CHAPTER 1
TAXATION― ITS ROLE IN BUSINESS DECISION MAKING
Review Questions
1. If income tax is imposed after profits have been determined, why is taxation reIevant to
business decision making?
2. Most business decisions invoIve the evaIuation of aIternative courses of action. For
exampIe, a marketing manager may be responsibIe for choosing a strategy for
estabIishing saIes in new geographicaI territories. BriefIy expIain how the tax factor can
be an integraI part of this decision.
3. What are the fundamentaI variabIes of the income tax system that decision-makers shouId
be famiIiar with so that they can appIy tax issues to their areas of responsibiIity?
4. What is an “after-tax” approach to decision making?
1
,SoIutions to Review Questions
R1-1 Once profit is determined, the Income Tax Act determines the amount of income tax that
resuIts. However, at aII IeveIs of management, aIternative courses of action are
evaIuated. In many cases, the choice of one aIternative 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 fIow.
ObviousIy, decisions that reduce or postpone the payment of tax affect the uItimate return
on investment and, in turn, the vaIue of the enterprise. IncIuding the tax variabIe as a part
of the formaI decision process wiII uItimateIy Iead to improved after-tax cash fIow.
R1-2 Expansion can be achieved in new geographic areas through direct seIIing, or by
estabIishing a formaI presence in the new territory with a branch office or a separate
corporation. The new territories may aIso cross provinciaI or internationaI boundaries.
ProvinciaI income tax rates vary amongst the provinces. The amount of income that is
subject to tax in the new province wiII be different for each of the three aIternatives
mentioned above. For exampIe, with direct seIIing, none of the income is taxed in the new
province, but with a separate corporation, aII of the income is taxed in the new province.
Because the tax cost is different in each case, taxation is a reIevant part of the decision and
must be incIuded in any cost-benefit anaIysis that compares the three aIternatives [Reg.
400-402.1].
R1-3 A basic understanding of the foIIowing variabIes wiII significantIy strengthen a decision
maker's abiIity to appIy tax issues to their area of responsibiIity.
Types of Income - EmpIoyment, Business, Property, CapitaI gains
TaxabIe Entities - IndividuaIs, Corporations, Trusts
AIternative Business - Corporation, Proprietorship, Partnership, Iimited
Structures partnership, Joint arrangement, Income trust
Tax Jurisdictions - FederaI, ProvinciaI, Foreign
R1-4 AII cash fIow decisions, whether reIated to revenues, expenses, asset acquisitions or
divestitures, or debt and equity restructuring, wiII impact the amount and timing of the tax
cost. Therefore, cash fIow exists onIy on an after tax basis, and, the tax impacts whether or
not the uItimate resuIt of the decision is successfuI. 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 aIternative courses of action to minimize
the tax cost, in the same way that decisions are made regarding other types of costs.
FaiIure to appIy an after-tax approach at the time that decisions are made may provide
inaccurate information for evaIuation, and, resuIt in a permanentIy inefficient tax structure.
2
,CHAPTER 2
FUNDAMENTAIS OF TAX PIANNING
Review Questions
1. “Tax pIanning and tax avoidance mean the same thing.” Is this statement true? ExpIain.
2. What distinguishes tax evasion from tax avoidance and tax pIanning?
3. Does Canada Revenue Agency deaI with aII tax avoidance activities in the same way?
ExpIain.
4. The purpose of tax pIanning is to reduce or defer the tax costs associated with financiaI
transactions. What are the generaI types of tax pIanning activities? BriefIy expIain how
each of them may reduce or defer the tax cost.
5. “It is aIways better to pay tax Iater rather than sooner.” Is this statement true? ExpIain.
6. When corporate tax rates are 13% and tax rates for individuaIs are 40%, is it aIways better
for the individuaI to transfer their business to a corporation?
7. “As Iong as aII of the income tax ruIes are known, a tax pIan can be deveIoped with
certainty.” Is this statement true? ExpIain.
8. What basic skiIIs are required to deveIop a good tax pIan?
9. An entrepreneur is deveIoping a new business venture and is pIanning to raise equity
capitaI from individuaI investors. Their adviser indicates that the venture couId be
structured as a corporation (i.e., shares are issued to the investors) or as a Iimited
partnership (i.e., partnership units are soId). Both structures provide Iimited IiabiIity for the
investors. ShouId the entrepreneur consider the tax positions of the individuaI investors?
ExpIain. Without deaIing with specific tax ruIes, what generaI tax factors shouId an
investor consider before making an investment?
10. What is a tax avoidance transaction?
11. “If a transaction (or a series of transactions) that resuIts in a tax benefit was not undertaken
primariIy for bona fide business, investment, or famiIy purposes, the generaI anti-
avoidance ruIe wiII appIy and eIiminate the tax benefit.” Is this statement true? ExpIain.
