26 April 1990 Internal T.I. 59517 F - Bonus Expenditures

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.

April 26, 1990

Dear Sirs:

This is in reply to your letter of January 17, 1990 requesting our opinion in the following hypothetical situation.

The facts you describe are as follows:

Company A is a Canadian controlled private corporation with two individual shareholders, A and B.  A owns 80% of the shares, and B owns the other 20%.  A and B are not related and both are actively involved in the day to day operations of the business.

Company X has for many years accrued bonuses to the two shareholders at year end in the ratio of their shareholdings sufficient to reduce the net income before tax to the company to $200,000.  A large portion of the net bonuses paid to the majority shareholder have been lent back to the corporation each year on a demand non interest bearing basis.  Total cumulative advances from shareholder A to the corporation are approximately $1,000,000. Shareholder B does not have any loans to the company.

The company proposes to pay interest on the demand note to shareholder A, and the payment will be made as part of the year end accrual to the shareholders, and will form part of the total remuneration to shareholder A.  In this situation, shareholder B will not have his bonus reduced due to the fact that interest is credited or paid to shareholder A.

An example, which you supplied, explains further:

You question whether the bonuses are deductible in the year of accrual and whether the amendments to section 12 of the Income Tax Act ("the Act") apply to interest paid on shareholder advances.

Our Comments

Although you have asked for a technical interpretation, it would a appear that a proposed transaction by a particular taxpayer is involved.  Thus this matter would appear to be more appropriately the subject of an Advance Income Tax Ruling.  We are, however, prepared to provide some general comments.

In our opinion, provided the bonus expenditures were made or incurred for business purposes, are reasonable in the circumstances and are paid on or before the day that is 180 days after the end of the taxation year in which the expense was incurred, the bonuses will be deductible in the year of accrual.  The provisions of subsection 78(4) are relevant and if the amount of the bonus is unpaid on the day that is 180 days after the end of the taxation year in which the expense was incurred, the amount of the bonus shall be deemed not to have been incurred as an expense in the year and be deemed to be incurred as an expense in the taxation year in which the amount of the bonus is laid.  The onus is on the taxpayer to show that the amount of the bonus is bona fide and reasonable and that the expenditure is incurred for the purposes of gaining or producing income from a business.  We note that a formula such as that set out in your example may yield reasonable results in some years and not in others, because the issue of reasonableness will depend on the services rendered by A and B as employees rather than on their status as shareholders.  Revenue Canada has set out general comments on the reasonableness of bonuses in response to a Canadian Tax Foundation Round Table question.  We enclose a copy for your convenience.

The amendment to subsection 12(4) requires individuals to include accrued interest income on an annual basis for investment contracts acquired or materially altered after 1989.  In our opinion, a demand note is an "investment contract" as that term is defined in paragraph 12(11)(a) of the Act and an alteration of a note whereby a non-interest bearing note became interest bearing would be considered material.  Thus, in your example shareholder A would be required to report the accrued interest on an annual basis.

The above comments are only expressions of opinion on the application of the Income Tax Act to hypothetical examples and as such should not be construed as advance income tax rulings, nor are they binding on the Department.

We trust our comments are of assistance

Your truly,

for DirectorBusiness and General DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch