31 May 2005 Internal T.I. 2004-0106951I7 - 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: Whether the amount paid to each of the shareholders of the corporation should be considered a bonus or a winding up dividend and whether the amounts paid are reasonable in the circumstances.

Position: Amounts paid to shareholders A and C are reasonable bonus amounts. Amounts paid to shareholders B, D, E, F and G are not bonus amounts but benefits conferred on them in their capacity as shareholders on the discontinuance of the business. The amounts paid to these shareholders are deemed to be dividends pursuant to subsection 84(2) of the Act.

Reasons: 15(1), 84(2), CRA policy

 		May 31, 2005

	XXXXXXXXXX  Tax Services Office	HEADQUARTERS
	XXXXXXXXXX 	Luisa A. Majerus, CA
	Verification and Enforcement Division	(613) 832-3488

		2004-010695

Reasonableness of Shareholder/Manager Remuneration

This is in response to your email dated December 9, 2004, requesting our views on whether the amounts paid to each of the shareholders of the corporation should be considered a bonus or a winding up dividend and whether the amounts paid are reasonable in the circumstances.

Background

The corporation, a Canadian Controlled Private Corporation (referred herein as the "Company"), paid an amount to each of its seven shareholders in 2003 after the sale of all of its assets and XXXXXXXXXX. Only two of the seven shareholders were active in the day-to-day operations of the Company.

The seven shareholders include the president "A" who owns approximately XXXXXXXXXX% of the common shares of the Company, the vice-president "B" who owns approximately XXXXXXXXXX% of the common shares, the secretary-treasurer "C" who is the general manager of operations and owns approximately XXXXXXXXXX% of the common shares and the four directors "D", "E", "F" and "G" who each own approximately XXXXXXXXXX% of the common shares. Shareholders A and C are active in the Company and reported salaries from the Company in 2003 and previous years. The other shareholders are not paid a salary from the Company but are all XXXXXXXXXX who supply XXXXXXXXXX to the Company for resale. Shareholder A was paid a much larger amount than that paid to each of B, C, D, E, F or G.

Our Comments

It is our general view that where an individual is a shareholder of a corporation, is a Canadian resident who is active in the day-to-day operations of the corporation's business and is paid a bonus out of profits of normal business operations, the amount of the bonus is likely reasonable and the deduction to the corporation will be allowed. Furthermore, a bonus paid out of profits from the sale of the corporation's assets will not in and of itself result in a denial of the deduction to the corporation. This policy has been the subject of two different presentations at the Canadian Tax Foundation's annual conference in 2001 and 2003. For further information please refer to Income Tax Technical News #22 and #30 which can be found on our website at www.cra-arc.gc.ca.

In the case at hand, only two of the seven shareholders are active in the day-to-day operations of the Company and are the only two shareholders who have been paid a salary from the Company. Accordingly, it is our view that the bonuses paid to Shareholders A and C, were paid to them in their capacity as employees and the amounts are reasonable and deductible to the Company in the circumstances.

However, the amounts paid to each of Shareholders B, D, E, F and G represent a benefit that is conferred on them in their capacity as shareholders of the Company on the discontinuance of the business. It is our view that, by virtue of subsection 84(2) of the Income Tax Act, the Company is deemed to have paid a dividend to Shareholders B, D, E, F and G since there is a respectable argument that such amounts were paid on the discontinuance of the business. Accordingly, these shareholders must report the dividends received from the Company in their income. In such circumstances, the Company is not entitled to a deduction for the amounts paid to Shareholders B, D, E, F and G. However, these shareholders will be entitled to a dividend tax credit.

We trust this information is helpful.

John Oulton, CA
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch