2007 Ruling 2007-0246871R3 - Whether a bonus is deductible in the circumstances

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 a bonus to be paid out of proceeds of disposition of business property, including goodwill, will be reasonable in the circumstances.

Position: Yes, based on the facts provided.

Reasons: The issue of the reasonableness of the amount of a bonus payment is a question of fact. In this ruling, all of the relevant facts are known.

XXXXXXXXXX 								2007-024687

XXXXXXXXXX, 2007

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request - XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, and your other correspondence, in which you requested an advance income tax ruling on behalf of the taxpayers described in this letter. You have advised that to the best of your knowledge, and that of each of the taxpayers, none of the issues involved in this Ruling is:

(i) in an earlier return of any of the taxpayers or a related person;

(ii) being considered by a tax services office (TSO) or taxation centre (TC) in connection with a previously filed tax return of any of the taxpayers or a related person;

(iii) under objection by any of the taxpayers or a related person;

(iv) before the courts or if a judgment has been issued the time limit for appeal to a higher court has expired; or

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

You have also advised that to the best of your knowledge, and that of the taxpayers, that the proposed transactions will not result in any of the taxpayers or any related person described herein being unable to pay its existing outstanding tax liabilities.

DEFINITIONS

In this letter, all monetary amounts are expressed in Canadian dollars unless otherwise indicated, and the following terms or expressions have the meaning specified:

(a) "Act" means the Income Tax Act R.S.C. 1985 (5th Supp.) c.1 as amended from time to time and consolidated to the date of this letter and unless otherwise expressly stated every reference herein to a part, section or subsection, paragraph or subparagraph, and clause or subclause is a reference to the relevant provision of the Act, and the Income Tax Regulations thereunder are referred to as the Regulations;

(b) "Active Business" has the meaning of "active business carried on by a corporation" as assigned by subsection 125(7);

(c) "Arm's Length" has the meaning assigned by section 251;

(d) "BCA" means the Business Corporations Act (XXXXXXXXXX);

(e) "BN" means the business number issued to the particular entity by CRA;

(f) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned by subsection 125(7);

(g) "CRA" means the Canada Revenue Agency;

(h) "Fair Market Value" means the highest price available in an open and unrestricted market between informed and prudent parties dealing at Arm's Length;

(i) "Individual 1" means XXXXXXXXXX;

(j) "Individual 2" means XXXXXXXXXX;

(k) "Individual 3" means XXXXXXXXXX;

(l) "Opco" means XXXXXXXXXX;

(m) "Paragraph" refers to a numbered paragraph in this advance income tax ruling;

(n) "Proceeds of Disposition" has the meaning assigned by section 54;

(o) "Proposed Transactions" means the transactions described in Paragraphs 8 and 9;

(p) "SIN" means Social Insurance Number; and

(q) "Taxation Year" is the taxation year of Opco that commenced on XXXXXXXXXX and ending on XXXXXXXXXX.

FACTS

1. Opco is a CCPC that was incorporated under the BCA on XXXXXXXXXX. Opco's principal place of business and head office is XXXXXXXXXX. Opco files its federal tax returns at the XXXXXXXXXX TC and the XXXXXXXXXX TSO administers its federal tax affairs. Opco's taxation year ends on XXXXXXXXXX.

2. Opco XXXXXXXXXX (the "Business") and has operated the Business since it was incorporated. The Business has at all times been an Active Businesses carried on by Opco exclusively in Canada. The issued and outstanding shares of Opco consist of voting common shares ("Common Shares"), voting Class A Special Shares ("Class A Shares") and non-voting Class B Special Shares ("Class B Shares"), which are held as follows:

	Shareholder	Common Shares		Class A Shares		Class B Shares

	Individual 1	XXXXXXXXXX 		XXXXXXXXXX 		XXXXXXXXXX
	Individual 2	XXXXXXXXXX 		XXXXXXXXXX 		XXXXXXXXXX 

	Total		XXXXXXXXXX 		XXXXXXXXXX 		XXXXXXXXXX 

3. Individual 1 and Individual 2 are married individuals who reside at XXXXXXXXXX . Individual 1 and Individual 2 also have an adult child, Individual 3, who resides at XXXXXXXXXX. Each of Individual 1, Individual 2 and Individual 3 (collectively hereinafter referred to as the "Individuals") is resident in Canada for the purposes of the Act. The Individuals file their income tax returns at the XXXXXXXXXX TC while the XXXXXXXXXX TSO administers their income tax affairs.

4. Each of the Individuals is active in the Business. Individual 3 has worked for Opco part-time since XXXXXXXXXX and full-time since XXXXXXXXXX while Individual 1 and Individual 2 have worked for Opco on a full-time basis since the Business commenced.

5. On XXXXXXXXXX that were used in the Business (the "Business Assets"), with the exception of Opco's building and sundry office equipment, were sold for their Fair Market Value of $XXXXXXXXXX to an Arm's Length person (XXXXXXXXXX ). The Proceeds of Disposition arising on the sale of the Business Assets were allocated as follows:

XXXXXXXXXX
XXXXXXXXXX

Opco anticipates that its net income for the Taxation Year that is attributable to the sale of the Business Assets will be approximately $XXXXXXXXXX before the payment of any bonuses to the Individuals. Such net income of Opco will be comprised of approximately $XXXXXXXXXX in respect of recaptured capital cost allowance and $XXXXXXXXXX in respect of the sale of eligible capital property that will be included in Opco's income pursuant to subsection 14(1). Opco may earn some investment income for the Taxation Year from the temporary investment of the sale proceeds. The shareholders of Opco are currently contemplating whether to rent or sell Opco's building.

6. Prior to the sale of the Business, Individual 1 was the General Manager. Individual 1 dealt with the day-to-day business operations and scheduled XXXXXXXXXX, employee hours, hiring, contract negotiations, asset purchases and financing. Individual 1 worked a minimum of XXXXXXXXXX, but on many occasions, worked XXXXXXXXXX.

Individual 2 was the Office Manager. Individual 2 was responsible for bookkeeping, payroll, invoicing and payables. Individual 2 completed all government-filing requirements and forms for Opco including GST returns and making employee tax deduction remittances. Individual 2 typically worked XXXXXXXXXX.

XXXXXXXXXX

Salaries were kept at a modest level to ensure there was excess cash available to purchase XXXXXXXXXX , a large amount of funds had to be retained by Opco. The annual salaries paid by Opco to Individual 1, Individual 2 and Individual 3 since XXXXXXXXXX were as follows:

	Year		Individual 1		Individual 2	Individual 3

	XXXXXXXXXX 	XXXXXXXXXX 		XXXXXXXXXX 	XXXXXXXXXX 

7. As a result of Individual 1, Individual 2 and Individual 3's years of dedication and entrepreneurial skills the Business flourished and Opco's gross revenue over the last XXXXXXXXXX years more than doubled. Moreover, the Individuals' determination to keep their salaries at modest levels made the Business more valuable when it was sold.

PROPOSED TRANSACTIONS

8. Prior to the end of the Taxation Year, the board of directors of Opco will declare bonuses (the "Bonuses") payable to each of the Individuals in the aggregate amount of approximately $XXXXXXXXXX such that the Opco will, at that time, have a legal obligation to pay the Bonuses.

The Bonuses will be allocated among the Individuals as follows:

Individual 1	$XXXXXXXXXX
Individual 2	$XXXXXXXXXX
Individual 3	$XXXXXXXXXX
Total			$XXXXXXXXXX 

9. Opco will pay the Bonuses no later than XXXXXXXXXX.

PURPOSE OF THE PROPOSED TRANSACTION

10. The purpose of the payment of the Bonuses is to remunerate the Individuals for their efforts and contributions towards the success of the Business carried on by Opco.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, our ruling is set forth below.

A. Provided Opco withholds source deductions from the Bonuses in accordance with the rules prescribed in the Act and the Regulations and remits the source deductions to the Receiver General of Canada within the prescribed time, section 67, subsection 78(4) and paragraph 18(1)(a) will not apply to prohibit Opco from deducting the amount of the Bonuses in computing its income from an Active Business carried on by it in the Taxation Year.

The above ruling is subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and is binding on CRA provided that the Proposed Transactions are completed by XXXXXXXXXX. The above ruling is based on the law as it presently reads and does not take into account any proposed amendments to the Act and the Regulations which, if enacted into law, could have an effect on the ruling provided herein.

Unless otherwise confirmed in the above ruling, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:

(a) the amount or Fair Market Value of any item referred to this letter;

(b) the allocation of the proceeds from the sale of the Business Assets described in Paragraph 5; or

(c) any goods and services tax consequences, provincial income tax consequences or any other tax consequences relating to the facts or proposed transactions other than those specifically described in the ruling given above.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch