P a g t Ii 0F6 THIS EXAMINATION CONSISTS OF 6 PAGES PLEASE ENSURE THAT YOU HAVE A COMPLETE PAPER THE UNIVERSITY OF BRITISH COLUMBIA FACULTY OF LAW FINAL EXAMINATION -APRIL 2015 LAW 407.002 Professor Cui TOTAL MARKS: 100 TIME ALLOWED: 3 HOURS Plus 30 minutes reading time ******************* NOTE: 1. This is an open book examination. 2. ANSWER ALL QUESTIONS. THIS EXAMINATION CONSISTS OF 2 QUESTIONS THE FIRST QUESTION IS WORTH 60 MARKS AND THE SECOND 40 MARKS (ALLOCATION OF MARKS WITHIN EACH QUESTION INDICATED TN SQUARE BRACKETS AFTER THE QUESTION)
Pu 20F6 LAW 407, Section 2 QUESTION 1 (60 points) George Rembrandt is a mathematics professor married to Suzanne Langevin, an experienced lawyer who has worked with some leading Canadian law firms. In early 2014, they moved to Vancouver as a family: George joined the computer science faculty at UBC, whereas Suzanne became a Counsel in the corporate department of a Vancouver law firm. They have two children, Sunny (aged 10) and Sophia (aged 6), for whom George and Susanne found a good public school to attend. George s salary as a professor at UBC is $95,000 a year, whereas Suzanne is used to drawing more than $200,000 a year in pay as a lawyer they still feel bemused by this discrepancy in earned income, given that both work very hard and George s mathematical talent seems much rarer in supply than good lawyering skills. George, however, is no geeky recluse. Before becoming an academic, he was one of the founders of a technology company, Neonex, which in 2005 saw its shares listed on the Toronto Stock Exchange. Before the listing, George exercised stock options he had been granted as a company founder to acquire 10,000 Neonex shares. At the time of the exercise, the fair market value of Neonex shares was $10 per share. That value has risen since 2005 and when George sold 5,000 of the Neonex shares he held in early 2014, his net proceeds from the sale were $150,000 quite a bit more than his salary. Originally intending to use this money and other savings to buy a house in Vancouver, George and Suzanne decided to temporarily live in UBC s faculty rental housing a nice 4-bedroom apartment whose market rental value is $3,500 a month, but which UBC rents to George for $2,800 a month. In the meantime, the couple began to look for opportunities to buy a farm on Vancouver Island, which they could spend time at with Sunny and Sophia during the summers. At her new law firm, Suzanne s base salary in 2014 was $170,000, and at the end of the year, she was told that she would receive a bonus of $20,000 for the year, which was subsequently paid to her in February 2015. She was also offered a $30,000 interest-free loan by the law firm to pay for various settlement expenses in Vancouver, which she did not have to pay back until starting in the third year of her employment at the firm. Suzanne drew the full $30,000 of the loan, originally intending to use it for making a down payment on a house in Vancouver, but since she and George decided to delay such a purchase, she kept the funds for other uses. Though delighted by the beautiful climate and natural surroundings of Vancouver, both George and Suzanne retain rigorous work routines during the children s school year. George usually goes to the office at least one day of each weekend he can concentrate better without Sunny and Sophia around. Suzanne also does work over the weekends, but she does it from home most of the time the law firm office feels like an especially desolate place on a weekend day. They decided to hire a part-time nanny/housekeeper to help taking care of Sunny and Sophia and also with household chores. A friend referred
Pa:e 130F6 them to a nanny agency, which charged them a $500 finder s fee, but which very soon helped them identify a very capable young woman named Sunaree. Sunaree works 4 hours each weekday afternoon to pick up the two girls from their after-school programs, cook dinner while watching over the children until George or Suzanne gets home; she also works one day every weekend for 6 hours to help Suzanne at home. For the year 2014, George and Suzanne paid Sunaree a total of $15,000, including $1,000 for several weeks during the summer when the family was away and did not use Sunaree s help. George and Suzanne thought the $1,000 was well worth it to retain Sunaree s assistance. In fact, Sunaree s availability enabled George to go to Switzerland for a month in April 2014, to collaborate with a mathematician there. In addition to hiring Sunaree, George and Suzanne paid $2,000 for each of Sunny and Sophia for their afterschool programs. In summer 2014, the