Chapter Objectives

Be able to: Explain why income taxes are important to the business decision

process. Explain why income tax laws are not as complex as they are perceived

to be. Outline the four fundamental tax variables to be considered in the

business decision process. Explain why management’s role in the tax process is to apply known

tax law. Explain the five areas which would contribute to an efficient

management approach to taxation.

The Role of Taxation in the Decision Process

Management decisions in all areas of responsibility have the common goal of maximizing long-term wealth by cash flow enhancement.

This decision making involves identifying and analyzing alternative courses of action, including after-tax cash flows.

Since the amount and timing of income tax can vary significantly between alternatives, the impact of taxes should always be considered in the decision-making process of all managers.

The Complexity Issue - Mountain or Molehill?

Even though the Income Tax Act is written and presented in a complex manner, its fundamental structure and concepts are not complex.

In fact, only about one-third of the Act regularly affects business decisions and this one-third has a logical flow and a close-knit structure that includes a limited number of variables.

The major variables include the following:Entities subject to taxationTypes of incomeAlternative forms of business structureTax jurisdictions

Knowing the general concepts of these variables and how these variables interact will enable managers to recognize which items affect normal business decisions.

Management’s Role and Approach to Taxation

Management’s role is to be aware of and apply known tax law, as opposed to interpreting tax law which is the function of independent advisors.

All factors that affect profit and cash flows are relevant to a business decision. Income tax would be one of these relevant factors and should be addressed in the same manner as other relevant factors.

Including tax implications is not synonymous with tax avoidance. It is simply the inclusion of a relevant cost and, in fact, the lowest tax alternative may not be the alternative chosen.

The management process will be enhanced when the decision maker is aware of the amount and timing of the related tax consequences.

Development of a Management Approach

Income tax is a relevant cost: Income tax must be treated as a controllable expense. Cash flows must be treated on an after-tax basis.

Management has responsibilities: The tax effects of decisions must be allocated directly to the functional

manager involved. There must be a means for bridging the gap between interpreting the Act and

applying the Act to business problems.

An independent advisor should be utilized: An independent advisor should be engaged to assist with applying taxation in

the decision structure.