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: Are there any income tax implications when unrelated persons are deemed not to be dealing with each other for EI purposes?
Position: There may be income tax implications. Question of fact
Reasons: Since the EI Act uses the income tax definition of arm's length, there may be implications when persons are considered not to be dealing at arm's length for EI purposes. Audit may want to review transactions between the persons for any tax implications.
October 8, 2003
Pat Lychak HEADQUARTERS
Manager Wayne Antle, CGA
CPP/EI Eligibility Division (613) 957-2102
Revenue Collections Directorate
2003-002939
Non-Arm's Length Transactions
This is further to your letter of July 10, 2003, concerning the income tax implications that arise when unrelated persons are considered not to be dealing with each other at arm's length for employment insurance purposes.
Where an employer and an employee are not dealing with each other at arm's length, then, pursuant to paragraph 5(2)(i) of the Employment Insurance Act (the "EI Act"), the employment is not insurable. Paragraph 5(3)(a) of the EI Act provides that the question of whether persons are not dealing with each other at arm's length shall be determined in accordance with the Income Tax Act (the "Act").
With respect to unrelated persons, paragraph 251(1)(c) of the Act states that "it is a question of fact whether persons not related to each other are at a particular time dealing with each other at arm's length". In some circumstances, unrelated persons may not deal with each other at arm's length, while, for other situations the same persons may. When evaluating whether unrelated persons are dealing at arm's length, each particular transaction or series of transactions must be examined on its own merits. Interpretation Bulletin IT-419R Meaning of Arm's Length provides some general guidelines to help in determining whether there is an arm's length relationship between unrelated persons for a given transaction or series of transactions.
When unrelated persons are considered not to be dealing with each other at arm's length for employment insurance purposes, there may also be income tax implications. The Act contains numerous provisions dealing with transactions between persons not dealing with each other at arm's length. For example, subsection 69(1) of the Act may apply to change the proceeds of disposition or adjusted cost base of property transferred between persons not dealing at arm's length, where the transaction does not occur at fair market value.
In addition, transactions occurring between persons not dealing at arm's length may need to be examined more carefully than similar transactions between persons dealing at arm's length. For example, while salaries or wages paid by a corporation to individuals not dealing at arm's length with the corporation may be deductible business expenses, these salaries would be scrutinized more closely than salaries paid to arm's length employees in order to determine if the expenditures were in fact laid out to earn income from the business, and if the amounts paid were reasonable given the services being performed. In order for an expense to be deductible, it must, among other things, be incurred for the purpose of gaining or producing income (paragraph 18(1)(a) of the Act), and be reasonable in the circumstances (section 67 of the Act).
We are only able to provide definitive comments on the income tax implications that may arise when transactions occur between persons not dealing with each other at arm's length in the context of a particular fact situation Therefore, when employment is ruled not insurable because the persons are considered not to be dealing with each other at arm's length at a particular time, and there is some concern that this decision could also have income tax implications, then the issue should be discussed with a technical advisor in the Verification & Enforcement Division ("V&E") of the applicable tax services office. V&E may also be able to assist when consideration is being given to making a factual determination that unrelated persons are not dealing with each other at arm's length pursuant to paragraph 251(1)(c) of the Act.
We trust that our comments will be of assistance.
John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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