One of the important concepts in Canadian taxation is integration. Discuss the mechanisms built into the Canadian tax system for Canadian controlled private corporations to allow for integration. In your discussion, include the taxes put into the system to prevent deferral, the dividend gross-up and dividend tax credit prior to 2014 and for tax years after 2013. Discuss both investment income and business income. Question 2. Memo To: Staff Accountant From: Manager Date: June 6, 2014 Subject: Hema Ltd. Share Issues.
Hema Ltd. , was incorporated in Ontario in 1991 to carry on a small manufacturing business. The corporation has been a client since its incorporation. Both of the two classes of the issued shares of Hema Ltd. are qualifying small business corporation shares. Penny has always owned all 10,000 of the Class A shares which have a PUC and an ACB of $100 and a FMV of $950,000. All 1,000 of the Class B shares are owned by Jacqui, a long-time key employee. Jacqui paid $10,000 for the Class B shares at the time of their issuance.
The Class B shares now have a FMV of $50,000. Below is a summary of my notes from a meeting that I had with Penny in connection with several transactions involving Hema Ltd. and its shares. Penny has been talking with a business associate whose accountant has offered some advice that has attracted her attention. Penny respects her associate’s decisions and, thus, is contemplating a freeze of her shares of Hema Ltd. in favour of her children, all of whom are adults. Penny wants to transfer her Class A shares of Hema Ltd. to Brindle Holdings Ltd.
(BHL) in return for fixed-value preferred shares. Common shares of BHL will be subscribed for by her children, using their own money. Penny would like to crystallize her capital gains exemption, of which the entire $750,000 is available. At the same time, she would like to freeze the current value of her interest in the Hema Ltd. Class A shares. Penny has no limitations in claiming the capital gains deduction, such as a cumulative net investment loss balance. From the discussions with her associate, Penny thought that the following plan could be implemented.
She will transfer the Class A shares of Hema Ltd. to BHL, electing a transfer price of $750,100 under S. 85(1). As consideration, she will receive from BHL a note for $750,100 and voting, redeemable preferred shares with a legal stated capital (LSC) and FMV of $199,900 and sufficient votes to control BHL. Hema Ltd. is one of many shareholders of Dykon Ltd. , a widely-held small business corporation. Hema Ltd. holds 10,000 shares of Dykon Ltd. , representing about 12% of Dykon Ltd. ’s outstanding shares. Hema Ltd.
bought these shares to facilitate an assured source of supply of some critical raw materials. The Dykon Ltd. shares cost Hema Ltd. $150,000 and are valued at $25 each. Dykon Ltd. ’s corporate records indicate that the PUC of its shares is $1 per share. Cyphon Ltd. , a Canadian corporation, is intent on acquiring all of the shares of Dykon Ltd. Cyphon Ltd. ’s shares now trade on the TSX at $20. Cyphon Ltd. has made an offer to all of the shareholders of Dykon Ltd. under which they could choose between the following: (a) for each Dykon Ltd. share, Cyphon Ltd. would pay 1.
25 Cyphon Ltd. shares, or (b) for each Dykon Ltd. share, Cyphon Ltd. would pay $5 in cash and one Cyphon Ltd. share. Hema Ltd. would like to reorganize its capital structure in respect of the Class B shares owned by Jacqui, in order to decrease the per-share value of shares that can be issued to some newly promoted key employees. Jacqui has agreed to exchange all of her Class B shares for $15,000 in cash and Class C preferred shares with a FMV and LSC of $35,000 and a very attractive dividend rate.
Hema Ltd.will be able to issue new Class C shares to certain employees, including Jacqui, at a value of, perhaps, $10 per share. Prepare a letter to Penny detailing the tax consequences of these plans to the various shareholders of the shares described. Where feasible, recommend changes to the plans that will allow the described objectives to be achieved in a more tax effective manner, while avoiding any adverse tax consequences. In the case of the Cyphon Ltd. offer for the Dykon Ltd. shares, please tell Penny the option Cyphon Ltd. should choose to avoid any immediate adverse tax consequences.