CHAPTER 1:

Taxation – Its Role in

Decision Making

Prepared by
Kristie Dewald
University of Alberta

Electronic Presentations in Microsoft® PowerPoint®

Copyright © 2017 McGraw-Hill Education Limited 1

 CHAPTER ONE
Taxation – Its Role in Decision Making
I. Taxation and the Financial Decision Process
A. Taxation – a Controllable Cost
B. Cash Flow after Tax
II. The Fundamental Income Tax Structure and its
Complexity
III. Conclusion

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 I. Taxation and the
Financial Decision Process
• Businesses are subject to many forms of taxation from:
– Municipal, provincial, federal governments

• Income tax is levied at the federal and provincial levels

– It is the most significant form of taxation
– Based on profits

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 I. Taxation and the
Financial Decision Process
• Return on Investment measured by cash-flows.
– Cash flows are after tax
– Every decision has a tax impact,
– That tax impact affects cash flows.

• Ultimate Goal – Maximization of shareholder wealth –

decisions that:
• Reduce, or
• postpone the payment of tax.
will increase overall shareholder wealth.

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 I. Taxation and the
Financial Decision Process
• Decision-making process involves:
– Identifying alternative courses of action and analyzing:
• the short-range costs,
• long-range costs, and
• benefits for each alternative.

• Amount and timing of tax payable can vary significantly

between alternatives.

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 I. Taxation and the
Financial Decision Process

Decision making process

Determine possible courses of action

Short-range Long-range
Costs and benefits Costs and benefits

Tax implications
of each
alternative.
Leads to improved cash flows and long-term maximization of value.

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 I. Taxation and the
Financial Decision Process
A. Taxation – A Controllable cost
• Considered a cost of doing business.
• Similar to other relevant costs.
• Decision makers must
• Attempt to understand and
• Control tax costs
• Should be considered a Controllable cost.

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 I. Taxation and the
Financial Decision Process
B. Cash Flow after Tax:
• All cash flow should be considered after tax.
• Analysis cannot be of value without considering the tax
impact.
• Positive after-tax cash flow is considered favourable.
• Managers should consider alternatives that will
minimize tax.
• Failure to take an after-tax approach:
• May impose a permanently inefficient tax structure, or
• May result in an unfavourable decisions that appeared
favourable on a pre-tax basis.

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 I. Taxation and the
Financial Decision Process
Consider the cost of a 8% wage increase pre-tax value:

Employer: Employee:
25% tax rate 45% tax rate
6% after tax cost 4.4% after tax value

The real cost to one party is different from the real

benefit to the other.

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 II. Fundamental Income Tax
Structure and its Complexity
Major variable in decision making:

1. Taxpayer – three entities:

i. Individuals,
ii. Corporations, and
iii. Trusts.

2. Types of income:
i. Business,
ii. Property,
iii. Employment, and
iv. Capital Gains.

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 II. Fundamental Income Tax
Structure and its Complexity
Major variable in decision making (cont’d):

3. Business and 4. Tax Jurisdictions:

Investment i. Provincial,
Structures: ii. Federal, and
i. Proprietorship, iii. Foreign.
ii. Corporation,
iii.Partnership,
iv. Limited
Partnership,
v. Joint Venture, and
vi. Income trusts.

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 II. Fundamental Income Tax
Structure and its Complexity

Business Income
Alternative Structure

Partnership Joint
Corporation Venture

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 Conclusion

• Taxation is a major variable that must be included in all

financial decisions
– Cannot be ignored simply because
it seems too complex.

• Taxation as part of the formal

decision making process will
improve cash flows.

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