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Assessment: Income Tax Planning Web - Academic Partners Unit 2 Post-Assessment (C115V20U2L0A25Q20)
Date Submitted: 07/10/2022 07:38:00 PM
Total Correct Answers: 20
Total Incorrect Answers: 0

Your Mark (total correct percentage): 100%

1 Maryanne operates a bakery as a sole proprietorship. Last year, the bakery had sales of $220,000, expenses of
$118,000 and Maryanne withdrew cash of $46,000 from the business bank account to meet her living expenses.
What statement is true?

Correct

The correct answer:

The bakery had a net profit of $102,000.

Your answer:

The bakery had a net profit of $102,000.

Solution:

Under the Income Tax Act, the net income of the business (basically revenue minus expenses) is the personal income of
the sole proprietor. Thus, the net income of the business is taxable to the owner even if he or she leaves it in the
business bank account and does not make any cash withdrawals.

Maryanne's bakery had a net profit of $102,000 calculated as (revenue - expenses) or ($220,000 - $118,000). This
amount is taxable to Maryanne.

2 Cassandra runs an unincorporated, freelance desktop publishing business. In order to purchase a new
computer system and sophisticated colour printer for her business, she took out a bank loan for
$45,000. One year later, Cassandra was in a skiing accident and was unable to work for six months.
Unfortunately, she did not have any disability insurance and she had insufficient capital within the
business to make her bank loan payments. Which of the following statements is TRUE?

Correct

The correct answer: The bank is legally entitled to seize her car to pay the debt.
Your answer: The bank is legally entitled to seize her car to pay the debt.
Solution:

Although a loan may be for business purposes, a sole proprietor is personally liable for all debts and other liabilities
incurred in the operation of the business. Creditors may seize the proprietor's business and/or personal property to pay
business debts.

(Choice A is true.) Cassandra is a sole proprietor who is unable to make the payments required on a business loan. So,
the bank can legally seize Cassandra's car to pay the debt.
3 Sophie operates a consulting practice as a sole proprietor. Which of the following statements about the
tax treatment of her business is FALSE?

Correct

The correct answer: Sophie can choose to leave some income in the business in the form of retained earnings, thereby
deferring personal tax until she withdraws the funds.
Your answer: Sophie can choose to leave some income in the business in the form of retained earnings, thereby
deferring personal tax until she withdraws the funds.
Solution:

Under the Income Tax Act, the net income of the business is the income of the sole proprietor. Thus, the business
income is taxable to the proprietor even if he or she does not receive any cash distributions and he or she leaves the
money in the business. The property used by a sole proprietorship is considered to be the property of the sole proprietor.
Accordingly, capital gains or losses on the disposal of property used in the business are treated exactly the same as
capital gains or losses on any property owned by an individual. Because the net income or loss of a partnership flows
through to its partners, the income tax treatment of sole proprietors is essentially the same as that of partners.

(Choice A is false.) Sophie operates her business as a sole proprietorship. So, Sophie cannot defer personal tax on her
business income by choosing to leave some income in the business in the form of retained earnings.

4 Valerie owns a home-based technical writing business as a sole proprietor. She paid $20,000 to her
editorial assistant, $5,000 to her son as her computer technician and $30,000 to herself as salary. How
much can she deduct as a business expense on her income tax return?

Correct

The correct answer: $25,000

Your answer: $25,000
Solution:

A sole proprietor cannot deduct the money that he or she paid to himself or herself as salary, as a business expense.
However, a sole proprietor can deduct the amounts paid to others, including family members, provided that the wages
are reasonable for the services provided.

(Choice C) Valerie paid $20,000 to her editorial assistant, $5,000 to her son as her computer technician, and $30,000 to
herself as salary. Valerie cannot deduct the money she paid to herself as salary. However, she can deduct the amounts
paid to others for a total of $25,000, calculated as ($20,000 + $5,000).

5 Bob and Dave are thinking about setting up a business together. Bob wants to draft a partnership
agreement, but Dave says it would be a waste of time and he just wants to get down to business.
Suppose that they do not execute a partnership agreement. Which of the following would not be a
necessary characteristic of their business?

