The assets of the retailing business are as follows — Dan Dash has decided incorporate his July 1st plans transfer Inc corporation

Dan Dash has decided to incorporate his retailing business. On July 1st he plans to transfer the assets of the business to Dash Inc., a corporation owned wholly by him, in exchange for a note of $535,000, being the fair market value of the assets.

The assets of the retailing business are as follows:

Dan also plans to transfer his shares of Grape Expectations, a publicly-traded company, to Dash Inc. He purchased the shares of Grape Expectations two years ago for $60,000. He plans to transfer them to Dash Inc. for $50,000, the estimated fair market value.

Required:

Prepare a memo for Dan outlining the tax implications of his plans and provide detailed recommendations as to how he can accomplish his goals in a more tax effective manner.

SOLUTION

Income from sale of assets for debt:

If Dan transfers the business assets to a corporation for debt as he plans, he will incur taxable capital gains of $30,000 and income of $160,000 as outlined below.

	Selling Price FMV	Tax Value	Business Income	Taxable Capital gain	Note
Acc. Rec.	$ 5,000	$ 8,000		$ 0	(1)
Inventory	200,000	120,000	$ 80,000
Land	60,000	20,000		20,000
Building	180,000	100,000	60,000	10,000
Equip	50,000	70,000	0		(2)
Goodwill	40,000	0	20,000	.
	$535,000	$318,000	$160,000	$30,000

The cost of the property to the corporation for tax purposes is as follows.

	Capital cost	UCC/CEC	ACB	Other Tax Cost
Acc. Rec.			$ 8,000 (1)
Inventory				$120,000 (2)
Land			20,000 (2)
Building	$160,000 (3)	$100,000 (2)	160,000
Equip	100,000 (4)	50,000	100,000
Goodwill		0.50 (5)

A More Tax Effective Manner:

For the Equipment there is not a more tax-effective manner. For the other assets Dan should use election provisions available in the Income Tax Act, i.e., Section 22 and Section 85.

Section 22 election on the Accounts Receivable

A Section 22 election is a joint election made by the seller and the purchaser. In order to make the election Dan must be selling all or substantially all the assets used in a business, including the receivables, to a purchaser who plans to carry on the business. As these conditions are met, a Section 22 election can be used.

Under Section 22, Dan will get a $3,000 business loss. The corporation must include the $3,000 in its income and will be allowed to claim a reserve for doubtful accounts [ITA 20(1)(l)] and to write off bad debts [ITA 20(1)(p)] against business income as appropriate at its year end. Without a Section 22 election the corporation would not be allowed a reserve or a bad debt write-off against these receivables. Instead, collection of an account for less than its cost to the corporation would result in a capital loss to the corporation.

Dan would still transfer the receivables to the corporation for a note equal to the FMV of the receivables. However, for tax purposes a Section 22 election would be made. [Section 22 elections are discussed in Chapter 5, Part III (J)].

Section 85 election to defer recognition of recapture and capital gains on other assets -

A section 85 election is a joint election made by the seller and the purchaser. In order to use section 85 for the other assets, Dan is going to have to change the consideration received for the other assets from all debt to a combination of shares and debt [ITA 85(1)].

	Asset Value	Tax Value	Elected Amount	--Consid Debt	eration-- Shares	Income
Inventory	200,000	120,000	$120,000	$120,000	$ 80,000	$0
Land	60,000	20,000	20,000	20,000	40,000	0
Building	180,000	100,000	100,000	100,000	80,000	0
Goodwill	40,000	0	1	0	40,000	0.50
	$480,000	$240,000	$240,001	$240,000	$240,000

🔒

Unlock the complete assignment

You are viewing the free preview. Purchase this assignment once to reveal the complete resource.

$9.99 USD

Secure checkout is completed by Stripe.

The total of the debt and share consideration equals the fair market value of the assets transferred to the corporation. In each case the debt is limited to the Section 85 elected amount [ITA 85(1)(b)]. For the goodwill, $1 of debt and $39,999 of shares could have been taken as consideration with the same resulting income for tax purposes.

The cost of the property to the corporation for tax purposes after the elections under Section 22 and Section 85 is as follows.

	Capital cost	UCC/CEC	ACB	Other Tax Cost
Acc. Rec.			$ 8,000 (1)
Inventory				$120,000 (2)
Land			20,000 (2)
Building	$160,000 (3)	$100,000 (2)	160,000
Equip	100,000 (4)	50,000	100,000
Goodwill		0.50 (5)

Notes:

Face value.

Elected amount [ITA 85(1)].

Because the building is a depreciable property which has been acquired under a Section 85 election at a price lower than Dan’s cost, the capital cost of the building for future recapture purposes is deemed to be Dan’s cost, $160,000 [ITA 85(5)].

Because the equipment is a depreciable property which has been acquired from a non-arm’s length person (Dan) at a price lower than Dan’s cost, the capital cost of the equipment for future recapture purposes is deemed to be Dan’s cost, $100,000 [ITA 13(7)(e)(iii)].

On a purchase of eligible capital property at an elected amount of $1, the corporation would add $0.50 (i.e., ¾ x $1 – ½ x $0.50 (Dan’s income under ITA 14(1)(b))) to its CEC account [amount A of the definition of cumulative eligible capital in ITA 14(5)(b)].

The ACB of the share consideration received on the section 85 transfer is $1, computed as follows [ITA 85(1)(f) & (g)]:

Elected amount $240,001

Less: allocation to debt (240,000)

Allocation to shares $ 1

The PUC of the share consideration received is $1 [ITA 85(2.1)]. The PUC of the shares reflects the tax-paid cost of the assets transferred to the corporation that has not or will not be recovered tax-free in non-share consideration. In this case all of the tax-paid cost of the assets was recovered by tax-free debt. The $1 of PUC represents the $1 elected as proceeds in excess of the tax-paid cost of the goodwill.

Dan’s consideration: FMV ACB PUC

Debt $240,000 $240,000 NA

Shares 240,000 1 $ 1

$480,000 $240,001 $ 1

Grape Expectations

If Dan transfers his shares of Grape Expectations, a public company, to Dash Inc., the $10,000 capital loss ($50,000 – $60,000) will be denied to Dan (superficial loss) [ITA 40(2)(g)] and will increase the ACB of the Grape Expectations shares now held by Dash Inc. to $60,000 ($50,000 + $10,000) [ITA 53(1)(f)].

The Grape Expectations shares are currently worth almost 10% value of the assets in Dash Inc. If Dan transfers these shares to Dash Inc. and they increase in value, Dan runs the risk of Dash Inc ceasing to be a Small Business Corporation (not meeting the 90% test). Dan should not transfer these shares to Dash Inc.