Chapter 16 Problem solutions

Problem 1 Solution : Capital Dividend Account

Effect on Income
Investments: ACL 1/2  ($22,000 – ($60,000 + $500))............................................ $(19,250)
Land: TCG 1/2 ´ ($1,000,000 – ($400,000 + $50,000)) 275,000
Building: TCG 1/2 ´ ($1,250,000 – ($700,000 + $60,000)) 245,00
Building: recapture ($450,000 – $700,000) 0
250,000

Equipment: recapture (($8,000 – $400) – $0).......................................................... 7,600

Class 14.1: goodwill and customer lists:

Proceeds......................................................................................... $ 95,000
Less: Cost....................................................................................... 40,000
Capital gain.................................................................................... $ 55,000
Taxable capital gain....................................................................... $27,500

UCC balance.................................................................................. $34,000

Lower of cost and proceeds (LOCP).............................................. (40,000)
(6,000)

Recapture........................................................................................ $6,000

Capital Dividend Account

Balance: January 1, 2023.......................................................................................... Nil
Investments: 1/2  ($22,000 – ($60,000 + $500)) untaxed portion........................... $(19,250)
Land: 1/2 ´ ($1,000,000 – ($400,000 + $50,000)) untaxed portion 275,00
Building: 1/2 ´ ($1,250,000 – ($700,000 + $60,000)) untaxed portion 0
245,000

Goodwill and customer lists: ½ (95,000 - $40,000) (untaxed portion)

27,500
Balance: December 31, 2023.................................................................................... $528,250
 The above can be summarized in tabular form as follows:

Capital
Dividend
Account

Untaxe
Income effect Untaxed Capital d life
fraction of dividen ins. Capital
net cap. d proceed dividen
Asset ABI AII gains received s d paid
Investments $(19,250) $(19,250)
Land........... 275,000 275,000
Building..... $250,000 245,000 245,000
Equipment. 7,600
Class 14.1. . 6,000 27,500 27,500
$ 263,600 $528,250 $528,250 0 0 0
Problem 2 Solution: Deemed Dividends

Explanation of paid-up capital and how it is calculated

 Calculated at the corporate level, not at the shareholder level
 Averaged over all shares issued
 No identification with the shareholder who contributed the share capital
 Not impacted by transactions among shareholders

Calculation of tax consequences

(a) SH

1350 P/S

Capital $110,500 cash

Inc. 28,000 assets
$138,500
PUC $148,500

PUC ACB
Corporation Gave
PUC (1,350 sh x $110) $148,500

Corporation Received
Cash $110,500
Assets 28,000
Total assets $138,500 $138,500

Deemed dividend $10,000 10,000

$148,500

The transaction results in an immediate deemed dividend of $10,000 since the PUC of the
preferred shares increased by $148,500, but the increase in the FMV of the assets was only
$138,500 [ssec. 84(1)]. The dividend would be a non-eligible dividend unless designated from
GRIP. Also, the ACB of the shares increases by $10,000 to $148,500 [para 53(1)(b)].
(b) Shareholder
ACB $16,000 PUC reduction: $4,000 or $8,000

Plastics Ltd.

FMV $35,000
PUC $5,500

PUC ACB
$4,000
Opening balance $ 5,500 $ 16,000
PUC reduction (4,000) (4,000)
$ 1,500 $ 12,000
No deemed dividend
$8,000
Opening balance $ 5,500 $ 16,000
PUC reduction (8,000) (5,500)
(2,500) $ 10,500
Deemed dividend $ 2,500

(i) The payment of $4,000 will not result in an immediate deemed dividend, as the payment is
less than the PUC of the shares ($5,500) [ssec. 84(4)]. This payment would be considered to
be a return of the original capital injected by the shareholders.
This payment will, however, reduce the adjusted cost base to $12,000 ($16,000 – $4,000)
[spar. 53(2)(a)(ii)]. This reduction would result in a higher capital gain upon ultimate
disposition of the shares because $4,000 of the cost in the shares has been recovered tax-
free by this payment.
(ii) The payment of $8,000 will result in an immediate deemed dividend of $2,500 because the
payment of $8,000 is in excess of the PUC of $5,500. The ACB of the shares will be
reduced by the non-taxed portion of the payment of $5,500 ($8,000 – $2,500).

(c) Shareholders
4,500 c/s 15% stock dividend – PUC 3,375

Festivals Ltd.

PUC $22,500
 # PUC ACB DD 82(1)

Opening balance 4,500 22,500

Stock dividend of 15% 675 3,375 3,375 3,375
Ending balance 5,175 25,875

The payment of the stock dividend of $3,375 increased the PUC by $3,375 but it does not result
in a deemed dividend, because paragraph 84(1)(a) excludes a stock dividend from deemed
dividend treatment under section 84.
However, subsection 82(1) and the definition of an “amount” [ssec. 248(1)] require that a
dividend equal to the increase in PUC be included in income.
In addition, the ACB increases by $3,375.

(d) Shareholder Cash $15,400

100% Common shares
Common shares repurchased one year later

Baker Corp Ltd. Assets $38,400

Issuance

Assets 38,400
Cash (15,400)
Net assets contributed 23,000

PUC/ACB Common shares 23,000

Redemption

Repurchase price $30,000

PUC (23,000)
Deemed dividend 7,000

Proceeds of disposition $30,000

Deemed dividend (7,000)
Adjusted Proceeds of Disposition 23,000
ACB 23,000
0
(i) The contribution of the assets will not result in a deemed dividend as long as the increase in the
PUC of the shares of $23,000 does not exceed the increase in net assets of $23,000 ($38,400 –
$15,400).
(ii) The shareholder of Baker Corp. Ltd. will receive a $7,000 deemed dividend, the repurchase
value exceeds PUC [ssec. 84(3)]. Since the ACB of the shares is $23,000 (i.e., $38,400 − -
$15,400), there will also be no capital gain or loss on the redemption (i.e., proceeds ($23,000) –
ssec. 84(3) dividend (nil) – ACB ($23,000)).