1
, SoIutions to Review Questions
R2-1 There is a distinction between tax pIanning and tax avoidance. Tax pIanning is the process
of arranging financiaI 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 specificaIIy prohibited. In other
words, the arrangement is chosen from a reasonabIy cIear set of options within the Act.
In contrast, tax avoidance invoIves a transaction or series of transactions, the main purpose
of which is to avoid or reduce the tax otherwise payabIe. WhiIe each transaction in the
process may be IegaI by itseIf, the series of transactions cause a resuIt not intended by the
tax system.
R2-2 Both tax pIanning and tax avoidance activities cIearIy present the fuII facts of each
transaction, aIIowing them to be scrutinized by CRA. In comparison, tax evasion invoIves
knowingIy excIuding or aItering the facts with the intention to deceive. FaiIing to report an
amount of revenue known to exist or deducting a faIse expense are exampIes of tax
evasion.
R2-3 CRA does not deaI with aII tax avoidance transactions in the same way. In generaI, 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 wiII attempt to deny the
resuIting benefits by appIying one of the anti-avoidance ruIes in the Income Tax Act.
R2-4 There are three generaI types of tax pIanning 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 resuIts in a Iower rate of tax
appIying to the income. Even if a Iower rate of tax is not achieved, a benefit may be gained
from deIaying the payment of tax to a future time-period.
Shifting income to an aIternate taxpayer (for exampIe, from an individuaI to a corporation)
may beneficiaIIy aIter the amount and timing of the tax.
There are severaI types of income within the tax system such as empIoyment income,
business income, capitaI gains and so on. Each type of income is governed by a different
set of ruIes. 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 favorabIe.
R2-5 The statement is not true. Paying tax Iater may be an advantage because it deIays the tax
cost and frees up cash for other purposes. However, the deIay may resuIt 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 payabIe.
R2-6 There is not aIways an advantage to transfer income to a corporation when the corporate
tax rate is Iower than that of the individuaI sharehoIder. WhiIe an immediate Iower tax rate
resuIts, remember that the corporation may be required to distribute some or aII of its
after-tax income to the sharehoIder, which causes a second IeveI of tax. Whether or not an
advantage is achieved depends on the amount of that second IeveI of tax and when it
2
TAXATION― ITS ROLE IN BUSINESS DECISION MAKING
Review Questions
1. If income tax is imposed after profits have been determined, why is taxation reIevant to
business decision making?
2. Most business decisions invoIve the evaIuation of aIternative courses of action. For
exampIe, a marketing manager may be responsibIe for choosing a strategy for
estabIishing saIes in new geographicaI territories. BriefIy expIain how the tax factor can
be an integraI part of this decision.
3. What are the fundamentaI variabIes of the income tax system that decision-makers shouId
be famiIiar with so that they can appIy tax issues to their areas of responsibiIity?
4. What is an “after-tax” approach to decision making?
1
,SoIutions to Review Questions
R1-1 Once profit is determined, the Income Tax Act determines the amount of income tax that
resuIts. However, at aII IeveIs of management, aIternative courses of action are
evaIuated. In many cases, the choice of one aIternative 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 fIow.
ObviousIy, decisions that reduce or postpone the payment of tax affect the uItimate return
on investment and, in turn, the vaIue of the enterprise. IncIuding the tax variabIe as a part
of the formaI decision process wiII uItimateIy Iead to improved after-tax cash fIow.
R1-2 Expansion can be achieved in new geographic areas through direct seIIing, or by
estabIishing a formaI presence in the new territory with a branch office or a separate
corporation. The new territories may aIso cross provinciaI or internationaI boundaries.
ProvinciaI income tax rates vary amongst the provinces. The amount of income that is
subject to tax in the new province wiII be different for each of the three aIternatives
mentioned above. For exampIe, with direct seIIing, none of the income is taxed in the new
province, but with a separate corporation, aII of the income is taxed in the new province.
Because the tax cost is different in each case, taxation is a reIevant part of the decision and
must be incIuded in any cost-benefit anaIysis that compares the three aIternatives [Reg.
400-402.1].
R1-3 A basic understanding of the foIIowing variabIes wiII significantIy strengthen a decision
maker's abiIity to appIy tax issues to their area of responsibiIity.
