Canadian Income Taxation : Planning And Decision Making, 2013-2014 Edition Solution Manual

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CHAPTER 1TAXATION―ITS ROLE IN BUSINESS DECISIONMAKINGReview Questions1.If income tax is imposed after profits have been determined, why is taxation relevant tobusinessdecisionmaking?2.Most business decisions involve the evaluation of alternative courses of action. Forexample, a marketing manager may be responsible for choosing a strategy for establishingsales in new geographical territories. Briefly explain how the tax factor can be an integralpart of this decision.3.What are the fundamental variables of the income tax system that decision makers shouldbe familiar with so that they can apply tax issues to their areas of responsibility?4.What is an “after-tax” approach to decision making?

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Solutions to Review QuestionsR1-1Once profit is determined, the amount of income tax that results is determined by theIncomeTax Act. However, at all levels of management, alternative courses of action are evaluatedand decided upon. In many cases, the choice of one alternative over the other may affectboth the amount and the timing of future taxes on income generated from that activity.Therefore, the person making those decisions has a direct input into future after-tax cashflow. Obviously,decisions that reduce or postpone the payment of tax affect the ultimatereturn on investment and, in turn, the value of the enterprise. Including the tax variable as apart of the formal decision process will ultimately lead to improved after-tax cash flow.R1-2Expansion can be achieved in new geographic areas through direct selling, or by establishinga formal presence in the new territory with a branch office or a separate corporation. The newterritories may also cross provincial or international boundaries. Provincial income tax ratesvary amongst the provinces. The amount of income that is subject to tax in the new provincewill be different for each of the three alternatives mentioned above. For example, with directselling,none of the income is taxed in the new province, but with a separate corporation,allof the income is taxed in the new province. Because the tax cost is different in each case,taxation is a relevant part of the decision and must be included in any cost-benefit analysisthat compares the three alternatives[Reg.400-402.1].R1-3A basic understanding of the following variables will significantly strengthen adecisionmaker's ability to apply tax issues to their area of responsibility.Types of Income-Employment,Business,Property,CapitalgainsTaxable Entities-Individuals,Corporations,TrustsAlternative Business-Corporation,Proprietorship,Partnership,LimitedStructurespartnership,Jointventures,IncometrustsTax Jurisdictions-Federal,Provincial,ForeignR1-4Allcash flow decisions, whetherrelatedto revenues, expenses, asset acquisitions ordivestitures, or debt and equity restructuring, will impact the amount and timing of the taxcost. Therefore, cash flow exists only on anafter taxbasis,and, thetaximpactswhether ornot the ultimate result of the decision is successful. An after-tax approach to decision-makingrequires each decision-maker to think "after-tax" for every decision at the time the decision isbeing made,and,to consider alternative courses of action to minimize the tax cost, in thesame way that decisions are made regarding other types of costs.Failure to apply an after-tax approach at the time decisions are made mayprovide inaccurateinformation for evaluation, and,result in a permanently inefficient tax structure.

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CHAPTER 2FUNDAMENTALS OF TAX PLANNINGReviewQuestions1.“Tax planning and tax avoidance mean the same thing.” Is this statement true? Explain.2.What distinguishes tax evasion from tax avoidance and tax planning?3.Does the Canada Revenue Agency deal with all tax avoidance activities in the same way?Explain.4.The purpose of tax planning is to reduce or defer the tax costs associated with financialtransactions. What are the general types of tax planning activities? Briefly explain how eachof them may reduce or defer the tax cost.5.“It is always better to pay tax later rather than sooner.” Is this statement true? Explain.6.When corporate tax rates are15% and tax rates for individuals are 40%, is it always betterfor the individual to transfer his or her business to a corporation?7.“As long as all of the income tax rules are known, a tax plan can be developed withcertainty.” Is this statement true? Explain.8.What basic skills are required to develop a good tax plan?9.An entrepreneur is developing a new business venture and is planning to raise equity capitalfrom individual investors. Her advisor indicates that the venture could be structured as acorporation (i.e., shares are issued to the investors) or as a limited partnership (i.e.,partnership units are sold). Both structures provide limited liability for the investors. Shouldthe entrepreneur consider the tax positions of the individual investors? Explain. Withoutdealing with specific tax rules, what general tax factors should an investor consider beforemaking an investment?10.What is a tax avoidance transaction?11.“If a transaction (or a series of transactions) that results in a tax benefit was not undertakenprimarily for bona fide business, investment, or family purposes, the general anti-avoidancerule will apply and eliminate the tax benefit.” Is this statement true? Explain.

