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 ISSUE:
Whether management fees and bonuses paid out of the proceeds of disposition of the assets of a business are reasonable.
Position TAKEN:
Reasonable.
Reasons FOR POSITION TAKEN:
Payments were made to compensate direct and indirect shareholders for their contributions to the success of the operating corporation.
XXXXXXXXXX 2003-003987
XXXXXXXXXX, 2003
Dear XXXXXXXXXX:
Re: Advance Income Tax Ruling
XXXXXXXXXX ("OpCo") - Business Number XXXXXXXXXX
and XXXXXXXXXX ("ManageCo") - BN XXXXXXXXXX
We are writing in response to your letter of XXXXXXXXXX, requesting an advance income tax ruling on behalf of OpCo and ManageCo. We also confirm various additional correspondence and conversations (XXXXXXXXXX).
To the best of our knowledge, the issues involved in this ruling request are not:
(i) the subject of an earlier return of OpCo or ManageCo or any related parties;
(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of OpCo or ManageCo or any related parties;
(iii) under objection by OpCo or ManageCo or any related parties;
(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; and
(v) the subject of a ruling previously considered by the Directorate.
FACTS
Our understanding of the relevant facts and the proposed transactions is as follows:
1. OpCo has carried on the business of XXXXXXXXXX.
2. The shareholders of OpCo are as follows:
a. XXXXXXXXXX ("HoldCo"), BN XXXXXXXXXX, owns XXXXXXXXXX% of the issued and outstanding common shares.
b. XXXXXXXXXX ("Mr. A"), Social Insurance Number (SIN) XXXXXXXXXX, owns XXXXXXXXXX% of the issued and outstanding common shares.
3. The shareholders of HoldCo are as follows:
a. XXXXXXXXXX ("HoldCo B"), BN XXXXXXXXXX, owns XXXXXXXXXX% of the issued and outstanding common shares.
b. XXXXXXXXXX ("Mr. C"), SIN XXXXXXXXXX, owns XXXXXXXXXX% of the issued and outstanding common shares.
4. XXXXXXXXXX of HoldCo B is XXXXXXXXXX ("Mr. B"), SIN XXXXXXXXXX.
5. Mr. C also owns XXXXXXXXXX% of the issued and outstanding common shares of XXXXXXXXXX ("HoldCo C"), BN XXXXXXXXXX . HoldCo C owns XXXXXXXXXX% of the issued and outstanding common shares of ManageCo.
6. OpCo, HoldCo, HoldCo B, HoldCo C, and ManageCo are all Canadian-controlled private corporations as defined in subsection 125(7) of the Income Tax Act (the "Act"). The corporations all file their income tax returns at the XXXXXXXXXX Taxation Centre and have the XXXXXXXXXX Tax Services Office as their Tax Services Office.
7. Mr. A, Mr. B and Mr. C are all residents of XXXXXXXXXX, Canada, file their income tax returns at the XXXXXXXXXX Taxation Centre and have the XXXXXXXXXX Tax Services Office as their Tax Services Office.
8. OpCo, HoldCo and ManageCo are all members of an associated group and have filed their corporate income tax returns reflecting their associated status. Due to the fact that the total "taxable capital employed in Canada" (within the meaning assigned by subsection 181.2(1) of the Act) of the group is in excess of $XXXXXXXXXX, subsection 125(5.1) of the Act applies such that none of the above-noted corporations is entitled to claim the small business deduction pursuant to subsection 125(1) of the Act.
9. Mr. A had been responsible for operations in the XXXXXXXXXX since incorporation, while management of OpCo is provided through ManageCo.
10. Mr. B and Mr. C are employees of ManageCo and are active in the day-to-day management of OpCo. They were directly responsible for negotiating, over the past year and a half, the sale of assets on behalf of OpCo, detailed in paragraph 12 below.