Correct

The correct answer: They must both take an active role in the business.
Your answer: They must both take an active role in the business.
Solution:

If there is no partnership agreement in place, the operation of the partnership is governed by the default rules of the
provincial Partnership Acts. This legislation requires that all partners share equally in the capital and profits of the
business. The default provisions also specify that all partners must have the opportunity to participate actively in the
business, but their active participation is not required for the partnership to exist.
In order to be accepted as a partnership under the Income Tax Act, the objective of the arrangement must be to make a
profit. All general partners are jointly and severally liable for all of the debts and obligations of the business, regardless
of whether or not a partnership agreement is in place.

(Choice C) Bob and Dave have not executed a partnership agreement, so their business is governed by the default rules
of their provincial Partnership Act. So, it is not necessary for both of them to take an active role in the business.

6 June, Gene, and Jerry, friends for 15 years, have investigated forming a partnership to build houses.
They plan to each contribute an equal amount of capital to the business. Why would a written
partnership agreement be important for them?

1. the partnership cannot exist without a formal agreement

2. oral agreements are not legally binding
3. a partnership arrangement would allow them to vary the terms of their working arrangement
from those prescribed by provincial partnership legislation
4. a formal agreement would make the partnership a separate legal entity from the partners

Correct

The correct answer: 3 only

Your answer: 3 only
Solution:

A detailed partnership agreement allows the partners to vary the terms of the partnership from the default rules
specified by provincial legislation, as well as detailing the operations and conduct of business, salaries, and a plan for
dissolution of the partnership. A partnership can come into existence without any legal formalities. If there is a formal
agreement, it can be written or oral. However, a written agreement would provide more protection than an oral one. A
partnership cannot be a separate legal entity from the partners even if a partnership agreement is in place.

(Statement 3 is true.) So, a partnership arrangement would allow them to vary the terms of their working arrangement
from those prescribed by provincial partnership legislation.

7 Helen is a member of a four-person partnership. Which of the following statements concerning the
computation of Helen's income and losses for the taxation year is FALSE?

Correct

The correct answer: If the partnership realizes a capital gain, Helen's share must be reported as business income.
Your answer: If the partnership realizes a capital gain, Helen's share must be reported as business income.
Solution:

The Income Tax Act states that when a taxpayer is a member of a partnership, his or her income and losses for the
taxation year are to be computed as if:

the partnership were a separate person resident in Canada

income, losses and taxable capital gains and losses retain their character in respect of source and nature
the income or losses are allocated to the partners according to their respective interests in the capital or income
of the partnership

(Choice B is false.) Helen is a member of a partnership. So, if the partnership realizes a capital gain, Helen would report
her share as a capital gain, not as business income.
8 Which of the following statements concerning a partnership interest is FALSE?

Correct

The correct answer: A partner cannot roll over capital property to the partnership.
Your answer: A partner cannot roll over capital property to the partnership.
Solution:

A partner may contribute depreciable or other capital property to a partnership, instead of cash. Normally this transfer
will be done at fair market value. However, if this would result in the realization of an undesired capital gain or recapture
of CCA, the partner may file an election to roll over the property at its adjusted cost base (ACB) or undepreciated capital
cost (UCC). Because this rollover is permitted under ITA 97(1), it is often referred to as a Section 97 rollover.

A partnership interest is treated as non-depreciable capital property for tax purposes. The partner's initial adjusted cost
base for his or her partnership interest is the price that he or she paid for the interest, or the actual or elected value of
the property that he or she transferred to the partnership. This ACB is adjusted on an ongoing basis to reflect additions
or withdrawals of capital, as well as the income or losses of the partnership. The partner's share of net income is added
to the ACB of his or her partnership interest, while his or her share of losses is deducted from that ACB.

(Choice C is false.) So, a partner may file an election to roll over capital property to the partnership under Section 97 of
the Income Tax Act.

9 Two sisters, Helen and Marsha, formed a partnership, with each contributing $100,000 and their full-time services.
Their partnership agreement allocates all capital gains to Helen, who had previously incurred significant capital
losses that she has not yet been able to deduct. The agreement also specifies that Marsha is to receive an initial
allocation of income equal to 135% of the amount of capital gains credited to Helen. The agreement specifies that
any balance of income is to be divided equally and that all losses are shared equally.

The partnership realized a $50,000 capital gain and $150,000 of other income. Helen and Marsha were surprised to
learn that the Canada Revenue Agency challenged their allocation. Why was the CRA justified in overriding the
allocation specified in the partnership agreement drafted by Helen and Marsha?

1. The primary purpose of the allocation agreement appears to have been to reduce Helen's tax bill.
2. Helen and Marsha are sisters.
3. The Income Tax Act requires that the capital gains must be allocated equally between partners.
4. The Income Tax Act requires that income must be allocated equally between the partners.

Correct

The correct answer:

1 and 2 only

Your answer:

1 and 2 only

Solution:

A partnership agreement can be used to vary the default provision of equal sharing of income, losses or capital gains.
However, according to the Income Tax Act, the Canada Revenue Agency can override this allocation if:

the principal reason for the agreement may reasonably be considered to be the reduction or postponement of
income tax (ITA 103(1))
the partners are not dealing at arm's length and the allocation is not reasonable considering the capital invested,
 work performed or any other relevant factor (ITA 103 (1.1))

(Statement 1 is true.) The principal reason that the sisters chose to allocate all of the capital gains to Helen was to
reduce income taxes, because she had unused capital losses.

(Statement 2 is true.) Helen and Marsha are not dealing at arm's length because they are sisters.

10 Kevin would like to calculate the adjusted cost base of his partnership interest. Which of the following
factors should NOT be included in the calculation of his ACB?

Correct

The correct answer: his share of the CCA claimed by the partnership
Your answer: his share of the CCA claimed by the partnership
Solution:

In a simple case, the adjusted cost base of a partnership interest is calculated as (capital contributions - capital
withdrawals + share of profits - share of losses). Although a taxpayer must report his or her share of the CCA claimed by
a partnership when the partner files his or her personal tax return, this affects his or her taxable business income,
not the ACB of his or her partnership interest.

(Choice B) While Kevin must report his share of the CCA claimed by the partnership, this affects his taxable business
income, not his ACB. So, Kevin would not include his share of the CCA claimed by the partnership when calculating the
ACB of his partnership interest.

11 Which of the following amounts is NOT deducted from the adjusted cost base of a partnership interest?

Correct

The correct answer: the partner's share of income from the partnership
Your answer: the partner's share of income from the partnership
Solution:

The common adjustments to the adjusted cost base of a partnership interest are listed below.

Additions to ACB (ITA 53(1))

capital contributed by the partner, excluding loans to the partnership

the partner's share of the partnership's net income or profit
the partner's share of the non-taxable portion of any capital gains
the partner's share of any assistance or benefit in respect of Canadian resource property or exploration or
development expense incurred in Canada

Deductions from ACB (ITA 53(2))

the partner's share of partnership drawings and capital distributions

the partner's share of losses of the partnership
the partner's share of exploration and development expenses (which are deducted by the partners personally)
the partner's share of the investment tax credits

(Choice B) So, the partner's share of income from the partnership is added, not deducted, from the adjusted cost base of
a partnership interest.
12 Amanda acquired an interest in a general partnership by making an initial capital contribution of
$100,000. Over the period that she remained a partner, her share of the net partnership profit was
$32,000 and she received cash distributions of $160,000. She sold the partnership interest for $20,000.
Which of the following statements is TRUE?

Correct

The correct answer: As a result of selling her partnership interest, Amanda had a capital gain of $48,000.
Your answer: As a result of selling her partnership interest, Amanda had a capital gain of $48,000.
Solution:

Upon disposition of his or her partnership interest, a partner's capital gain will be the excess of the proceeds of
disposition over the adjusted cost base, or ACB. The ACB will be the sum of the partner's capital contributions plus his or
her share of any profits, minus his share of any losses, minus any cash distributions that he or she received.

(Choice C is true.) Amanda originally contributed $100,000 to the partnership. During her tenure as partner, her share of
the profits was $32,000 and she received cash distributions of $160,000. So, her ACB is -$28,000, calculated as (capital
contributions + share of profits - cash distributions) or ($100,000 + $32,000 - $160,000). So, Amanda will have a
capital gain upon selling her partnership interest of $48,000, calculated as (proceeds - ACB) or ($20,000 - (-$28,000)).

13 John and Jim decided to leave their salaried positions to start a general partnership. Which of the
following statements are FALSE?

1. They may be able to reduce their personal income taxes during the start-up years.
2. They can deduct partnership losses from their other sources of income.
3. They may be able to realize a tax deferral on their business income.
4. They will have limited personal liability for the debts of the business.

