CHAPTER 2:

Fundamentals of Tax
Planning

Prepared by
Daniel Mahne, CPA, MTax
RSM Canada

Electronic Presentations in Microsoft® PowerPoint®

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 Fundamentals of Tax Planning

I. What Is Tax Planning?

II. Types of Tax Planning

III. Skills Required for Tax Planning

IV. Restrictions to Tax Planning

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 A. Shifting Income from One Time Period to
Another
• In most cases, there is little opportunity to choose
between discretionary alternatives.

• Can sometimes choose between alternatives:

• i.e. reserves - can choose to claim a deduction from income
in a different time period.

• Must consider future tax rates in the decision to shift

income.

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 A. Shifting Income from One Time Period to
Another2
• Future tax rates may be greater than, less than, or the
same as current tax rates.
• Current tax rates being lower than future tax rates
provides an opportunity to save taxes when recognizing
income now vs. later.
• Current tax rates being higher than future tax rates
triggers a tax cost when recognizing income now vs.
later.
• Also consider finance costs to pay tax now rather than
later.

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 Shifting Income Example
The following is tax information for ABC Corp.
• Tax rate on income < $500,000 13%
• Tax rate on income > $500,000 27%
• Year 1 income after reserve = $150,000
($20,000 reserve can be delayed to Year 2)
• Year 2 income is estimated to be $550,000
• Cash is being used to take advantage of 2% early
payment discounts (assume equivalent to an annual rate
of 36%)

Determine the ultimate tax savings from shifting the reserve

to Year 2.

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 Shifting Income Solution
If the $20,000 reserve is deducted in Year 2 instead of
Year 1, income is shifted from Year 2 to Year 1.

Increase in Year 1 tax ($20,000 x 13%) $ 2,600

Decrease in Year 2 tax ($20,000 x 27%) (5,400)

Tax reduction $(2,800)

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 Shifting Income Solution2

• Must also consider the financing cost of prepaying $2,600

tax one year in advance
• Purchasing costs would increase by $936 ($2,600 x 36%)
• These costs would be deductible and save tax of $253
($936 x 27%)
• Therefore, the net cost, after-tax is $683
• Overall savings:
Tax savings $2,800
Finance cost of prepaying tax (683)
$2,117

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 A. Shifting Income from One Time Period to
Another3

In making a decision to shift income, must determine:

• Future tax rates
• Discretionary opportunities within the Tax Act (i.e.
reserves)
• Time value of money

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 B. Transferring Income to Another Entity

• Individuals can accumulate wealth by using one or

more different entities:
• Corporations, proprietorship, partnerships, trusts, etc.

• The tax treatment varies with the entity chosen.

• Ultimately, the wealth leads back to the individual or

family members.

• Shifting income to a different structure

may reduce or significantly delay tax payable.

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 B. Transferring Income to Another Entity2

For example:
• An individual may run a business through a corporation or as a
sole-proprietor.
• Individual needs $40,000 after-tax
• Corporate tax rates – 13% on first $500,000; 27% on excess
• Personal tax rates:
First $50,000 20%
Next $50,000 30%
Next $56,000 40%
Next $66,000 45%
Income over $222,000 50%

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 B. Transferring Income to Another Entity3
Unincorporated Incorporated

Bus. Profits $100,000

Business profits $100,000
Less Salary (50,000)

Taxes (20% of 50,000; 30% Corporate

(25,000) (6,500)
of 50,000) Taxes (13%)

Personal expenses (40,000)

After-tax cash flows $35,000 $43,500

Incorporation provides an extra $8,500 available

for expansion
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 B. Transferring Income to Another Entity4

Other factors to consider:

• Future requirements for cash distributions from corporation
• Corporate profits in excess of $500,000 incur higher rates of
tax
• Losses incurred in corporation
• Business failure, sale of business, etc.
• Shareholder dies or leaves the country

Tax planning involves anticipating possible future events.

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 C. Converting Income from One Type to
Another
Four basic types of income:
1.Employment (Chapter 4)
2.Business (Chapter 5)
3.Property (Chapter 7)
4.Capital gains (Chapter 8)

Amount & timing of taxable income to be reported depends

on the type of income.

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 C. Converting Income from One Type to
Another2
• Can alter the amount of tax and its timing by adjusting a
financial transaction to generate a different type of
income.
• It is not always simple to convert one type of income
to another.
• Converting income may also involve shifting that income
from one entity to another.
• May also consider converting costs to acquire goods or
services from one type of expenditure to another

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 III. Skills Required for Tax Planning

• Anticipation – envision the complete cycle

• Flexibility – seek out alternative methods

• Speculation – anticipate tax effects

• Application of compound interest

• Perspective – common sense must prevail

• Global approach – consider all sides

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 IV. Restrictions to Tax Planning

• Tax planning is divided between acceptable and

unacceptable activities

• The Income Tax Act specifically prohibits a number of

activities
anti-avoidance rules

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 IV. Restrictions to Tax Planning2
A. Specific Anti-Avoidance Rules:
• Two general types of financial transactions:
• Between parties with a close relationship (not at arm’s
length), and
• Between parties completely independent of each other
(arm’s length)

• Authorities are more concerned with those not at arm’s

length
• Several provisions have been designed to limit tax
avoidance activities

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 IV. Restrictions to Tax Planning3
B. The General Anti-Avoidance Rule (GAAR)
• When a person is involved in a tax “avoidance transaction”;
• Receives a “tax benefit”; and
• There has been a “misuse or abuse” of the Income Tax Act,
the tax will be adjusted to deny the benefit [245(2)]

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 IV. Restrictions to Tax Planning4
• A transaction is not an avoidance transaction if,
• Its primary objective is other than to obtain a tax benefit
• Undertaken primarily for bona fide business, investment or
family purposes [245(3)]

• In effect, this establishes a business purpose or

economic reality test
• Helps distinguish between unacceptable and acceptable
planning activities

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 IV. Restrictions to Tax Planning5
• For a tax plan to be rejected it must:
• Fail the business purpose test; and,
• Must be extreme - that it is not within the “spirit” of the tax
system [245(4)]

• Proposed updates to GAAR

• GAAR is undergoing proposals to add a new an actual
“economic substance test” when considering whether there
is a “misuse or abuse” for transactions occurring after 2023.
Additionally, the proposals include a potential 25% penalty
tied to the tax benefit enjoyed.

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 Conclusion

• Tax Planning – conscious effort to direct financial

activities to eliminate, reduce, or defer tax
• There is some flexibility in the tax system
• Planning activities must be consistent with prudent business
activities

• Good tax planning involves applying business basics.

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