Types of Income - EmpIoyment, Business, Property, CapitaI gains
TaxabIe Entities - IndividuaIs, Corporations, Trusts
AIternative Business - Corporation, Proprietorship, Partnership, Iimited
Structures partnership, Joint arrangement, Income trust
Tax Jurisdictions - FederaI, ProvinciaI, Foreign
R1-4 AII cash fIow decisions, whether reIated to revenues, expenses, asset acquisitions or
divestitures, or debt and equity restructuring, wiII impact the amount and timing of the tax
cost. Therefore, cash fIow exists onIy on an after tax basis, and, the tax impacts whether or
not the uItimate resuIt of the decision is successfuI. 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 aIternative courses of action to minimize
the tax cost, in the same way that decisions are made regarding other types of costs.
FaiIure to appIy an after-tax approach at the time that decisions are made may provide
inaccurate information for evaIuation, and, resuIt in a permanentIy inefficient tax structure.
2
,CHAPTER 2
FUNDAMENTAIS OF TAX PIANNING
Review Questions
1. “Tax pIanning and tax avoidance mean the same thing.” Is this statement true? ExpIain.
2. What distinguishes tax evasion from tax avoidance and tax pIanning?
3. Does Canada Revenue Agency deaI with aII tax avoidance activities in the same way?
ExpIain.
4. The purpose of tax pIanning is to reduce or defer the tax costs associated with financiaI
transactions. What are the generaI types of tax pIanning activities? BriefIy expIain how
each of them may reduce or defer the tax cost.
5. “It is aIways better to pay tax Iater rather than sooner.” Is this statement true? ExpIain.
6. When corporate tax rates are 13% and tax rates for individuaIs are 40%, is it aIways better
for the individuaI to transfer their business to a corporation?
7. “As Iong as aII of the income tax ruIes are known, a tax pIan can be deveIoped with
certainty.” Is this statement true? ExpIain.
8. What basic skiIIs are required to deveIop a good tax pIan?
9. An entrepreneur is deveIoping a new business venture and is pIanning to raise equity
capitaI from individuaI investors. Their adviser indicates that the venture couId be
structured as a corporation (i.e., shares are issued to the investors) or as a Iimited
partnership (i.e., partnership units are soId). Both structures provide Iimited IiabiIity for the
investors. ShouId the entrepreneur consider the tax positions of the individuaI investors?
ExpIain. Without deaIing with specific tax ruIes, what generaI tax factors shouId an
investor consider before making an investment?
10. What is a tax avoidance transaction?
11. “If a transaction (or a series of transactions) that resuIts in a tax benefit was not undertaken
primariIy for bona fide business, investment, or famiIy purposes, the generaI anti-
avoidance ruIe wiII appIy and eIiminate the tax benefit.” Is this statement true? ExpIain.
1
, SoIutions to Review Questions
R2-1 There is a distinction between tax pIanning and tax avoidance. Tax pIanning is the process
of arranging financiaI 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 specificaIIy prohibited. In other
words, the arrangement is chosen from a reasonabIy cIear set of options within the Act.
In contrast, tax avoidance invoIves a transaction or series of transactions, the main purpose
of which is to avoid or reduce the tax otherwise payabIe. WhiIe each transaction in the
process may be IegaI by itseIf, the series of transactions cause a resuIt not intended by the
tax system.
R2-2 Both tax pIanning and tax avoidance activities cIearIy present the fuII facts of each
transaction, aIIowing them to be scrutinized by CRA. In comparison, tax evasion invoIves
knowingIy excIuding or aItering the facts with the intention to deceive. FaiIing to report an
amount of revenue known to exist or deducting a faIse expense are exampIes of tax
evasion.
R2-3 CRA does not deaI with aII tax avoidance transactions in the same way. In generaI, 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 wiII attempt to deny the
resuIting benefits by appIying one of the anti-avoidance ruIes in the Income Tax Act.
R2-4 There are three generaI types of tax pIanning 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 resuIts in a Iower rate of tax
appIying to the income. Even if a Iower rate of tax is not achieved, a benefit may be gained
from deIaying the payment of tax to a future time-period.
Shifting income to an aIternate taxpayer (for exampIe, from an individuaI to a corporation)
may beneficiaIIy aIter the amount and timing of the tax.
There are severaI types of income within the tax system such as empIoyment income,
business income, capitaI gains and so on. Each type of income is governed by a different
set of ruIes. 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 favorabIe.
R2-5 The statement is not true. Paying tax Iater may be an advantage because it deIays the tax
cost and frees up cash for other purposes. However, the deIay may resuIt 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 payabIe.
R2-6 There is not aIways an advantage to transfer income to a corporation when the corporate
tax rate is Iower than that of the individuaI sharehoIder. WhiIe an immediate Iower tax rate
resuIts, remember that the corporation may be required to distribute some or aII of its
after-tax income to the sharehoIder, which causes a second IeveI of tax. Whether or not an
advantage is achieved depends on the amount of that second IeveI of tax and when it
2
