling similar products or providing similar services [spar. 111(5)(a)(ii)].
Thus, $54,000 of the non-capital loss incurred prior to November 1, 2005 is deductible for the June 30, 2007
taxation year. None of it is deductible for the June 30, 2006 taxation year due to the loss in that year. The
remainder ($100,000 – $54,000 = $46,000) can be carried forward to 2008 subject to these same restrictions.
 Solutions to Chapter 11 Assignment Problems 235
These restrictions do not apply to the non-capital loss ($25,000 – $6,000 = $19,000) incurred in the taxation
year ended June 30, 2006. Thus $11,000 of the 2006 non-capital loss is deductible in 2007, in addition to the
$54,000 mentioned above.
Part B (i) (Maximum election)
Paragraph 111(4)(e) allows Transtek to elect to be deemed to have disposed of the repair shop land for
proceeds of $140,000 (maximum) and the repair shop building for proceeds of $230,000 (maximum). If Transtek
makes this election, the A.C.B. of the land on November 1, 2005 will be $140,000 and the A.C.B. of the building
will be $230,000. The new undepreciated capital cost for the building will be limited by paragraph 13(7)(1) to
$150,000 + 1/2 ($230,000 – 150,000) = $190,000.
The income for the taxation year ended October 31, 2005 will be as follows:
Par. 3(a): Business income........................................................................................................ Nil
Property income........................................................................................................ Nil
Par. 3(b): Net capital gains:
Taxable capital gains:
Repair shop land ($140,000 – $80,000) × 1/2................................. $ 30,000
Repair shop building ($230,000 – $150,000) × 1/2......................... 40,000
$ 70,000
Allowable capital loss ($20,000 × 1/2)................................................ (10,000) $ 60,000
Par. 3(c) ............................................................................................................ $ 60,000
Par. 3(d) Business loss....................................................................................... $ (60,000)
Less: recapture — building ($147,000 – $150,000)........................... 3,000
$ (57,000)
Property loss....................................................................................... (5,000) (62,000)
Division B income....................................................................................................................... Nil
Division C deductions:
Par. 111(1)(a) Net capital loss from 2004..................................................... $ (5,000)
Par. 111(1)(b) Non-capital loss:
Business.......................................................... $( Nil)
Property........................................................... (Nil) (Nil) (5,000)
Taxable income........................................................................................................................... Nil
Non-capital loss balance, Nov. 1, 2005: Business Property Total
Balance, Jan. 1, 2005............................................................... $ 40,000 $ 2,000 $ 42,000
Added in taxation year ended Oct. 31/05
($60K – $5K – $5K – $57K.................................................... 7,000 Nil 7,000
Utilized in taxation year ended Oct. 31, 2005 or expired........ (Nil) (2,000) (2,000)
Remaining............................................................................... $ 47,000 Nil $ 47,000

The $47,000 remaining may reasonably be regarded as a loss from carrying on business and thus is
deductible in a taxation year after October 31, 2005, subject to the restrictions discussed in Part A.
By making the maximum elections possible, the non-capital loss balance of Transtek at November 1, 2005
has been significantly reduced.
Part B (ii) (Minimum election to utilize expiring losses)
The following losses will expire October 31, 2005, if not utilized:
The 2004 net capital loss.............................................................................................. $ 5,000
The Oct. 31, 2005 allowable capital loss...................................................................... 10,000
The rental loss portion of the 2004 non-capital loss..................................................... 2,000
The Oct. 31, 2005 rental loss........................................................................................ 5,000
$ 22,000

It is impossible to utilize the rental loss portion of the 2004 non-capital loss of $2,000 without triggering
sufficient income under paragraph 3(c) to utilize the entire October 31, 2005 business loss. This would not be
beneficial. Therefore, only $20,000 of the expiring losses will be used.
236 Introduction to Federal Income Taxation in Canada
To utilize these losses in the taxation year ending October 31, 2005, a capital gain of 2 × $20,000 = $40,000
is needed. To avoid recapture, the election should be made on the land, not the building.* Thus, Transtek will
elect under paragraph 111(4)(e) to be deemed to have disposed of the repair shop land for proceeds of $120,000,
i.e., (2 × $20,000) + 80,000. The A.C.B. of the land at November 1, 2005 will be $120,000.

* An alternative is considered below.

The income for the taxation year ended October 31, 2005 will be as follows:
Par. 3(a) Business income........................................................................................................ Nil
Property income........................................................................................................ Nil
Par. 3(b) Net capital gains:
Taxable capital gain:
Repair shop land ($120,000 – $80,000) × 1/2..................................... $ 20,000
Allowable capital loss ($20,000 × 1/2)................................................ (10,000) $ 10,000
Par. 3(c)....................................................................................................................................... $ 10,000
Par. 3(d) Business loss....................................................................................... $ (60,000)
Property loss....................................................................................... (5,000) (65,000)
Division B income....................................................................................................................... Nil
Division C deductions:
Par. 111(1)(a) Net capital loss from 2004............................................................................ $ (5,000)
Taxable income............................................................................................................................ Nil

The net capital loss claimed has no effect on taxable income, but it will increase the non-capital loss balance.
The non-capital loss balance at November 1, 2005 is computed as follows:
Balance, Jan. 1, 2005................................................................................................................... $ 42,000
Par. 3(d) Loss for taxation year ended Oct. 31, 2005:
from business........................................................................................ $ 60,000
from property........................................................................................ 5,000
$ 65,000
Add: Net capital loss deducted.............................................................................. 5,000
$ 70,000
Less: Par. 3 (c) amount determined above............................................................ 10,000 60,000
*
Balance, Oct. 31, 2005................................................................................................................ $ 102,000
Less: the unutilized non-capital property loss............................................................................. 2,000
Balance, Nov. 1, 2005................................................................................................................. $ 100,000

* Exactly equal to the business loss above.

Only the portion of the non-capital loss that may reasonably be regarded as a loss from carrying on a
business ($40,000 + $60,000 = $100,000) is deductible after October 31, 2005. It is subject to the restrictions
discussed in Part A.
Summary:
The three alternatives presented above are summarized as follows for comparative purposes:
Taxable Income for the Deemed Taxation Year Ended October 31, 2005:
No election Maximum election Partial election
Par. 3(a) Income from non-capital sources (≥ 0)....................... Nil Nil Nil
Par. 3(b) Net taxable capital gains (≥ 0):
Deemed taxable capital gains (elective):
land..................................................... Nil $ 30,000 $ 20,000
building.............................................. Nil 40,000 Nil
Accrued allowable capital loss
(automatic):
rental land........................................... $ (10,000) Nil (10,000) $ 60,000 (10,000) $ 10,000
Par. 3(c) Par. 3(a) + par. 3(b)..................................................... Nil $ 60,000 $ 10,000
 Solutions to Chapter 11 Assignment Problems 237

Par. 3(d) Losses from non-capital sources and

ABILs:
Loss from business operations.................... $ (60,000) $ (60,000) $(60,000)
Recapture (elective): building..................... Nil 3,000 Nil
Loss from property...................................... (5,000) (65,000) (5,000) (62,000) (5,000) (65,000)
Division B income...................................................................... Nil Nil Nil
Optional net capital loss deducted........................ Nil (5,000) (5,000)
Non-capital loss deducted:
From property.............................................. Nil Nil Nil
From business.............................................. Nil Nil Nil (Nil) Nil Nil
Taxable income.......................................................................... Nil Nil Nil

