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: Whether shareholder/manager remuneration paid from the proceeds of the sale of business assets is reasonable
Position: Yes.
Reasons: Other than the fact that the amounts are paid on the sale of business assets, the situation is within the scope of the CRA's policy on the reasonableness of such amounts. Given the facts in this case surrounding the sale of the business assets, the amount of the bonus is reasonable in the circumstances.
XXXXXXXXXX 2004-010113
XXXXXXXXXX, 2004
Dear XXXXXXXXXX:
Re: Advance Income Tax Ruling Request - XXXXXXXXXX
This is in reply to your letter dated XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of XXXXXXXXXX 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 CRA.
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.
Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:
Definitions
1. "Corporation" is XXXXXXXXXX.
2. "Franchisor" is XXXXXXXXXX.
3. "Franchisor's Subsidiary" is XXXXXXXXXX, a subsidiary of the Franchisor.
4. "XXXXXXXXXX Franchise" is the Corporation's XXXXXXXXXX business operated under a license granted to the Corporation by the Franchisor.
5. "Franchise Assets" are the Corporation's assets that are used in the XXXXXXXXXX Franchise.
6. "Shareholder A" is XXXXXXXXXX.
7. "Shareholder B" is XXXXXXXXXX.
8. "Shareholder C" is XXXXXXXXXX.
9. "Shareholder D" is XXXXXXXXXX.
10. "Shareholder E" is XXXXXXXXXX.
11. "Shareholder F" is XXXXXXXXXX.
12. "Shareholder G" is XXXXXXXXXX.
13. "Active Shareholders" are, collectively, Shareholder A, Shareholder B, Shareholder C and Shareholder G.
Facts
14. The Corporation was incorporated pursuant to the Companies Act (XXXXXXXXXX) on XXXXXXXXXX and was continued under the Business Corporations Act (XXXXXXXXXX) on XXXXXXXXXX.
15. The shareholdings of the Corporation are as follows:
Shareholder A XXXXXXX Class "A" Common Shares
Shareholder B XXXXXXX Class "A" Common Shares
Shareholder C XXXXXXX Class "A" Common Shares
Shareholder D XXXXXXX Class "A" Common Shares
Shareholder E XXXXXXXClass "B" Non-Voting Preferred Shares
Shareholder F XXXXXXXClass"C"Non-VotingPreferred Shares
Shareholder G XXXXXXX Class "C" Non-VotingPreferred Shares and XXXXXXX Class "D" Voting Preferred Shares
16. All of the Shareholders of the Corporation are residents of XXXXXXXXXX, Canada, file their income tax returns at the XXXXXXXXXX Taxation Centre and deal with the XXXXXXXXXX Tax Services Office.
17. The Active Shareholders are employees of the Corporation and are jointly responsible for the operation of all the businesses carried on by the Corporation.
18. At the beginning of XXXXXXXXXX, the Corporation carried on XXXXXXXXXX separate businesses, one of which was the XXXXXXXXXX Franchise. All of the Active Shareholders are active in the day-to-day operations of the XXXXXXXXXX Franchise and were directly responsible, to a certain extent, for negotiating the sale of the Franchise Assets that is discussed below.
19. The Corporation originally acquired and began operating the XXXXXXXXXX Franchise as a XXXXXXXXXX. The terms of the XXXXXXXXXX Franchise license are set out in a license agreement (hereafter, the "License Agreement") entered into on XXXXXXXXXX.
20. The License Agreement gave the Corporation the exclusive right to carry on the XXXXXXXXXX Franchise within a defined geographic territory that included XXXXXXXXXX.
21. The term of the License Agreement was for XXXXXXXXXX years, beginning in XXXXXXXXXX.
22. The Corporation and the Active Shareholders operated the XXXXXXXXXX Franchise from XXXXXXXXXX until the business was sold in XXXXXXXXXX. The Active Shareholders are the Corporation's key employees and each of them has been fundamental in all of the Corporation's business activities since it was incorporated.
23. In XXXXXXXXXX and XXXXXXXXXX, the Franchisor began to purchase independent franchise operations such as the XXXXXXXXXX Franchise carried on by the Corporation.
24. In XXXXXXXXXX, Franchisor's Subsidiary expressed an interest in purchasing the XXXXXXXXXX Franchise from the Corporation.
25. On XXXXXXXXXX, the Corporation received a draft asset purchase agreement from the Franchisor's Subsidiary for purchase of the Franchise Assets.
26. After several months of negotiations, on XXXXXXXXXX, the Corporation entered into an asset purchase agreement (hereafter, the "Purchase Agreement") with the Franchisor and the Franchisor's Subsidiary.
