Question

It is now late May 2018 and you, CPA, have just finished meeting with your partner, Ms. Wong. Ms. Wong wants your help with some clients of hers.

One client, Garden Supplies Co. (GSC) has had a new shareholder buy shares. Ms. Wong wants you to tell her if GSC is a resident of Canada for tax purposes in 2018 and describe the personal tax consequences that Mrs. Gardiner will have from her 2018 share sale. You can ignore the acquisition of control rules. Also, given the list of GSC’s 2018 expenditures in Exhibit I, calculate the total 2018 expenses that are deductible in 2018 when computing net income for tax purposes. GSC is very profitable and wants to claim the maximum amount of deductions possible. You do not need to comment on non-deductible items.

Note: Additional information about GSC is provided in Exhibit I.

Another client, Mr. Rich, who is a non-resident of Canada, has just purchased a newly built townhouse in Canada for $1,500,000 that he plans to rent out. The home was purchased on May 1, 2018 and will be rented out starting on July 1, 2018. What Canadian income tax obligations will Mr. Rich face in 2018? If you have any recommendations that will reduce Mr. Rich’s Canadian income tax obligations (in 2018 or in future years) with respect to his rental property, then you should provide them. Additional information about Mr. Rich is provided in Exhibit II.

Ms. Wong wants you to draft a memo to her answering her questions. She says you can ignore provincial income taxes, ignore foreign taxes and ignore any income tax treaties. Explain your answers, show all your detailed calculations and give Income Tax Act (ITA) section, subsection and paragraph (where applicable) references and Income Tax Regulations section and subsection references in order to support your answers. When giving references you must be specific. Do not just list multiple references!

Exhibit I

Garden Supplies Co.

Garden Supplies Co (GSC) is a private company that was incorporated in Canada in 1963 by Mr. Taft. Mr. Taft subscribed for 1,000 common shares in return for $100 (in aggregate). GSC does not have any other shares outstanding

GSC has a December 31^st year-end and its board of directors meetings are typically held in the United States (U.S.)

GSC operates gardening supply stores in Canada and it started with one store in Toronto in 1963. Now it has 10 stores throughout Canada

In 2005, Mr. Taft sold his shares to Mrs. Gardiner for $1M in aggregate (which was their FMV at the time)

In late January 2018, Mrs. Gardiner sold 600 of her GSC common shares for $3,000 per share to Marcus Jones, an arm’s length person (she still owns 400 common shares of GSC)

In January 2018, Mrs. Gardiner paid $3,500 to a chartered business valuator to value her GSC shares and paid $2,500 in legal fees related to her sale of GSC shares

The FMV of GSC was determined to be $3M

Mrs. Gardiner incurred $300 of safety deposit box rental fees in 2018 and she keeps her GSC share certificates in her safety deposit box

Assume GSC is not a qualified small business corporation

Marcus Jones is a non-resident of Canada

In 2018 GSC incurred the following expenditures:

Income taxes paid of $124,500

Salary and wages expense paid of $390,000

In addition, GSC accrued a bonus payable to Mrs. Gardiner of $70,000 for work performed in 2018. This bonus will not be paid until May 31, 2019

Interest expense paid of $5,000 on a bank loan used to finance business operations

Dividends paid to shareholders of $55,000

Warranty expense accrued of $25,000 (based on estimated warranty costs). The actual cost in 2018 of servicing warranties was $20,000

Purchased new shelving units to display merchandise on April 1, 2018 for $200,000

Purchased new computer software for $3,000 on January 1, 2018

Purchased goodwill for $40,000 as part of a business acquisition on January 1, 2018

Purchased a patent, with an 18-year legal life remaining on December 31, 2018 for $10,000

Accrued office supply expenses of $12,000, for supplies purchased (and used) in late 2018. Payment of this account payable was made in early 2019

Paid $7,000 for Toronto Blue Jays (baseball) tickets used to take large customers out to games

Incurred $4,000 of legal fees related to obtaining bank financing, and

Incurred lobbying expenses of $1,300 for matters related to the business

Assume all expenditures are reasonable unless otherwise indicated

Assume the prescribed interest rate is 1% at all times

Exhibit II

Mr. Rich

Mr. Rich’s rental income is property income; i.e., he is not running a business

Mr. Rich wants to minimize his Canadian rental income and he does not have any other Canadian income

Mr. Rich has prepared the following (assume that all the expenses below are paid in 2018 and are reasonable):

Mr. Rich’s Canadian Rental Income

For the year-ended December 31, 2018

Gross rental revenue ($4,000 per month)                                                       $24,000

Mortgage interest ($2,200 per month)                                    $13,200

Property taxes ($610 per month)                                            $3,660

Maintenance and repairs ($500 per month)                            $3,000

Insurance ($200 per month)                                                    $1,200

Total expenses                                                                                                $21,060

Net income                                                                                                       $2,940

Answer 1

Following are the personal tax consequences that Mrs. Gardiner will have from her 2018 share sale

Particulars	$
Sales Consideration (600 shares * $3000 per share)	1,800,000
Less: Transfer Expenses $(2500+3500)	(6000)
Net Sales Consideration	1,794,000
Less: Cost of Acquisition (600 shares * $1000)	(600,000)
Taxable Capital Gains in the hands of Mrs. Gardiner	1,194,000

Calculation of the total expenses of GSC that are deductible in 2018 when computing net income for tax purposes

Particulars	$
Salary & Wages expenses paid	390,000
Interest expenses paid	5,000
Actual warranty expenses	20,000
Office supply expenses	12,000
Selling expenses (tickets to customers)	7,000
Legal expenses	4,000
Lobbying expenses	1,300
Total expenses of GSC that are deductible in 2018	439,300