Non-Capital Losses Available for Carryforward at Deemed Taxation Year Ended Oct. 31, 2005:
No election Maximum election Partial election
Balance from Jan. 1, 2005.......................................................... $ 42,000 $ 42,000 $ 42,000
Non-capital loss — Oct. 31, 2005:
Par. 3(d) losses — see above........................ $ 65,000 $ 62,000 $ 65,000
Add: net capital losses deducted................... Nil 5,000 5,000
$ 65,000 $ 67,000 $ 70,000
Less: par. 3(c) income — see above............. Nil 65,000 60,000 7,000 10,000 60,000
$ 107,000 $ 49,000 $ 102,000
Less: losses utilized at Oct. 31, 2005..................... Nil Nil Nil
losses not utilized but expired:
Current property loss............................ $ 5,000 Nil Nil
Carryforward property loss.................. 2,000 7,000 2,000 2,000 2,000 2,000
Available for carryforward from Nov. 1, 2005.......................... $ 100,000 $ 47,000 $ 100,000
Net Capital Losses available for Carryforward.......................... Nil Nil Nil

The results of the above comparison of the three alternatives are further summarized as follows:
Alternatives (A) (B)(i) (B)(ii)
Taxable income................................................................. Nil Nil Nil
Net capital loss deducted................................................... Nil $ 5,000 $ 5,000
Non-capital loss balance, Nov. 1, 2005............................. $ 100,000 47,000 100,000
A.C.B. of repair shop land................................................. 80,000 140,000 120,000
A.C.B. of repair shop building.......................................... 150,000 230,000 150,000
U.C.C. of repair shop building.......................................... 147,000 190,000 147,000
*

* $147,000 + $3,000 + 1/2 × ($230,000 – $150,000)

Alternative B (ii) is better if the non-capital loss can be offset by income generated in the next seven years.
The resultant lower A.C.B. of the land and building under this option is only relevant on a disposition. The lower
U.C.C. on the building only represents an opportunity loss of C.C.A. at a 4% declining balance rate.
Consider the alternative of electing deemed proceeds of disposition of $190,000 (i.e., (2 × $20,000) +
$150,000) on the repair shop building. Income under paragraph 3(b) would be the same as for Part B (ii).
However, the business loss under paragraph 3(d) would be only $57,000 (i.e., $60,000 – $3,000 recapture), since
recapture would be triggered. This would reduce the non-capital loss balance at November 1, 2005 by $3,000 to
$97,000. However, the UCC of the repair shop building could be increased from $147,000 to $170,000 (i.e., +
$3,000 of recapture + $20,000 of taxable capital gain). The increased CCA base would begin to shelter income
from tax, in this case, in the year ended June 30, 2006, when the corporation earns a profit. If, for example, the
corporation uses a discount rate of 10% and faces a tax rate of 20%, the present value of the tax shield on the
incremental UCC base of $23,000 (i.e., $170,000 – $147,000) is:
$23,000 × .04 × .20
= $1,314
.04 + .10
The value of the extra $3,000 in the non-capital loss balance in the same year and at the same assumed tax
rate of 20% is $600 (i.e., 20% of $3,000).
238 Introduction to Federal Income Taxation in Canada
Problem 3
[ITA: 111(4), (5), (5.1); 249(4)]
In 2002, a chain of bakeries, called Buscat Ltd., commenced operation. The industry is highly competitive
and because of Mr. Buscat’s lack of marketing skills, the corporation incurred losses in the first three taxation
years of operations as follows:

Non-capital Capital
Taxation year-end losses losses
Dec. 31, 2002.................................................. $ 60,000 $ 12,000
Dec. 31, 2003.................................................. 45,000 8,000
Dec. 31, 2004.................................................. 25,000 4,000
On July 1, 2005, Mr. Buscat decided to sell 75% of his common shares to Mr. Bran, owner of Buns Plus
Ltd. Mr. Bran has been in the business of supplying bread dough, pastry dough and bun bags for ten years and
has been very successful. Buns Plus Ltd. has two divisions: a bakery and a coffee shop, which it intends to
transfer to Buscat Ltd.
The following income tax data relates to Buscat Limited’s operations from January 1, 2005 to June 30,
2005:
(a) Business loss (before inventory valuation).. $ 10,000
(b) Allowable capital loss................................. 2,000
(c) Property loss................................................ 5,500
(d) Assets at June 30, 2005:
Cost/A.C.B. U.C.C. F.M.V.
Inventory............................. $ 85,000 — $ 65,000
Land.................................... 155,000 — 195,000
Building.............................. 65,000 $ 45,000 75,000
Bakery equipment............... 100,000 86,000 70,000
During the later part of the 2005 calendar year, the bakery/coffee shop of Buns Plus Ltd. was transferred to
Buscat Ltd. For the six-month period ending on December 31, 2005, Buscat Limited had net income of $90,000
from all its businesses.
The net income earned was as follows:
Buscat bakery..................................................... $ (55,000)
Buns Plus bakery................................................ 130,000
Coffee shop........................................................ 15,000
$ 90,000
In the 2006 taxation year, Buscat Ltd. expects to earn $250,000, of which $65,000 will be from the original
Buscat bakery business and $20,000 from the coffee shop business.
— REQUIRED
Prepare an analysis of the income tax implications of the acquisition of shares. In your analysis, consider the
two election options from which an election choice is most likely to be made.
 Solutions to Chapter 11 Assignment Problems 239
Solution 3
The data given in the problem statement can be summarized as follows:

The two election options to consider are the maximum election and the partial election.
If the maximum election is made, the $20,000 of recapture offsets the business loss, leaving $26,000 (i.e.,
$46,000 – $20,000) of net business loss. The $25,000 of taxable capital gain offsets the $19,500 of expiring
losses, leaving $5,500 (i.e., $25,000 – $19,500) to offset the remaining $26,000 of business loss, leaving $20,500
of that business loss. As a result, the non-capital loss available for carry forward from June 30, 2005 is $150,500
(i.e., $20,500 + $130,000).
If only a partial election is made to offset the $19,500 of expiring losses, the current business loss of
$46,000 is not offset and, hence, is available to carry forward, along with the $130,000 of non-capital losses,
from June 30, 2005 for a total of $176,000. If the election is made on the land, the ACB of the land can be
increased without a tax cost.
Note that if no election is made there is no income to offset the current business loss of $46,000 or the non-
capital loss carryforward of $130,000. Therefore, the non-capital loss available to carry forward from June 30,
2005 is $176,000 (i.e., $46,000 + $130,000), which is the same as in the partial election, but there is no increase
in any cost value..
Deemed Year-end
Buscat Ltd. is deemed to have a taxation year ending June 30, 2005, immediately before the acquisition of
control by Buns Plus Ltd. on July 1, 2005 [ssec. 249(4)]. Tax returns will have to be filed for this short taxation
year (i.e., 6 months) and amounts such as C.C.A. will have to be prorated. In addition, the short taxation year will
cause the counting of a carryforward year for the non-capital losses from 2002, 2003 and 2004.
240 Introduction to Federal Income Taxation in Canada
Loss from Non-capital Sources
Losses from non-capital sources for the deemed taxation year ended June 30, 2005, before any elections and
options are computed as follows:
Loss from business....................................................................................................... $ 10,000
Add: Inventory loss [ssec. 10(1)] ($85,000 – $65,000).............................................. 20,000
Bakery equipment — Deemed CCA ($86,000 – $70,000)................................ 16,000
Total business losses..................................................................................................... $ 46,000
Add: Property loss (will expire unless utilized by June 30, 2005).............................. 5,500
Total losses from non-capital sources........................................................................... $ 51,500

Maximum Election
Division B income and taxable income
Par. 3(a) Income from non-capital sources................................................................................ Nil
Par. 3(b) Net taxable capital gains:............................................................................................
Election on land [($195,000 – $155,000) × 1/2].................................................. $ 20,000
Election on building [($75,000 – $65,000) × 1/2]................................................ 5,000
$ 25,000
Less: Allowable capital loss................................................................................ 2,000
Par. 3(c) Sum of par. 3(a) plus par. 3(b) less any Subdivision e deductions (nil)...................... $ 23,000
Par. 3(d) Property loss........................................................................................... $ 5,500
Business losses....................................................................................... 46,000
$ 51,500
Less: Building recapture......................................................................... 20,000 31,500
Sec. 3 income................................................................................................................................ Nil
Division C deductions:
Net capital losses: 2002..................................................................................... $ 6,000
2003..................................................................................... 4,000
2004..................................................................................... 2,000 $ 12,000
Taxable income............................................................................................................................. Nil

Non-capital losses available for carryforward after acquisition of control:

Balance — July 1, 2005
2002 non-C.L..................................................................................................... $ 60,000
2003 non-C.L..................................................................................................... 45,000
2004 non-C.L..................................................................................................... 25,000 $ 130,000
Non-C.L. from deemed taxation year before acquisition of control:
Total par. 3(d) loss (see above calculation)....................................................... $ 31,500
Add: Net capital loss deducted.......................................................................... 12,000
$ 43,500
Less: Par. 3(c) income above............................................................................. 23,000 20,500
Total non-capital losses................................................................................................................. $ 150,500

The $150,500 loss carryforward balance must “reasonably be regarded as its loss from carrying on a
business.”
2002, 2003 and 2004 loss carryforwards from a business as stated in the question............... $ 130,000
June 30, 2004 business loss net of recapture..................................................... $ 26,000
Less portion of this loss used against par. 3(c) income*................................... 5,500 20,500
$ 150,500

* Par. 3(c) income........................................................................................................ $ 23,000

Less:
Property losses....................................................................... $ 5,500
Net capital losses restored as business losses....................... 12,000 17,500
$ 5,500
 Solutions to Chapter 11 Assignment Problems 241
The non-capital losses will expire as follows, assuming that Buscat Ltd.’s fiscal year-end after the
acquisition of control returns to December 31.
2002 non-C.L. — on December 31, 2008
2003 non-C.L. — on December 31, 2009
2004 non-C.L. — on December 31, 2013
2005 deemed taxation year — on December 31, 2014
The adjusted cost base/capital cost of the properties which were deemed to be sold at their fair market values
would be:
Capital U.C.C. Adjusted
cost cost base
Bakery equipment................................................................... $ 100,000 $ 70,000 $ 100,000
Land........................................................................................ n/a n/a 195,000
Building*................................................................................ 70,000 70,000 75,000

* $65,000 + 1/2 ($75,000 – $65,000).

In order for these non-capital losses to be deductible in subsequent fiscal periods, two conditions in
subparagraph 111(5)(a)(i) must be met:
(a) the bakery business which generated the loss must be carried on throughout the taxation year in which
the non-capital loss is deducted; and
(b) the bakery business must be carried on for profit or with a reasonable expectation of profit.
It would appear that both conditions will be met, since the Buscat business is being carried on and Buns Plus
expects that the Buscat bakery business will earn a profit of $65,000 in 2006.
If the conditions of subparagraph 111(5)(a)(i) are met, then the non-capital losses may be deducted from
income of the bakery business that generated the loss plus the income from the sale of similar products or
services. If it can be assumed that the bakery business, transferred to Buscat Ltd., sells similar products and/or
services as the Buscat bakery business, then the maximum $90,000 of non-capital losses can be deducted on
December 31, 2005 as follows:
Lesser of:
(a) Net income for year...................................................................................................... $ 90,000
(b) Income from: the loss business............................................................... Nil
the sale of similar products.............................................. $ 130,000 $ 130,000

The remaining $60,500 ($150,500 – $90,000) of non-capital losses can be carried forward to 2006 subject to
the deductibility tests discussed above.
Partial election
The minimum amount to be elected upon under paragraph 111(4)(e) (i.e., proceeds of disposition) should be
an amount equal to 2 times the sum of:
(a) the allowable capital loss of $2,000 which is about to expire,
(b) the net capital losses of $12,000 which would otherwise expire, and
(c) the property loss of $5,500 which otherwise expires plus the adjusted cost base of the property to be
elected upon.
If the land was chosen as the asset to trigger all of the taxable capital gain, then the deemed proceeds would
be determined as:
[2 × ($2,000 + $5,500 + $12,000) + $155,000] or $194,000
The resulting taxable income computation would be:
Par. 3(a) Non-capital sources of income Nil
Par. 3(b) Net taxable capital gain:
Land, 1/2 ($194,000 – $155,000)......................................................... $ 19,500
Allowable capital loss......................................................................... (2,000) $ 17,500
Par. 3(c) Sum of par. 3(a) plus par. 3(b) less any Subdivision e deductions (nil).................... $ 17,500
242 Introduction to Federal Income Taxation in Canada
Par. 3(d) Property loss....................................................................................... $ 5,500
Business loss....................................................................................... 46,000
$ 51,500
Less: Building recapture..................................................................... Nil 51,500
Sec. 3 income.............................................................................................................................. Nil
Division C
Net capital loss............................................................................................................................ $ 12,000
Taxable income........................................................................................................................... Nil
Non-capital losses available for carryforward after the acquisition of control:
Balance, July 1, 2005................................................................................................................... $ 130,000
Non-capital losses from the deemed taxation year ended June 30, 2004.............. $ 51,500
Add: Net capital losses deducted above................................................................ 12,000
$ 63,500
Less: Par. 3(c) income above................................................................................ 17,500 46,000
*
Total non-capital losses............................................................................................................... $ 176,000

* Exactly equal to the business loss above.

Summary
The two alternatives presented above are summarized as follows for comparative purposes:
Taxable Income for the Deemed Taxation Year Ended June 30, 2005:
Maximum Partial
election election
Par. 3(a) Income from non-capital sources (≥ 0)................................ Nil Nil
Par. 3(b) Net taxable capital gains (≥ 0):
Deemed taxable capital gains (elective):
land.................................................... $ 20,000 $ 19,500
building.............................................. 5,000 Nil
Allowable capital loss............................... (2,000) $ 23,000 (2,000) $ 17,500
Par. 3(c) Par. 3(a) + par. 3(b)............................................................. $ 23,000 $ 17,500
Par. 3(d) Losses from non-capital sources and ABILs:
Loss from business.................................... $ (46,000) $ (46,000)
Recapture (elective): building................... 20,000 Nil
Loss from property.................................... (5,500) (31,500) (5,500) (51,500)
Division B income............................................................................... Nil Nil
Optional net capital loss deducted........................................................ (12,000) (12,000)
Non-capital loss deducted.................................................................... Nil Nil
Taxable income.................................................................................... Nil Nil

Non-Capital Losses available for Carryforward at Deemed Taxation Year ended June 30, 2005:
Maximum election Partial election
Balance, Jan. 1, 2005............................................................................ $ 130,000 $ 130,000
Non-capital loss — June. 30, 2005:
Par. 3(d) losses — see above.................................... $ 31,500 $ 51,500
Add: net capital losses deducted............................... 12,000 12,000
$ 43,500 $ 63,500
Less: par. 3(c) income — see above......................... 23,000 20,500 17,500 46,000
$ 150,500 $ 176,000
Less: losses utilized at June 30, 2005............................. Nil Nil
losses not utilized but expired............................... Nil Nil Nil Nil
Available for carryforward from June. 30, 2005.................................. $ 150,500 $ 176,000
Net Capital Losses available for Carryforward................................... Nil Nil
 Solutions to Chapter 11 Assignment Problems 243

The results of the above comparison of the two alternatives are further summarized as follows:

Alternatives (a) (b) Difference

Taxable income......................................................................... 0 0 0
Net capital loss deducted.......................................................... $ 12,000 $ 12,000 0
Total non-capital losses available for carryforward.................. 150,500 176,000 $ 25,500
A.C.B. of land........................................................................... 195,000 194,000 (1,000)
U.C.C. of building..................................................................... 70,000 45,000 (25,000)
A.C.B. of building..................................................................... 75,000 65,000 (10,000)
Alternative (b) is better if the additional $25,500 of non-capital loss can be offset by income generated in the
next 10 years. The resultant lower A.C.B. of the land under this option is only relevant on a disposition. The
lower U.C.C. on the building only represents a loss of C.C.A. at a 4% declining balance rate. On the other hand,
if an additional $25,500 of income cannot be generated in the next seven years (i.e., business losses continue),
Alternative (a) is better.
244 Introduction to Federal Income Taxation in Canada
Problem 4
[ITA: 9–20; 38–55; 110.1–112]
The controller of Video Madness Inc. has prepared the accounting income statement for the year ended
April 30, 2005:
VIDEO MADNESS INC.
INCOME STATEMENT
FOR THE YEAR ENDED APRIL 30, 2005
Sales.................................................................. $ 995,000
Cost of sales...................................................... $ 523,000
Administrative expenses................................... 185,000 708,000
Operating income.............................................. $ 287,000
Other income and expenses.............................. 55,000
$ 342,000
Provision for income taxes................................ 102,000
Net income........................................................ $ 240,000

Other Information
(1) Included in the calculation of “Administrative expenses”:
(a) Interest on late income tax payments............................. $ 435
(b) Depreciation and amortization (maximum capital cost
allowance of $149,500).................................................. 104,900
(c) Club dues for the local Country Club............................. 1,750
(d) Federal political contributions........................................ 2,500
(e) Donations to registered charities.................................... 22,500
(f) Property tax with respect to vacant land not being used
in the course of the business........................................... 3,000
(g) Life insurance premium with respect to the president
(the company is the beneficiary; not required for
financing)....................................................................... 1,950
(2) Included in the calculation of “Other income and
expenses”:
(a) Landscaping of ground around new premise................. 4,800
(b) Fees paid with respect to the investigation of a suitable
site for the company’s manufacturing plant................... 5,500
(c) Dividends received from taxable Canadian corporation
of $42,800 and foreign corporation dividends received
(not from a foreign affiliate) of $5,500 (Cdn.)............... 48,300
(d) Gain from the sale of another piece of land, used in the
business, sold for $200,000 in March (purchased for
$73,800)......................................................................... 126,200
(e) Loss on sale of investments held as capital property
purchased for $85,000 and sold for $75,000.................. 10,000
(3) Loss carryforwards from 2004 are:
(a) Non-capital losses.......................................................... 73,800
(b) Net capital losses (realized in 1999).............................. 75,000
— REQUIRED
Prepare a schedule reconciling the accounting net income to income for tax purposes and taxable income.
Indicate the appropriate statutory reference for your inclusions or exclusions.
 Solutions to Chapter 11 Assignment Problems 245
Solution 4
Net income before income taxes.................................................................................................. $ 342,000
Add: Loss on the sale of investment [ssec. 9(3)]................................................. $ 10,000
Depreciation and amortization [par. 18(1)(b)]........................................... 104,900
Interest on income tax payments [par. 18(1)(t)]......................................... 435
Club dues [par. 18(1)(l)]............................................................................ 1,750
Political contributions [par. 18(1)(n)]........................................................ 2,500
Charitable donations [par. 18(1)(a)]........................................................... 22,500
Property tax on vacant land [ssec. 18(2)]................................................... 3,000
Life insurance premium [pars. 18(1)(a), (b), (c)]....................................... 1,950 147,035
Subtotal...................................................................................................... $ 489,035
Deduct: Capital cost allowance [par. 20(1)(a)].................................................... $ 149,500
Gain on sale of land [ssec. 9(3)]............................................................. 126,200 275,700
$ 213,335
Add: Taxable capital gain on business land [sec. 38]: 1/2 × ($200,000 –
$73,800)................................................................................................. $ 63,100
Allowable capital loss on investments [sec. 38]: 1/2 × ($75,000 –
$85,000):................................................................................................ (5,000) 58,100
Net income under Division B................................................................................ $ 271,435
Less Division C deductions:
Charitable donations [sec. 110.1]................................................................... $ 22,500
Dividends [sec. 112]...................................................................................... 42,800
Non-capital loss [par. 111(1)(b)]................................................................... 73,800
Net capital loss [par. 111(1)(a)]: $75,000 × 4/3 × 1/2..................................... 50,000 189,100
Taxable income..................................................................................................... $ 82,335