27. Pursuant to the Purchase Agreement:
(a) The Franchisor's Subsidiary agreed to purchase the following Franchise Assets (hereafter, the "Purchased Assets"):
(i) Certain tangible personal property, equipment, improvements and fixtures owned by the Corporation and used in the XXXXXXXXXX Franchise,
(ii) The available, reusable, office supplies in unbroken packages, printed materials and counter supplies relating to the XXXXXXXXXX Franchise,
(iii) Goodwill associated with the XXXXXXXXXX Franchise;
(iv) Certain permits used in the XXXXXXXXXX Franchise insofar as such permits were assignable, and
(v) Certain records required to be maintained by the Corporation under the License Agreement for the XXXXXXXXXX Franchise;
(b) The Franchisor's Subsidiary assumed certain contracts and leases entered into by the Corporation; and
(c) Each of the Active Shareholders and the Corporation entered into Non-Competition Agreements with the Franchisor and the Franchisor's Subsidiary.
28. The Purchase Agreement provided for the following payments:
(a) Goodwill: $XXXXXXXXXX
(b) Cancellation of the License Agreement: $XXXXXXXXXX
(c) Non-Competition Payments:
(i) Corporation: $XXXXXXXXXX
(ii) Shareholder A: $XXXXXXXXXX
(iii) Shareholder B: $XXXXXXXXXX
(iv) Shareholder C: $XXXXXXXXXX
(v) Shareholder G: $XXXXXXXXXX
(d) Motor Vehicles: $XXXXXXXXXX
(e) Personal Property, Office Supplies and Fixtures: $XXXXXXXXXX.
29. The sale of the Purchased Assets resulted in the following income inclusions for the Corporation under the Act:
(a) Subsection 13(1): $XXXXXXXXXX.
(b) Subsection 14(1): $XXXXXXXXXX.
30. The Active Shareholders reported their Non-Competition Payments as non-taxable capital receipts.
31. The Corporation continues to carry on its other businesses notwithstanding the sale of the XXXXXXXXXX Franchise.
32. The Corporation has historically declared and paid bonuses to its shareholders who are active in its businesses so that taxable income approximates the small business deduction limit. Consistent with this practice, the Corporation declared bonuses payable to the Active Shareholders on XXXXXXXXXX (hereafter, the "Bonus") in the aggregate amount sufficient to reduce its net income to $XXXXXXXXXX. The precise amount of the Bonus was to be determined as soon as practicable after draft financial statements were completed for the Corporation's taxation year ended XXXXXXXXXX.
33. The amount of Bonus has subsequently been determined to be $XXXXXXXXXX, which, if deductible will reduce the Corporation's active business income from $XXXXXXXXXX to $XXXXXXXXXX.
34. The Bonus is allocated among the Active Shareholders as follows:
Shareholder A $XXXXXXXXXX
Shareholder B $XXXXXXXXXX
Shareholder C $XXXXXXXXXX
Shareholder G $XXXXXXXXXX
$XXXXXXXXXX
Proposed Transactions
35. The Corporation will pay the Bonus to the Active Shareholders as described in paragraph 34 above on or before XXXXXXXXXX.
Purpose of the Proposed Transactions
36. The purpose of the proposed transactions is as follows:
(a) To remunerate the Active Shareholders in a tax efficient manner for their contribution to the success of the Corporation and, more specifically, the XXXXXXXXXX Franchise, and for their efforts in negotiating the successful sale of the XXXXXXXXXX Franchise; and
(b) To allow the Corporation to reduce its income from an active business carried on in Canada to approximately the small business deduction limit for the XXXXXXXXXX taxation year, thereby eliminating the Corporation's exposure to a higher corporate income tax rate on income that is in excess of the small business deduction limit.
Rulings Given
37. 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;
(c) There are no other transactions, which may be relevant to the ruling requested; and
(d) The Corporation withholds source deductions from the amount of the Bonus in accordance with prescribed rules and remits the source deductions to the Receiver General within the prescribed time,
our rulings are as follows:
A. Paragraph 18(1)(a), section 67 and subsection 78(4) 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, and
B. Pursuant to subsection 5(1) of the Act, the amount of the Bonus paid to each of the Active Shareholders, must be included in calculating their respective employment income in XXXXXXXXXX.
These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued on May 17, 2002 by the CRA, and are binding on the CRA provided that the Proposed Transactions related to the payment of the Bonus are carried out within the time frame described in paragraph 35 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, and without restricting the generality of the foregoing, in no way implies acceptance by the CRA of the allocation of payments under the Agreement between the Purchased Assets and Non-Competition Payments as described in paragraph 28 above.
Yours truly,
XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch
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