2004 Ruling 2004-0092931R3 - Deductibility 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.

Principal Issues: Shareholder/manager remuneration.

Position: Deductibility of shareholder/manager remuneration paid out of the proceeds from the sale of business assets.

Reasons: Remuneration is deductible since it is reasonable and incurred for the purpose of earning business income.

XXXXXXXXXX 2004-009293

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request - XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling in respect of the above-noted company as it pertains to the deductibility of shareholder/manager remuneration. We also acknowledge the additional information supplied in your e-mail of XXXXXXXXXX.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the ruling request:

(i) is in an earlier return of a taxpayer or a related person;

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of a taxpayer or a related person;

(iii) is under objection by a taxpayer or a related person;

(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; and

(v) is the subject of a ruling previously issued by the Directorate.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

Definitions

1. "Corporation" is XXXXXXXXXX.

2. "Shareholder A" is XXXXXXXXXX.

3. "Shareholder B" is XXXXXXXXXX.

4. "Shareholder C" is XXXXXXXXXX.

5. "Shareholder D" is XXXXXXXXXX, father of Shareholder B and Shareholder C.

6. "Shareholder E" is XXXXXXXXXX, wife of Shareholder D, and mother of Shareholder B and Shareholder C.

Our understanding of the relevant facts, proposed transactions and the purpose of the proposed transactions is as follows:

Facts

7. The Corporation is a "Canadian-controlled private corporation" as defined in subsection 125(7) of the Act.

8. The Corporation has a fiscal year end of XXXXXXXXXX.

9. The Corporation and Shareholders A to E file their taxation returns at the XXXXXXXXXX Taxation Centre and deal with the XXXXXXXXXX Tax Services Office.

10. The Corporation was incorporated pursuant to the Business Corporations Act, XXXXXXXXXX, under the name of XXXXXXXXXX and commenced to carry on an active business of XXXXXXXXXX.

11. On XXXXXXXXXX, the Corporation sold the majority of its business assets, consisting of XXXXXXXXXX, to a corporation whose shares were traded on a major Canadian stock exchange. Shortly after that transaction the Corporation changed its name to its current name.

12. In XXXXXXXXXX, the Corporation acquired a number of XXXXXXXXXX and re-commenced active business operations, carrying on a similar business to that which it had carried on prior to XXXXXXXXXX, using the same types of assets, operating in many of the same geographic locations as it had previously, providing services to many of the same customers as it had previously, and employing some of the same individuals in its business as it had previously.

13. Between XXXXXXXXXX and XXXXXXXXXX, the Corporation owned XXXXXXXXXX. The corporation used these assets (hereafter the "Business Assets") in its business of XXXXXXXXXX owned by third-party customers in the XXXXXXXXXX industry (hereafter the "Business").

14. The Corporation is family-owned and managed. The shareholdings of the Corporation are as follows:

Shareholder
Number and Share Class
Percentage Common
Percentage Preferred
A
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXX

XXXXXXXX
B
XXXXXXXXXX

XXXXXXXX
C
XXXXXXXXXX

XXXXXXXX
D
XXXXXXXXXX

XXXXXXXX
E
XXXXXXXXXX

XXXXXXXX

15. Shareholder A is family-owned and managed. The shareholdings of Shareholder A are as follows:

Shareholder
Number and Share Class
Percentage Common
Percentage Preferred
B
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXX

XXXXXXXX
C
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXX

XXXXXXXX
D
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXX

XXXXXXXX
E
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXX

XXXXXXXX

16. On XXXXXXXXXX, the Corporation sold the majority of the Business Assets to XXXXXXXXXX (hereafter the "Purchaser"), a subsidiary of XXXXXXXXXX, an unrelated party.

17. The Corporation received $XXXXXXXXXX (hereafter referred to as the "Proceeds") from the Purchaser in consideration for the sale. The Business Assets that have been sold to the Purchaser include XXXXXXXXXX.

18. During the year, the Corporation also sold some other Business Assets, including XXXXXXXXXX for proceeds of $XXXXXXXXXX.

19. The Corporation's total gain for accounting purposes with respect to the sale of the Business Assets for the fiscal year ended XXXXXXXXXX, is $XXXXXXXXXX. For income tax purposes, the sale of the Business Assets resulted in recapture under subsection 13(1) of the Act in the amount of $XXXXXXXXXX.

20. Shareholders B, C and D (hereafter referred to as the "Shareholder/Managers") were active in the day-to-day management of the operations of the Business prior to the sale of the Business Assets, and are currently directors and officers of the Corporation.

21. Shareholder D is and always has been the most influential employee of the Corporation in terms of its success from incorporation to the present day. A great deal of the Corporation's success is attributable to Shareholder D's particular skills, knowledge of the Business, relationship with key customers and contacts within the XXXXXXXXXX industry as a whole. Shareholder B was at one time responsible for the day-to-day operations of the Corporation. Both Shareholder B and Shareholder C are the key owner/managers of other corporations in the XXXXXXXXXX industry whose businesses were closely aligned with that of the Corporation prior to the sale of the Business Assets. Shareholder B and Shareholder C participated directly in the key strategic and operating decisions of the Corporation in XXXXXXXXXX and for many years prior to that, and have provided key insights stemming from their involvement in the other corporations that they are involved with.

22.The Shareholder/Managers are all residents of XXXXXXXXXX, Canada.

23. The Corporation is associated with Shareholder A and with XXXXXXXXXX other Canadian controlled private corporations, all of whom have fiscal years ending on XXXXXXXXXX. The business limit, as defined in subsection 125(2) of the Act, of the group of associated companies for their fiscal year ending XXXXXXXXXX, is $XXXXXXXXXX, all of which will be allocated to the Corporation. Subsection 125(5.1) of the Act will reduce the business limit eligible to the Corporation and its associated companies to Nil for XXXXXXXXXX .

24. On XXXXXXXXXX, the Directors of the Corporation declared a bonus in the amount of $XXXXXXXXXX (hereafter referred to as the "Bonus"). The majority of the Bonus is related to the recapture resulting from the sale of the Business Assets and is payable to the Shareholder/Managers. A portion of the Bonus that is not related to the recapture is payable to key employees of the Corporation, all of whom are unrelated to the Corporation and its shareholders, who deal at arm's length with the corporation and who are residents of Canada. It is intended that the Bonus will be paid as follows:

Payee
Amount

Shareholder B
XXXXXXXXXX
Shareholder C
XXXXXXXXXX
Shareholder D
XXXXXXXXXX
Key Employees
XXXXXXXXXX

Total
XXXXXXXXXX

25. The amount of the Bonus is such that for the fiscal year ended XXXXXXXXXX, the income of the Corporation for the year from an active business, as defined in subsection 125(7) of the Act (hereafter referred to as "active business income"), will be $XXXXXXXXXX and its taxable income will be $XXXXXXXXXX.

26. The Corporation has historically paid out large bonuses each year to reduce the Corporation's active business income to an amount that approximates its share of the business limit for the year in question after the reduction pursuant to 125(5.1) of the Act.

27. Past bonuses that were payable to the Shareholder/Managers and other key employees are as follows:

Fiscal End
Amount

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

28. The amount of the Bonus was unanimously authorized by the Corporation's Board of Directors and approved by its shareholders. Subsequently, the Corporation and the Shareholder/Managers became aware that the Canada Revenue Agency had clarified its policy on when such remuneration would be considered reasonable for purposes of section 67 of the Act, and as a result, the Corporation and the Shareholder/Managers jointly decided that the Bonus would not be paid until such time as a favourable advanced income tax ruling could be obtained on the income tax status of the Bonus.

29. The Corporation has not yet filed its corporate income tax returns for its fiscal year ending XXXXXXXXXX.

Proposed Transactions

30. The Corporation will pay the Bonus on or before the 179th day following its XXXXXXXXXX taxation year-end upon satisfaction of the condition described in paragraph 28 above.

Purpose of the Proposed Transactions

31. The purpose of the payment of the Bonus is to remunerate the Shareholder/Managers in a tax efficient manner for their contribution towards the successful management of the Corporation.

Rulings Given

Provided that:

(a) The preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions;

(b) The proposed transactions are completed in the manner described above;

(c) There are no other transactions, which may be relevant to the ruling requested; and

(d) The Corporation withholds source deductions from the amount of the Bonus in accordance with prescribed rules and remits the source deductions to the Receiver General within the prescribed time,

our rulings are as follows:

A. Paragraph 18(1)(a), section 67 and subsection 78(4) of the Act will not apply to prohibit the Corporation from deducting the amount of the Bonus in computing its business income for the taxation year ended XXXXXXXXXX, and

B. Pursuant to subsection 5(1) of the Act, the amount of the Bonus paid to each of the Shareholder/Managers and key employees, must be included in calculating their respective employment income in XXXXXXXXXX.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CRA on May 17, 2002, and are binding on the Canada Revenue Agency provided the Proposed Transactions related to the payment of Bonus is carried out within the time frame described in paragraph 30.

These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Except as expressly stated, these rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch