Ms. Maya Regierk wants to transfer the assets of her unincorporated wholesaling business to a newly incorporated company of which she is the only shareholder. She has just received the proforma financial statements that you prepared as at December 31, 2008 and wants to transfer the assets by January 1, 2009.

Maya wants to avoid triggering any income tax on the transfer. Liabilities of the proprietorship, except for the mortgage, are to be assumed by the corporation, first, in payment for assets transferred to the corporation other than under a subsection 85(1) election and, then, in payment for assets transferred to the corporation by a subsection 85(1) election. The mortgage is to be assumed by the corporation in partial payment for the land and the building. New debt is to be issued (to the nearest $100) by the corporation to the maximum that will permit a full deferral of unrealized income on assets transferred. She will own only common shares after the transfer.

The following is the pro forma balance sheet of Maya Wholesaling, as at December 31, 2008, along with expected fair market values at that time. The proprietorship has used the same asset values and depreciation for accounting and tax purposes.

Maya Wholesaling

(a sole proprietorship)

Pro Forma Balance Sheet

as at December 31, 2008

AssetsBook ValueFMV

Cash$14,200 $14,200

Marketable securities, at cost13,000 7,600

Accounts receivable (face value: $138,800; reserve: $10,900)127,800109,300

Inventory28,40040,400

Prepaid insurance3,3003,300

Land in Waterloo held for speculation, at cost 54,600273,000

Fixed assets (see schedule below)175,900235,000

Purchased customer list (cost: $9,800; CEC balance: $4,800)6,40012,000

$423,600$694,800

Liabilities and Proprietor's Equity

Bank loan$68,800

Accounts payable and accrued liabilities95,100

Mortgage on land and buildings101,600

265,500

Owner's capital158,100

$423,600

Maya has indicated that she has recently received an unsolicited offer of $746,500 for all of the assets of his business together (without the assumption of liabilities). This amount appears to be a good indication of the fair market value of her business.

Schedule of Fixed Assets

CostUCCFMV

Land$ 87,400$103,800

Class1 (building)60,100$ 47,00092,900

Class8 (office furniture)54,60024,00020,800

Class 10 (computer and automotive equipment;

no accrued capital gains on any asset)41,20017,50015,300

Class 12 (computer software)5,500Nil2,200

Required:

Analyze in technical detail the following issues in preparation of your advice to Maya.

(a)With respect to the assets described above consider:

(i)which assets should not be transferred to the corporation, with a very brief explanation of why;

(ii)which assets should be transferred to the corporation, but cannot or should not be transferred to the corporation under a subsection 85(1) election, with a very brief explanation and an indication of how these assets should be transferred and what amount of assumed and new (if any) debt consideration should be taken for each such asset; and

(iii)which assets should be transferred to the corporation under a subsection 85(1) election and the consideration that should be received for each asset so transferred.

(45 minutes)

(b)Compute the adjusted cost base and the paid-up capital for tax purposes of the common share consideration, showing the technical details of your calculation of these amounts.

(7 minutes)

(c)Maya's good friend, Janna, who considers herself somewhat of a tax expert, has indicated that it would be a good idea for income splitting purposes to have Maya's husband incorporate the company and subscribe for 100 common shares with $100 of his own funds, since he is in the lower tax bracket. Then, Maya would take, as consideration for the assets transferred under a subsection 85(1) election, preferred shares with a fair market value of $60,000 and no common shares. Explain, briefly, to Maya, with any numbers derived technically or conceptually, as necessary, the immediate tax consequences of her friend's advice.

(9 minutes)

(d)Eleven years from now, the common shares issued to Maya in part (a)(iii), above, plus some additional common shares issued to her on a later capital contribution of $25,000 in cash are expected to be worth $325,000. The only change to the adjusted cost base or paid-up capital computed in part (b), above, will be as a result of this one additional issue of common shares. Maya will have fully utilized her $750,000 capital gains exemption on other shares. At that time in 11 years, Maya will want to freeze the value of her investment in the corporation using a capital reorganization under section 86 in which she receives debt of the corporation, if possible, and preferred shares. What is the maximum amount of debt (to the nearest $100) that she can receive without realizing any income, using section 86? What are the fair market value, adjusted cost base and paid-up capital of the preferred shares that she will receive under section 86? Show all technical calculations necessary to prove your answers to these questions.

(15 minutes)