Question 1 - 25 marks

Ms. Dundastard, a Canadian resident, has owned all of the shares of Dundas Distributors Inc. (DDI) for over 10 years. She is also the president and the key employee of the corporation which carries on a wholesale distribution business in the Niagara Peninsula of Ontario. The corporation's asset mix has been quite stable for the past three years. The corporate Balance Sheet at September 30, 2020, and appraised fair market values (FMV), shows the following:

Assets Balance Sheet FMV

Cash $ 3,600 $ 3,600

Accounts receivable (net of $1,500 allowance) 13,400 12,700

Inventory 190,000 200,000

Term deposits 155,000 155,000

Shares in Trading Spaces Suppliers Ltd. (TSSL) 23,000 18,700

Land 140,000 215,000

Building, fixtures and equipment (net of amortization) 215,000 305,000

$740,000 $910,000

Liabilities

Accounts payable $ 18,000

Future income taxes 45,000

Long-term debt 325,000

388,000

Capital

Common shares 1,000

Retained earnings 351,000

$740,000

When the above assets were appraised, a valuation of the corporation's customer lists and goodwill, due to location and management, determined that they were worth $90,000.

The term deposits represent a build-up of surplus funds that have not been required in DDI's business over the last several years.

The shares owned by DDI in TSSL are common shares and amount to 18% of the total FMV of TSSL common shares. TSSL, which has no investment assets, is a CCPC carrying on its business across southern Ontario and is a supplier to DDI.

Ms. Dundastard is considering a transaction that will realize her capital gains exemption, none of which she has used to date.

Required:

A. Advise Ms. Dundastard on whether her shares in DDI can be considered to be qualified small business corporation shares (QSBCS). If not, advise her on the most tax effective steps that should be taken to ensure that the shares qualify.

B. As part of the plan that she is considering and ignoring any steps recommended in Part (A), Ms. Dundastard will transfer her shares to a holding corporation which she will incorporate with her husband, so that she and her husband will each own 50% of the common shares of the holding corporation. In return for her shares in DDI, she will receive preferred shares with a FMV of $657,000, which is equal to the FMV of her common shares in DDI. The preferred shares will pay a 3% dividend annually. Her husband stays home to look after the couple's three young children and is a part-time PhD student in socialist philosophy. If DDI builds up too much in non-active investment assets in future years, explain why section 74.4 would apply and show the results of its application. Assume a prescribed interest rate of 4%.