Correct

The correct answer: 3 and 4

Your answer: 3 and 4
Solution:

Proprietorships, partnerships and corporations all offer tax advantages in specific situations. Because the income of a
partnership flows through immediately to the partners, the partners cannot realize a deferral on their business income.
However, a partnership could result in a reduction in personal income taxes during the business's start-up years,
because of the flow-through of losses, which can be deducted from other sources of income.

All general partners are jointly and severally personally liable for the debts and obligations of the partnership. Therefore,
each partner is subject to unlimited liability.

(Statement 3 is false.) As general partners, Jim and John will be required to report their share of partnership income on
their personal tax returns. So, they will not be able to realize a deferral on their business income.

(Statement 4 is false) As members of a general partnership, both John and Jim are personally liable for the obligations of
the partnership.

14 Jack is in a partnership with two other partners. He has decided to leave the partnership, but is unsure
about the proper course of action. Which of the following statements about the disposition of Jack's
interest in the partnership are TRUE?

1. Jack's partnership interest is considered to be his depreciable capital property.

2. Jack's capital gain or loss will be calculated as the proceeds of the disposition less his ACB and
 qualifying outlays and expenses.
3. When Jack disposes of his partnership interest, the other partners will be deemed to have
disposed of their partnership interests, and will have no choice but to include any resulting
taxable capital gains in their income.
4. Jack's ACB would have been increased by his share of partnership profits and decreased by any
drawing he received from the business.

Correct

The correct answer: 2 and 4

Your answer: 2 and 4
Solution:

A partnership interest is considered to be non-depreciable capital property. If a partner disposes of his or her partnership
interest, it will result in a capital gain or loss to the extent the proceeds of disposition exceed the sum of the partner's
adjusted cost base (ACB) and qualifying outlays and expenses. In a simple case, the adjusted cost base of a partnership
interest is calculated as (capital contributions - capital withdrawals + share of profits - share of losses).

If one partner leaves a partnership, the partnership is automatically dissolved and all partners are assumed to have
disposed of their partnership interests. However, the remaining partners can make use of the Section 97 rollover
provisions to transfer their existing partnership interests to a new partnership, thus avoiding the realization of capital
gains or losses.

(Statement 2 is true.) Jack's partnership interest is considered to be non-depreciable capital property, so when he
disposes of that partnership interest, he will realize a capital gain or loss, calculated as the proceeds of the disposition
less his ACB and qualifying outlays and expenses.

(Statement 4 is true.) In a simple case, the adjusted cost base of a partnership interest is calculated as (capital
contributions - capital withdrawals + share of profits - share of losses). So, Jack's ACB would have been increased by his
share of partnership profits and decreased by any drawing he received from the business.

15 Arnold is one of 10 limited partners of Whizbang Products. A numbered company, 123456 Canada Inc.,
is the general partner. Which of the following statements is TRUE?

Correct

The correct answer: If Whizbang realizes a loss, Arnold may be able to deduct his share of this loss from his other
sources of income.
Your answer: If Whizbang realizes a loss, Arnold may be able to deduct his share of this loss from his other sources of
income.
Solution:

All limited partnerships must have at least one general partner, who is referred to as the promoter. The general partner
has unlimited liability, while the limited partners are not personally liable for the debts and obligations of the business,
as long as they do not take an active role in the business.

A limited partnership cannot be formed until the partnership files a declaration containing prescribed information with
the provincial registrar in accordance with the province's Limited Partnership Act.

As with general partnerships, the profits and losses of a limited partnership are allocated to the partners and must be
reported on their personal tax returns. However, in the case of a limited partnership, each partner can only deduct his or
her share of losses up to his or her "at-risk" amount.

(Choice C is true.) Arnold is a limited partner in Whizbang. So, if Whizbang realizes a loss, Arnold will be able to deduct
his share of this loss from his other sources of income, up to his at-risk amount.
16 Randy, Noel and Lysander are partners in a limited partnership. Randy is the general partner and Noel
and Lysander are limited partners. Randy embezzled from the partnership and absconded to Latin
America. Noel and Lysander decided to take over the management of the firm and continued to operate
the business. Which of the following statements are TRUE?

1. When Lysander and Noel began managing the business, they became liable for the partnership's
debts.
2. Even though Lysander and Noel assumed management roles, as limited partners, the most
Lysander and Noel can lose is their investment in the partnership.
3. The partnership can continue to operate as a limited partnership without a general partner.
4. The partnership can continue to operate as a limited partnership without a limited partner.

