2004 Ruling 2004-0060191R3 - ATR-Deduct. of 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: The deductibility of shareholder/manager remuneration that is paid out of income triggered from the proceeds of a sale of business assets

Position: Remuneration is deductible.

Reasons: Amount is reasonable and incurred for the purpose of earning business income.

XXXXXXXXXX 2004-006019

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request - XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, in which 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 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.

6. "Shareholder E" is XXXXXXXXXX.

7. "Shareholder F" is XXXXXXXXXX.

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

Facts

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

9. From XXXXXXXXXX until XXXXXXXXXX, the Corporation operated a XXXXXXXXXX business (hereafter referred to as the "Business") as a franchisee of XXXXXXXXXX (hereafter referred to as the "Franchisor").

10. The Corporation is primarily a family owned and managed business. The shareholdings of the Corporation are as follows:

Shareholders
Common
Shares
%
Class A
Preferred
%

Shareholder A
XXXXXX
XXXX
XXXXXXX
XXXX
Shareholder B
XXXXXX
XXXX
XXXXXXX
XXXX
Shareholder C
XXXXXX
XXXX
XXXXXXX
XXXX
Shareholder D
XXXXXX
XXXX
XXXXXXX
XXXX
Shareholder E
XXXXXX
XXXX
XXXXXXX
XXXX
Shareholder F
XXXXXX
XXXX
XXXXXXX
XXXX

Total
XXXXXX
XXXX
XXXXXXX
XXXX

11. Shareholder C is the only shareholder of the Corporation who is not a family member and is not related in any way to the other shareholders of the Corporation.

12. On XXXXXXXXXX, the Corporation sold the Business to the XXXXXXXXXX (hereafter referred to as the "Purchaser"), a company related to the Franchisor.

13. The Corporation received $XXXXXXXXXX (hereafter referred to as the "Proceeds") in consideration for the sale of the Business. The Corporation's total gain for accounting purposes with respect to the sale of the Business is $XXXXXXXXXX, calculated as follows:

Asset
Purchase
Price
Book Value
Gain (Loss)

Land
XXXXXXXX
XXXXXXX
XXXXXXX
Buildings
XXXXXXXX
XXXXXXX
XXXXXXX
Other Fixed Assets
XXXXXXXX
XXXXXXX
XXXXXXX
Working Capital
XXXXXXXX
XXXXXXX
XXXXXXX
Franchise Rights
XXXXXXXX
XXXXXXX
XXXXXXX
Goodwill
XXXXXXXX
XXXXXXX
XXXXXXX

Less: Transaction Costs
XXXXXXX

Total
XXXXXXXX

XXXXXXX

14. The Franchise Rights and Goodwill described in paragraph 13 above, are each an "eligible capital property" as defined in section 54 of the Act. Pursuant to subsection 14(5) of the Act, the Corporation's "cumulative eligible capital" balance prior to the sale of the Business was nil. As a result of the disposition of the Franchise Rights and Goodwill, an amount will be included in the Corporation's business income for the taxation year ended XXXXXXXXXX, pursuant to subsection 14(1) of the Act.

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

16. The Shareholder/Managers are residents of XXXXXXXXXX.

17. On XXXXXXXXXX , the Corporation declared a bonus in the amount of $XXXXXXXXXX (hereafter referred to as the "Bonus"), which is payable to the Shareholder/Managers as follows:

Shareholder
Amount

Shareholder A
XXXXXX
Shareholder B
XXXXXX
Shareholder C
XXXXXX

Bonus Total
XXXXXX

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

Proposed Transactions

19. The Corporation will pay the amount of the Bonus that is payable to the Shareholder/Managers from the Proceeds within XXXXXXXXXX days from the date that the condition described in paragraph 18 above is satisfied.

Purpose of the Proposed Transactions

20. The purpose of the payment of the Bonus is to remunerate the Shareholder/Managers 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; and

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

our rulings are as follows:

A. Section 67 and paragraphs 18(1)(a) and 18(1)(e) 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.

B. Provided the Bonus will be paid on or before XXXXXXXXXX, subsection 78(4) of the Act will not apply to prohibit the Corporation from deducting the amount in computing its business income for the taxation year ended XXXXXXXXXX.

C. The amount of the Bonus that will be paid by the Corporation to the Shareholder/Managers must be included in calculating their employment income in XXXXXXXXXX, pursuant to subsection 5(1) of the Act.

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 CRA provided the Proposed Transactions are carried out within the time frame described in paragraph 19 above.

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