ADMN 3710 tax ch 1

Chapter 1: Taxation – Its Role in Decision Making

Introduction

• Importance of understanding taxation in the context of financial decision making.

• Overview of content covered in this chapter.

I. Taxation and the Financial Decision Process

• Businesses encounter various forms of taxation:

  • Municipal, provincial, and federal government taxes.

  • Income tax is the most significant, levied at both federal and provincial levels based on profits.

A. Return on Investment

• Measured through cash flows.

• Cash flows must consider the tax impact:

  • Every business decision potentially influences cash flows through tax obligations.

  • The ultimate goal is to maximize shareholder wealth:

    • Strategies to either reduce or defer tax payments will enhance overall shareholder wealth.

B. Decision-Making Process

• Involves identifying alternatives and analyzing:

  • Short-range costs

  • Long-range costs

  • Benefits of each alternative

• Amount and timing of tax payable can differ significantly between options, influencing financial outcomes.

C. Determining Possible Courses of Action

• Evaluate:

  • Short-range costs and benefits

  • Long-range costs and benefits

  • Tax implications of each alternative

• Leads to improved cash flow and maximizes long-term value of the firm.

II. Taxation – A Controllable Cost

• Taxation is part of business costs, akin to other relevant costs.

• Decision-makers should:

  • Understand tax costs.

  • Seek to manage tax expenses efficiently.

III. Cash Flow After Tax

• Relevant cash flow analysis must always consider the after-tax perspective:

  • A positive after-tax cash flow is advantageous.

  • Alternatives should be evaluated that minimize tax liability to prevent:

    • Inefficient tax structures.

    • Poor decision-making based on pre-tax evaluations.

Example: Wage Increase Calculation

• Illustration of tax implications:

  • Employer perspective: 8% wage increase under 27% tax rate results in a 5.8% after-tax cost.

  • Employee perspective: Under a 50% tax rate, translates to a 4% after-tax value.

• Indicates that costs and benefits differ between parties based on tax implications.

IV. Fundamental Income Tax Structure and Its Complexity

• Critical factors influencing decision making:

  • Types of income: Business, Property, Employment, Capital Gains.

  • Taxpayers classified into three entities: Individuals, Corporations, Trusts.

A. Business and Investment Structures

• Various structures that affect taxation:

  • Proprietorship

  • Corporation

  • Partnership

  • Limited Partnership

  • Joint Arrangement

  • Income Trust

B. Tax Jurisdictions

• Tax variables impact decision-making based on jurisdictions:

  • Provincial

  • Federal

  • Foreign

Conclusion

• Emphasizes that taxation is a crucial variable in financial decisions.

• Tax implications should not be disregarded due to perceived complexity.

• Integrating taxation into formal decision-making enhances cash flows.