Karen owns all the common shares of K Ltd. which was incorporated in 1997 to hold her 85% interest in Cyber Corp. Cyber Corp. distributes computer equipment and games to retail stores in southern Ontario. Both corporations are CCPCs. The following is a balance sheet prepared as at December 31, 2012.
Cyber Corp.
Balance Sheet
As at December 31, 2012
Assets
Cash ...................................................................................... $ 4,500
Marketable securities (FMV $700,000) ............................................ 300,000
Accounts receivable (FMV $780,000) ............................................. 800,000
Inventory (FMV $920,000) .......................................................... 920,000
Prepaid expenses (FMV $1,000) ....................................................... 1,000
Fixed assets (FMV $150,000) ....................................................... 140,000
.........................................................................................$2,165,500
Liabilities & Shareholders' Equity
Accounts payable and accrued liabilities ........................................ $ 600,000
Loans payable ......................................................................... 400,000
Future income taxes .................................................................. 100,000
Share capital .............................................................................. 1,000
Retained earnings ................................................................... 1,064,500
.........................................................................................$2,165,500
The relative values of Cyber Corp.'s assets have remained stable over the past three years. The marketable securities comprise Cyber Corp.'s investment portfolio which is not held as part of the corporation's business activities. The estimated value of the goodwill of the business is $200,000.
K Ltd. was recently offered $1,450,000 for the 85% interest in Cyber Corp. However, Karen has talked the prospective purchaser into buying the shares of K Ltd. instead of the shares of Cyber Corp., as she understands that by selling the shares of K Ltd. she is able to receive a tax-free $750,000 capital gain.
K Ltd. has term deposits of $100,000 in addition to the shares of Cyber Corp.
REQUIRED
(A) Advise Karen as to whether the shares of K Ltd. are qualified small business corporation (QSBC) shares.
(B) If the shares of K Ltd. are not QSBC shares, then suggest a method for purifying K Ltd. and indicate the tax consequences of your recommendations.