TAX 361

Research Assignment

Christine Corman- 102291971

Case- 1

The lawyer’s intentions when he withdrew his entire capital account from his law firm was to

save on interest from taking out a mortgage, while being able to deduct the interest to repay the bank

loan because it is used to replenish capital and in essence produce income.

According to CICA Handbook expenses used to gain income are, in fact deductible. CICA does

not define the term interest, rather they use the determination of the Supreme Court of Canada which

defines interest as “the return or consideration or compensation for the use or retention by one person of

a sum of money, belonging to, in a colloquial sense, or owed to another.” By definition the amount of

monies owed from the loan taken out by the lawyer in order to replenish his capital would be considered

interest. Expenses that are incurred to earn income are deductible under the CICA regulations. Because

of this reasoning it would appear that the interest created by the loan to replace the capital is fully

deductible. This would be a true statement, in my opinion.

The fact that the lawyer has used capital from his company in order to purchase a home is belief

of what tax planning should be. CICA has seen it all and has created provisions even for tax avoidance

of this nature. If this were a completely acceptable practice it would be common practice among the

business world and it simply is not. The implications of mixing business with personal affairs becomes

very sticky
in nature and appropriate policies needed to be introduced in order to bring a general fairness to this

policy. The practice of using capital in order to finance a personal mortgage seems somewhat unfair.

According to my research, imputed interest to combat this practice. Imputed interest is defined as

interest considered to be paid, even through no interest payment has been made. In essence CICA

calculates the interest that should have been paid on the mortgage amount at a fair rate and the Lawyer

will be responsible for this amount with taxes.

Another reason the lawyer could be burned by this transaction is the fact that he is, in essence

using company funds in order to finance his personal mortgage. Because this is not an acceptable the

lawyer will need to calculate a taxable benefit. The portion of the mortgage 100% that is used for

personal purposes. The entire amount of the mortgage is used for personal purposes and thereby the full

amount will be added to the lawyer’s taxable income.

In closing, technically this bank loan expense is deductible. The mortgage, contrary to the

lawyer’s belief is simply not interest free. While the lawyer has attempted to take his tax planning into

his own hands he may have made a potentially toxic business decision. At year end the lawyer could be

surprised with a vary large tax bill that he has neither planned or saved for.

So as you can see, this “tax saving” game the lawyer has attempted to play may seem to save

taxes and interest in somewhat of a loophole but in the long run it works out to costing more. CICA is

constantly updating and amending its practices. They have employees that are well versed in all areas of

the tax code, this way of saving taxes is simply too easy to make logical sense. The lawyer should have

known that this situation was simply too good to be true and consulted an accountant before making

such a brazen business decision.

CASE-2

1) POD 125,000- less disposition 15,000= 110,000

Less cost: (50,000)

Capital gain: $60,000

Taxable capital gain x50%: $30,000

2)

There are several things to consider when deciding if a transaction is business oriented or capital

in nature. These steps are important in deciding the nature of the transaction because the end result

is very different and the taxes related to the transaction are different depending on the type of

transaction which is undertaken. In order to make the decision the following factors will be applied.

a. Relation of the transaction to the taxpayer’s business: the transaction may be considered

business income transaction depending on the similarity to their normal business or

profession. In the current situation the accountant works in an office with real estate

agents and completes real estate transactions every day. But, he is in the business of

accounting, not the business of real estate. Also, the land was purchased on the advice of

a client which may indicate that the accountant had prior knowledge of the potential

profitability of the land, which would lean toward a business transaction. However, there

are still several items to consider before deciding.

b. Activity or organization normally associated with trade: in essence how was the

transaction handled. Was it handled the way someone who would normally buy and sell

land would? In this case the accountant does not seem to have undertaken any

extraordinary practices in order to purchase or sell the land. This would indicate that the

transaction is capital in nature.

 c. Nature of assets involved: the type of asset used. Assets that are more commonly used as

inventory (eg. shoes, Pepsi). These are items that are normally sold for a profit, and not

used to generate income on their own. The land sold in this transaction would be

considered a fixed commodity because it on its own can generate income and is not

considered income by the accountant. This step would indicate a transaction that is

capital in nature.

d. Number and frequency of transactions by the same taxpayer in a given period of time: If a

taxpayer undertakes several similar transactions over a relatively short period of time, this

may indicate that the transactions are to be considered business income. In this case,

however, this is the only transaction of this nature that the accountant has undertaken in at

least two years. This would indicate the transaction was capital in nature.

e. Length of the period of ownership of the asset: the length an asset is held may be useful

in determining the nature of said asset. The shorter the asset is owned, the more likely it

is business income. The asset involved in this transaction has been held for two years,

indicating that the accountant has not been trying to sell and gain a profit and indicates

that this transaction is capital in nature.

f. Circumstances that caused the disposition: An unsolicited offer would indicate that no

expectation of funds was considered before agreeing to sell the asset. The case indicates

that the offer to purchase was indeed unsolicited, thereby indicating

Based on the answers to the above questions that determine the nature of the asset, I will

assume that the transaction is capital in nature. This will be beneficial to the accountant because

he will now be taxed on 50% of his profit, instead of having to include the full amount as

business income.