The following items were correctly included on the accounting income statement:
(a) Landscaping costs [par. 20(1)(aa)];
(b) Site investigation fees [par. 20(1)(dd)];
(c) Dividends from taxable Canadian corporations [par. 12(1)(j)]; and
(d) Dividends from foreign corporations [par. 12(1)(k)].
246 Introduction to Federal Income Taxation in Canada
Problem 5
[ITA: 124; ITR: 400]
The taxpayer, whose head office was in Manitoba, manufactured and sold various fans. Local sales agencies
were maintained in Ontario and in Quebec. At the Ontario agency, two qualified representatives handled business
under the company name. They were authorized to sign quotations. Contracts could be made, terms of payment
arranged and credit given without reference to the head office in Winnipeg. The company name was displayed
for public visibility, was used on calling cards, and was listed in the telephone directory. The Ontario agency,
occupying one-half of a building with warehouse facilities, maintained an inventory worth about $6,000. Orders
for standard-sized fans were filled from stock-in-trade. Orders for large fans were filled from the head office in
Winnipeg. The Quebec agency was substantially similar to that in Ontario.
— REQUIRED
Determine whether or not the company has a “permanent establishment” in the provinces of Ontario and
Quebec. In reaching a conclusion, compare this situation with the case of M.N.R. v. Sunbeam discussed in this
chapter.
 Solutions to Chapter 11 Assignment Problems 247
Solution 5
[Reference: Chicago Blower (Canada) Ltd. v. M.N.R., (T.A.B.) 66 DTC 471]
(A) Facts fall within Regulation 400(2)(b)
(i) the company carried on business in each province through an agent,
— the agent was established in a particular place, clearly identified to the public,
— occupied building with various warehouse facilities,
— the agent had general authority to contract,
— the agent had a stock of merchandise from which he filled orders,
— the exception to this was on orders for larger fans,
— thus, the condition was met at least in part,
(ii) therefore, the company does have a “permanent establishment” in the provinces indicated.
(B) This conclusion differs from that in the Sunbeam case which can be distinguished on its facts,
(i) in the Sunbeam case, the taxpayer’s representatives in Quebec did not have authority to make contracts
on the company’s behalf,
(ii) there was no telephone listing in the company’s name and that name did not appear on any business
signs.
248 Introduction to Federal Income Taxation in Canada
Problem 6
[ITA: Part I.3]
Larger Than Life Inc., a public corporation in the service industry, had the following balance sheet as at
December 31, 2005:

($ 000’s)
Cash.......................................................................................... 40,000
Accounts receivable (net) ........................................................ 50,000
Inventory .................................................................................. 60,000
Investment in Canadian subsidiary .......................................... 120,000
Unsecured demand loan to Mr. Filth E. Rich ........................... 60,000
Future income taxes (debit) ..................................................... 20,000
Total assets ............................................................................... 350,000
Accounts payable ..................................................................... 55,000
Bank indebtedness (due on demand) ........................................ 75,000
Mortgage due to Mrs. Low N. Shark ....................................... 35,000
Common shares ........................................................................ 65,000
Retained earnings ..................................................................... 120,000
Total liabilities and equity ....................................................... 350,000

The investment has been accounted for using the equity basis with the carrying value being computed as
follows:
Original cost of shares.............................................................. $ 110,000
Accumulated share of subsidiary’s earnings............................. 20,000
Accumulated dividends received.............................................. (10,000)
Carrying value.......................................................................... $ 120,000

Larger Than Life’s taxable income for its taxation year ended December 31, 2005, was $9,000,000 with
82% of its income being earned in a province. Larger Than Life grew significantly during 2005. In 2004, the
corporation was not even subject to Part I.3 tax and its taxable income was only $800,000 (all earned in the
province of Ontario). The corporation had no taxable income in the prior six years.
— REQUIRED
Determine Larger Than Life’s Part I.3 tax liability for its 2005 tax year. Assume that Larger Than Life is
allocated $40,000,000 of the capital deduction in its related group of corporations.
 Solutions to Chapter 11 Assignment Problems 249
Solution 6
Capital
Capital stock [par. 181.2(3)(a)]............................................................................... $ 65,000,000
1
Retained earnings [par. 181.2(3)(a)]....................................................................... 110,000,000
Bank debt [par. 181.2(3)(c)].................................................................................... 75,000,000
Mortgage payable [par. 181.2(3)(d)]....................................................................... 35,000,000
Future income taxes (debit) [par. 181.2(3)(h)]........................................................ (20,000,000)
Total capital.................................................................................................................... $ 265,000,000
Investment allowance2
Investment in subsidiary [par. 181.2(4)(a)]............................................................. $ 110,000,000 1
Taxable capital ($265,000,000 – $110,000,000)............................................................ $ 155,000,000
Taxable capital employed in Canada (82% of $155,000,000)........................................ $ 127,100,000
Capital deduction (as allocated in related group)........................................................... 40,000,000
Amount subject to Part I.3 tax........................................................................................ $ 87,100,000
Part I.3 tax @ 0.175%.................................................................................................... $ 152,425 (A)
2005 surtax (4% of 28% of $9,000,000)......................................................................... $ 100,800
2005 Canadian surtax payable (82% of $100,800)......................................................... $ 82,656 (B)
2005 Part I.3 tax liability — (A) minus (B).................................................................... $ 69,769
2004 surtax (4% × 28% × 100% × $800,000)............................................................. $ 8,960
Part I.3 tax payable ($69,769 – $8,960) ([sec. 181.1(4)]................................................ $ 60,8093

— NOTES TO SOLUTION
(1) Subsection 181(3) requires that the equity method not be used in determining amounts to be included in
capital and the investment allowance. Therefore, $10,000,000 has been subtracted from both the carrying value
of the investment and retained earnings in order to remove the effect of the equity method of accounting.
(2) The demand loan receivable does not qualify for the investment allowance since it is neither owing
from a corporation [par. 181.2(4)(b)] nor a bond, debenture, note, mortgage, hypothec, or similar obligation of
another corporation [par. 181.2(4)(c)].
(3) This amount can be offset by Canadian surtax payable in the following three years. No further unused
surtax credits exist from the preceding seven years.
250 Introduction to Federal Income Taxation in Canada
Problem 7
[ITA: 125.1]
One of your manufacturing clients, Mano-Pac Limited, a public company, provides you with the following
information in order to calculate their manufacturing and processing profit deduction:
(a) Salary expenses are represented by:
Accounting staff........................................................... $ 200,000
Quality control staff..................................................... 150,000
Plant staff..................................................................... 800,000
Plant supervisors and maintenance............................... 90,000
Distribution staff (responsible for distribution of
finished products)................................................. 65,000
Receiving department staff (responsible for receiving
and storing raw materials).................................... 45,000
Clerk responsible for purchasing raw materials........... 35,000
$ 1,385,000
(b) Fixed assets of Mano-Pac Ltd.:
Data processing equipment........................................... $ 50,000
Manufacturing equipment............................................ 900,000
Office equipment.......................................................... 100,000
Vending machines etc. in employee cafeteria.............. 10,000
$ 1,060,000
(c) Taxable income is comprised of:
Manufacturing income................................................. $ 375,000
Investment income....................................................... 65,000
Division B income....................................................... $ 440,000
Less: charitable donations............................................ 15,000
Taxable income............................................................ $ 425,000

— REQUIRED
Calculate the manufacturing and processing profit deduction Mano-Pac Ltd. can claim.
 Solutions to Chapter 11 Assignment Problems 251
Solution 7
Calculation of manufacturing and processing profits deduction from tax:
7% of lesser of:
(a) Canadian manufacturing and processing profits.................................................. $ 374,970 1
(b) Taxable income................................................................................................... $ 425,000
7% of $374,970 = $26,248
— NOTE TO SOLUTION
(1) Calculation of Canadian manufacturing and processing profits:
MC + ML
MP = × ADJUBI
C+L
$105,882 + $1,385,000
= × $375,000
$106,000 + $1,385,000
= $374,970

(a) ADJUBI (Adjusted Business Income):

Division B income...................................................................................................... $ 440,000
Less: Investment income............................................................................................. 65,000
$ 375,000
(b) C (Cost of Capital):
10% of gross capital cost of assets ($1,060,000) =..................................................... $ 106,000
(c) MC (Cost of Manufacturing and Processing Capital):
10% of manufacturing assets ($900,000).................................................................... $ 90,000
100/85 of total (100/85 × $90,000) =......................................................................... $ 105,882
Lesser of: (i) cost of capital (C).................................................................................. $ 106,000
(ii) cost of manufacturing and processing capital (MC)............................. $ 105,882
(d) L (Cost of Labour):
Total salary expenses.................................................................................................. $ 1,385,000
(e) ML (Cost of Manufacturing and Processing Labour):
Portion of total salary expenses used in qualified activities:
Total salary expenses........................................................................................... $ 1,385,000
Less*: Accounting......................................................................... $ 200,000
Distribution........................................................................ 65,000
Raw materials clerk........................................................... 35,000 (300,000)
$ 1,085,000
100/75 of $1,085,000........................................................................................... $ 1,446,667
Lesser of: (i) cost of labour (1)................................................................................... $ 1,385,000
(ii) cost of manufacturing and processing labour (ML).............................. $ 1,446,667

* Regulation 5202: definition of qualified activities.

