Not long ago, Colson and Harmantz formed a corporation to carry on a construction business. Each owned 50% of the common shares, which were issued at a nominal cost. In addition, each shareholder sold certain of his own property to the corporation. Colson sold construction equipment to the corporation for $60,000 (its fair market value). He originally purchased the equipment for $75,000. At the time of the sale, it had an undepreciated capital cost of $40,000. For tax purposes, the corporation and Colson elected that the transfer price was $40,000. Consideration for the sale consisted of the following:

Note payable to Colson……………..	$40,000
Preferred shares ……………………...	20,000
…………………………………...	$60,000

Two months after the incorporation, Harmantz and Colson had a dispute, which they could not resolve. Colson now has decided to leave the company. The departure agreement includes the following terms:

• Colson will buy back his old equipment from the corporation at the current fair market price of $60,000, paying in cash.

• Immediately after the equipment sale, the corporation will use its new cash of $60,000 to pay off its debt of $40,000 to Colson and buy back his preferred shares for $20,000. In addition, the corporation will buy back Colson’s common shares for a nominal cost. 

Although the corporation has not begun any construction, it expects to earn a large profit in its first year if the contract bid is accepted. Some of the expected profits will be subject to a corporate tax rate of 25%. Colson has significant personal income and is subject to a 45% tax rate.

Required:

1. What are the tax consequences to both the corporation and Colson as a result of the above transactions?

2. Will double taxation occur? If it will, calculate the amount.

3. If you were Harmantz, would you have agreed to have the corporation pay Colson $60,000 for the debt and the preferred shares? Explain.

4. Assume that Colson was the sole shareholder of the corporation and had sold the equipment to the corporation in the same manner as described previously. Assume further that shortly after incorporation, the company sold the equipment to a third party for cash and discontinued its existence by paying off its debt and cancelling its shares. What amount would Colson have received? Calculate the amount of double taxation, if any. Would your calculation be different if the corporate tax rate were 15%?