11. Mr. B and Mr. C provide their services to OpCo as employees of ManageCo. In exchange for these services, OpCo pays monthly management fees to ManageCo to cover direct costs plus additional management fees based on the profits generated by OpCo (the "Additional Fees"). From the XXXXXXXXXX fiscal years, the average monthly management fees never exceeded $XXXXXXXXXX. The Additional Fees have been set at an annual rate of XXXXXXXXXX% of Opco's income. ManageCo pays bonuses to Mr. B and Mr. C totalling the Additional Fees in proportion to their respective ownership interests in HoldCo. The remaining XXXXXXXXXX% of OpCo's income is paid as a bonus to Mr. A, the XXXXXXXXXX of OpCo. This has been the practice of OpCo since incorporation and has been agreed upon by the three key operators of the business (Mr. A, Mr. B and Mr. C) prior to the payment of any Additional Fees or bonuses. ManageCo is the only corporation from which Mr. B and Mr. C are remunerated. Where no profits were generated by Opco, no Additional Fees were charged by ManageCo and no salaries or bonuses were paid by ManageCo to Mr. B and Mr. C in respect of their services provided to OpCo.
12. In XXXXXXXXXX, each "depreciable property" as defined in subsection 13(21) of the Act of OpCo was sold to an arm's length party for an aggregate of $XXXXXXXXXX. The sale will result in approximately $XXXXXXXXXX of recaptured capital cost allowance and capital gains of $XXXXXXXXXX for OpCo's XXXXXXXXXX, year-end, in addition to approximately $XXXXXXXXXX of regular business income earned prior to the sale.
13. OpCo does not have "cumulative eligible capital" as defined in subsection 14(5) of the Act, nor any resource pools or resource profits or losses for purposes of the Act and the Income Tax Regulations.
14. The proposed payment of the Additional Fees and bonuses, described in paragraph 15, does not entitle ManageCo to reduce taxes through use of the small business deduction, as it is a member of the same associated group as OpCo and HoldCo. In addition, the Additional Fees are not being used to utilize losses within the corporate group as no losses have been incurred by ManageCo. The Additional Fees and bonuses will simply offset each other resulting in no impact on the taxable income of ManageCo.
PROPOSED TRANSACTIONS
15. OpCo will pay Additional Fees and a bonus totalling the taxable income of the corporation in a manner consistent with prior years. In particular, OpCo's income (prior to the payment of the bonus and Additional Fees) will be paid as follows: XXXXXXXXXX% as a bonus to Mr. A and XXXXXXXXXX% in Additional Fees to ManageCo. ManageCo will then pay bonuses equal to the Additional Fees split between Mr. B and Mr. C in proportion to their respective ownership interests in HoldCo. The proposed payments will be made subsequent to receipt of a favourable advance income tax ruling from the Income Tax Rulings Directorate of the Canada Revenue Agency.
PURPOSE OF PROPOSED TRANSACTIONS
16. The purpose of the proposed transactions is to remunerate, in a tax efficient manner, Mr. A, Mr. B and Mr. C, for their contribution to the success of OpCo.
RULINGS GIVEN
Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions, and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:
A. The deductibility of the bonus by OpCo to be paid to Mr. A will not be prohibited by paragraph 18(1)(a) or section 67 of the Act.
B. The deductibility of the Additional Fees incurred by OpCo will not be prohibited by paragraph 18(1)(a) or section 67 of the Act.
C. The Additional Fees earned by ManageCo will be included in ManageCo's business profits for the year pursuant to subsection 9(1) of the Act.
D. The deductibility of the bonuses declared by ManageCo to be paid to Mr. B and Mr. C will not be prohibited by paragraph 18(1)(a) or section 67 of the Act.
E. The bonuses will be included in the employment income of Mr. A, Mr. B and Mr. C by virtue of section 5 of the Act in XXXXXXXXXX when received.
F. Subsection 245(2) will not apply as a result of the proposed transactions to redetermine the tax consequences confirmed by the rulings given above.
The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002, and are binding on the Canada Revenue Agency provided that the transactions are completed before XXXXXXXXXX.
These rulings are based on the Act in its present form and do not take into consideration any proposed amendments to the Act.
Yours truly,
XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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