252 Introduction to Federal Income Taxation in Canada
Problem 8
[ITA: 123; 124; 126]
Barltrop Limited is a Canadian public company involved in the software consulting business. Its controller
provided you with the following information related to its 2005 taxation year ended December 31:
Income under Division B from consulting business including
$100,000 earned in U.S. operations (before deducting
$16,000 U.S. tax paid)....................................................... $ 264,000
Canadian investment royalty income........................................ 10,000
U.K. non-foreign affiliate income (before $3,000 tax
withheld)............................................................................ 20,000
Taxable dividend received from non-connected Canadian
corporations....................................................................... 5,000
Taxable capital gains................................................................ 6,000
Charitable donations................................................................. 100,000
Unused foreign tax credit in respect of U.S.............................. 3,000
Net capital losses carried forward arising in 1999.................... 12,000
Barltrop Limited has permanent establishments in the U.S., B.C. and Alberta. Its gross revenues and salaries
and wages data have been allocated as follows:
British
Columbia Alberta U.S.
Gross revenues..................... $ 3,000,000 $ 3,000,000 $ 4,000,000
Salaries and wages................ 500,000 300,000 200,000
Assume that the British Columbia corporation tax rate is 13.5% and the Alberta rate is 11.5%. Also, assume
that taxable income for Alberta is computed on the same basis as federal taxable income.
Gross revenues exclude income from property not used in connection with the principal business operation
of the corporation.
— REQUIRED
Compute the total tax payable by the company for the 2005 taxation year, including provincial tax. Show all
calculations.
 Solutions to Chapter 11 Assignment Problems 253
Solution 8
Income under Division B from consulting business.................................................................... $ 264,000
Canadian investment royalty income........................................................................................... 10,000
U.K. non-foreign affiliate income............................................................................................... 20,000
Taxable dividend received from non-connected Canadian corporations..................................... 5,000
Taxable capital gains................................................................................................................... 6,000
Income under Division B............................................................................................................. $ 305,000
Deduct:
Charitable donations (not exceeding 75% × $305,000 = $228,750).................................... (100,000)
Canadian dividends received................................................................................................ (5,000)
1999 net capital loss ($12,000 × 1/2 / 3/4; limited to taxable capital gains of $6,000)........... (6,000)
Taxable income........................................................................................................................... $ 194,000
Basic federal tax at 38% of $194,000.......................................................................................... $ 73,720
Deduct: Abatement from federal tax (see Schedule 1)................................................................ (13,580)
Net............................................................................................................................................... $ 60,140
Add: Federal surtax @ 4% of 28% × $194,000.......................................................................... 2,173
Deduct:
Non-business foreign tax credit (see Schedule 2)................................................................. (3,000)
Business foreign tax credit (see Schedule 3)........................................................................ (19,000)
Tax reduction (7% of $194,000)........................................................................................... (13,580)
Part I tax payable (federal).......................................................................................................... $ 26,733
Provincial tax:
British Columbia 13.5% of $77,600..................................................................................... 10,476
Alberta rate 11.5% of $58,200............................................................................................. 6,693
Total tax....................................................................................................................................... $ 43,902

Schedule 1: Abatement from federal tax

B.C. Alberta Total U.S. Total
Cdn.
Gross revenues...................................... $3,000K $3,000K $6,000K $4,000K $10,000K
% gr. revenues (1)................................. 30% 30% 60% 40% 100%
Salaries and wages................................ $500K $300K $800K $200K $1,000K
% S&W (2)............................................ 50% 30% 80% 20% 100%
(1) + (2)
................................................ 40% 30% 70% 30% 100%
2

Abatement: 10% of 70% of $194,000 = $13,580

Allocation of income to: B.C. 40% × $194,000 = $77,600
Alberta 30% × $194,000 = $58,200
Schedule 2: Non-business foreign tax credit (U.K. income)
Lesser of:
(i) tax paid $ 3,000
income from U.K. tax otherwise payable after
(ii) income less dividends and × abatement plus surtax minus
net capital loss carryover general tax reduction
$20,000
× ($60,140 + $2,173 – $13,580)
$305,000 − $5,000 − $6,000
$20,000
× $48,733 =..................................................................... $ 3,315
$294,000
Lesser amount is $3,000.
254 Introduction to Federal Income Taxation in Canada
Schedule 3: Business foreign tax credit (U.S. income)
Least of:
(i) tax paid ($16,000 + $3,000).............................................................................................. $ 19,000
income from U.S. tax otherwise payable
(ii) income less dividends and × plus surtax minus
net capital loss carryover general tax reduction
$100,000
× ($73,720 + $2,173 – $13,580)
$305,000 − $5,000 − $6,000
$100,000
× $62,313 =..................................................................... $ 21,195
$294,000
(iii) tax otherwise payable before any reduction or credits plus surtax less non-business tax
credit ($73,720 + $2,173 – $13,580 – $3,000).................................................................. $ 59,313
Lesser amount is $19,000.
 Solutions to Chapter 11 Assignment Problems 255
Problem 9
[ITA: 12(1)(t); 37; 127(5)–(11); ITR:2900]
Infotech is a public company in its first year of business in the information technology industry. It operates
out of a plant in Ottawa, Ontario. In 2005, it incurred $2,200,000 of scientific research and experimental
development expenditures (SR&ED) which qualify for deduction under subsection 37(1) of the Act. The break-
down of these expenses is as follows:
Current SR&ED expenditures [par. 37(1)(a)]............................... $ 1,700,000
Capital SR&ED expenditures [spar. 37(1)(b)(i)]
• new equipment.............................................. $ 300,000
• used equipment............................................. 200,000 500,000
Total SR&ED expenditures........................................................... $ 2,200,000

