CHAPTER 3

LIABILITY FOR TAX, INCOME DETERMINATION, AND ADMINISTRATION OF THE

INCOME TAX SYSTEM
Solutions to Key Concept Questions

KC 3-4

[Income categories]

a) Property income h) Employment income

b) Other income i) Property income

c) Business income j) Business income

d) Capital gain k) Capital gain

e) Employment income l) Capital gain

f) Business income m) Business income

g) Property income

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KC 3-5

[ITA: 3 – Net income]

Taxpayer A Taxpayer Taxpayer C

B

3(a) Employment Income $30,000

Business income

Property income

Other income (pension) $40,000 .

40,000 30,000

3(b) Taxable capital gains $25,000 0

Allowable capital losses (0) (3,000)

Excess 25,000 0

40,000 25,000 30,000

3(c) Other deductions 0 0 (265)

40,000 25,000 29,735

3(d) Business loss (20,000)

Property loss (1,000) (0)

(1,000) (20,000)

Net Income $39,000 $ 5,000 $29,735

Taxpayer C has $30,000 of employment income and is entitled to a deduction for CPP enhanced
contributions of 1% of ($30,000 – basic exemption $3,500) = $265

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KC 3-6

[ITA: 3 – Net income]

3(a) Employment income $60,000

Business income 3,000

Property income (interest) 2,000

65,000

3(b) Taxable capital gain $18,000

Allowable capital loss (20,000)

Excess 0 0

65,000

3(c) Other deductions (565)

64,435

3(d) Business loss (7,000)

Allowable business investment loss (5,000) (12,000)

Net income $52,435

Maureen has $60,000 of employment income and is entitled to a deduction for CPP enhanced
contributions of (5.95% - 4.95%) x ($60,000 – basic exemption $3,500) = $565.

3
Problems

Solution to P3-1

a) Tax liability of Jay:

Employment Income $40,000
Property Income 15,000
$55,000
Less business loss (20,000)
$35,000

Tax @ 40% $14,000

Tax liability of Charlotte:

Employment Income $40,000

Property Income 15,000
$55,000

Tax @ 40% $22,000

b) Charlotte's business loss belongs exclusively to the corporation as a separate taxable entity. The loss
in the corporation is preserved and can be offset against future profits of the business, if they occur
within 20 years [ITA 111(1)(a)].

Alternatively, Charlotte may dispose of the shares of the corporation at a reduced value and may
recognize a capital loss of which only one-half is available for tax purposes. Assuming the
corporation is a small business corporation, the loss is an allowable business investment loss which
can be offset against other sources of income, but not until the year in which the shares are
disposed. Therefore, both the timing and amount of loss which can be used to reduce income are
affected [ITA 38, 39(1)(c)].

c) Impact on return on investment: because Jay's tax liability is $8,000 less in year 2023, Jay has a
greater cash flow which can be used for reinvestment. This increased cash flow may provide a
greater long-term return on investment than can be achieved by Charlotte (who may reduce taxes
from the loss at some future time). In addition, if Charlotte recognizes the loss from a sale of shares,
a lesser amount of tax savings will be received as only one-half of the loss is deductible.

Because Jay has higher cash flow than Charlotte in the first year, Jay can use this cash flow to fund
the loss of the business thereby reducing the risk of a complete business failure. Consequently, Jay
may achieve greater and more immediate success from the business. In other words, the increased
cash flow may reduce the risk of business failure.

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Solution to P3-3

[Income categories]

a) Employment income
b) Other income
c) Other income
d) Property income
e) Business income
f) Allowable business investment loss
g) Other deductions
h) Capital gain
i) Business income
j) Other deductions
k) Business income
l) Employment income

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Solution to P3-4

The statutory scheme formula is found in Section 3 of the ITA.

3(a) Employment income $30,000

Business income - Enterprise A 10,000

Property income 5,000

Other sources 12,000

57,000

3(b) Taxable capital gains $15,000

Allowable capital losses (20,000) 0

57,000

3(c) Other deductions (3,000)

54,000

3(d) Losses:

Business Loss - Enterprise B (3,000)

Allowable Business Investment Loss (2,000) (5,000)

Net income for tax purposes $49,000

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Solution to P3-5

While the company lost $11,000 during the year, the calculation of income for tax purposes is considerably
different. There are two reasons for this. First, the gain and loss on the sales of public corporation shares
are capital gains and only 1/2 of the actual amounts are applicable for tax purposes.

Second, in accordance with the aggregating formula, the capital loss on sale #2 can only be deducted to
the extent of taxable capital gains earned in the year. This treatment is different from other types of losses
(like the loss on real estate rentals) which can be offset against all other sources of income [ITA 3].

The tax calculation is as follows:

3(a) Business income $181,000

3(b) Taxable capital gain (1/2 of $7,000) $ 3,500

Allowable capital loss (1/2 of $177,000) (88,500) 0

181,000

3(c) Other deductions 0

181,000

3(d) Loss from real estate rentals (22,000)

Net Income and Taxable income $159,000

Tax payable (13% x $159,000) $ 20,670