Today is June 24, 2023, and you, CPA, are a senior associate working in the tax department of a mid-market accounting firm. You were recently assigned to work on a special tax engagement for Prairie Paper Packing Ltd. (Prairie), a Canadian controlled private corporation (CCPC) operating in Alberta. Prairie specializes in the designing, manufacturing, and distribution of cardboard packing solutions and promotional materials. Your manager, Brook Buckwold, explains your task:
“For the past several months, Eve Boucher, the owner-manager of Prairie, has been negotiating the sale of her business. The purchaser has offered Eve $7.5 million for the shares of Prairie and is not interested in the acquisition of assets.”
“Eve would like to know what the after-tax proceeds would be on the sale of the shares. She would like to maximize the proceeds. As a result, you will need to determine if the shares of Prairie will be Qualified Small Business Corporation (QSBC) shares on the proposed purchase date of August 31, 2023. If the shares do not qualify as QSBC shares, I would like you to suggest steps that can be taken to ensure they do qualify. We have been provided with a projected balance sheet for the closing date (Appendix I) and I have sent you the notes from my meeting with Eve (Appendix II).”
“In addition, Dwight Wechsler, the new controller at Prairie is a CPA, but his background is primarily in external audit, so he does not have a great deal of experience dealing with GST/HST matters. He has asked us to assist him in determining the correct GST/HST treatment of several transactions (Appendix III).”
“I would like you to prepare a report which addresses these issues.”
You return to your desk and begin to work on your task.
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Appendix I
PRAIRIE PAPER PACKING LTD.
PROJECTED BALANCE SHEET
For the year ended August 31, 2023
(unaudited)
Assets
Current
Cash
$ 871,168
Money market funds
3,006,778
Inventory
5,539,676
Receivables, net
752,378
Prepaid expenses
30,000
10,200,000
Property, plant, and equipment, net
8,147,154
$ 18,347,154
Liabilities
Current
Accounts payable and accruals
$ 4,353,214
Current portion of long-term debt
315,051
4,668,265
Long-term debt
7,876,285
Due to Prairie Paper Services Inc.
3,331,735https://peachytutors.com/a-comparative-analysis-of-acquisition-and-merger-strategies-case-studies-from-canadian-companies/
15,876,285
Shareholder’s Equity
Share capital
100
Retained earnings
2,470,769
2,470,869
$ 18,347,154
Taxation — Practice Case 7 Case
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Appendix II
Notes from meeting with Eve Boucher
• Eve originally incorporated Prairie in 1999. She likes to keep things simple. Eve is planning to use the proceeds from the share sale to fund her early retirement.
• Eve has never previously used her lifetime capital gains deduction. Her marginal tax rate is 40%.
• Excess funds have built up in Prairie over time and have been invested in money market funds for liquidity purposes so that the money is easily accessible for any business expansion opportunities. The difference between the cost and fair market value of the money market investment is nominal.
• Property plant and equipment held by Prairie was independently appraised at $10 million. Based on current selling prices for Prairie’s products, the net realizable value of the inventory is $7.2 million. The value of internally generated goodwill is the difference between the selling price of the shares and the fair value of Prairie’s net assets. All other assets and liabilities have fair values equal to book values. Prairie’s asset mix has not changed significantly since 2018.
• The $7.5 million selling price for the shares was established based on the projected balance sheet and asset values as at August 31, 2023. The purchase and sale agreement states the purchase price for the shares will be reduced if the fair value of net assets is significantly lower than projected. The agreement also states that the company must maintain a working capital balance of $2 million at the closing date, which is the amount of working capital that the parties believe is required to run the business. In the agreement, working capital is defined as current assets minus current liabilities as per the company’s financial statements.
• Eve’s husband Roger owns 100% of the shares of Prairie Paper Services Inc. (PPSI). Previously, part of Prairie’s paper packaging business was outsourced to this entity and 100% of its income was earned from Prairie. Roger was actively engaged in managing PPSI. When the rules for specified corporate income were introduced, eliminating PPSI’s ability to claim the small business deduction, Prairie discontinued outsourcing the paper packaging business to PPSI. The purchaser of Prairie has no interest in acquiring PPSI and Eve and Roger are not sure what to do with PPSI after the sale of Prairie. PPSI’s only significant asset is its receivable from Prairie and it has no liabilities.
Taxation — Practice Case 7 Case
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Appendix III Email from Dwight Wechsler, Corporate Controller
Hi CPA,
We file monthly GST/HST returns, but we have fallen behind due to the transition from the old controller to me. Our last filing was for March 2023. I’m getting caught up but it would be great if you could provide some guidance on the following transactions:
Revenue
• We acquired two new major customers that we will be shipping cardboard products to. One is located in Alberta and the other is located in the United States. The sale to the U.S. customer is our first foreign sale and we are scheduled to ship the product in August of 2023. In both cases, the goods will be shipped from our warehouse in Alberta. What rate should we charge on these sales?
• We also have a new contract to provide marketing design services starting in July 2023. The work will be completed in Alberta and we will bill the customer’s head office in Nova Scotia. What rate should we charge?
• We have a proprietary manufacturing process for a unique cardboard display called “The Alpaca.” Unlike other cardboard displays, Alpaca displays are shipped pre-assembled and folded flat to 2 inches or less. Through a series of hooks and rubber bands the displays instantly unfold when the packaging is removed. We recently licensed the Canadian rights to the manufacturing process to a major Canadian printing company based in Ontario. I’m not sure if we need to charge GST on the royalties and if we do, what rate to use.
I’ve looked up the HST rates for Ontario and Nova Scotia, and they are 13% and 15% respectively.
Taxation — Practice Case 7 Case
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Appendix III (continued) Email from Dwight Wechsler, Corporate Controller
Expenses
• In July of 2022, Prairie leased a passenger vehicle for Eve for $1,000 plus $50 in GST. She uses the vehicle about 60% of the time for work related purposes. How much of a GST input tax credit can we claim each month?
• We have a supplier who offers a 10% volume discount if we purchase $75,000 of product from them in a year. The discount is not applied until this threshold is surpassed, but once we are eligible, the discount applies retroactively to all purchases made in the year and it is applied to the after-tax amount. As of June 2023, we’ve purchased $80,000 of product and the supplier has issued a credit note of $8,400 (10% of $80,000 plus 10% of the $4,000 of GST applicable on these purchases). We have already claimed $1,750 of input tax credits on purchases made between January and March. There were no purchases in April or May. What is the amount of the input tax credit for June?
It would also be great if you could let me know when any net GST/HST remittances are due.
Many thanks,
Dwight
Introduction
As a senior associate in the tax department of a mid-market accounting firm, I have been tasked with assisting Prairie Paper Packing Ltd. (Prairie), a Canadian controlled private corporation (CCPC) based in Alberta, in maximizing the after-tax proceeds from the sale of its shares. In this report, I will address the key issues raised by our client, Eve Boucher, and the corporate controller, Dwight Wechsler. These issues revolve around the qualification of Prairie’s shares as Qualified Small Business Corporation (QSBC) shares, as well as the correct treatment of GST/HST in various transactions.
Qualification of Prairie’s Shares as QSBC Shares
Eve Boucher’s primary concern is to determine whether Prairie’s shares will qualify as QSBC shares upon the proposed sale date of August 31, 2023. The qualification of shares as QSBC shares is crucial because it can lead to significant tax advantages for the seller. To assess this, we need to consider the following factors:
Lifetime Capital Gains Deduction: Eve has never used her lifetime capital gains deduction, which is available to Canadian residents when disposing of QSBC shares. This deduction can provide substantial tax savings.
Fair Market Value of Assets: The fair market value of Prairie’s assets, particularly property, plant, and equipment and inventory, plays a vital role in determining the qualification of shares as QSBC shares.
Working Capital Requirement: The purchase and sale agreement stipulates that Prairie must maintain a working capital balance of $2 million at the closing date. We need to ensure this requirement is met.
Ownership of Prairie Paper Services Inc. (PPSI): We also need to consider the implications of PPSI, which is owned by Eve’s husband, Roger. Given the history of PPSI’s relationship with Prairie, we must assess any potential impact on the sale of Prairie’s shares.
To address these issues, we will need to conduct a comprehensive analysis of Prairie’s financial statements, asset values, and the terms of the purchase and sale agreement. If the shares do not currently qualify as QSBC shares, we will explore strategies to ensure they do qualify, such as optimizing asset values or restructuring the company’s operations.
GST/HST Guidance for Prairie
Dwight Wechsler, the corporate controller, has requested guidance on various GST/HST matters. We will address these issues as follows:
GST/HST Rates for Sales: For sales to new customers in Alberta and the United States, we must determine the applicable GST/HST rates. Sales within Alberta would generally be subject to the 5% GST, while sales to the United States would likely be zero-rated for GST purposes.
Billing for Services to Nova Scotia: Billing for marketing design services to a customer in Nova Scotia would involve the application of the 15% HST rate, given the provincial tax rate.
GST on Royalties: Determining whether GST should be charged on royalties from licensing the manufacturing process to a company in Ontario requires a careful review of GST rules related to intangible property.
Input Tax Credits (ITCs): Calculating ITCs for expenses such as leasing a vehicle and volume discounts on purchases requires an assessment of eligible ITCs and proper documentation.
GST/HST Filing and Remittances: Providing information on the timing of net GST/HST remittances is crucial for ensuring compliance with tax obligations.
Conclusion
In conclusion, our report aims to assist Prairie Paper Packing Ltd. in maximizing the after-tax proceeds from the sale of its shares and ensuring compliance with GST/HST regulations. To achieve these objectives, we will conduct a thorough analysis of Prairie’s financials, asset values, and the terms of the purchase agreement. Additionally, we will provide clear guidance on the correct GST/HST treatment of various transactions. By addressing these issues comprehensively, we aim to support Eve Boucher and Prairie in their financial goals and tax compliance efforts.
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