9.305 Homework Assignment 1 due October 221A. Murdoch 98.10.12
It is April 1999. Kent Clarke has come for you for tax help. He would like you to calculate income for tax purposes for his company Kent Co. and then to prepare his 1998 personal tax return. Kent Co. is a partnership. Kent, who is the CEO, and his partner G. Me, who is the CFO, each own 50%. Kent Co. makes men’s and women’s jeans and retails them through its warehouse store in North Winnipeg. Although several other retailers have expressed an interest in selling the jeans he makes, currently he is able to sell all he can make through his warehouse store.
Kent’s only source of income is amounts received from Kent Co. His wife (Lois) has stayed home for several years raising their three children, Super (age 16), Duper (age 12) and Trooper (age 8). Her only source of income was an inheritance of $50,000 she received in December 1998 from her maternal grandmother.
Kent is concerned with the amount of tax he is paying. Given that his wife and children pay no taxes, he is wondering if there would be some way to reduce the total taxes paid by the family.
The condensed income statement for his business, as prepared by the CFO is as follows:
Kent Co.
Condensed Income Statement
For the Year Ended December 31, 1998
Sales...... $3,965,300
Cost of sales...... ( 2,098,400)
Gross profit...... 1,866,900
General, sale, and administrative expenses...... (1,641,600)
Income from operations...... 225,300
Net gains on sales of fixed assets...... 91,000
Rental operations income (loss)...... (1,650)
Income before taxes...... $314,650
Kent provides you with the following information, all of which has been reflected in the annual financial statements:
(1)The company accrues warranty expenses based on a percentage of the sales for the year. At the end of 1997, the accrued warranty payable was $72,900. At the end of 1998, the accrued warranty payable had increased to $76,960.
(2)The following items are included in the advertising and promotion account:
Sponsorship for a local amateur basketball team...... $2,500
Payment for an advertising billboard in the local hockey arena...... 2,000
Charitable donations...... 15,000
Political contributions to the federal Reform party...... 200
Meals and entertainment...... 34,600
Staff party...... 11,000
$65,300
(3)Cost of sales includes the wages of the manufacturing employees totaling $500,000. General, sales and administrative costs include salaries of $200,000 plus $48,000 for Kent and $48,000 for G. Me.
(4)In addition to the salaries and wages, the company pays its required share of CPP and UIC premiums. It also provides health and insurance benefits to its employees. These benefit costs were as follows:
Health insurance premiums paid for the group policy...... $79,000
Life insurance premiums paid on the group life policies...... 93,000
Life insurance on term life policies on various executives ($500 per
month)...... 6,000
Kent Co. pays 100% of the premiums required under these plans. Kent Co. is the designated beneficiary of the term life insurance plans. Employees are the designated beneficiaries of the two group plans.
Due to some significant expenditures on equipment during the year, there was a significant amount of debt incurred on November 1st. As part of the financing arrangement, the bank required the insurance policies on the executives as collateral. The premiums paid are equal to the net cost of pure insurance and the amount of the loan exceeds the face amount of the insurance.
(5)Other expenses deducted in calculating income from operations include:
Depreciation...... $139,000
Interest and penalties on late payment of property taxes.....1,598
Legal fees incurred in the negotiation of the bank financing..5,673
Legal fees in defending the company against a wrongful
dismissal suit...... 19,450
Membership fees in various golf clubs for the executives (the executives receiving these make important business contacts at the golf clubs) 7,000
Landscaping around the building and offices...... 3,560
$176,281
(6)On January 1, 1998, the adjusted cost base and undepreciated capital cost for each class of its assets was as follows:
...... ACB UCC
land$113,000
Class 3:building440,000 $220,000
Class 8:office furniture and equipment95,00060,000
Class 12:small tools21,000 7,400
Class 43:manufacturing equipment175,000 90,000
The building, which cost $440,000 in 1987, was sold October 1 for $255,000. (The land was sold for $129,000. It had cost $113,000.) It was the only item in Class 3 at the time of its sale. A new building was purchased November 1 for $750,000 on land that cost $105,000. No jeans were made in October and all inventory was shipped or sold by September 30. Most staff were laid off during October; essential staff operated out of office space rented for $10,000. Both the old and the new building were used as follows:
Receiving and storing of cloth and other raw materials...... 10%
Jean making...... 25%
Retail space...... 35%
Administrative space...... 20%
Staff room...... 10%
New office furniture was purchased November 2 for $20,000. The purchase replaced old assets originally costing $80,000, which were sold for $5,000.
Some small tools originally costing 13,000 were sold in July for a total of $7,000.
On June 30, 1998, the company acquired a patent with 15 years remaining in its useful life. The company paid $15,000 for the patent, which allows it to produce jeans more efficiently.
(7)The company established a separate rental operation with the purchase of the two buildings on August 1, 1998. The operation is run by a full time manager who earns $2,500 a month. In addition, each building has an on-site part-time manager who earns $600 a month. The capital cost and net rental income (before depreciation and CCA) for each was as follows:
Capital costIncome
Building 1...... $48,000$4,500
Building 2...... 45,0004,000
REQUIRED
(A) [50 marks]
Provide the assistance Kent Clarke has requested. This should include:
Computing 1998 income for tax purposes for Kent Co.
Computing 1998 income (in accordance with Section 3 of the Act) and taxes payable for Kent.
(B) [50 marks]
G. Me. would like to retire. Kent does not have the cash to buy him out, and is instead considering taking the company public. Kent would retain his 50% ownership in the company, and the remaining 50% of the shares would be offered to the public. A new CFO would be hired, who would likely earn the same salary as G. Me. currently gets. Kent would like to get some idea of the tax implications of being a public company rather than a partnership. To assist him:
Calculate income (in accordance with Section 3 of the Act) and taxes payable for Kent Co. for 1998, as if the shares had been sold to the public in 1997 and the company had been listed on the Winnipeg Stock Exchange since then.
Calculate Kent’s income and income taxes payable assuming
(1)He received the same salary as given above.
(2)Instead of salary, he received dividends equal to 80% of the salary. (Of course this means that he would also have to give dividends to the other shareholders too.)
(C) [35 marks]
Support the items included in your calculations by reference to the Act and/or Regulations.