13 March 1989 Income Tax Severed Letter 5-7581 - [890313]

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.

Revenue Canada Taxation

Head Office

XXXX

R. B. Day (613) 957-2136

MAR 13 1989

XXXX

We are writing in reply to your letter of February 13, 1989, wherein you requested our views regarding the application of section 67, paragraph 18(1)(a) and subsection 245(2) of the Income Tax Act, to salaries and bonuses paid to shareholders/employees of corporations. Your particular concern is whether or not salaries or bonuses paid by Canadian Controlled Private Corporations and deducted from property income may be considered to be unreasonable or an avoidance transaction in either of the following hypothetical situations.

Situation 1

A corporation's only assets are $5,000,000 of Treasury Bills and Guaranteed Investments Certificates of major Canadian banks. The company is wholly owned by one individual shareholder, who spends approximately 100 hours per year administering the corporate investments. The company earned $500,000 in interest income in the year and deducted salaries of $500,000 to arrive at a taxable income of NIL for the year. The salary was in the form of a bonus payable to the sole shareholder which will be paid within 180 days of the fiscal year end. This is the first full year that the company has held cash investments, as in prior years, it operated an active business which was recently sold.

Situation 2

A corporation's sole asset is a six unit apartment building which generated net rental income of $25,000 per year before bonuses to the shareholder. The company is wholly owned by one individual shareholder who spends approximately 50 hours per year administering the corporation and dealing with tenants. The company accrued a bonus of $25,000 to its sole shareholder which was paid within 180 days after the fiscal year end. The company normally follows the practice of distributing its profits as bonuses, however, annually makes a decision based on the overall tax effect.

From your review of various comments in the Canadian Tax Conference reports for 1981, 1986 and 1987 you have concluded that this Department would not apply a reasonableness test to salaries deducted from property income or capital gains provided the salaries were paid to a shareholder in proportion to shares held by him.

Our Comments

The reasonableness of a salary or bonus is a question of fact which can only be determined by a thorough review of the circumstances of each particular situation. This type of review is generally performed by the local District Office and we are therefore unable to provide specific confirmation as to the deductibility of the bonuses outlined in your letter. However, the comments made by the Department on this subject at the 1981 and 1984 Canadian Tax Foundation continue to reflect the Department's position.

Generally, to determine the reasonableness of salaries paid to employees-shareholders comparisons with like services performed in similar businesses are required. Information to be considered would include: the duties performed by the employee and the time expended in carrying out these duties, and remuneration paid by other businesses of a similar size to employees who render services corresponding to those of the employee concerned.

In the case of principal shareholder-managers of a corporation, the Department generally will not consider their remuneration excessive in the following circumstances: the corporation's normal practice is to distribute its profits to these individuals in the form of bonuses or additional salary, or the corporation has a policy of declaring bonuses to the shareholder - managers for corporate profits stemming from special knowledge, skills or connections, etc. of that person. It would not be considered reasonable for a shareholder who provides little or no services to the corporation to receive a large bonus. Although we are unable to give you a definitive reply to your enquiry we trust that the above comments will be helpful.

for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch