Multiple Choice Questions

Chapter 02 - Fundamentals of Tax Planning 2-1 Chapter 02 Fundamentals of Tax Planning

Multiple Choice Questions

• The CEO at Big Company Corporation has decided to sell a piece of capital equipment

after the company's year-end in order to avoid paying capital gains tax this year. Which tax planning method will the CEO be using?

• Transferring income to another entity.
• Converting the nature of income from one type to another.
• Shifting income from one time period to another.
• This is a form of tax evasion and is not allowed.

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Topic: 02-05 Types of Tax Planning

Topic: 02-06 Shifting Income from One Time Period to Another

Topic: 02-07 Transferring Income to Another Entity

Topic: 02-08 Converting Income from One Type to Another

• Which of the following scenarios illustrates a potential tax avoidance scheme?
• Property transferred between arm's-length parties is valued at fair market value.
• Dividends received from shares transferred from a wife to her husband are taxed in the

hands of the wife.

• A shareholder owns two corporations and undertakes legal steps in order to permit loss

utilization between the two companies.

• A man transfers property to his child at a value less than fair market value.

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Blooms: Understand

Topic: 02-04 Tax Avoidance

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Chapter 02 - Fundamentals of Tax Planning 2-2

• The controller of Little Company Ltd. has decided to sell a piece of capital equipment after

the company's year-end in order to avoid paying tax on capital gains this year. The controller is engaging in

• tax avoidance.
• tax evasion.
• tax planning.

D. GAAR.

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Topic: 02-02 Tax Planning Defined

• Certain skills are necessary for successful tax planning. One of these skills is applying the

time value of money. Which of the following is FALSE regarding this skill?

• Applying the time value of money is a tool used for wealth accumulation.
• If a taxpayer invests $1,000 at 8% and subsequently earns $48 in after-tax income on the

investment at the end of the first year, the taxpayer's tax rate is 40%.

• If a taxpayer earns an annual return of 12% and is subject to a 40% tax rate, the annual

after-tax return is 4.8%.

• If a taxpayer invests $1,000 for one year at a rate of return of 14% and is subject to a 45%

tax rate, the after-tax value of the investment will be $1,077.(12%  [1 - .4]) = 7.2% after-tax return.

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Topic: 02-08 Converting Income from One Type to Another

Chapter 02 - Fundamentals of Tax Planning 2-3

• Which of the following statements regarding GAAR is true?
• The purpose of GAAR is to catch tax evaders.
• When an avoidance transaction takes place, the anti-avoidance rule is automatically

applied in all circumstances.

• Canada Revenue Agency states that "A transaction will not be an avoidance transaction if

the taxpayer establishes that it is undertaken primarily for bona fide business, investment or family purposes."

• Individuals who organize their affairs in order to pay as little tax as possible will

automatically be subject to GAAR.

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Blooms: Understand

Topic: 02-11 Specific Anti-Avoidance Rules

Short Answer Questions

• Steven James earned $150,000 this year in profits from his proprietorship. The rate of tax

for Canadian-controlled private corporations in his province is 13% on the first $500,000 of

income. Personal tax rates (federal plus provincial) in James' province are:

On the first $47,000 24% On the next $47,000 32% On the next $51,000 40% On the next $61,000 45% On income over $206,000 50%

Chapter 02 - Fundamentals of Tax Planning 2-4

(All rates are assumed for this question.)

Steven withdraws $3,000 per month for his personal living expenses. All remaining profits are used to pay taxes and to expand the business. Steven expects the same business after-tax profits next year.

Steven is considering incorporating his business next year. If he incorporates, he will pay himself a gross salary of $48,000.

Required:

• Determine the increase in Steven's cash flow if he incorporates his company? Show all

calculations.

• Name the type of tax planning that Steve would be engaging in if he incorporated his

company.

A) Excess cash as a proprietorship:

Pre-tax Profits $150,000

Tax:

24% 47,000 $11,280

32% 47,000 15,040

40% 51,000 20,400

45% 5,000 2,250

(Assume federal plus provincial rates)

(48,970)

After-tax profits $101,030 Living expenses withdrawn (36,000) Available for expansion $65,030

Excess cash as a corporation: