9 November 2001 External T.I. 2001-0092515 - SHAREHOLDER-MANAGER REMUNERATION

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

What criteria must be met relative to ownership and management structure of a CCPC before reasonableness of an owner manager bonus/salary would be challenged?

Position:

Clarified position on reasonableness of remuneration to shareholder-managers.

Reasons:

See below.

Topic 4: Owner/Manager Remuneration

For over 20 years, many Canadian-controlled private corporations (CCPC's) have followed a practice of paying salaries and bonuses to shareholder-managers in amounts sufficient to reduce the taxable income of the corporation to or below the limits that qualify for the small business deduction. This issue was addressed at the annual conference of the Canadian Tax Foundation in 1981. In answer to question 42 of the Round Table session, it was stated that:

In general, the reasonableness of salaries and bonuses paid to principal shareholder-managers of a corporation would not be challenged when:

the general practice of the corporation is to distribute the profits of the company to its shareholder-managers in the form of bonuses or additional salaries; or

the company has adopted a policy of declaring bonuses to the shareholders to remunerate them for the profits the company has earned that are attributable to special know-how, connections or entrepreneurial skills of the shareholders.

As a result of recent technical interpretations that discuss the treatment of remuneration to indirect shareholders, there has been some concern over how the CCRA will treat remuneration paid to employee-shareholders.

Questions and Responses

Question 1

In light of the above, will the CCRA outline the criteria that must be met relative to the ownership and management structure of a CCPC before the CCRA's position on the reasonableness of salaries and bonuses referred to above would be applied?

Response 1

As a general rule, all expenses are subject to section 67. However, based on the specific situation that was presented during the 1981 Roundtable, we stated that we would not challenge the reasonableness of salaries or bonuses in the context of a CCPC paying a bonus to a shareholder-manager in order to reduce the CCPC's taxable income to the small business deduction limit. It is important to note that in 1981, we mentioned bonuses to the principal shareholder-manager. This was to ensure we would be taxing the salaries in Canada. This position still applies today.

Question 2

Does this position apply to salaries and bonuses paid to inactive shareholders?

Response 2

No. We will apply our position only in the context of a CCPC and active shareholder-managers who are resident in Canada.

Question 3

Does the use of holding companies affect the CCRA's position on the reasonableness of salaries and bonuses to principal shareholder-managers?

Response 3

No. We will not question the reasonableness of the payments as long as the salaries and bonuses are paid to managers who are shareholders of the CCPC, either directly or through a holding company, Canadian residents, and actively involved in the day-to-day operations of the company. The key is that the Canadian resident recipients must be active in the operating business and contribute to the income- producing activities from which the remuneration is paid.

Question 4

I realize that the question in 1981 was quite specific and that it dealt with the bonusing down to the small business deduction limit. Would the CCRA challenge the reasonableness of salaries and bonuses that resulting in the CCPC having taxable income below the small business deduction limit?

Response 4

No. The CCRA would not normally have any concerns on reasonableness when salaries and bonuses are paid to active shareholder-managers of a CCPC if they are Canadian residents active in the income producing activities of the company.

Question 5

Does the CCRA have problems with reasonableness of salaries and bonuses when other family members own shares of the CCPC either directly or through a holding company or even through a trust?

Response 5

No. As long as the recipients of the salaries and bonuses are active shareholder-managers resident in Canada, we would not challenge the reasonableness of the amount.

Question 6

Let me complicate this a little bit. Would the CCRA challenge the reasonableness of inter-corporate management fees paid by Opco to Holdco (assuming they are both CCPCs)?

Response 6

Yes. Our position is limited to salaries and bonuses paid directly to individuals resident in Canada who are active shareholder-managers of a CCPC. We therefore reserve the right to challenge the reasonableness of any inter-corporate management fees.

Question 7

I realize that your 1981 Roundtable response implicitly dealt with active business income earned by a CCPC. Will the CCRA extend the position to include CCPCs that earn non-active business income?

Response 7

We will not normally challenge the reasonableness of salaries and bonuses paid out of non-active business income as long as the other principles that I mentioned above are adhered to (i.e., the payor is a CCPC and the recipients are active shareholder-managers who are resident of Canada).

Question 8

Did the decision in Safety Boss Limited v. R (2000 DTC 1767) change the CCRA's position on the reasonableness of salaries and bonuses?

Response 8

No. The Safety Boss case, which was decided under the informal procedures, does not change our position because the facts of the case are not consistent with our position. At the time of the payments in question:

- Safety Boss Limited was not a CCPC;
- The bonus was paid to a shareholder-manager who was not a resident of Canada; and
- The management fees were paid to a related, non-resident corporation.

The CCRA questioned the reasonableness of the bonus and management fees. Based on the particular facts of the case, the Tax Court found that the payments were reasonable.

Prepared by Marc Vanasse