Reference no: EM132268468
It is March 1, 2019. You recently began working as an intern for Drake & Associates, a professional practice specializing in taxation services. At a recent meeting, you and an associate meet Natalie Wells, one of the owners and founders of Your Yoga Zone
("YYZ"), an Ontario corporation. In preparation for the meeting, you summarized some relevant facts from your review of prior years' files and permanent records (see Exhibit I). Extracts from YYZ's financial statements over the last three years were also compiled for ease of reference during the meeting (see Exhibit II).
Natalie needs some help dealing with some sad news. Her co-owner, Trisha, has been diagnosed with a terminal illness. Over the last year, Trisha has become less active in the operations, leaving all decision-making to Natalie. In taking care of her financial affairs, Trisha wishes to liquidate her investment in YYZ now. According to their shareholders' agreement, Natalie has the first option to buy. Natalie has funds for the transaction so financing is not an issue, but she is looking for advice on how best to structure the buyout. If she needs to use a holding company, she would like to understand why. Otherwise, a simple and cost-effective structure is her preference.
Overall, Trisha is a dear, old friend, and Natalie wants the transaction to be fair and to minimize tax costs for both shareholders.
This turn of events has made Natalie think of her future. She wants to consider some estate and succession planning options as far as her corporate holdings are concerned. You have noted her wishes from the meeting (see Exhibit III).
The senior associate in charge of the YYZ engagement asks you to prepare a preliminary memorandum addressed to Natalie in which you recommend courses of action that meet Natalie's objectives.
In addition, the senior associate requests a memorandum for the firm's files that outlines the options considered in arriving at the final recommendations for the client. This technical memo will be forwarded to the tax lawyers who will draft all legal documentation (i.e. purchase and sale agreements, share certificates, and corporate resolutions). As a result, the technical memo must detail amounts and attributes for assets and consideration in any proposed transactions. Ensure any references to authoritative support are noted.
Finally, you are reminded that where choices exist, Natalie would prefer the options that minimize costs, especially income taxes.
Background Information
• Natalie Wells is 67 years old and currently the co-owner of YYZ.
• Natalie and her two best friends from college had incorporated YYZ in 1975 under the corporate laws of Ontario, Canada. At that time, 1,000 common shares were issued for $1 each. Trisha owned 400 shares; Patty owned 300 shares; and Natalie owned the balance of 300 common shares, which represented their respective contributions.
• About 10 years ago, Patty decided to retire in Europe. Natalie paid Patty
$150,000 for her 30% interest when the net assets of the corporation were worth $500,000. The shareholders of YYZ became Trisha (40%) and Natalie (60%). Their ownership interests of YYZ have not changed since then.
• Since incorporation, most of the assets of YYZ have been used in its business of providing yoga and wellness classes to all ages. YYZ was one of the first companies to introduce Yogalates to its members, a fitness routine that combines Pilates exercises with the postures and breathing techniques of yoga. The public's increasing awareness of total body wellness combined with YYZ's innovative programs contribute to its continued growth and demand.
• The shareholders of YYZ believe in supporting Canadian business. Three
years ago, YYZ invested in one of its suppliers, Yoga Apparel Place ("YAP"). YAP is a CCPC whose assets are all used to produce quality yoga clothing for local residents. YYZ paid $200,000 for 15% of YAP, which represents its stake of common shares outstanding and current value.
• In 2018, YYZ advanced $200,000 to Trisha to cover some experimental medical treatment. This loan was due to a personal temporary cash shortfall. It will repaid as soon as some investments are liquidated.
• Just before Patty retired, Natalie inherited a portfolio of public company shares from her deceased uncle's estate. After using some of the funds to purchase Patty's shares, Natalie still retained $700,000 worth of Canadian bank stocks. These bank shares are now worth $1,300,000.
• The investment returns on her bank shares have done well over the last couple of years, enough to supply Natalie with a steady stream of dividends to complement her income.
• YYZ's annual net income per financial statements approximates its annual taxable income.
• When Patty left, valuations were prepared, and they supported the value of YYZ at $500,000. Today, the value of YYZ is estimated at $1.25 million, a value that both remaining shareholders have agreed on. Over the last 3 years, the value of YYZ has climbed steadily (2016: $1 million; 2017: $1.1 million; 2018: $1.25 million). Market studies continue to show future growth potential in this industry.
• Natalie has not claimed the enhanced capital gains deduction to date.
• Both Natalie and Trisha were born in London, Ontario, Canada, where they continue to live and work today. Both shareholders incur personal tax at the top marginal rates. Natalie is a single-mother of one daughter, Joy (40 years old). Joy worked at YYZ part-time before going away to university and starting her family in Toronto.
• Recently divorced, Joy has returned home to settle in London with her mother. Joy also has two young children (10-year old Nathan and 5-year old Nicole). While Trisha has dealt with her health issues, Joy has been actively involved with helping her mom at YYZ over the past year. It has been easier now with her youngest in full-time school.
Attachment:- Canadian Business Taxation.rar