Infotech’s federal income tax rate after abatement is 22.12%. Its taxable income before deducting the
$2,200,000 claim under section 37 is $3,200,000.
— REQUIRED
(A) Compute the maximum investment tax credit available to Infotech in 2005.
(B) Compute the company’s net federal Part I tax payable after the investment tax credit, assuming a
maximum section 37 deduction is claimed.
(C) What is the amount, if any, of the investment tax credit carryover?
(D) Compute the company’s deduction or income inclusion in the following year if no further SR&ED
expenditures are made.
256 Introduction to Federal Income Taxation in Canada
Solution 9
(A) The maximum investment tax credit is
20% × [$1,700,000 + $300,000] = $400,000
Note that the used equipment is not a qualified expenditure for the purposes of sec. 127(9)
because it is not new property [Reg. 2902(2)(iii)].
(B) Taxable income before sec. 37 deduction................................................................. $ 3,200,000
Sec. 37 deduction...................................................................................................... (2,200,000)
Taxable income......................................................................................................... $ 1,000,000
Net tax 22.12%.......................................................................................................... $ 221,200
Investment tax credit................................................................................................. (221,200)
Net federal tax payable under Part I.......................................................................... Nil
(C) The remaining investment tax credit of $178,800 (ie., $400,000 – $221,200) may be carried back
three and forward ten years.
(D) Sec. 37 SR&ED expenditures in first year................................................................ $ 2,200,000
Sec. 37 deduction in first year................................................................................... (2,200,000)
Balance at the beginning of the second year............................................................. Nil
Less: ITC claim for first year.................................................................................... (221,200)
Recapture in second year [sec. 12(1)(t)].................................................................... 221,200
Balance after recapture.............................................................................................. Nil
If no further SR&ED expenditures are made in the following year, the income inclusion would be
$221,200 [sec. 12(1)(t)].
 Solutions to Chapter 11 Assignment Problems 257
Problem 10
[ITA: 123; 124; 125.1; 126; 127(5)]
Up, Up and Away Limited is a public corporation that manufactures hot air balloons in the province of New
Brunswick. For the year ended September 30, 2005, its accounting income statement was as follows:
Sales...................................................................................... $ 1,225,000
Cost of sales and other expenses including C.C.A................ (725,000)
Operating profit..................................................................... $ 500,000
Other net income................................................................... 198,500
Net income before taxes........................................................ $ 698,500
Provision for taxes................................................................ (200,725)
Net income............................................................................ $ 497,775

Selected Additional Information

(1) Other income includes:
Dividends from taxable Canadian corporation.................... $ 85,000
Canadian interest income..................................................... 52,500
Foreign interest income, net of withholding taxes of 61,000
$10,000................................................................................
(2) Up, Up and Away Limited has a non-capital loss carryforward of
$255,545.
(3) Up, Up and Away Limited purchased qualified equipment costing
$250,000 which is eligible for the investment tax credit.
(4) The M&P profits calculation under Regulation 5200 yielded $435,000.
(5) Donations to registered charities were $9,755 (deducted from
accounting income).
— REQUIRED
Calculate the total taxes payable for 2005 using a 13% provincial rate of tax. (For the calculation of the
foreign tax credit, assume that there is no general tax reduction. Then, calculate the general tax reduction to show
that this assumption is accurate.)
258 Introduction to Federal Income Taxation in Canada
Solution 10

Income under Division B:

Operating profits.......................................................................................................................... $ 500,000
Dividends from taxable Canadian corporations........................................................................... 85,000
Canadian investment income (i.e., interest income).................................................................... 52,500
Foreign investment income ($61,000 + $10,000)........................................................................ 71,000
$ 708,500
Add: donations.......................................................................................................................... 9,755
Division B income....................................................................................................................... $ 718,255
Less: Division C deductions:
Taxable dividends deductible under sec. 112.......................................................... $ 85,000
Donations (max. 75% of $718,255 = $538,691)..................................................... 9,755
Non-capital losses................................................................................................... 255,545 350,300
Taxable income................................................................................................................................... $ 367,955
Federal tax (38% of $367,955)............................................................................................................ $ 139,823
Federal abatement (10% of $367,955)................................................................................................ (36,796)
Federal tax after abatement................................................................................................................. $ 103,027
Add: surtax (4% of $103,027)............................................................................................................. 4,121
$ 107,148
Less: M & P profits deduction(1)................................................................................... $ 25,757
Foreign non-business tax credit(2)........................................................................ 10,000
Tax rate reduction(3)............................................................................................. Nil 35,757
Federal tax before investment tax credit.............................................................................................. $ 71,391
Investment tax credit (10% of $250,000)............................................................................................ (25,000)
Part I federal tax payable..................................................................................................................... $ 46,391
New Brunswick tax @ 13% of $367,955............................................................................................ 47,834
Total tax liability................................................................................................................................. $ 94,225

— NOTES TO SOLUTION
(1) Manufacturing and processing profits deduction
Lesser of:
(i) M. & P. profits....................................................................................................... $ 435,000
(ii) Taxable income..................................................................................................... $ 367,955
7% of $367,955 =.................................................................................................. $ 25,757
(2) Foreign non-business tax credit
Lesser of:
(i) Amount paid.......................................................................................................... $ 10,000
$71,000
(ii) × $107,148 ........................................................................... $ 12,013
$718,255 − $85,000
(3) Tax reduction
Taxable income.................................................................................................................. $ 367,955
Less: 100/7 M&P profits deduction (100/7 × $25,757)..................................................... 367,955
Net...................................................................................................................................... Nil

Therefore, there is no tax rate reduction, since all taxable income is eligible for the M&P profits deduction.
 Solutions to Chapter 11 Assignment Problems 259
Problem 11
[ITA: 123; 124; 125.1; 126; 127(5)]
Tecniquip Limited is a public corporation whose head office is located in Toronto, Ontario. The activities of
the corporation are carried on through permanent establishments in the provinces of Ontario and Alberta, and in
the United States.
The following is an allocation of selected items for the fiscal year ended December 31, 2005.
Ontario Alberta U.S. Total
($ 000) ($ 000) ($ 000) ($ 000)
Sales............................................. $ 6,000 $ 400 $ 4,600 $ 11,000
Salaries:
Production employees............. $ 900 $ 300 $ 1,000 $ 2,200
Payroll benefits for
production employees......... 10 0 0 10
Office employees.................... 320 170 410 900
Purchasing agents................... 120 90 180 390
Raw material receiving
& storing employees... 200 220 280 700
Finished goods warehouse
employees........................... 500 0 0 500
Plant maintenance staff........... 80 20 60 160
Finished product inspectors.... 110 60 130 300
Sales staff............................... 300 100 300 700
$ 2,540 $ 960 $ 2,360 $ 5,860
Assets owned (capital cost):
Office buildings...................... $ 300 $ 0 $ 250 $ 550
Office equipment.................... 90 0 70 160
Equipment used in SR&ED.... 250 0 0 250
Manufacturing plants.............. 1,750 40 900 2,690
Warehouses for finished
goods................................... 800 40 1,220 2,060
Land........................................ 1,000 10 600 1,610
$ 4,190 $ 90 $ 3,040 $ 7,320
Assets leased (annual rental
cost):
Production machinery............. $ 540 $ 10 $ 80 $ 630
Automobiles for sales staff..... 2 0 2 4
$ 542 $ 10 $ 82 $ 634

