Buckwold and Kitunen, Canadian Income Taxation, 2016-2017 Ed.
Solutions Manual Chapter One
1
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 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?

Buckwold and Kitunen, Canadian Income Taxation, 2016-2017 Ed.
Solutions Manual Chapter One
2
Solutions to Review Questions
R1-1 Once profit is determined, the amount of income tax that results is determined by the
Income Tax Act. However, at all levels of management, alternative courses of action are
evaluated and decided upon. 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 ventures, Income trusts
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

Buckwold and Kitunen, Canadian Income Taxation, 2016-2017 Ed.
Solutions Manual Chapter Two
3
CHAPTER 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 the 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 15% and tax rates for individuals are 40%, is it always better
for the individual to transfer his or her 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. Her advisor 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.

Buckwold and Kitunen, Canadian Income Taxation, 2016-2017 Ed.
Solutions Manual Chapter Two
4
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 clearly 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 that was 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 when it is 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 terms,
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 considered to be 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),
the amount and timing of the tax may be beneficially altered.
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

Buckwold and Kitunen, Canadian Income Taxation, 2016-2017 Ed.
Solutions Manual Chapter Two
5
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

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Buckwold and Kitunen, Canadian Income Taxation, 2016-2017 Ed.
Solutions Manual Chapter Two
6
Key Concept Questions
QUESTION ONE
The Income Tax Act contains a general anti-avoidance rule (GAAR) in section 245. Consider
each of the following situations and determine whether the GAAR will likely apply. Income tax
reference: ITA 245(1),(2),(3),(4); IC 88-2.
1. Chris transferred her consulting business to a corporation primarily to obtain the benefit of
the low corporate tax rate.
2. Paul owns 100% of the shares of P Ltd. Paul provides services to P Ltd. In the current year
he received no remuneration for his services because the payment of a salary to Paul would
increase the amount of the loss that P Ltd. will incur in the year.
3. A Canadian-controlled private corporation pays its shareholder/manager a bonus that will
reduce the corporation’s income to the amount eligible for the low tax rate. The bonus is not
in excess of a reasonable amount.
4. A profitable Canadian corporation has a wholly owned Canadian subsidiary that is
sustaining losses and needs additional capital to carry on its business. The subsidiary could
borrow the funds from its bank but could not obtain any tax saving in the current year by
deducting the interest expense due to its loss situation. Therefore, the parent corporation
borrows the funds from its bank and subscribes for additional common shares of the
subsidiary. The parent corporation reduces its taxable income by deducting the interest
expense. The subsidiary uses the funds to earn income from its business.
QUESTION TWO
John has owned all of the shares of Corporation A and Corporation B since their inception. In the
current year, John had Corporation A transfer, on a tax-deferred basis, property used in its
business to Corporation B. The reason for the transfer is to enable Corporation B to apply the

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Buckwold and Kitunen, Canadian Income Taxation, 2016-2017 Ed.
Solutions Manual Chapter Two
7
Solutions to Key Concept Questions
KC 2-1
[ITA: 245(2) – GAAR]
The GAAR provision in ITA 245(2) is to be used when specific anti-avoidance provisions do not
suffice. For the GAAR to apply, the following four conditions must be met:
1) A tax benefit results from a transaction or part of a series of transactions [ITA 245(1) –
“tax benefit” definition],
2) The transaction is an avoidance transaction, in that, it was not undertaken primarily for
bona fide purposes other than to obtain the tax benefit [ITA 245(3) – “Avoidance

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Buckwold and Kitunen, Canadian Income Taxation, 2016-2017 Ed.
Solutions Manual Chapter Two
8
KC 2-2
[ITA: 245(2) – GAAR]
The GAAR provision in ITA 245(2) is to be used when specific anti-avoidance provisions do not
suffice. For the GAAR to apply, the following four conditions must be met:
1) A tax benefit results from a transaction or part of a series of transactions,
2) The transaction is an avoidance transaction, in that, it was not undertaken primarily for
bona fide purposes other than to obtain the tax benefit,
3) No other provision of the Act stops the taxpayer from achieving the intended tax
advantage, and
4)

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Buckwold and Kitunen, Canadian Income Taxation, 2016-2017 Ed.
Solutions Manual Chapter Three
10
11. One often hears that “corporations are entitled to more deductions for tax purposes than
individuals.” Based on your reading of Chapter 3, is this statement true? Explain.
12. If an individual earns a living as a lawyer, what possible categories of income, for tax
purposes, may he or she generate? Describe the circumstances for each possible
classification.
13. What types of income for tax purposes may result when a profit is achieved on the sale
of property (e.g., land)?
14. Individual A, a Canadian resident, owns and operates a profitable small farm in North
Dakota, U.S.A. He also has a large amount of money earning interest in an American
bank. Individual B, also a Canadian resident, owns 100% of the shares of an American
corporation that operates a profitable small farm in North Dakota. The corporation also
has a large amount of money earning interest in an American bank.
Describe and compare the tax positions of these two individuals who conduct the same
activities but use different organizational structures.
15. Jane Q owned an apple orchard for 20 years. During that time, she had cultivated a
unique brand of apple that was popular with health food fans. Toward the end of the
20X0 growing season, Q became seriously ill and put the orchard up for sale. Q’s
neighbour agreed to purchase the entire orchard for $250,000. It upset Q to have to sell
at that time of year because that year’s crop was of high quality and in three weeks
would have been ripe for picking.
What types of property might have been included in the total purchase price of
$250,000? For tax purposes, what types of income might have been generated from the
sale of the orchard? Explain your answer.

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Buckwold and Kitunen, Canadian Income Taxation, 2016-2017 Ed.
Solutions Manual Chapter Three
21
Problems
PROBLEM ONE
John Day and Carol Knight conduct similar financial activities. Each is employed and has a
portfolio of investments, and during the current year, each started a separate small business.
Their financial results for the year ended December 31, 20X1, are identical, as follows:
Employment income $40,000
Interest income from investment portfolio 15,000
Loss from new small business operation (20,000)
The only difference between Day and Knight is that Day operated his business as a
proprietorship, whereas Knight operated her business from a wholly owned corporation.
Required:
1. Assuming that individual tax rates are 40%, compare the tax liability of Day with that of
Knight for 20X1.
2. How and when may Knight utilize her business loss to reduce her tax liability?
3. What impact may the difference in tax treatment have on Day’s and Knight’s wealth
accumulation and on their long-term returns on investment?

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Canadian Income Taxation 2016/2017 Edition Solution Manual

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