Reference no: EM133050150

Questions -

Q1. Loans To Employees - Fred Ethridge is a valued employee of a large Canadian company. He is in the process of negotiating a new compensation package for the coming year. As he is looking to purchase a new residence, one of the alternatives that is being considered is an interest free loan that would be used to purchase this property.

Fred needs $350,000 to comfortably finance this purchase. As he has an excellent credit rating, the Royal Bank is prepared to extend the $350,000 on a 5 year, closed mortgage at a rate of 4.75 percent. The company has indicated that they will extend a $350,000, 5 year, interest free loan in lieu of a raise. The Company's accounting department will calculate the after tax cost of providing the loan and his employer will offer Fred the alternative of additional salary that has the same after tax cost to the Company.

The Company is subject to tax at a combined federal/provincial rate of 29 percent. When funds are available, the Company has alternative investment opportunities that earn a pre-tax rate of 10 percent. Because of Fred's current high salary, any additional compensation will be taxed at a combined federal/provincial rate of 49 percent.

Assume that the prescribed rate for the current year is 2 percent.

Required - A. Determine the tax consequences to Fred and the cost to the Company, in terms of lost after-tax earnings, of providing Fred with a $350,000 interest free loan for the first year of the loan.

B. Determine the amount of additional salary that could be provided to Fred for the same after tax cost to the Company that you calculated in Part A.

C. Which alternative would you recommend that Fred accept? Explain your conclusion.

Q2. Loans To Employees - Albert Lee is an employee of a large Canadian company. As he has performed exceptionally well in recent years and has become sought after by competitors, the Company is planning to increase his compensation in an effort to retain him.

Mr. Lee has developed a growing interest in investing in options and, in order to finance this activity, he is looking to borrow $500,000. His bank has indicated that they would be prepared to loan this amount to him at a rate of 6 percent. This is attractive in that he anticipates that his activity in the options market will generate a pre-tax return of at least 15 percent.

Given this situation, Mr. Lee has indicated to his employer that, instead of additional remuneration in the form of salary, he would be prepared to accept a $500,000 interest free loan for 3 years. He would fully invest this sum in options.

The Company is subject to tax at a combined federal/provincial rate of 27 percent. When funds are available, the Company has alternative investment opportunities that earn a pre-tax rate of 9 percent. Any additional compensation for Mr. Lee will be taxed at a combined federal/provincial rate of 46 percent.

Assume that the prescribed rate for the current year is 2 percent.

Required - A. Determine the tax consequences to Mr. Lee and the cost to the Company, in terms of lost after-tax earnings, of providing Mr. Lee with a $500,000 interest free loan for the first year of the loan.

B. Determine the amount of additional salary that could be provided to Mr. Lee for the same after tax cost to the Company that you calculated in Part A.

C. Which alternative would you recommend that Mr. Lee accept? Explain your conclusion.

Q3. Employee Stock Options - Opting Inc. has a very generous stock option plan that allows all of their long term employees to participate. Sandra has worked for the Company for over 10 years and has participated in this plan on a regular basis. With regards to the last options granted to her, the following information is relevant:

On January 1, 2017, Sandra was granted options to acquire 275 of the Company's shares at a price of $15.00 per share.

At a later point in time, when Sandra exercises these options, the Company's shares have a fair market value of $17.50 per share.

On December 1, 2019, all of the shares acquired with the options are sold.

Required - Indicate the tax effect on Sandra of the transactions that took place during 2017, 2018, and 2019 under each of the following independent Cases. Your answer should include the effect on both Net Income For Tax Purposes and Taxable Income. Where relevant, identify these effects separately.

Case A Opting is a Canadian controlled private company. At the time the options were granted, the Company's shares had a fair market value of $16.00 per share. The options are exercised on February 28, 2017. When the shares are sold, the proceeds of disposition are $20.25 per share.

Case B Opting is a Canadian public company. At the time the options were granted, the Company's shares were trading at $16.00 per share. The options are exercised on February 28, 2017. When the shares are sold, the proceeds of disposition are $16.00 per share.

Case C Opting is a Canadian public company. At the time the options were granted, the Company's shares were trading at $14.00 per share. The options are exercised on July 1, 2018. When the shares are sold, the proceeds of disposition are $19.75 per share.

Case D Opting is a Canadian controlled private company. At the time the options were granted, the Company's shares had a fair market value of $14.00 per share. The options are exercised on July 1, 2018. When the shares are sold, the proceeds of disposition are $21.50 per share.