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Solutions toReviewQuestionsR2-1There is a distinction between tax planning and tax avoidance. Tax planning is the process ofarranging financial transactions in a manner that reduces or defers the tax cost and thatarrangement is clearly provided for in theIncome Tax Actor is not specifically prohibited. Inother words, the arrangement is chosen from a reasonably clear set of options within theAct.In contrast, tax avoidance involves a transaction or series of transactions,the main purposeof which is to avoid or reduce the tax otherwise payable. While each transaction in theprocess may be legal by itself, the series of transactions cause a result that was not intendedby thetaxsystem.R2-2Both tax planning and tax avoidance activitiesclearlypresent the full facts of eachtransaction, allowing them to be scrutinized byCRA. In comparison, tax evasion involvesknowingly excluding or altering the facts with the intention to deceive. Failing to report anamount of revenue when it is known to exist or deducting a false expense are examples oftax evasion.R2-3CRAdoes not deal with all tax avoidance transactions in the same way. In general terms,CRAattempts to divide tax avoidance transactions between those that are an abuse of thetax systemand those that are not. When an action is considered to be abusive,CRAwillattempt to deny the resulting benefits by applying one oftheanti-avoidance rules in theIncome Tax Act.R2-4There are three general types of tax planning activities:Shifting income from one time period to another.Transferring income to another entity.Converting the nature of income from one type to another.Shifting income to another time period can be abenefitif it results in a lower rate of taxapplying to the income. Even if a lower rate of tax is not achieved, abenefit may be gainedfrom delaying the payment of tax to a future time period.Shifting income to an alternate taxpayer (for example, from an individual toacorporation), theamount and timing of the tax may be beneficially altered.There are several types of income within the tax system such as employment income,business income, capital gains and so on. Each type of income is governed by a different setof rules. For some types of income,the timing,the amount of income recognized, and theeffective tax rateis different from other types. By converting one type of income to another, abenefit may be gained if the timing of income recognition,the amount recognized,and/ortheeffective tax rateis favorable.R2-5The statement is not true. Paying tax later may be an advantage because it delays the taxcost and frees up cash for other purposes. However, the delay may result in a higher rate oftax in the future year compared to the current year. In such circumstances there is a trade offbetween the timing of the tax and the amount of tax payable.R2-6Thereis not always an advantage to transfer income to a corporation whenthe corporatetaxrate is lower than that of the individual shareholder. While an immediate lower tax rateresults, remember that the corporation may be required to distribute some or all of itsafter-tax income to the shareholder which causes asecond level oftax. Whether or not anadvantage is achieved depends on the amount of that second level of tax and when it occurs.Other factors may also be relevant such as the tax treatment of a possible business failure orsale.

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R2-7The statement is not true. Knowing the tax rules is, of course, a major element in the taxplanning process,but,it does not guarantee the expected outcome. Planning means thatcertain steps are taken now in preparation for certain activities that may occur in the future.However, those anticipated activities might not occur and the desired tax result may not beachieved. Tax planning also requires that one must anticipate and speculate on possiblefuture scenarios and relate them to the current tax planning steps. Those scenarios are nevercertain.R2-8To develop a good tax plan, one must be able to:Understand the fundamentals of the income tax system.Anticipate the complete cycle of transactions.Develop optional methods of achieving the desired business result and analyzeeach oftheir tax implications.Speculate on possible future scenarios and assesstheir likelihood.Measure the time value of money.Place the tax issue in perspective by applying common sense and sound businessjudgement.Understand the tax position of other parties involved in the transaction.R2-9Yes, the entrepreneur should consider the tax position of the potential investors. They will betaking a risk in accepting the investment. If the entrepreneur knows the tax effect on theinvestors,of each alternative organization structure,the entrepreneurcan choose the onethat providesinvestorsthe most favorable tax treatment(i.e.,one that reduces their after-taxloss if the investment fails, or increases their after-tax income if it succeeds). Before makingthe investment the investor should determine the tax impact on:income earned by the venture,income distributed to the investor,lossesincurred by the venture,the loss of the investment if the venture fails, andthegain on theinvestment when it is eventually sold.R2-10A tax avoidance transaction is a term used within the general anti-avoidance rule(GAAR)oftheIncome Tax Act. An avoidance transaction is a transaction or series of transactions thatresults in a tax benefit and was not undertaken primarily for bona fide business, investment orfamily purposes[ITA245].R2-11The statement is not true. In order for the tax benefit to be denied under the general anti-avoidance rule(GAAR), the transaction, in addition to not being primarily forbona fidebusiness, investment or family purposes, must be considered to be a misuse or abuse of theincome tax system as a whole. What constitutes a misuse or abuse is not always clear.However, certain avoidance transactions are permitted and others are not[ITA245(3), IC 88-2].___________________________________________________________

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Key ConceptQuestionsQUESTION ONETheIncome Tax Actcontains a general anti-avoidance rule (GAAR) in section 245.Consider eachof the following situations and determine whether the GAAR will likelyapply.Income tax reference:ITA 245(1),(2),(3),(4); IC 88-2.1.Chris transferred her consulting business to a corporation primarily to obtain the benefitof thelow corporate tax rate.2.Paul owns 100% of the shares of P Ltd.Paul provides services to P Ltd. In the currentyearhe received no remuneration for his services because the payment of a salary toPaul wouldincrease the amount of the loss that P Ltd. will incur in the year.3.A Canadian-controlled private corporation pays its shareholder/manager a bonus thatwillreduce the corporation’s income to the amount eligible for the low tax rate.Thebonus is not inexcess of a reasonable amount.4.A profitable Canadian corporation has a wholly owned Canadian subsidiary that is sustaininglosses and needs additional capital to carry on its business.The subsidiary couldborrow thefunds from its bank but could not obtain any tax saving in the current yearby deducting theinterest expense due to its loss situation.Therefore, the parent corporationborrows the fundsfrom its bank and subscribes for additional commonshares of the subsidiary.The parentcorporation reduces its taxable income by deductingthe interest expense.The subsidiaryuses the funds to earn income from its business.QUESTION TWOJohn has owned all of the shares of Corporation A and Corporation B since their inception.Inthecurrent year, John had Corporation A transfer, on a tax-deferred basis, propertyused in its businessto Corporation B.The reason for the transfer is to enable CorporationB to apply the income earnedon the transferred assets against its non-capital losses.Will the GAAR in ITA 245(2) apply to disallow the tax benefit?Income tax reference: ITA245(1),(2),(3),(4);IC 88-2.

