10 April 2002 External T.I. 2002-0128865 - SH BONUS - DEDUCTION FROM CAPITAL GAIN

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: Whether a corporation can pay a bonus to an active shareholder to offset the taxable portion of a capital gain. Also, if a corporation has both active business income and a capital gain, whether it has the choice of allocating the bonus against either the active business income or the taxable portion of the capital gain.

Position: No.

Reasons: Pursuant to subparagraph 40(1)(a)(i) of the Income Tax Act, outlays or expenses may only be deducted in computing a taxable gain if "they were made or incurred by the taxpayer for the purpose of making the disposition." Based on jurisprudence, this provision requires that expenses must be incurred or made directly for the purposes of making the disposition.

XXXXXXXXXX 2002-012886
J. Gibbons, CGA

April 10, 2002

Dear XXXXXXXXXX:

We are replying to your letter dated March 7, 2002, in which you requested our views concerning the reasonableness of salaries and bonuses paid out of capital gains to active shareholders resident in Canada. Our comments are of a general nature only since we cannot confirm the tax implications of particular transactions unless the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R4.

In particular, you enquired whether a corporation can reduce the taxable portion of a capital gain by the payment of a bonus to an active shareholder. Also, if a corporation has both active business income and a capital gain, you wish to know whether it has the choice of allocating the bonus against either the active business income or the taxable portion of the capital gain.

Our comments

As you know, our views with respect to the reasonableness of salaries and bonuses to shareholder/managers are outlined in Income Tax Technical News Issue No. 22 (TN #22). You referred to our statement therein that we would not generally challenge the reasonableness of salaries and bonuses paid out of non-active business (emphasis added) income as long as the payer was a Canadian-controlled private corporation and the recipients were active shareholder/managers who were resident in Canada.

Pursuant to subparagraph 40(1)(a)(i) of the Income Tax Act, outlays or expenses may only be deducted in computing a taxable gain if "they were made or incurred by the taxpayer for the purpose of making the disposition." In this regard, we refer to the following comments by the Tax Court in Avis Immobilien G.M.B.H. (94 DTC 1039), which was upheld by the Federal Court of Appeal:

The words "for the purpose of" in subparagraph 40(1)(a)(i) mean "for the immediate or initial purpose of" and not the eventual or final goal which the taxpayer may have in mind. To give the words the latter meaning would permit the most indirect or most distantly related outlay or expense to reduce the amount of a gain. This could not have been Parliament's intent. We are not dealing in subparagraph 40(1)(a)(i) with the computation of income from a business, which is of an ongoing nature, but, rather, expenses or outlays made or incurred to dispose solely of capital properties. The statutory provision under consideration sets out a rule to determine a taxpayer's capital gain from the disposition of property and only expenses or outlays to be applied in reducing the gain are those incurred or made directly for the purposes of making the disposition. Subparagraph 40(1)(a)(i) does not contemplate expenses or outlays which may have merely facilitated the making of the disposition or which were entered into on the occasion of the disposition.

On the basis of the foregoing, it is our view that salaries and bonuses are not deductible in computing a capital gain, and accordingly the policy in TN#22 on the reasonableness of the amount of salaries and bonuses would not apply in such a case. As noted above, that policy applies only to the calculation of corporate business income, active or otherwise.

We trust that these comments will be of assistance.

Yours truly,

John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate

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