Correct

The correct answer: 1 only

Your answer: 1 only
Solution:

All limited partnerships must have at least one limited partner and one general partner. The general partner always has
unlimited liability for the debts and obligations of the business. Limited partners are exempt from personal liability for
the debts and obligations of the partnership as long as they do not participate in the management of the partnership.
Limited partners can still deduct partnership losses from their other sources of income, but only to the extent of their at-
risk amount.

(Statement 1 is true.) Lysander and Noel were limited partnerships, but they began to actively manage the business
once Randy absconded to Latin America. So, when Lysander and Noel began managing the business, they became liable
for the partnership's debts.

17 Renata invested $40,000 in a shoe company as a limited partner. She was able to write off $40,000 over
three years on her tax return. Last year, the partnership operated at a loss of $100,000 of which her
share was $15,000. She unconditionally guaranteed a bank loan of $10,000 for the company. How much
is she able to deduct in business losses for last year?

Correct

The correct answer: $10,000

Your answer: $10,000
Solution:

Limited partners can deduct their share of partnership losses from their other sources of income, but only to the extent
of their at risk amount. Their at-risk amount is the amount they invested, plus the value of any personal guarantees on
business loans.

(Choice B) Renata's share of last year's business loss is $15,000. However, she can only deduct losses up to her at risk
amount. Because she has previously written off losses of $40,000, her ACB at the beginning of last year was zero. By
guaranteeing the bank loan, she increased her at risk amount to $10,000, so she can deduct $10,000 as a business loss,
calculated as (the lesser of her at-risk amount and her share of the business loss) or (the lesser of $10,000 and
$15,000).

18 The "at-risk" rules in the Income Tax Act apply to which of the following?
Correct

The correct answer: limited partners

Your answer: limited partners
Solution:

At-risk rules were included in the Income Tax Act to limit the amount of business losses that a limited partner may
deduct from other sources of income. In particular, these rules were designed to combat the abusive nature of some tax
shelters. The rules prevent investors from taking tax deductions for more than the amount of money that they stand to
lose.

(Choice B) So, the "at-risk" rules in the Income Tax Act apply to limited partners.

19 Cheryl is a freelance artist. She has turned the attic of her home into a studio, which is totally devoted to
her artwork. She also holds small art classes in her studio. Which of the following statements are
FALSE?

1. Cheryl can calculate the portion of household expenses that she can use as tax deductions by
dividing the area of her studio by the total area of her home.
2. Cheryl can claim capital cost allowance on part of her home.
3. Cheryl can claim a business loss if her business-use-of-home expenses exceed her net income
from the business.
4. Cheryl can deduct a portion of her property taxes and mortgage interest from her business
income.

Correct

The correct answer: 3 only

Your answer: 3 only
Solution:

The business-use-of-home expense includes a portion of all home-related expenses, including operation and
maintenance costs such as heating, electricity, cleaning services, landscaping and lawn maintenance services. It also
includes a portion of property taxes, mortgage interest, home insurance, and capital cost allowance (CCA). The portion
of household expenses that a taxpayer can use as a tax deduction can be calculated by dividing the area devoted to the
business by the total area of her home. Alternatively, it can be calculated by dividing the number of rooms devoted to
the business by the total number of rooms in the home.

Business-use-of-home expenses cannot create or increase a business loss that can then be used to offset the taxpayer's
other income.

(Statement 3 is false). Business-use-of-home expenses cannot create or increase a business loss that can then be used
to offset the taxpayer's other income. So, Cheryl cannot claim a business loss if her business-use-of-home expenses
exceed her net income from the business.

20 Debbie borrowed $100,000 and used the funds to purchase the preferred shares of a bluechip company. She held
the investment for the entire year. Assuming an interest rate of 5%, what amount can she deduct as an allowable
interest expense?

Correct

The correct answer:

$ 5,000
 Your answer:

$ 5,000

Solution:

You can usually deduct the interest expense incurred on any loan if the funds are used to purchase an investment that
has the potential to earn business or property income. There is no need to have any investment income in a specific year
in order to take the deduction. There need only be the potential to earn investment income.

Debbie's investment in the stock market has the potential to produce property income in the form of dividends. So,
Debbie can deduct 100% of her interest expense, or $5,000, calculated as (balance outstanding x loan rate) or
($100,000 x 5%).

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