It is now January 16, 2021.

You, CPA, work in the tax department of a public accounting firm and are working closely with the Audit Team for your firms client S-cool Supplies Ltd. (SSL). SSL is a Canadian controlled private corporation (CCPC), specializing in school materials and classroom supplies. The company is owned entirely by Walter Black. SSL has a December 31st fiscal year-end. SSL has properly claimed the small business deduction in the current and in prior years.

During the annual audit for SSLs December 31, 2020 year-end, the Audit Team has sent you the e-mail below and has asked for your help.

Hi CPA, We are conducting our annual audit for SSLs December 31, 2020 year-end. The tax return is prepared annually by SSLs internal accounting team. I have a copy of the companys Schedule 1- Net Income (Loss) for Income Tax Purposes of its T2 for 2020, and I am writing for explanations on the tax treatment on a few income statement items.

1. The notes to the financial statements state that the company is involved in a lawsuit, and it is highly probable that SSL will have to pay $1,000,000 in damages in 2021. SSL has accrued the full amount in its 2020 year-end financial statements and has treated the amount as deductible for tax purposes.

2. Marketing expenses totaled $20,000 for the year. Of this amount, $15,000 related to advertising in Canadian educational magazines aimed at the Canadian market, which was treated as deductible for tax purposes. The remaining $5,000 related to advertising in U.S educational magazines for the Canadian market, which was treated as nondeductible for tax purposes.

3. Walters 2020 salary was $150,000. The entire amount was paid in 2020. Other employees who work in similar positions as Walter get paid relatively the same amount. Walters entire salary was treated as deductible for tax purposes.

4. For accounting purposes, an inventory reserve of $11,000 was deducted. This is a general reserve not based on the lower of cost or net realizable value. Schedule 1 of the T2 shows no adjustment for this.

5. Accounting and legal fees for 2020 totaled $50,000. Included in this amount are our audit fees for 2019 in the amount of $15,000. Legal fees related to general matters, including maintenance of the minute books and documentation of general transactions throughout the year. The entire $50,000 was treated as deductible for tax purposes.

6. In August 2020, SSL sent five members of its upper management on a school supply convention in Las Vegas. The convention included many networking sessions and professional seminars on the up-and-coming school supplies, including new technology 3 that will available in Canadian and U.S. classrooms for the upcoming school year. This was the only convention SSL sent employees to in 2020. The total cost for the convention itself was $5,000, and SSL treated this as non-deductible for tax purposes.

For points 1 through 6 above, please explain whether SSL reported each transaction correctly on its tax return. If SSLs treatment of the item is incorrect and requires an adjustment, please advise of the correct treatment. If SSL treated the item correctly, can you please explain to us why no adjustment is necessary? We do not need to know the specific Income Tax Act section references.

In December 2020, SSL received a reassessment notice from the CRA regarding its 2018 fiscal taxation return which was assessed one month after its filing deadline. I did not look into the details, but our audit partner does not agree with the CRAs assessment. How long do we have to file a notice of objection for this? Also, how can the CRA be adjusting the 2018 year when it is 2021!? On another note, Walter contacted us asking us about his personal tax installments for 2021. I am not sure why he did not reach out to you directly. Can you please calculate his minimum installments for 2021 using the CRAs method and let us know what the due date is for each payment? For 2019, Walter paid income taxes of $25,500. He estimates that his 2020 taxes will be $32,500 so assume this will be the actual 2020 amount.

Thanks for your help. This is quite urgent, so if you could get me the answers to all my questions within the next three hours that would be great!

Please respond to the Audit Teams queries.