Q4. Employee Stock Options - During January, 2017, Lastech Inc. issued options to their employee, Ms. Marianne Black. The options allowed Ms. Black to acquire 1,500 of the Company's common shares at an option price of $23 per share. At the point in time when the options were exercised, the fair market value of the shares was $25 per share.

All of the shares that are acquired through the options are sold on December 31, 2019 at a price of $28 per share.

Required - Indicate the tax effect on Ms. Black of the transactions that took place during 2017, 2018, and 2019 under each of the following independent Cases. Your answer should include the effect on both Net Income For Tax Purposes and Taxable Income. Where relevant, identify these effects separately.

Case A Lastech Inc. is a Canadian public company. At the time the options were granted, the shares were trading at $22 per share. The options were exercised on July 1, 2018.

Case B Lastech Inc. is a Canadian public company. At the time the options were granted, the shares were trading at $24 per share. The options were exercised on July 1, 2018.

Case C Lastech Inc. is a Canadian controlled private corporation. At the time the options were granted, the Company's shares had a fair market value of $23 per share. The options were exercised on July 1, 2018.

Case D Lastech Inc. is a Canadian controlled private corporation. At the time the options were granted, the Company's shares had a fair market value of $24 per share. The options were exercised on July 1, 2017.

Q5. Employment Income - On January 2, 2019, Ms. Shirley Kantor moves from London, Ontario, to Thunder Bay, Ontario, in order to begin employment with Northern Enterprises Ltd. (NEL). Her salary for the year was $142,000. NEL withheld the following amounts from her earnings:

Federal And Provincial Income Tax

Registered Pension Plan Contributions $32,500

(NEL Makes A Matching Contribution) 3,200

EI Premiums 860

CPP Contributions 2,749

United Way Donations 450

Professional Association Dues 1,250

Other Information:

1. Shirley's moving expenses total $6,800. NEL reimbursed Shirley for 100 percent of these costs.

2. For the year ending December 31, 2019, Shirley was awarded a bonus of $32,000. Of this total, $25,000 was paid during 2019, with the remainder payable in January, 2020.

3. NEL provided Shirley with a car to be used in her employment activities and paid the operating costs for the year that totalled $8,100. The cost of the car was $39,550, including HST of $4,550. The car was available to Shirley throughout 2019. She drove a total of 63,000 kilometers. This included 8,000 kilometers of personal use. Hint: Total Benefit: $5,694

4. In negotiating her new position with NEL, Shirley had asked for a $50,000 interest free loan as one of her benefits. NEL's human resources department indicated that the CEO would not approve any employee loans. However, they agreed to advance $50,000 of her 2020 salary as of November 1, 2019.

5. In her employment related travels, Shirley has accumulated over 100,000 Aeroplan points. During 2019, she and her partner Diane used 50,000 of these points for a weekend flight to New York City. If she had purchased them, the tickets would have cost a total of $940.

6. NEL provided Shirley with the following additional benefits:

Allowance For Acquiring Business Clothing $4,800

Squash Club Membership (No Employment Related Usage) 2,800

Financial Advisor Fees 1,200

7. Shirley's previous employer was a Canadian controlled private corporation. In 2018, she was granted options to buy 500 of the company's shares at $20 per share. This option price was higher than the estimated fair market value of the company's shares at the time the options were granted. On January 2, 2019, Shirley exercised these options. At this time the fair market value of the shares was $28 per share. Shirley immediately sells the shares for $28 per share. Hint: Total Benefit: $4,000

8. Shirley was required by her employer to acquire a laptop computer to be used in her employment duties. At the beginning of 2019, she purchased a computer at a cost of $1,356, including HST of $256. During 2019, her expenditures for computer related supplies totalled $150.

Required - Determine Shirley's net employment income for the year ending December 31, 2019.

Q6. Comprehensive Employment Income - Ms. Martha Gobel is a linguist, specializing in Asian languages. As the daughter of a Canadian diplomat, she has become familiar with the many customs and practices found throughout Asia. In 2018, a headhunting firm in B.C. connected her with Golden Mountain Experiences (GME), a public company, which had begun operations in Whistler, B.C. GME had need of a representative to promote their Canadian services to Asian tour operators and executives.

When her mother was diagnosed with ovarian cancer, Martha moved into her house in Ottawa to help care for her. Her mother died in early 2018, leaving Martha her considerable estate, including her house. When GME offered her a position in November, 2018 with a start date of January 1, 2019, she immediately accepted.

 

The final tax return of her mother stated the fair market value of her house was $525,000 on March 3, 2018. When Martha put the house on the market on November 15, 2018, the listing price was only $450,000 because a nearby landfill had inexplicably started to emit a very foul odor.

At the urging of the listing agent who said the stench was growing stronger, she accepted an offer for $390,000 in April, 2019, resulting in a $135,000 loss on this property.

Other Information:

Other information relevant to 2019 is as follows:

1. GME owned a suite hotel and offered her the use of a unit there at a rate of $2,000 per month. The regular monthly rate for the unit was $5,000 per month. She moved in on January 1, 2019. Through contacts, she finds a large townhouse in Whistler that she purchases on May 15, 2019 for $1,600,000. After doing extensive renovations, she moves out of the hotel and into her townhouse on July 1, 2019.

2. As an incentive to accept the position, GME agreed to compensate her for one-half of any loss on the sale of her Ottawa home. The $67,500 [(1/2)($135,000)] payment was made on May 30, 2019.

3. In order to help Martha with the purchase of her new townhouse, GME provided her with a $100,000 interest free housing loan. The funds are provided to Martha on May 1, 2019. Assume that the prescribed rate for all of 2019 is 2 percent.

4. During 2019, Martha earned a salary of $175,000. This included several large bonuses due to her exceptional sales ability. The Company withheld the following amounts from her salary:

Income Taxes $53,000

CPP 2,749

EI 860

RPP Contributions 2,500

Payment For Personal Use Of Automobile 1,200

5. GME contributed $2,500 on Martha's behalf to the Company's RPP.

6. GME provides group medical coverage to all of its employees. The private health plan premiums paid by GME on Martha's behalf cost $1,115 for the year.

7. During the year, Martha received two non-cash gifts from GME, a season ski pass worth $1,000 and a Christmas gift certificate redeemable at many restaurants in Whistler Village for $100.

8. Her favourite uncle visited her and went skiing with a day pass that Martha provided. He died after falling and hitting his head on a boulder while skiing out of bounds. GME provided Martha with grief counseling services worth $665. She considered the counsellor incompetent and the sessions useless.

9. Up until her uncle's death, Martha purchased many day passes at Whistler for friends and families using GME's 15 percent corporate discount. A statement from GME stated that Martha had saved a total of $1,050 using the discount in 2019.

10. Martha was granted options to buy 100 of the company's shares at $100 per share when she joined the staff of GME. At that time, the shares were trading at $94 per share. On May 10, 2019, the shares are trading at $123 per share. She acquires 50 shares for cash of $5,000 on that date. She is still holding these shares on December 31.

11. GME provided Martha with a membership in the exclusive Blackcomb Ski Club And Spa. The cost of the annual membership was $5,000. Martha took her clients there for meals and drinks. GME paid all the charges on her account as they were related to potential clients of GME. For 2019, this amounted to $22,200.

12. GME provides Martha with a luxury vehicle that she uses to drive her clients on tours and to and from the airport. It was purchased in late 2018 for $120,000, including GST and PST. The vehicle was used by Martha throughout 2019. During the year, she drove the vehicle a total of 102,000 kilometers, of which 90,000 were related to her employment duties. GME pays all operating and maintenance costs, a total of $23,000 during the year. GME withheld $1,200 from her December salary to pay for her personal use of the vehicle for 2019.

13. Martha's demanding job requires her to meet with clients at all hours of the day and night because many of them are on international flights. GME will provide her with a signed form T2200 stating that she is required to pay for certain employment expenses without reimbursement and use a portion of her home for work.

Martha has renovated in order to have a separate area in her townhouse to be used exclusively to entertain her clients, in addition to signing the contracts. She has no receipts for the renovations she did. She was unable to find a contractor who would invoice and accept cheques. Since she needed the work finished quickly, Martha reluctantly paid cash. She used this work space between July 1 and December 31, 2019. This work space occupied 600 square feet of the 2,222 square feet available in her townhouse.

Work space related expenditures are as follows:

Monthly Maintenance Fee (For 6 Months) $5,400

Hydro (For 6 Months) 450

Property Insurance (6 Months) 575

Property Tax (6 months) 2,600

Big screen TV used solely for the entertainment of clients (promotional videos, ski races, etc.) 2,600

Office Furniture 5,600

Furniture for client's entertainment area 12,400

14. Martha received an allowance of $400 per month for 6 months to cover the costs of maintaining a workspace in her home.

Required - Determine Martha's net employment income for 2019.