For the year ended December 31, 2005, Tecniquip Limited

obtained the following results:
Income from manufacturing operations in Ontario..................... $ 1,000,000
Income from manufacturing operations in Alberta..................... 240,000
Income from manufacturing operations in the United States
(before $200,000 Cdn. of US taxes paid)................................ 800,000
$ 2,040,000
Canadian-source interest income (investment)........................... 12,000
Foreign-source investment income (before $3,000 in foreign
tax withheld)............................................................................ 20,000
Taxable capital gain.................................................................... 10,000
Taxable dividends from taxable Canadian corporations............. 15,000
Net income under Division B...................................................... $ 2,097,000
260 Introduction to Federal Income Taxation in Canada
In computing income from manufacturing, the corporation claimed a deduction of $150,000 under
subsection 37(1) of the Act for scientific research and experimental development (SR&ED). $100,000 of the
deduction related to expenditures of a current nature and $50,000 was the cost of equipment purchased during the
year for use by it in scientific research and experimental development carried on in Canada.
During the year, the corporation made charitable donations totalling $50,000 and claimed non-capital losses
of $60,000 and the net capital losses carried forward from 1999 of $9,000.
— REQUIRED
Compute the federal Part I tax payable and provincial tax at 12% for Ontario and 11.5% for Alberta,
assuming that taxable income allocated to those provinces is the appropriate provincial tax base. Show all
calculations, whether or not necessary to your final answer. (For the calculation of the manufacturing and
processing profits deduction, assume that the foreign tax credit is equal to the foreign tax paid. However, show
the full calculation of the foreign tax credits, including the effect of the general tax reduction.)
 Solutions to Chapter 11 Assignment Problems 261
Solution 11
Net income under Division B.................................................................................................... $ 2,097,000
Division C deductions: Dividends from taxable Canadian corporations.................................. (15,000)
Charitable donations (max. 75% × $2,097,000)................................ (50,000)
Net capital losses ($9,000 × 1/2 / 3/4)................................................... (6,000)
Non-capital losses............................................................................... (60,000)
Taxable income......................................................................................................................... $ 1,966,000
Tax @ 38%................................................................................................................................ $ 747,080
Federal abatement1..................................................................................................................... (115,994)
$ 631,086
Surtax2....................................................................................................................................... 22,019
$ 653,105
Non-business foreign tax deductions3........................................................................................ (3,000)
Business foreign tax deductions4............................................................................................... (200,000)
Manufacturing and processing profits deduction5...................................................................... (67,529)
Tax reduction6............................................................................................................................ (70,091)
Federal tax before investment tax credit.................................................................................... $ 312,485
Investment tax credit7................................................................................................................ (30,000)
Federal Part I tax payable.......................................................................................................... $ 282,485
Provincial tax payable: Ontario @ 12% × $963,340............................................................... $ 115,601
Alberta @ 11.5% × $196,600............................................................ 22,609
$ 138,210

— NOTES TO SOLUTION
(1) Federal abatement:
Gross revenue Salaries & wages
Amount % Amount % Average percentage
1
Ontario........... $ 6,000,000 54.6% $ 2,540,000 43.3% /2 (54.6% + 43.3%) = 49.0%
1
Alberta........... 400,000 3.6 960,000 16.4 /2 (3.6% + 16.4%) = 10.0%
1
$ 6,400,000 58.2 $ 3,500,000 59.7 /2 (58.2% + 59.7%) = 59.0%
U.S................. 4,600,000 41.8 2,360,000 40.3
Total............... $ 11,000,000 100.0% $ 5,860,000 100.0%

Allocation of taxable income to each province:

Ontario................................................................................. 49% × $1,966,000 = $ 963,340
Alberta................................................................................. 10% × $1,966,000 = 196,600
Taxable income earned in a province or territory................ $ 1,159,940
Abatement is 10% × $1,159,940 = $115,994.
(2) Surtax: (28% × $1,966,000) × 4% = $22,019
(3) Non-business foreign tax deduction:
lesser of:
(a) tax paid $ 3,000
foreign non - business income tax otherwise payable
(b) × (basic – abatement + surtax
Div. B income - par.111(1)(b) - sec.112
– general reduction)
$20,000
× ($653,105 − $70,091) .............................................. $ 5,617
$2,097,000 − $6,000 − $15,000
262 Introduction to Federal Income Taxation in Canada

(4) Business foreign tax deduction:

least of:
(a) tax paid........................................................................................................................ $ 200,000
foreign non - business income tax otherwise payable
(b) × (basic + surtax
Div. B income - par.111(1)(b) - sec.112
– general reduction)
$800,000
× ($747,080 + $22,019 − $70,091) ....................................
$2,097,000 − $6,000 − $15,000 $ 269,367
(c) tax otherwise payable minus non-business foreign tax deduction ($747,080 +
$22,019 – $70,091 – $3,000)...................................................................................... $ 696,008

(5) Manufacturing and processing profits deduction:

7% of the lesser of:
(i) Canadian manufacturing and processing profits.......................................... $ 964,697
(ii) Taxable income – (3 × ssec. 126(2))
($1,966,000 – (3 × $200,000))..................................................................... $ 1,366,000
7% × $964,697 = $67,529

MC + ML
MP = × ADJUBI
C+L
$879,000 + $2,520,000
= × $1,240,000
$879,000 + $3,490,000

= $964,697

Adjusted business income (ADJUBI):

Income from an active business carried on in Canada ($1,000,000 +
$240,000) = $1,240,000
Cost of capital (C):
10% × capital cost of depreciable property owned that is used to
earn business income in Canada:
Ontario — ($4,190,000 – $1,000,000)................................................................. $ 3,190,000
Alberta — ($90,000 – $10,000)........................................................................... 80,000
$ 3,270,000
× 10%
$ 327,000
plus the rental cost for the year of such assets that are leased instead of purchased:
($542,000 + $10,000) 552,000
$ 879,000
Cost of manufacturing and processing capital (MC):
Portion of cost of capital used in qualified M&P activities:
Cost of manufacturing plants in Ontario and Alberta ($1,750,000 + $40,000)........... $ 1,790,000
Cost of equipment used in SR&ED............................................................................. 250,000
$ 2,040,000
× 10%
$ 204,000
Plus the rental cost of the production machinery ($540,000 + $10,000)..................... 550,000
$ 754,000
/85 × $754,000 = $887,059
100

Cannot exceed the cost of capital, $879,000.

 Solutions to Chapter 11 Assignment Problems 263

Cost of Labour (L):

Salaries and wages related to carrying on business in Canada:
Ontario salaries, net of payroll benefits...................................................................... $ 2,530,000
Alberta salaries, net of payroll benefits....................................................................... 960,000
$ 3,490,000
Cost of manufacturing and processing labour (ML):
Portion of cost of labour used in qualified M&P activities:
Production employees ($900,000 + $300,000).................................................... $ 1,200,000
Raw material receiving & storing ($200,000 + $220,000).................................. 420,000
Plant maintenance staff ($80,000 + $20,000)...................................................... 100,000
Finished product inspectors ($110,000 + $60,000)............................................. 170,000
$ 1,890,000
/75 × $1,890,000 = $2,520,000
100

Cannot exceed the cost of labour, $3,490,000.

(6) Tax reduction
Taxable income $ 1,966,000
Less: 100/7 M&P profits deduction (100/7 × $67,529)..................................................... 964,700
Net...................................................................................................................................... $ 1,001,300
7% of $1,001,300............................................................................................................... $ 70,091

(7) Investment tax credit: 20% × $150,000 = $30,000

Since all $150,000 of the expenditure was deducted in 2005, all $30,000 of the ITC claimed in 2005 will be
included in income in 2006 [par. 12(1)(t)].