As the auditor for Skies Limited, a Canadian-controlled private corporation, you have discovered in 80-5-147-1472 your 2012 year-end audit several items that require further consideration. Mr. Scott is an 80% shareholder and president of the company which has a December 31 fiscal year-end.
The following items were expensed during the year:
Salary for Mr. Scott (assume equal to employment compensation) ........................ $90,000
Royalty payable to Mr. Scott on material prepared for the corporation ..................... 54,000
Contribution to registered pension plan (money purchase plan) for
Mr. Scott whose employee contributions are being matched by the corporation ............ 3,000
The royalty was the only item not paid during the fiscal year. In fact, it was still unpaid at the time of the audit and Mr. Scott indicated to you that it could not be paid until sometime in 2013 when he anticipated that the company would have sufficient cash.
The records showed that the corporation had made several loans to Mr. Scott or to his son, age 30, who owns the other 20% of the shares of the corporation and is, also, an employee of the corporation. Each of the following was evidenced by a separate promissory note, duly signed and approved by the Board of Directors:
(a) A $180,000 non-interest bearing loan, dated August 1, 2012, repayable in $18,000 annual installments, to permit Mr. Scott's son to purchase previously unissued, fully paid shares from the corporation at their fair market value;
(b) A $270,000 3% loan, dated June 1, 2012, repayable over 15 years in equal instalments of principal payable on the anniversary date, but with interest payable monthly, to enable Mr. Scott to purchase a new home, a few blocks from his old home; and
(c) A $24,000 4% loan, dated October 1, 2012, with no principal repayment arrangements, but with interest paid quarterly, to permit Mr. Scott to purchase a car to be used in his employment with the corporation.
Mr. Scott had repaid $4,800 of the car loan on May 31, 2013 and expressed the intention to repay $4,800 annually for four more years.
Any interest required to be paid on the loans at the indicated rates was paid in 2012. Assume the prescribed rates for 2012 were 4% for the first and second quarters, and 5% for the third and fourth quarters.
REQUIRED
(A) Discuss the deductibility of expenses contained in the foregoing information (excluding the shareholder loans).
(B) Discuss the tax implications of the shareholder loans if Mr. Scott and his son received the loans by virtue of being:
(i) Shareholders,
(ii) Employees.
Support your answer with specific calculations where appropriate and provide reasons for your conclusions.