Gobeil's Strategic Case Studies™
Sample Questions

Last year, Holdco Inc. purchased a 90-day $10,000 US T-bill for $9,860 when the exchange rate was $0.685. When the 90-day $10,000 US T-bill matured, the exchange rate was $0.864.

World Equity Benchmark Shares (WEBS) represent an investment in a portfolio of shares that tracks the performance of a specific Morgan Stanley International (MSCI) country index. WEBS are currently offered for 17 different countries, including Japan. WEBS are traded just like any stock, but they track a specific country index.

Fred is concerned about the stability of the WEBS Japan, but he thinks there is just as much chance that they may jump in value as experience a sudden decline. His objectives are to protect himself from catastrophic losses; while also allowing him to benefit from a sudden market advance.

Irene feels that it is imperative that they earn a return of at least 8% on their retirement savings if they are to meet their retirement objectives. Fred is of the opinion that they should earn at least 11% on all of their investments.

Holdco Inc. received a dividend of $0.742 per share from its shares of the iShares CDN Large Cap 60 Index Fund. Which of the following statements are FALSE?

1. Holdco Inc. will have to pay Part I tax on the dividend.
2. Holdco Inc. will have to pay a refundable Part IV tax on the dividend.
3. Holdco Inc. must gross-up the dividend before including it in income.
4. Holdco Inc. can claim the dividend tax credit.

Answer is (C). (Concepts) The iShares CDN Large Cap 60 Index Fund with ticker symbol XIU seeks to provide long-term capital growth by replicating the performance of the S&P®/TSX® 60 Index through investments in the constituent issuers of such index, net of expenses. Each share represents an equal beneficial interest in a trust that holds stocks of companies included in that Index. The fair market value per share is about 1/10th of the value of the index plus an amount for undistributed dividends.

The S&P®/TSX® 60 Index is comprised of 60 of the largest by market capitalization and most liquid securities listed on the TSX, selected by S&P using its industrial classifications and guidelines for evaluating issuer capitalization, liquidity and fundamentals.

Dividends received by a corporation are included in its income, but unlike dividends received by an individual, there is no gross-up or dividend tax credit. Dividends received from other taxable Canadian corporations, from corporations resident in Canada and controlled by the receiving corporation, and from certain non-resident corporations may be deducted in computing the taxable income of the recipient corporation (ITA 112(1)). In effect, the recipient corporation does not have to pay ordinary income tax, referred to as Part I tax, on the dividends and they pass tax free from one taxable corporation to another.

Dividends received from portfolio investments are subject to a refundable Part IV tax of 33.33%. When the corporation pays dividends to its shareholders, it gets a refund of $1 for every $3 of dividends paid. Dividends received by a corporation are not eligible for the dividend tax credit.

(Case situation) Holdco Inc. received a dividend of $0.742 per share from its shares of the iShares CDN Large Cap 60 Index Fund.

(Statement 1 is false.) Dividends received from other taxable Canadian corporations may be deducted in computing the taxable income of the recipient corporation, thereby excluding those dividends from Part I tax. The iShares CDN Large Cap 60 Index Fund flows through the dividends from the stocks included in the stock index, which are taxable Canadian corporations. So, Holdco Inc. will not have to pay Part I tax on the dividend.

(Statement 2 is true.) The shares of the iShares CDN Large Cap 60 Index Fund are a portfolio investment for Holdco Inc. Dividends received from portfolio investments are subject to a refundable Part IV tax of 33.33%. So, Holdco Inc. will have to pay a refundable Part IV tax on the dividend.

(Statement 3 is false.) Dividends received by a corporation are included in its income, but unlike dividends received by an individual, there is no gross-up or dividend tax credit. So, Holdco Inc. need not gross-up the dividend before including it income.

(Statement 4 is false.) Dividends received by a corporation are included in its income, but unlike dividends received by an individual, there is no gross-up or dividend tax credit. So, Holdco Inc. cannot claim the dividend tax credit.

Answer is (D). At December 31 of this year, the strip bond would be worth $27,178.

(Concepts) A strip bond is sold at a discount and matures at par. The difference between the two prices is the interest income to the investor. The yield for each bond can easily be calculated with a financial calculator. Enter the number of payments per year (P/YR), the purchase price (PV), the face amount (FV), ×P/YR to give the number of compounding periods (N) and solving for the interest rate (I/YR). Because the bonds do not pay interest, the payment (PMT) amount is zero. If the payments are zero, the mode (MODE) is irrelevant.

(Case situation) On January 1 of 2005, Holdco purchased a 5 year, $30,000 strip bond at issue. It has an adjusted cost base of $20,897 and fair market value of $24,149. As at December 31 of this year, the prevailing interest rate on Holdco's strip bond was 5%.

(Choice D is true.) So, at December 31 of this year, the strip bond would be worth $27,178, calculated by entering DISP = number of decimal places to display = 0, P/YR = payments per year = 2, ×P/YR = number of years = term to maturity as at December 31 of this year = ((January 1, 2005 + 5 years) - December 31, 2005) = 2, I/YR = nominal annual interest rate = 5%, PMT = periodic payments = $0, FV = maturity value = $30,000 and solving for PV = present value.