Matthew and Jonathan have owned a manufacturing company, Mattjon Limited, for 20 years. Matthew, who is 55 years old, retired from the business on December 31, 20X0. He and his wife plan to travel throughout Canada during his retirement.
It is now January 5, 20X1. Jonathan would like to purchase Matthew€™s 50% share of Mattjon. A recent appraisal put the value of the company at $2 million. Jonathan does not have the cash resources to complete the purchase and is concerned about his ability to meet the debt service costs if he has to borrow money to purchase Matthew€™s shares.
As the two men are friends, Jonathan would like to structure the purchase so that it provides the greatest possible tax deferral to Matthew. Jonathan has heard that holding companies are sometimes used in these situations, but he does not know what such an arrangement would involve. He has also heard about the capital gains deduction and wonders whether it could be applied to this transaction.
Neither Jonathan nor Matthew has disposed of any capital property in the past. Extracts from the balance sheet of Mattjon are provided in Exhibit I on the next page. The owners of Mattjon have asked you to prepare a memo suggesting how this transaction might be structured.
Required:
Prepare the memo.
* Adapted, with permission, from the 1990 Uniform Final Examination ©1990 of the Canadian Institute of
Chartered Accountants, Toronto, Canada. Any changes to the original material are the sole responsibility of W.J. Buckwold and have not been reviewed or endorsed by the CICA.

Note 1: Mattjon is considering relocating its facilities to cheaper industrial land, as a recent appraisal valued the company€™s land at $550,000.The market value of all other assets approximates book value. Mattjon uses capital cost allowance rates for purposes of financial statement amortization.
Note 2: For tax purposes, all shares have paid-up capital and an adjusted cost base equal to $100 per share. Matthew owns the class A preferred shares and Jonathan the class B preferred shares. Both classes of preferred shares are non-voting, non-participating, and redeemable at their paid-up capital of $100 per share.
Note 3: All of the retained earnings are represented by part profits that have qualified for the small business deduction.

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EXHIBITI MATTJON LIMITED Extracts from Balance Sheet As at December 31, 20X0 (unaudited) Assets (Note 1) Current Cash Accounts receivable Inventory S 25,000 150,000 300,000 S475,000 Fixed Land (note 1) Building (net of accumulated amortization) Machinery and equipment (net of accumulated S 50,000 100,000 amortization) 75.000 225,000 Long term: Government bonds Liabilities $70,000 Accounts payable Income and other taxes payable 30000 $100,000 Shareholders' Equity Capital stock (Note 2): 2 common shares 600 class A preferred shares 600 class B preferred shares $ 200 60,000 60,000 779.800 Retained earnings (Note 3) 900.000