Use the coversheet. The assignment question is after the coversheet.
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Must attach this coversheet to your solution.
Follow the directions.
Your answers, including calculations and appendices, must:
· not exceed 7 pages (maximum). Note: the coversheet does not count in the page limit but all other pages do count. You should number your pages;
· be double spaced;
· be Times New Roman (or an equivalent sized) font;
· have 12 point font (minimum);
· have normal margins (i.e., margins of at least one inch on the top, bottom and each side); and
· have "Portrait" as the page layout (and not "Landscape").
CPA, work for National Limited (NL) an accounting professional corporation in Canada. It is now August 2016 and you have just finished meeting with John Jones, the president of NL, and Alex Keaton, a client of NL.
Alex is a 65 year-old resident of Canada who is considering doing an estate freeze. Additional information about your client is provided in the Exhibit. John wants you to describe and calculate the federal income tax consequences to your client from the proposed estate freeze.
Make sure you describe all the income tax consequences to both Alex and to Newco and show your calculations.You should give Income Tax Act(ITA)section, subsection and paragraph (where applicable) references in order to support your answer.Do not list multiple ITA references.You do not need to suggest any improvements to the proposed estate freeze at this time and you can ignore Division E.1 of the ITA (Minimum tax).
Separate from this proposed estate freeze, another client of NL, Winnie, who is at arm's length with Alex, is considering making a large investment in a foreign public company. The foreign investment is expected to earn $100,000 of dividends (from a non-Canadian company) each year and John wants you to calculate any income tax savings or cost in 2017 from earning $100,000 of foreign dividends personally versus earning it in a new investment holding corporation (Holdco). See the Exhibit for additional details. John says that you should assume that Holdco will pay all after-tax cash out to Winnie as a dividend. Assume any dividend refund related to 2017 will also be paid to Winnie in 2017 as a dividend. John also says that for simplicity you can assume that any foreign tax credit will equal the foreign taxes paid. John reminds you that the March 22, 2016 federal budget has frozen the dividend gross-up and dividend tax credit at 2016 amounts, and the top federal personal income tax rate has been increased from 29% to 33%. John also says you should calculate the after-tax cash for each option and then compare the two to determine the tax savings or cost. Show all relevant calculations and round to the nearest dollar. You can ignore the basic personal tax credit. You do not need to give ITA references but you must consider federal and provincial income taxes (provincial tax rates are given in the Exhibit). Note: you will lose 1 mark for each incorrect item includedin your analysis of income tax savings or cost.
John asks you to look into one more issue for him, relating to a third client, Mr. Kay. Mr. Kay is a long-time tax client of NL. For his upcoming 2016 personal income tax return, Mr. Kay has asked NL to do the following:
"When you prepare my personal tax return, which you file electronically, I would like you to deduct $40,000 of interest expense from my income as a carrying charge. I did not incur any interest expense but I want a larger tax deduction to minimize my taxable income. I realize that I didn't incur this expense and do not have any documents supporting this amount, but since we file tax returns electronically we may not need any supporting documents. If I get audited then I'll pay any extra tax owing but I'd like to take the chance. I am fine with this risk. If you help with this, in addition to my regular fees, I'll also pay your firm one-third of any tax savings that I get with regards to this additional deduction. This way we can both benefit."
John wants your advice on what specifically should be done in this situation and why? No calculations and no ITA references are needed.
Exhibit
Additional information
· Alex currently owns all of the shares of Growth Inc. (GI), a CCPC with an October 31st year-end. GI has 1,000 common shares issued and outstanding
· GI is a manufacturer of linens and it is a small business corporation (SBC). Alex's shares are QSBC shares. Alex has never used any of his capital gains exemption and he wants to use this now, if possible
· GI was incorporated in 1990 by a person who is at arm's length from Alex. In 1990, the initial shareholder subscribed for 1,000 common shares of GI and paid $3,000, in aggregate, into the company to buy the shares. In 2002, Alex bought the 1,000 common shares from the initial shareholder for $200,000, in aggregate, which was the fair market value (FMV) at the time
· Alex wants to transfer the future growth of GI to his adult child now (i.e., in 2016) without paying any income tax. Accordingly, Alex will incorporate a new company (Newco) and have his child subscribe for new common shares of Newco. Alex wants to use subsection 85(1) of the Act, and if possible, and he does not want to incur any income tax
· Alex wants to receive the maximum amount of boot (as a note receivable) and preferred shares for the balance of consideration when he sells his GI shares to Newco in 2016 as part of the estate freeze
· GI is not associated with any other company and its taxable capital has always been less than $10 million
· The GI common shares are currently worth $1,500 per share (i.e., $1,500,000 in aggregate)
· Alexwants to minimize his income tax at death and he wants to keep control of the business while he is alive
· Alex earns more than $250,000 per year in income
· Winnie also earns more than $250,000 per year in income before considering the $100,000 of additional foreign dividends that she may also earn
· The $100,000 of foreign dividends will be subject to foreign income tax of 15%. Hence, Winnie will only actually receive $85,000 after $15,000 of foreign income tax is withheld
· The investment in a foreign company will represent less than 1% of the shares of the foreign company and the foreign company will not be a foreign affiliate
· Winnie wants to claim the maximum possible foreign tax credit
· Both Alex and Winnie live in a province with the following provincial tax rates (effective for 2016 and 2017):
o Personal tax rate on income over $100,000 21%
o Personal tax rate on income equal to and below $100,000 11%
o Dividend tax credit on taxable amount of eligible dividends 10%
o Dividend tax credit on taxable amount of non-eligible dividends 4.3%
o The dividend gross-up equals the federal dividend gross-up
o Corporate tax rate on active business income of $500,000 or less 4.5%
o Corporate tax rate on all other income 11.5%
· If Winnie incorporates a new investment holding corporation (Holdco) she will be the sole-shareholder and its only employee. Holdco will have a December 31st year-end and Holdco will have only one permanent establishment (in the same province that Winnie lives in). You can assume that the new corporation will be incorporated on January 1, 2017, it will not be associated with any other companies and its taxable capital will be less than $10M
· Alex and Winnie are not active traders of securities and they do not have any specialized knowledge about stocks or bonds
· You can ignore any income tax treaties
· Assume that the prescribed interest rate for all periods is 2%.