Judy Whyte owns all of the common shares of Danube Manufacturing Ltd. Whyte purchased the shares 10 years ago directly from the corporate treasury at a cost of $50,000. The company regularly earns a pre-tax profit from an active business of $180,000. Whyte has decided to sell the shares of the company to Peter Blue for $700,000. Blue has only $400,000 cash available, but a local bank has agreed to provide a loan of $300,000 for the balance of the purchase price.

Information relating to the company as of the last fiscal year end is as follows:

Paid-up capital of the common shares ………………	$ 50,000
Retained earnings …………………………………..	500,000

Both Whyte and Blue have other sources of income and are in a 45% marginal tax bracket on regular income, 28% on eligible dividends and 35% on non-eligible dividends. Whyte has asked for your advice with respect to the sale of the company. She has mentioned that a friend recently sold his company after transferring his shares to a holding company and that in so doing he gained some deferral benefits.

You are also the accountant for Blue, and he has also sought your advice.

Required:

1. Compare the tax consequences, to Whyte, of the following alternatives:

• Whyte sells shares directly to Blue.

• The corporation buys back all the common shares from Whyte and issues new shares to Blue. This alternative should examine both eligible and non-eligible dividends.

2. Outline to Whyte the advantages, if any, of first transferring the shares to a holding corporation. Show calculations for each of the alternatives mentioned in 1, and inform Whyte of the short-term and long-term implications.

3. How could Whyte transfer her shares of Danube to a new holding corporation without any immediate tax consequences?

4. Assuming that Whyte will sell her shares directly to Blue for $700,000, answer the following questions with respect to Blue:

(a) How will the interest payments on the bank loan be treated for tax purposes?

(b) If Blue must obtain money from Danube to repay the principal of the bank loan, what is the fastest possible time period that the loan can be repaid? (You may assume that interest can be paid from personal funds.)

(c) If Blue establishes a holding corporation to borrow money ($300,000) to buy the shares, how fast will he be able to repay the loan principal? (Exclude interest considerations.)

d) If the holding corporation makes the acquisition, what problem does the interest cost present? How can a later corporate reorganization overcome this problem, and when should this occur?

(e) If Blue uses a holding corporation, he will contribute $400,000 of his own cash to the company to assist with the purchase. Should he loan the $400,000 to the corporation or acquire $400,000 of its common shares? Explain.