RembrandtlLangevin family spent several weeks on Vancouver Island, during which time grandparents from both sides visited. While the grandparents looked after the children, George and Suzanne visited farms available for sale as much as possible, and were ultimately successful in finding a farming property that satisfied their tastes. The seller, Rob Bennie, owns several nearby farms, and offered to manage the farm that he would sell to George and Suzanne during the months when they live in Vancouver. George and Suzanne, of course, would pay a management fee to Rob, as well as pay for other costs of maintaining the farm. Rob says that the farm will generate for George and Suzanne some miscellaneous income, including the easement fee described below, that would help defray the farm expenses. Rob is willing to sell the farm to George and Suzanne for $1 million if paid immediately. However, George and Suzanne negotiated with Rob to pay the purchase price over the course of five years, with an initial instalment of $400,000, and four more annual instalments of $180,000 each. The sale closed on September 30, 2014, when George and Suzanne paid Rob Bennie the initial instalment of $400,000, financed by George s $150,000 sales proceeds of Neonex shares, the $30,000 of loan proceeds Suzanne got from her law firm, $120,000 of their prior savings, and $100,000 of cash that Suzanne s parents give Suzanne as a gift. The title of the farm was changed to be under Suzanne s name. For the rest of 2014, George and Suzanne paid $4,000 for Rob s management of the farm as well as miscellaneous farm expenses. The farm also generated $2,000 of income for George and Suzanne, due to an easement given to a neighbour for using a path on the farm. This $2,000 is actually an annual payment for the use of the path for the entire year, but Rob did not claim for the portion that has accrued until August 31, 2014, because he mentally had factored that into the sales price. George and Suzanne, on the other hand, thought that Rob did not bargain for part of the 2014 easement fee because of the management fee he was receiving from George and Suzanne. It is now April 2015, and George and Suzanne are getting ready to file their 2014 income tax returns. They ve come to you, a tax return preparer at H&R Block, to find out about the federal income tax consequences of their activities in 2014 described above. In addition to any other legal issues that you may identify, please explain the following to George and Suzanne:
Pagt 140F6 1. What is the amount of George s taxable income, before he claims any deductions and tax credits? (9 points) 2. What is the amount of Suzanne s taxable income, before she claims any deductions and tax credits? (14 points) 3. Who, George or Suzanne or both, is/are entitled to claim childcare expense deductions, and how much of such deductions may they claim? (20 points) 4. What amounts paid by George or Suzanne in connection with purchasing and maintaining the farm may be deductible from either person s income? (17 points) END OF QUESTION 1
Page 150F6 QUESTION 2 (40 points) Tim Doohickey runs an unincorporated business in Vancouver called Doohickey Luggage, which repairs and sells luggage. The business has a small shopfront located on East 1st Avenue near Main Street in a warehouse building. The shop is out of the way and has no retail shoppers dropping by, so a main source of business is institutional clients. One example is airlines: when airline passengers arriving in Vancouver have baggage or suitcases that suffer damage during the course of travel, the airlines or passengers themselves would bring the damaged luggage to Tim s shop. Tim and his employees would repair the damage, or, if repair is not possible (usually because of damaged parts for which there is no ready replacement), the passenger may pick from a respectable collection of new luggage stored in the shop as replacement. Tim would be paid by the airlines for making the repairs, as well as for any luggage accepted by an aggrieved customer as replacement. In addition, since Tim is in the luggage business and is familiar with brands and manufacturers from all over the world (the result of the large variety of luggage transported by airlines), Tim also sells luggage online. Thus if a Vancouver customer is interested in a particular kind of suitcase made in Japan, she may be able to order it through Doohickey Luggage and have it delivered locally. Throughout 2014, Doohickey Luggage sold about 200 suitcases through independent customers, generating revenue of $35,000. Services provided to Air Canada alone generated $30,000 of revenue, $10,000 of which is from luggage replacement and $20,000 is from luggage repairs. Services provided to other airlines altogether generated $40,000, of which $15,000 is from luggage replacement and $25,000 is from luggage repairs. Tim s total cost of goods sold for the luggage sold or offered as replacement is $40,000. Tim was also able to secure new service agreements with two carriers, China Southern and China Eastern. Delta Airlines, however, unexpectedly terminated a contract with Doohickey Luggage that would have lasted until 2018, and paid $5,000 to Tim for the termination. Altogether, Tim s cost for hiring employees in the operation of Doohickey Luggage was $50,000. Moreover, he spent $1000 to buy a new work bench for luggage repair and disposed of the old work bench for $100. The workbench is a Class 8 asset entitled to 20% declining balance depreciation. Other costs, such as business insurance, utilities, etc. added up to $1,500 for the year. Tim does not have to pay rent for the shop because he owns the warehouse building in which the shop is located. He leases the rest of the building out to a car repair shop and another tenant. In 2014 he charged rent to these two tenants for a total of $30,000. The building had an undepreciated capital cost at the beginning of 2014 of $100,000, and is entitled to declining balance depreciation of 6% a year. The tenants are responsible for utilities and repairs for their own parts of the building, and if Tim has to incur any cost of repairs for those parts of the building, he charges the tenants separately for them. Half way through 2014, the owner of the car repair shop in Tim s building, John Chesterton, began to have some fmancial difficulties. He approached Tim for help, and said that if Tim could lend him some money, he would be able to continue to pay rent for the rest of the year. However, John s intention is to close the car repair shop by the end of
Pa 60F6 2014, and start a restaurant business in Bumaby. Tim knew that John would not be able to nm the car repair shop for long as he did not have a lot of customers. Tim also likes John as a person. So they drafted up a promissory note effective on July, 2014, whereby Tim lent John $30,000. John will use $7,500 of the proceeds to pay rent to Tim for the months of July-December 2014, and use the remaining to get his restaurant business in Burnaby started. John can demand the repayment of the loan at any time in 2014, but if he does not, he is entitled to be repaid on April 30, 2015, for both the principal amount of $30,000 and a premium of $4,500. Anticipating that he will be losing a major tenant, Tim decided that it is time for him to sell his warehouse and relocate his repair shop to somewhere near the Vancouver International Airport, which is just as cheap as the East 1st Avenue but less rundown. At the end of the 2014, he concluded the sale of the warehouse to a real estate speculator for $500,000. In the purchase and sale agreement, $90,000 of the consideration was allocated to the building and the remaining $410,000 to the subjacent lot. After checking his records, Tim confirmed his memory that he had originally purchased this lot of land for only $200,000. Tim s son, Leonard, had taken a tax course at Kwantlen Polytechnic University, so Tim asked Leonard to take a crack at preparing Tim s tax return for 2014. Unfortunately, Leonard has only a very foggy memory of what happened in his tax course. So he decided to ask you, his friend, to go over the facts laid out above. Specifically: 1. Leonard remembers that rules on depreciation involved playing with numbers, but not much else. Can you tell him what amounts of depreciation deductions Tim might be entitled to for the year for his businesses? (15 points) 2. Leonard also knows that Tim probably has to pay tax on the sale of the warehouse, but he is not sure how to compute that. Can you tell him what the amount of tax liability for the sale of the warehouse depends on? (12 points) 3. Leonard found out from Tim that as of early April, John Chesterton has not repaid the $30,000 he borrowed from Tim, nor has Tim demanded repayment. However, thanks to Tim s help, John s new restaurant business in Bumaby has gotten off to a promising start. Leonard doesn t see any tax consequences from this loan. What can you advise him about it? (8 points) 4. After answering the questions above, it took you little extra effort to figure out the entire amount of taxable income Tim Doohickey has from his businesses as set out above. Explain how you would compute that income. (5 points) END OF EXAMINATION