Question

Corporate Tax Payable

While for many years, Sweat Ltd. used a December 31 year end, a 2017 change in the nature of its business resulted in the Company requesting a change in their taxation year end to August 31. Based on the information provided, the CRA accepted this change.

The change will be implemented during 2017. Its Income Statement for the period January 1, 2017 through August 31, 2017, prepared in accordance with GAAP, is as follows:

Sweat Ltd.

Income Statement

8 Month Period Ending August 31, 2017

Sales (All Within Canada)                                                                            $916,000

Cost Of Sales                                                                                                    ( 485,000)

Gross Margin                                                                                                   $431,000

Other Expenses (Excluding Taxes):

        Wages And Salaries                                     ($153,400)

        Amortization                                                     ( 49,300)

        Rent                                                                      ( 56,700)

        Interest Expense                                              (   5,500)

        Foreign Exchange Loss                                   (   4,200)

        Travel And Promotion                                   ( 44,300)

        Bad Debt Expense                                            (   5,400)

        Warranty Expense                                           (   5,800)

        Charitable Donations                                      (   3,100)

        Other Operating Expenses                          ( 19,800)                    ( 347,500)

Operating Income                                                                                           $ 83,500

Gain On Sale Of Investments                                                                         3,900

Income Before Taxes                                                                                     $ 87,400

Other Information:

1.    In determining the Cost Of Sales, the Company deducted a $17,800 reserve for inventory obsolescence.

2.    Wages and salaries includes a $35,000 bonus to Sweat Ltd.’s CEO. Because she anticipates retiring at the end of 2018, this bonus will not be paid until January, 2019.

3.    Amortization is on the furniture and fixtures and delivery vehicles. The capital cost of the furniture and fixtures is $147,000 and, at January 1, 2017, the Class 8 UCC balance is $79,800. During 2017, new furniture was acquired at a cost of $20,500. Old furniture with a capital cost of $14,200 was sold for $9,500.

On January 1, 2017, the Class 10 UCC balance was $103,400. There were no additions or disposals in this Class during the 8 month period ending August 31, 2017.

4.    The interest expense relates to a line of credit that was used to finance seasonal fluctuations in inventory.

5.    The foreign exchange loss resulted from financing costs related to the purchase of merchandise in the United Kingdom.

6.    The travel and promotion expense consisted of the following items:

Business Meals And Entertainment                                           $15,200

Hotels And Airfare                                                                               21,400

Golf Club Memberships                                                                       7,700

Total Travel And Promotion Expense                                               $44,300

7.    For accounting purposes, the Company establishes a warranty reserve based on estimated costs. On January 1, 2017, the reserve balance was $5,400. On August 31, 2017, a new reserve was established at $6,200.

8.    The accounting gain on the sale of investments is equal to the capital gain for tax purposes.

9.    During the period January 1, 2017 through August 31, 2017, the Company declared and paid dividends of $27,600.

10. On January 1, 2017, the Company has available an $18,700 non-capital loss carry forward and a $6,250 [(1/2)($12,500)] net capital loss carry forward.

Required:  Calculate the minimum Net Income For Tax Purposes and Taxable Income for Sweat Ltd. for the 8 month period ending August 31, 2017. Indicate the amount and type of any carry forwards that will be available for use in future years.  

Answer 1

Computation of Minimum Net Income for Tax Purposes:-

1) Reserves for inventory obsolescence is to be provided by passing following entry :-

Cost of Goods Sold Account -Dr.

To Inventory Account

So, The Amount deducted shall be added back to Cost of Sales amount and it is to be accounted for Cost of Goods Sold accounting. This expense is not allowed for computation of taxable income.

2) Unpaid Bonus shall be added back to the profits as it Provision for Bonus payable is not allowed as deductible expenditure for tax purpose.

3) Loss on Sale of Furniture is not allowed as deduction for calculation of taxable profits.

4) interest expense relates to a line of credit that was used to finance seasonal fluctuations in inventory is not dedutible for tax purpose.

5) Foreign exchange loss relates to buying of merchandise is allowable expenditure as it is related to business only.

6) In case of business and promotions expenses only 50% of such expenditure is allowed as deduction and Membership fees for golf course is not allowed as deductible expenditure for tax purposes.

7) A warranty reserve based on estimated costs is not allowable expenditure for business purposes.

8) Gain on sale of investments is to be deducted from business income and it is taxable under the head of capital gain. It is to be adjusted against Capital Loss of $6,250

9) Dividend paid is allowed as deduction for taxation purpose

10) Non Capital Loss can be carried forward as follows :-

The non-capital loss arising in a tax year ending prior to March 23, 2004, back three years and forward seven years. A non-capital loss arising in a tax year ending after March 22, 2004 through December 31, 2005, back 3 years and forward 10 years. The company has Non Capital Loss which is deductible as Available Business Investment loss at 50%. So, Carried Forward Amount is $9,350

& Net Capital loss is to be carried forward for future tax years is after adjusting Capital gain on sale of investments $2,350.

Other adjustments :-

1) Charitable Donations is deduction seperately shown under the Deductions under tax savings expenses.