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 Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
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: There are no specific criteria in place but the more complex the structure, the more likely that reasonableness would be challenged especially if there is an undue tax advantages. The key is whether the recipient has been active in the business and contributed to the CCPC's profits from which the salary is paid, in which case the reasonableness of the amount would not likely be challenged.
Reasons: The law is very general and essentially we are required to look at the facts in making a judgment on reasonableness of the amount of salary or wages in particular circumstances.
Question 2
Owner-Manager Remuneration
Background
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:
a) 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
b) 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.
The shares of many private companies are owned by family holding companies. One or more of the family members are typically actively involved in the business in senior management positions. Such individuals may own the shares of the family holding company, members of their families or trusts established for the benefit of the individuals and/or family members.
During 2000, two interpretation letters written by the Income Tax Rulings Directorate (documents 2000-001308 and 2000-001603) have created some uncertainty as to the CCRA's position concerning the reasonableness of salaries and bonuses paid by an operating company to principals who are actively engaged in the business where the shares of the company are owned by family holding companies.
Question
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 will be applied?
CCRA's Response:
- We have not and do not intend to develop criteria relative to the ownership and management structure of a CCPC in relation to the determination of whether salaries and bonuses will be considered reasonable.
- In general terms, the comments made in response to question 41 of the Round Table are still applicable.
- The particular Rulings' responses noted above related to a specific set of facts:
- In the one situation, there were inactive shareholders, family trusts and generally, a somewhat less than straightforward set of facts in which case we could not categorically state that the reasonableness of the salaries would not be challenged. Although the first part of the response to question 42 of the 1981 Round Table referred to a private company earning substantially all its income from property, the information outlined in (1)(a) to (c)(1) of the response could also be obtained for a CCPC that carries on an active business when there is, for example, a more complex structure or an undue tax advantage.
- In the other situation, the corporate structure was not complex. The active owner-managers of Opco held their interests in Opco through wholly-owned Holdcos, and these Holdcos did nothing other than hold shares in Opco. On the basis that the Holdco shareholders were in fact the active owner-managers of Opco's business, we felt that we could categorically conclude that the reasonableness of the amount of the salaries paid to them by Opco would not likely be challenged. This conclusion was based on the principles summarized in (3)(a) and (b)(2) of the answer to question 41 at the 1981 Round Table.
- From the above, it may generally be concluded that the CCRA will not normally challenge reasonableness of salaries or bonuses paid out of business profits to owner-managers who are actively engaged in the day-to-day business operations of a CCPC. On the other hand, if they are paid for example, to holding companies or low-bracket family members, then they will always be subject to closer scrutiny.
Prepared by: John Oulton
Section 25
March 14, 2001
(1) No specific guidelines have been established to determine the reasonableness of salaries paid to employees-shareholders where a private company earns substantially all its income from property. The amount, if any, that is considered to be reasonable must be based on the facts of each particular case.
In general, when determining whether salaries paid to employees-shareholders are reasonable, comparisons with like services performed in the same or similar businesses are required. In making this evaluation the following information is usually obtained:
(a) the duties performed by the employee and the time expended in carrying out these duties,
(b) the remuneration of other employees of the same business who have similar types of responsibilities, experience, and skills,
(c) the remuneration paid by other businesses of a similar size to employees who render services corresponding to those of the employee concerned.
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(3) Subject to the bounds of reasonableness with respect to both the level of salary and bonuses for services performed and the rate of return on investment in shares, the Department generally accepts that a principal shareholder-manager is entitled to determine a mix of salary and dividend that he considers appropriate. Where there is more than one principal shareholder-manager, the creation of separate classes of shares solely to achieve dividend flexibility would usually lead to a presumption of artificiality.
In general, the Department will not challenge the reasonableness of salaries and bonuses paid to the principal shareholders-managers of a corporation when
(a) the general practice of the corporation is to distribute the profits of the company to its shareholders-managers in the form of bonuses or additional salaries; or
(b) the company has adopted a policy of declaring bonuses to the shareholders to remunerate them for the profits the company has earned that are, in fact, attributable to the special know-how, connections, or entrepreneurial skills of the shareholders.
Bonuses paid to shareholders other than the principal shareholders-managers will be subject to the normal test of reasonableness that is set out in (a) above.
(1) No specific guidelines have been established to determine the reasonableness of salaries paid to employees-shareholders where a private company earns substantially all its income from property. The amount, if any, that is considered to be reasonable must be based on the facts of each particular case.
In general, when determining whether salaries paid to employees-shareholders are reasonable, comparisons with like services performed in the same or similar businesses are required. In making this evaluation the following information is usually obtained:
(a) the duties performed by the employee and the time expended in carrying out these duties,
(b) the remuneration of other employees of the same business who have similar types of responsibilities, experience, and skills,
(c) the remuneration paid by other businesses of a similar size to employees who render services corresponding to those of the employee concerned.
1
(3) Subject to the bounds of reasonableness with respect to both the level of salary and bonuses for services performed and the rate of return on investment in shares, the Department generally accepts that a principal shareholder-manager is entitled to determine a mix of salary and dividend that he considers appropriate. Where there is more than one principal shareholder-manager, the creation of separate classes of shares solely to achieve dividend flexibility would usually lead to a presumption of artificiality.
In general, the Department will not challenge the reasonableness of salaries and bonuses paid to the principal shareholders-managers of a corporation when
(a) the general practice of the corporation is to distribute the profits of the company to its shareholders-managers in the form of bonuses or additional salaries; or
(b) the company has adopted a policy of declaring bonuses to the shareholders to remunerate them for the profits the company has earned that are, in fact, attributable to the special know-how, connections, or entrepreneurial skills of the shareholders.
Bonuses paid to shareholders other than the principal shareholders-managers will be subject to the normal test of reasonableness that is set out in (a) above.
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