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Solutions toKeyConceptQuestionsKC2-1[ITA: 245(2)–GAAR]The GAAR provision inITA245(2) is to be used when specific anti-avoidance provisions do notsuffice. For the GAAR to apply, the following four conditions must be met:1)A tax benefit results from a transaction or part of a series of transactions[ITA 245(1)–“taxbenefit” definition],2)The transaction is an avoidance transaction, in that,it was not undertaken primarily forbona fidepurposes other than to obtain the tax benefit[ITA 245(3)–“Avoidancetransaction” definition],3)No other provision of theAct stops the taxpayer from achieving the intended taxadvantage,and4)The transaction is an abusive transaction, in that,itcan reasonably be concluded that thetax benefit would result in a misuse or abuse of the Act, read as a whole[ITA 245(4)].The transactions described in each of the four situations:A tax benefit results in each case,The transactions have been undertaken primarily to obtain a tax benefit and are, forthat reason, avoidance transactions,andAre not subject to any other anti-avoidance rule in the Act,Therefore, the issue to be determined is whether the tax benefit would result in amisuse or abuseof the Act, read as a whole.Situation 1:There is nothing in the Act that prohibits Chris from incorporating herbusiness. Theincorporation is consistent with the Act read as a whole and, therefore, the GAAR would not apply.Situation 2: There is no provision in the Act requiring a salary to be paid to Paul and the failure topay a salary is,therefore,not contrary to the scheme of the Act read as a whole. The GAAR wouldnot apply to deem a salary to be paid by P Ltd. or received by Paul.Situation 3: The Act recognizes the deductibility of reasonable business expenses which includebonuses. The payment of the bonus is not an abusive transaction and, therefore, the GAAR shouldnot apply to the payment.Situation 4:The borrowing by the parent corporation is for the purpose of gaining or producingincome as required by paragraph 20(1)(c) of the Act. The GAAR should, therefore, not apply.Infact, CRA has indicated, in comfort letters, thatwhere one corporation (A Ltd.) borrows from afinancial institution to invest in shares of another corporation (B Ltd.) and B Ltd. re-loans the fundsback to A Ltd. and charges interest at a reasonable rate, thus, shifting income from A Ltd. to B Ltd.,thetransactions arepermissible and will not be challenged.

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KC2-2[ITA: 245(2)–GAAR]The GAAR provision inITA245(2) is to be used when specific anti-avoidance provisions do notsuffice. For the GAAR to apply, the following four conditions must be met:1)A tax benefit results from a transaction or part of a series of transactions,2)The transaction is an avoidance transaction, in that,it was not undertaken primarily forbonafidepurposes other than to obtain the tax benefit,3)No other provision of the Act stops the taxpayer from achieving the intended tax advantage,and4)The transaction is an abusive transaction,in that,it can reasonably be concluded that thetax benefit would result in a misuse or abuse of the Act, read as a whole.In the case of John and his two corporations:The transaction does result in a tax benefit as using the losses will reduce tax,It appears that the transaction was undertaken primarily for the tax benefit, andThere is no provision in theIncome Tax Actprohibiting the transfer of the property on a tax-deferred basis to a related corporation nor the deduction of the losses by Corporation B,So, the question that remains is whether the transaction is an abusive transaction.Since the Act contains specific provisions permitting the transfer of losses between relatedcorporations, the transfer in question is consistent with the scheme of the Act and, therefore, is notan abusive transaction. Thus,the GAAR should not apply.However, had the transfer of a property been undertaken to avoid a specific rule, such as a ruledesigned to preclude the deduction of losses after the acquisition of control of a corporation by anarm's length person, such a transfer would be a misuse of the provisions of the Act and be subjectto the GAAR [IC88-2].Where the GAAR applies, the tax benefit that results from an avoidance transaction will be denied.In order to determine the amount of the tax benefit that will be denied, the provision indicates thatthe tax consequences of the transaction to a person will be determined as is reasonable in thecircumstances.

