The goal of your answer is to acknowledge that at some point we will have a client that wants the impossible. You need to demonstrate your comfort level and competency in navigating the situation. You want to show that you can create solutions in challenging situations.

This isn't a trick question. You shouldn't say something like "I would never tell a client no." You should choose an example where you found a resolution to the situation that led to a compromise.

I think it is important to tell a client "no" if what they are asking is overly ambitious or could result in a negative outcome. The last thing I want to do is promise to deliver on something that I can't. My approach is not just telling a client "no, this can't be done." My approach is telling the client, "I can't accomplish that, but here is what I can do." By taking time to explore with the client, you may be able to find a solution or compromise that results in most of what they wanted to accomplish.