Reference no: EM133061198
Question - Ms. Shlemeel was the sole proprietor of a business that retailed specialty coffees. The business has a December 31 year-end. With the advice of her lawyer, Mr. Shlemozzel, she proposes to transfer the assets of the business on January 2, 2021 to a newly incorporated company called Shlemeel Coffees Unlimited Ltd., the common shares of which are owned by her husband. This corporation has a December 31 year-end. Ms. Shlemeel has provided you with the following balance sheet and additional information concerning her proprietorship.
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SHLEMEEL COFFEES BALANCE SHEET December 31, 2020
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Current Assets
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Cash
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$15,000
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Accounts receivable
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$35,000
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Less: Reserve for doubtful debts
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13,000
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22,000
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Inventory (not real estate), at cost (FMV$40,000)
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37,000
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Shares in Koffee Kart Ltd., at cost (FMV: $32,000)
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45,000
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Prepaid rent
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2,000
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$121,000
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Fixed assets
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Land, at cost (FMV: $210,000)
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60,000
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Building, at cost (FMV: $180,000)
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$160,000
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Less: accumulated amortization
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95,000
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65,000
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Equipment, at cost (FMV: $49,000)
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$100,000
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Less: accumulated amortization
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54,000
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46,000
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Computer system, at cost (FMV: $12,000)
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$25,000
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Less: accumulated amortization
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8,000
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17,000
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Computer software, at cost (FMV: $4,000)
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$6,000
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Less: accumulated amortization
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6,000
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-
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$309,000
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Current liabilities
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Accounts payable
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$20,000
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Current portion of mortgage
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27,000
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$47,000
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Long-term debt
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Mortgage payable
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$115,000
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Less: current portion
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27,000
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88,000
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$135,000
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Proprietor's equity
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174,000
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$309,000
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Additional Information
1. Income for tax and financial accounting purposes have always been the same.
2. The proprietorship has developed goodwill that has a fair market value of $71,000.
3. Liabilities are to be assumed by the new corporation. In addition, Ms. Shlemeel wants to take, as consideration for the transfer of assets under subsection 85(1), the maximum (to the nearest multiple of $1,000) in notes payable by the corporation to permit the maximum deferral of taxation on the transfer. She wants the remainder of the maximum fair market value of consideration in voting preferred shares. The shares will be retractable with a legal stated capital equal to their fair market value and sufficient votes to control the corporation.
4. Koffee Kart Ltd. is an arm's length Canadian-controlled private corporation. All of the corporation's assets are used in an active business carried on in Canada. Ms. Shlemeel owns 15% of the shares of Koffee Kart Ltd.
Required - Ms. Shlemeel has come to you, her accountant, for income tax advice on this proposed transaction.
(a) Identify, with a brief explanation, the business assets that:
(i) Should not be transferred to the corporation at all, and
(ii) Should be transferred to the corporation, but cannot or should not be transferred under a subsection 85(1) election and the amount and type of consideration that should be received for each asset.
(b) For the assets that should be transferred under a subsection 85(1) election to the corporation, indicate the maximum amount of debt (to the nearest multiple of $1,000) that can be taken. Also, indicate the amount of the shares that can be taken as consideration to defer all possible capital gains, losses and other income and to avoid other adverse tax consequences.
(c) Compute the adjusted cost base (ACB) of the consideration and the paid-up capital (PUC) for tax purposes of the shares received from the corporation on the transfer under a subsection 85(1) election.