INSTRUCTOR SOLUTIONS MANUAL
CANADIAN INCOME TAXATION: PLANNING AND DECISION MAKING
2025–2026 EDITION
CHAPTER NO. 01: TAXATION― ITS ROLE IN BUSINESS DECISION MAKING
REVIEW QUESTIONS
1. If income tax is imposed after profits have been determined, why is taxation relevant to
business decision making?
2. Most business decisions involve the evaluation of alternative courses of action. For
example, a marketing manager may be responsible for choosing a strategy for
establishing sales in new geographical territories. Briefly explain how the tax factor can be
an integral part of this decision.
3. What are the fundamental variables of the income tax system that decision-makers should
be familiar with so that they can apply tax issues to their areas of responsibility?
4. What is an “after-tax” approach to decision making?
SOLUTIONS TO REVIEW QUESTIONS
R1-1 Once profit is determined, the Income Tax Act determines the amount of income tax that
results. However, at all levels of management, alternative courses of action are evaluated.
In many cases, the choice of one alternative over the other may affect both the amount and
the timing of future taxes on income generated from that activity. Therefore, the person
making those decisions has a direct input into future after-tax cash flow. Obviously,
decisions that reduce or postpone the payment of tax affect the ultimate return on
investment and, in turn, the value of the enterprise. Including the tax variable as a part of
the formal decision process will ultimately lead to improved after-tax cash flow.
R1-2 Expansion can be achieved in new geographic areas through direct selling, or by
establishing a formal presence in the new territory with a branch office or a separate
corporation. The new territories may also cross provincial or international boundaries.
Provincial income tax rates vary amongst the provinces. The amount of income that is
subject to tax in the new province will be different for each of the three alternatives
mentioned above. For example, with direct selling, none of the income is taxed in the new
province, but with a separate corporation, all of the income is taxed in the new province.
Because the tax cost is different in each case, taxation is a relevant part of the decision and
must be included in any cost-benefit analysis that compares the three alternatives [Reg.
400-402.1].
R1-3 A basic understanding of the following variables will significantly strengthen a decision
maker's ability to apply tax issues to their area of responsibility.
Types of Income - Employment, Business, Property, Capital gains
Taxable Entities - Individuals, Corporations, Trusts
, Alternative Business - Corporation, Proprietorship, Partnership, Limited
Structures partnership, Joint venture, Income trust
Tax Jurisdictions - Federal, Provincial, Foreign
R1-4 All cash flow decisions, whether related to revenues, expenses, asset acquisitions or
divestitures, or debt and equity restructuring, will impact the amount and timing of the tax
cost. Therefore, cash flow exists only on an after tax basis, and, the tax impacts whether or
not the ultimate result of the decision is successful. An after-tax approach to
decision-making requires each decision-maker to think "after-tax" for every decision at the
time the decision is being made, and, to consider alternative courses of action to minimize
the tax cost, in the same way that decisions are made regarding other types of costs.
Failure to apply an after-tax approach at the time that decisions are made may provide
inaccurate information for evaluation, and, result in a permanently inefficient tax structure.
CHAPTER NO. 2: FUNDAMENTALS OF TAX PLANNING
REVIEW QUESTIONS
1. “Tax planning and tax avoidance mean the same thing.” Is this statement true? Explain.
2. What distinguishes tax evasion from tax avoidance and tax planning?
3. Does Canada Revenue Agency deal with all tax avoidance activities in the same way?
Explain.
4. The purpose of tax planning is to reduce or defer the tax costs associated with financial
transactions. What are the general types of tax planning activities? Briefly explain how
each of them may reduce or defer the tax cost.
5. “It is always better to pay tax later rather than sooner.” Is this statement true? Explain.
6. When corporate tax rates are 13% and tax rates for individuals are 40%, is it always better
for the individual to transfer their business to a corporation?
7. “As long as all of the income tax rules are known, a tax plan can be developed with
certainty.” Is this statement true? Explain.
8. What basic skills are required to develop a good tax plan?
9. An entrepreneur is developing a new business venture and is planning to raise equity
capital from individual investors. Their adviser indicates that the venture could be
structured as a corporation (i.e., shares are issued to the investors) or as a limited
partnership (i.e., partnership units are sold). Both structures provide limited liability for the
investors. Should the entrepreneur consider the tax positions of the individual investors?
Explain. Without dealing with specific tax rules, what general tax factors should an investor
consider before making an investment?
10. What is a tax avoidance transaction?
11. “If a transaction (or a series of transactions) that results in a tax benefit was not undertaken
primarily for bona fide business, investment, or family purposes, the general anti-
avoidance rule will apply and eliminate the tax benefit.” Is this statement true? Explain.
, SOLUTIONS TO REVIEW QUESTIONS
R2-1 There is a distinction between tax planning and tax avoidance. Tax planning is the process
of arranging financial transactions in a manner that reduces or defers the tax cost and that
arrangement is provided for in the Income Tax Act or is not specifically prohibited. In other
words, the arrangement is chosen from a reasonably clear set of options within the Act.
In contrast, tax avoidance involves a transaction or series of transactions, the main purpose
of which is to avoid or reduce the tax otherwise payable. While each transaction in the
process may be legal by itself, the series of transactions cause a result not intended by the
tax system.
R2-2 Both tax planning and tax avoidance activities clearly present the full facts of each
transaction, allowing them to be scrutinized by CRA. In comparison, tax evasion involves
knowingly excluding or altering the facts with the intention to deceive. Failing to report an
amount of revenue known to exist or deducting a false expense are examples of tax
evasion.
R2-3 CRA does not deal with all tax avoidance transactions in the same way. In general, CRA
attempts to divide tax avoidance transactions between those that are an abuse of the tax
system and those that are not. When an action is abusive, CRA will attempt to deny the
resulting benefits by applying one of the anti-avoidance rules in the Income Tax Act.
R2-4 There are three general types of tax planning activities:
• Shifting income from one time-period to another.
• Transferring income to another entity.
• Converting the nature of income from one type to another.
Shifting income to another time-period can be a benefit if it results in a lower rate of tax
applying to the income. Even if a lower rate of tax is not achieved, a benefit may be gained
from delaying the payment of tax to a future time-period.
Shifting income to an alternate taxpayer (for example, from an individual to a corporation)
may beneficially alter the amount and timing of the tax.
There are several types of income within the tax system such as employment income,
business income, capital gains and so on. Each type of income is governed by a different
set of rules. For some types of income, the timing, the amount of income recognized, and
the effective tax rate is different from other types. By converting one type of income to
another, a benefit may be gained if the timing of income recognition, the amount
recognized, and/or the effective tax rate is favorable.
R2-5 The statement is not true. Paying tax later may be an advantage because it delays the tax
cost and frees up cash for other purposes. However, the delay may result in a higher rate
of tax in the future year compared to the current year. In such circumstances, there is a
trade-off between the timing of the tax and the amount of tax payable.
R2-6 There is not always an advantage to transfer income to a corporation when the corporate
tax rate is lower than that of the individual shareholder. While an immediate lower tax rate
results, remember that the corporation may be required to distribute some or all of its
after-tax income to the shareholder, which causes a second level of tax. Whether or not an
, advantage is achieved depends on the amount of that second level of tax and when it
occurs. Other factors may also be relevant such as the tax treatment of a possible business
failure or sale.
R2-7 The statement is not true. Knowing the tax rules is, of course, a major element in the tax
planning process, but it does not guarantee the expected outcome. Planning means that
certain steps are taken now in preparation for certain activities that may occur in the future.
However, those anticipated activities might not occur and the desired tax result may not be
achieved. Tax planning also requires that one must anticipate and speculate on possible
future scenarios and relate them to the current tax planning steps. Those scenarios are
never certain.
R2-8 To develop a good tax plan, one must be able to:
• Understand the fundamentals of the income tax system.
• Anticipate the complete cycle of transactions.
• Develop optional methods of achieving the desired business result and analyze each of
their tax implications.
• Speculate on possible future scenarios and assess their likelihood.
• Measure the time value of money.
• Place the tax issue in perspective by applying common sense and sound business
judgement.
• Understand the tax position of other parties involved in the transaction.
R2-9 Yes, the entrepreneur should consider the tax position of the potential investors. They will
be taking a risk in accepting the investment. If the entrepreneur knows the tax effect on the
investors of each alternative organization structure, the entrepreneur can choose the one
that provides investors the most favorable tax treatment (i.e., one that reduces their after-
tax loss if the investment fails, or increases their after-tax income if it succeeds). Before
making the investment, the investor should determine the tax impact on:
• income earned by the venture,
• income distributed to the investor,
• losses incurred by the venture,
• the loss of the investment if the venture fails, and
• the gain on the investment when it is eventually sold.
R2-10 A tax avoidance transaction is a term used within the general anti-avoidance rule (GAAR)
of the Income Tax Act. An avoidance transaction is a transaction or series of transactions
that results in a tax benefit and was not undertaken primarily for bona fide business,
investment or family purposes [ITA 245].
R2-11 The statement is not true. In order for the tax benefit to be denied under the general anti-
avoidance rule (GAAR), the transaction, in addition to not being primarily for bona fide
business, investment or family purposes, must be considered to be a misuse or abuse of
the income tax system as a whole. What constitutes a misuse or abuse is not always clear.
However, certain avoidance transactions are permitted and others are not [ITA 245(3), IC
88-2].
CANADIAN INCOME TAXATION: PLANNING AND DECISION MAKING
2025–2026 EDITION
CHAPTER NO. 01: TAXATION― ITS ROLE IN BUSINESS DECISION MAKING
REVIEW QUESTIONS
1. If income tax is imposed after profits have been determined, why is taxation relevant to
business decision making?
2. Most business decisions involve the evaluation of alternative courses of action. For
example, a marketing manager may be responsible for choosing a strategy for
establishing sales in new geographical territories. Briefly explain how the tax factor can be
an integral part of this decision.
3. What are the fundamental variables of the income tax system that decision-makers should
be familiar with so that they can apply tax issues to their areas of responsibility?
4. What is an “after-tax” approach to decision making?
SOLUTIONS TO REVIEW QUESTIONS
R1-1 Once profit is determined, the Income Tax Act determines the amount of income tax that
results. However, at all levels of management, alternative courses of action are evaluated.
In many cases, the choice of one alternative over the other may affect both the amount and
the timing of future taxes on income generated from that activity. Therefore, the person
making those decisions has a direct input into future after-tax cash flow. Obviously,
decisions that reduce or postpone the payment of tax affect the ultimate return on
investment and, in turn, the value of the enterprise. Including the tax variable as a part of
the formal decision process will ultimately lead to improved after-tax cash flow.
R1-2 Expansion can be achieved in new geographic areas through direct selling, or by
establishing a formal presence in the new territory with a branch office or a separate
corporation. The new territories may also cross provincial or international boundaries.
Provincial income tax rates vary amongst the provinces. The amount of income that is
subject to tax in the new province will be different for each of the three alternatives
mentioned above. For example, with direct selling, none of the income is taxed in the new
province, but with a separate corporation, all of the income is taxed in the new province.
Because the tax cost is different in each case, taxation is a relevant part of the decision and
must be included in any cost-benefit analysis that compares the three alternatives [Reg.
400-402.1].
R1-3 A basic understanding of the following variables will significantly strengthen a decision
maker's ability to apply tax issues to their area of responsibility.
Types of Income - Employment, Business, Property, Capital gains
Taxable Entities - Individuals, Corporations, Trusts
, Alternative Business - Corporation, Proprietorship, Partnership, Limited
Structures partnership, Joint venture, Income trust
Tax Jurisdictions - Federal, Provincial, Foreign
R1-4 All cash flow decisions, whether related to revenues, expenses, asset acquisitions or
divestitures, or debt and equity restructuring, will impact the amount and timing of the tax
cost. Therefore, cash flow exists only on an after tax basis, and, the tax impacts whether or
not the ultimate result of the decision is successful. An after-tax approach to
decision-making requires each decision-maker to think "after-tax" for every decision at the
time the decision is being made, and, to consider alternative courses of action to minimize
the tax cost, in the same way that decisions are made regarding other types of costs.
Failure to apply an after-tax approach at the time that decisions are made may provide
inaccurate information for evaluation, and, result in a permanently inefficient tax structure.
CHAPTER NO. 2: FUNDAMENTALS OF TAX PLANNING
REVIEW QUESTIONS
1. “Tax planning and tax avoidance mean the same thing.” Is this statement true? Explain.
2. What distinguishes tax evasion from tax avoidance and tax planning?
3. Does Canada Revenue Agency deal with all tax avoidance activities in the same way?
Explain.
4. The purpose of tax planning is to reduce or defer the tax costs associated with financial
transactions. What are the general types of tax planning activities? Briefly explain how
each of them may reduce or defer the tax cost.
5. “It is always better to pay tax later rather than sooner.” Is this statement true? Explain.
6. When corporate tax rates are 13% and tax rates for individuals are 40%, is it always better
for the individual to transfer their business to a corporation?
7. “As long as all of the income tax rules are known, a tax plan can be developed with
certainty.” Is this statement true? Explain.
8. What basic skills are required to develop a good tax plan?
9. An entrepreneur is developing a new business venture and is planning to raise equity
capital from individual investors. Their adviser indicates that the venture could be
structured as a corporation (i.e., shares are issued to the investors) or as a limited
partnership (i.e., partnership units are sold). Both structures provide limited liability for the
investors. Should the entrepreneur consider the tax positions of the individual investors?
Explain. Without dealing with specific tax rules, what general tax factors should an investor
consider before making an investment?
10. What is a tax avoidance transaction?
11. “If a transaction (or a series of transactions) that results in a tax benefit was not undertaken
primarily for bona fide business, investment, or family purposes, the general anti-
avoidance rule will apply and eliminate the tax benefit.” Is this statement true? Explain.
, SOLUTIONS TO REVIEW QUESTIONS
R2-1 There is a distinction between tax planning and tax avoidance. Tax planning is the process
of arranging financial transactions in a manner that reduces or defers the tax cost and that
arrangement is provided for in the Income Tax Act or is not specifically prohibited. In other
words, the arrangement is chosen from a reasonably clear set of options within the Act.
In contrast, tax avoidance involves a transaction or series of transactions, the main purpose
of which is to avoid or reduce the tax otherwise payable. While each transaction in the
process may be legal by itself, the series of transactions cause a result not intended by the
tax system.
R2-2 Both tax planning and tax avoidance activities clearly present the full facts of each
transaction, allowing them to be scrutinized by CRA. In comparison, tax evasion involves
knowingly excluding or altering the facts with the intention to deceive. Failing to report an
amount of revenue known to exist or deducting a false expense are examples of tax
evasion.
R2-3 CRA does not deal with all tax avoidance transactions in the same way. In general, CRA
attempts to divide tax avoidance transactions between those that are an abuse of the tax
system and those that are not. When an action is abusive, CRA will attempt to deny the
resulting benefits by applying one of the anti-avoidance rules in the Income Tax Act.
R2-4 There are three general types of tax planning activities:
• Shifting income from one time-period to another.
• Transferring income to another entity.
• Converting the nature of income from one type to another.
Shifting income to another time-period can be a benefit if it results in a lower rate of tax
applying to the income. Even if a lower rate of tax is not achieved, a benefit may be gained
from delaying the payment of tax to a future time-period.
Shifting income to an alternate taxpayer (for example, from an individual to a corporation)
may beneficially alter the amount and timing of the tax.
There are several types of income within the tax system such as employment income,
business income, capital gains and so on. Each type of income is governed by a different
set of rules. For some types of income, the timing, the amount of income recognized, and
the effective tax rate is different from other types. By converting one type of income to
another, a benefit may be gained if the timing of income recognition, the amount
recognized, and/or the effective tax rate is favorable.
R2-5 The statement is not true. Paying tax later may be an advantage because it delays the tax
cost and frees up cash for other purposes. However, the delay may result in a higher rate
of tax in the future year compared to the current year. In such circumstances, there is a
trade-off between the timing of the tax and the amount of tax payable.
R2-6 There is not always an advantage to transfer income to a corporation when the corporate
tax rate is lower than that of the individual shareholder. While an immediate lower tax rate
results, remember that the corporation may be required to distribute some or all of its
after-tax income to the shareholder, which causes a second level of tax. Whether or not an
, advantage is achieved depends on the amount of that second level of tax and when it
occurs. Other factors may also be relevant such as the tax treatment of a possible business
failure or sale.
R2-7 The statement is not true. Knowing the tax rules is, of course, a major element in the tax
planning process, but it does not guarantee the expected outcome. Planning means that
certain steps are taken now in preparation for certain activities that may occur in the future.
However, those anticipated activities might not occur and the desired tax result may not be
achieved. Tax planning also requires that one must anticipate and speculate on possible
future scenarios and relate them to the current tax planning steps. Those scenarios are
never certain.
R2-8 To develop a good tax plan, one must be able to:
• Understand the fundamentals of the income tax system.
• Anticipate the complete cycle of transactions.
• Develop optional methods of achieving the desired business result and analyze each of
their tax implications.
• Speculate on possible future scenarios and assess their likelihood.
• Measure the time value of money.
• Place the tax issue in perspective by applying common sense and sound business
judgement.
• Understand the tax position of other parties involved in the transaction.
R2-9 Yes, the entrepreneur should consider the tax position of the potential investors. They will
be taking a risk in accepting the investment. If the entrepreneur knows the tax effect on the
investors of each alternative organization structure, the entrepreneur can choose the one
that provides investors the most favorable tax treatment (i.e., one that reduces their after-
tax loss if the investment fails, or increases their after-tax income if it succeeds). Before
making the investment, the investor should determine the tax impact on:
• income earned by the venture,
• income distributed to the investor,
• losses incurred by the venture,
• the loss of the investment if the venture fails, and
• the gain on the investment when it is eventually sold.
R2-10 A tax avoidance transaction is a term used within the general anti-avoidance rule (GAAR)
of the Income Tax Act. An avoidance transaction is a transaction or series of transactions
that results in a tax benefit and was not undertaken primarily for bona fide business,
investment or family purposes [ITA 245].
R2-11 The statement is not true. In order for the tax benefit to be denied under the general anti-
avoidance rule (GAAR), the transaction, in addition to not being primarily for bona fide
business, investment or family purposes, must be considered to be a misuse or abuse of
the income tax system as a whole. What constitutes a misuse or abuse is not always clear.
However, certain avoidance transactions are permitted and others are not [ITA 245(3), IC
88-2].
