Write Your Exam Code Here: P a e Ii OF 6 Return this exam question paper to your invigilator at the end of the exam before you leave the classroom. THIS EXAMINATION CONSISTS OF 6 PAGES PLEASE ENSURE THAT YOU HAVE A COMPLETE PAPER THE UNIVERSITY OF BRITISH COLUMBIA FACULTY OF LAW FINAL EXAMINATION -DECEMBER 2016 LAW 407/506 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 45 MARKS AN]) THE SECOND 55 MARKS (ALLOCATION OF MARKS WITHIN EACH QUESTION INDICATED IN SQUARE BRACKETS AFTER THE QUESTION)
Pae 120F6 LAW 407 QUESTION 1 (45 points) George is a professor of political science married to Suzanne, a corporate lawyer. They moved to Vancouver as a family in early 2014: George joined the faculty at the School of Public Policy at Simon Fraser University, whereas Suzanne worked at a Vancouver law firm. In early 2016, Suzanne was recruited to become the general counsel of a technology company, Unitek, the expansion of which in Vancouver is part of the high tech boom much discussed in local media. Suzanne was very pleased by the opportunity to work with Unitek, as she has felt for some time that her skills and experience were not fully utilized at the law firm, due to the limited client base (e.g. in the oil, gas, timber, and film industries) that the firm was able to attract. Unitek turned out to be an innovative company in many regards, much as Suzanne had anticipated. But she was pleasantly surprised by one development in particular after joining the company. Many Unitek employees have young children just like Suzanne (whose daughters, Sunny and Sophia, are now 12 and 8, respectively), and Unitek s management had directed its human resources department to examine the feasibility of a plan to support Unitek employees to send their children to schools that emphasize nurturing autonomous, life-long learners. After Suzanne joined Unitek, the feasibility study of the plan was completed and the plan itself was approved by the company s Board. Under the plan, Unitek employee s children are eligible for scholarships for enrolling in the private school Nadrona, which, in addition to the BC regular curriculum, offers education in art, music, drama, philosophy, and technology. (For example, Grades K-3 students learn basic computer programming, whereas Grades 4-12 students take part in an interdisciplinary technology program covering digital art and photography, computer programming, robotics, and web application development.) Entrance into Nadrona is fairly selective it is considered to be the right fit only for gifted children and Unitek s scholarship would be awarded only if the child of an employee is admitted. After some investigation, George and Suzanne were both intrigued by Nadrona. Sunny really likes the public school she is attending, so George and Suzanne only brought Sophia to Nadrona for an admissions test. She was offered admission for the 2016-17 academic year after the test, and Unitek consequently offered Sophia a scholarship of $15,000. Nadrona s current annual tuition is $18,000, $10,800 of which was payable in 2016. Unitek sent $10,800 directly to Nadrona, and the balance of $4,200 of scholarship would be paid in 2017 when further tuition installments are due. George did not change job or school in 2016, but he still had an interesting year at work. For the last few years, he has been invited by different international organizations to offer advice based on his scholarship, and has also been commissioned by several publishers to contribute chapters to books and treatises. He continued these activities in 2016, including attending some rather high-profile conferences with government officials. For most of such conferences, he is offered a daily stipend in addition to having his airfare
Pa.e 130F6 and accommodation costs covered or reimbursed. The stipend usually comfortably exceeds George s consumption needs on these trips, although he believes they are not extravagant. George also receives royalties and lump sum fees for his commissioned writing, which in 2016 totaled $15,000. George believes that he would have agreed to engage in these consulting activities to international organizations, and contributed (if solicited) his writing to the books and treatises, even with no or much less compensation. Sure, it is a nice feeling to see that other people value his time, but it is also the case that the consulting allows him to feel that his scholarship has a real world impact, and the writing is not too different in nature from his other scholarship for which he derives no separate monetary compensation. Moreover, all of these opportunities of consultation and publication are unsolicited by him, and for all he knows, may not continue. Nonetheless, for the last few years, George has reported all of the consulting fees, royalties, and author s compensation as taxable income, without deducting any expenses. On the other hand, he did not report any of his stipends and allowances for travel, even when they clearly exceed his out-of-pocket costs. In 2016, George had trouble getting paid his stipend for one 5-day trip to India. His airfare and accommodation were all taken care of by his Indian host, a university of Delhi. But it unfortunately turned out that, because of India s capital control regime, it could take some time and effort to wire his $2,000 stipend to Canada. George told his host that he was happy not to waste his and their time trying to make the wiring happen, the $2,000 was not important to him, and if the host was insistent on paying him, he wishes to contribute the $2,000 to his host for funding future collaborative research. In his own mind, he also does not plan to report the $2,000 stipend from this trip. One more thing worth mentioning for 2016 is that George and Suzanne finally bought a house in the Kitsilano neighborhood in Vancouver. They have been living in subsidized rental housing offered by SFU since moving to Vancouver, and had purchased a farm on Vancouver Island. They are happy with their current living arrangement, but nonetheless decided to buy the house in Kits for the following reasons. First, they liked the house a lot. But they may still have hesitated to make the purchase if it weren t for the fact that the seller, one Sylvie Langevin, was not ready to move out quite yet. Sylvie was specifically looking for buyers who would be willing to allow her to continue to live in the Kitsilano property for two years but she was also interested in selling the property at the current market price. Sylvie s realtor happened to know George and Suzanne, and subsequently brokered a deal where George and Suzanne would jointly purchase the property for $2.2 million, but give Sylvie the right to live in the house without paying rent for two more years after closing. Sylvie would be required to move out of the house in two years. This struck George and Suzanne as a perfect arrangement. But for it, an outright sale of the house would probably go for $2.5 million: George and Suzanne not only would have had to pay more, they would also have had to either move into the house immediately or find a tenant for it (the market rent charged for the house would be about $6,000 monthly). So George and Suzanne completed the purchase from Sylvie in August,