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CHAPTER 3LIABILITY FOR TAX, INCOME DETERMINATION, ANDADMINISTRATION OF THE INCOME TAX SYSTEMReviewQuestions1.Which of the following entities are subject to income tax?(a)proprietorship(b)individual(c)joint venture(d)trust(e)limited partnership(f)corporation(g)partnership2.Describe how the income earned by any of the non-taxable entities listed above isincluded in the Canadian tax system.3.How and when does income earned by a corporation affect the tax position ofanindividualwho is ashareholder?4.In describing who is liable for tax in Canada, theIncome Tax Actsimply states, “Anincome tax shall be paid,as requiredby this Act,on the taxable income for each taxationyear of every person resident in Canada at any time in the year.” Accepting that “person”includesbothanindividualandacorporation,brieflydiscussthemeaningandramifications of this statement.5.In what circumstances are non-residents subject to Canadian income tax?6.Can a Canadian resident be subject to tax in Canada as well as in a foreign country onthe same earned income? If yes, explain how. Also, what mechanism is available tominimize double taxation?7.Explain the difference betweennet income for tax purposesandtaxable incomefor thetaxable entities.8.Explain what is meant by the statutory scheme, and describe the scheme’s relevance tothe Canadian income tax system.9.For tax purposes, would you prefer that a financial loss be a capital loss or a businessloss? Explain.10.Explain the difference betweenincome from propertyanda gain on the sale of capitalproperty.

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11.One often hears that “corporations are entitled to more deductions for tax purposes thanindividuals.” Based on your reading of Chapter 3, is this statement true? Explain.12.If an individual earns a living as a lawyer, what possible categories of income, for taxpurposes, may he or she generate? Describe the circumstances for each possibleclassification.13.What types of income for tax purposes may result when a profit is achieved on the saleof property (e.g., land)?14.Individual A, a Canadian resident, owns and operates a profitable small farm in NorthDakota, U.S.A. He also has a large amount of money earning interest in an Americanbank. Individual B, also a Canadian resident, owns 100% of the shares of an Americancorporation that operates a profitable small farm in North Dakota. The corporation alsohas a large amount of money earning interest in an American bank.Describe and compare the tax positions of these two individuals who conduct the sameactivities but use different organizational structures.15.Jane Q owned an apple orchard for 20 years. During that time, she had cultivated aunique brand of apple that was popular with health food fans. Toward the end of the20X0 growing season, Q became seriously ill and put the orchard up for sale. Q’sneighbour agreed to purchase the entire orchard for $250,000. It upset Q to have to sellat that time of year because that year’s crop was of high quality and in three weekswould have been ripe for picking.Whattypesofpropertymighthavebeenincludedinthetotalpurchasepriceof$250,000? For tax purposes, what types of income might have been generated from thesale of the orchard? Explain your answer.

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Solutions toReviewQuestionsR3-1Of the seven entities listed the following are subject to tax:individualscorporationstrustsR3-2Proprietorships, partnerships, joint ventures and limited partnerships can all earn incomeas separate entities. However, for tax purposes the income is allocated annually to theowners of the entities and included in their income for taxpurposes. The owners arenormally one of the taxable entities, individuals, corporations or trusts.R3-3A corporation is a separate legal entity distinct from its owners-the shareholders.Consequently a corporation is taxed on its income earned in each taxation year. However,theafter-taxcorporateprofitsmaybedistributedasadividendtotheindividualshareholder. Upon receipt of the dividend the individual shareholder has earned propertyincome (return on the share capital) and is subject to tax consequences at that time[ITA12(1)(j),(k)].Alternatively, if the corporation does not distribute the after-tax profits but retains them forcorporate use, the value of the shares owned by the shareholder will increase in value. Ifand when the shareholder disposes of the shares a capital gain may result due to theincreased share value caused by the corporate earnings retained[ITA40(1)(a)(i)].R3-4This statement is important because it establishes the basic framework of the income taxsystem, who is liable for tax, and on what income.The statement indicates thattax iscalculated on the taxable income of residentpersons for each taxation year. By definingeach of therelevant terms in the statement the general scope of the tax system isapparent. It is,therefore,necessary to define the termsperson, resident, taxable income,andtaxation year[ITA2(1)].As stated in the question, both individuals and corporations are considered to be personsfor tax purposes. Therefore,resident individuals and resident corporations are liableforCanadian tax[ITA248(1)].Individuals are resident of Canada if they maintain a continuing state of relationship withthe country. Whether or not an individual has a continuing state of relationship is aquestion of fact determined from the facts of each situation. To establish this relationshipthe courts consider the time spent in Canada, motives for being present or absent, themaintenance of a dwelling place, the origin and background of the individual, the routineof life, and the existence of social and financial connections. If an individual does not havea continuing state of relationship,theindividualmay be deemed to be a resident if theindividual ispresent in Canada for 183 days or more in a particular year[ITA250(1)(a)].A corporation is a residentof Canadaif it has been incorporated in Canada[ITA250(4)].

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Taxable income is defined as the person's net income for tax purposes minus a limitednumber ofdeductions. Net income for tax purposes consists of world income derived fromfive specificsources: employment, business, property, capital gains, and other sources.These sources are combined in a basic formula known as the statutory scheme. If incomedoes not fit one of the above five categories, it is not taxable. Both individuals andcorporations determine net income for tax purposes using the same set of rules.Tax is calculated on taxable income for each taxation year. The taxation year of anindividual is the calendar year. The taxation year for a corporation is the fiscal periodchosen by the corporation, which cannot exceed one year, 53 weeks to be exact [ITA249(1),249.1(1)].Professionalcorporations(acorporationthatcarriesontheprofessional practice of an accountant, dentist, lawyer, medical doctor, veterinarian orchiropractor[ITA 248(1)]) are required to have a fiscal period that coincides with thecalendar year [ITA 249.1(1)(b)].R3-5A non-resident individual or corporation is subject to Canadian income taxin a mannersimilar to a Canadian residenton taxable income earned in Canada if they are employedin Canada, carry on business in Canada, or dispose of taxable Canadian property[ITA2(3)].In addition, a non-resident who does not have any of the above activities in Canada maybe subject to a special withholding tax(a flat tax)on income which has its source inCanada[ITA212].(For example, dividends, rents royalties, certain management fees,and so on.)R3-6Yes. The resident of Canada is taxed on world incomeandthe foreign country, which isthe source of that income, may also impose tax. For example, a Canadian corporationwhich operates a business branch location in a foreign country will be taxable on thebranch profits in both countries. In order to avoid double taxation, the Canadian taxcalculation permits a reduction of Canadian taxes for foreign taxes paid on the sameincome[ITA126(1), (2)].R3-7Netincomefortaxpurposesconsistsofataxpayer’scombinednetincomefromemployment, business, property, capital gains and other sources. The separate sourcesof income are combined in accordance with an aggregating formula which takes intoaccount any losses from the above sources. Net income for tax purposes is determinedby the same set of rules for individuals and corporations.Taxable income is the base amount upon which the rates of tax are applied, and isdetermined by reducing a taxpayer's net income for tax purposes (above) by a limitednumber of specific deductions. While individuals and corporations use the same formulafor determining net income, the calculation of taxable incomeisdifferent. Deductions forindividuals include a capital gainsdeduction onqualifiedproperties, and unused losses ofother years. Deductions for corporations include charitable donations, dividends fromCanadian corporations and foreign affiliates, and unused losses of other years.

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R3-8The statutory scheme is the fundamental base of the income tax system. It is simply anaggregatingformulawhichestablishestheconceptofataxpayer'sincomefortaxpurposes in comparison to other concepts of income. The formula defines what types ofincome are subject to tax and how any related losses affect a taxpayer's income. As theformula is restricted to five basic types of income activities, the scope of the tax system isestablished. The formula establishes that, although a taxpayer may carry on severalseparate activities, each separate type of income is not taxed separately but rather formspart of a total concept of income. As a result, with the exception of capital losses, a lossfrom one activity within a specified time period may be offset against the income derivedfrom other activities.In spite of the fact that the formula combines severaltypes of income into a single incomeamount, each type ofincome is determined in accordance with its own sets of rules. Theformula then binds them together and establishes their relationships.R3-9A taxpayer would normally prefer that a loss incurred be a business loss as opposed to acapital loss. In accordance with theaggregating formula for computing net income, abusiness loss can be deducted from any other source of income which increases theopportunity to reduce taxes payable as soon as possible. A capital loss, on the otherhand, can only be deducted against a capital gain and,therefore,its ability to reducetaxes payable is considerably restricted. In addition, only one-half of a capital loss isincluded as part of the aggregating formula[ITA3(b)].For example, a taxpayer who has employment income of $30,000 and a business loss of$30,000 has no net income under the aggregating formula and,therefore,no tax liability.However, if the same taxpayer has employment income of $30,000 and a capital loss of$30,000, a tax liability would be incurred because the net income for tax purposes wouldbe $30,000 (from employment) and the capital loss would remain unused.R3-10Income from property is the return that is earned on invested capital. For example,dividends earned on shares of a corporation are property income because they representthe return from the ownership of capital property (the shares). On the other hand, a gainderived from the sale of capital property is considered to be a capital gain. Using theprevious example, if the shares were sold at a profit the gain from that property would bea capital gain and not property income.R3-11Based on the determination of net income for tax purposes, the statement is not true.Both individuals and corporations determine net income for tax purposes in accordancewith the same aggregating formula. In addition, an individual who earns business incomedetermines that income in accordance with the same set of rules as a corporation thatearns business income.Withrespect totheconversion ofnet income fortax purposestotaxable income,individuals are entitled to a capital gainsdeduction whereas a corporation is not. In thiscontext an individual receives preferentialtreatment. In arriving at taxable income, acorporationcanreduceitsnetincomebydividendsreceivedfromotherCanadiancorporations,whereas,individualscannot.However,corporateincomeisultimately

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distributed to shareholders who are individuals and,therefore,this corporate advantage istemporary[ITA110.6, 112(1)].R3-12Working as a lawyer, an individual may earn either employment income or businessincome. If the lawyer provides services to a law firm as an employee in return for a salary,bonus, and fringe benefits, the income would constitute employment income. If the lawyerindependently provides services directly to clients on a fee-for-service basis, the incomederived is business income[ITA5(1), 9(1)].R3-13A profit derived from the sale of property may be classified as either business income orcapital gain. Using the example of property that is land, business income will occur if theland was acquired for the purpose of reselling it at a profit. Alternatively, if the land wasacquired, not for resale, but for long termuse to generate income or for personalenjoyment, the profit on the sale willbeacapital gain.R3-14All Canadian residents are taxed on their world income. The world income of individual Aincludes the business profits from the U.S. farm plus the interest earned from the U.S.bank account. These amounts are,therefore,taxable in Canada in the year earned. Theincome would also be taxable in the U.S. but Canadian taxes may be reduced by U.S.taxes on that income.In comparison, individual B's world income does not include the U.S. farm profits and theU.S. interest. This income belongs to the U.S. corporation and is,therefore,taxed only inthe U.S. The foreign corporation is not a resident of Canada and is not subject toCanadian tax.The after-tax profitsof the foreigncorporation may be distributed toindividual B in the form of dividends at some future time. Such foreign dividends wouldthen be part of B's world income and taxed a second time.Although both A and B conduct the same activities, the organization structure alters theamount and the timing of the related taxes on the income.R3-15The sale of the entire orchard for a total price of $250,000 may include the followingseparate properties:landthe permanent stock of treesthe almost mature crop of apples(The student may also recognize the possibility ofincluding equipment and the intangibleproperty of goodwill.)The sale of the land may result in a capital gain because it is property that was acquiredand used to generate income. Similarly the sale of the trees is capital property becausethetreesare used to produce a regular crop of apples.

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The profit on the sale of apples would constitute business income because theapplesarebeing produced for the purpose of resale at a profit. Even though the apples are notmature, they represent inventory in process.___________________________________________________________

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