Pare 140F6 making a $0.7 million down payment and borrowing $1.5 million. They now pay approximately $3,200 in monthly mortgage interest and an average of $1,000 monthly in other fees and charges. The 2017 tax return filing season is imminent. George and Suzanne are coming to you, a tax return preparer, to find out about the federal income tax consequences of their activities in 2016 described above. Please explain the following to George and Suzanne: 1. How and who (if anyone) should report the tuition Unitek provided to Sophia for attending Nadrona? (12 points) 2. Whether and how should George report his reimbursements and stipends for travel and the fees and royalties for authorship? Is he required to report any or all of them? If so, what expenses would he be able to claim deductions for? (18 points) 3. What are the tax consequences of the purchase of the Kitsilano property to George and Suzanne? (15 points) END OF QUESTION 1 QUESTION 2 (55 points) John Chesterton is a real estate agent in Vancouver, earning commissions on the sale of high-end residential properties. He is also the owner of two small farms on Vancouver Island, which he had inherited from his father in 2010: one is located in Saanich and the other near Genoa Bay. As his father did before him, John hires help to manage these farms, where produce is grown and livestock and poultry raised. Among the two farms, the Saanich property is particularly valuable because the market demand for farm property near Victoria has steadily grown over the years. In 2010, the fair market value of the Saanich farm had already reached approximately $1.5 million, and John was not surprised when, in April 2016, a family from Vancouver offered to buy the Saanich farm for $2 million. John was happy to sell the farm in Saanich: he personally likes the Genoa Bay part of the island better, and was in fact considering buying another farm property there that was much larger than the farm he had inherited from his father, and that would be easy to manage together with the inherited farm (both of which involved growing produce and raising livestock and poultry). Moreover, this additional property in Genoa Bay had a lodge that can be rented out during the summer months, which would generate additional income for the owner. So John accepted the offer to sell the Saanich farm for $2 million, the deal was closed in July 2016, and in September John purchased the much larger farm in Genoa Bay for $2.1 million, approximately $0.4 million of which can be allocated to the lodge. Because the purchase of the new Genoa Bay farm was made in September, John earned no rental income from it in 2016. Altogether, the three farms the inherited farm in Genoa Bay, the newly acquired farm in Genoa Bay, and the Saanich farm sold in 20 16
P a! e 5 OF 6 generated $20,000 of net loss from operations during 2016 under John s ownership: that is, the costs of maintaining the farms exceeded farm revenue by $20,000. In addition to the Vancouver Island farms and his real estate agent business, John also owned several residential apartment buildings in Kerrisdale, Vancouver, from which he derives rental income. In the fall of 2015, the owner of a run-down building on Labumum Street that had been converted into a rooming house decided to list the property for sale for $3.2 million. Although the value of this property (the Laburnum Street Property ) had been assessed at $3 million for municipal tax purposes in 2014, virtually all of this value was attributable to the land and none to the building. Thinking that the site would be ideal for another residential apartment building, John decided to purchase the property, tear down the existing building and construct a new one in its place. After talking to his tax advisor, John offered $3,250,000 for the property, on the condition that $2.5 million of this purchase price would be allocated to the building and $750,000 to the land. The vendor accepted the offer without paying any attention to the allocation of the purchase price, and John acquired the property in November 2015. Although an initial draft of the contract of purchase and sale stipulated that the Labumum Street Property would be delivered to John in a vacant state, John s tax advisors suggested that he should waive this condition in favour of a requirement that all tenants must vacate the building no later than April 30, 2016. In the first four months of 2016, John received rental income from these tenants of $20,000, incurred interest expenses (for these months) of $20,000 on the mortgage that he used to purchase the property, as well as property taxes of $1,500. He had net rental income from other residential apartment buildings he owned. The day that John obtained possession of the Laburnum Street Property, he submitted an application to the City of Vancouver to demolish the building and construct an eightstory apartment building on the same site. Approval for demolition was granted on March 15, 2016. Six weeks later, the last tenant vacated the Building and demolition commenced on May 1, 2016. The demolition took two weeks to complete and cost a total of $50,000. However, by August 31, 2016, the City had yet to approve the proposed development, and had floated the idea that John should reduce the height of the building to six stories. Frustrated with the delay and the prospect of additional conditions on the development, John decided to sell the Laburnum Street Property, leaving it to a subsequent purchaser to negotiate with the City. The next day, John listed the property for sale for $3.5 million, and was able to find a buyer and concluded the sale at that price on September 30, 2016. Please advise John on the tax issues under the Income Tax Act in respect of 2016 raised by the transactions described above. In particular: (1) What gain should John recognize from the disposition of the Saanich farm, and what should be his adjusted cost base of the newly acquired Genoa Bay farm? (20 points)
P a. e 6 OF 6 (2) How much, if any, of John s loss from operating the three farms in 2016 is deductible against his income from real estate commissions? (10 points) (3) What is the amount of income, gain, or loss that John would be required and allowed to recognize or claim from the cquisition, ownership, and disposition of the Laburnum Street Property, if his allocation of the purchase price of the property is respected? (13 points) (4) On what grounds might John s purchase price allocation not be respected, and in that case, how should John compute his income, gain or loss in 2016 from the acquisition, ownership, and disposition of the Laburnum Street Property? (12 points) END OF EXAMINATION