14 July 1989 Ruling 73861 F - Indirect Payments

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.

Subject:  Technical Interpretation of Subsection 56(2) of the Income Tax Act (the "Act")

This is in reply to your memorandum of April 25, 1989, wherein you requested our views on the Department's policy with respect to the recipient where subsection 56(2) of the Act is being applied in a situation similar to McClurg (88 DTC 6047).

Our understanding of your situation may be summarized as follows:

Husbands and wives hold shares in a corporation and the corporation declares and pays dividends only to the wives.  The wives receive the dividends and report them as income.  As a result of an audit, the Department took the position that the husbands conferred a benefit to their wives and subsection 56(2) of the Act was applied to tax husbands on that benefit.

It is your opinion that there is no reason to delete the income from wives as they properly reported the dividend income earned on their shares.

Based upon the above, we will respond to your questions in the order in which they were posed.  Concerning the application of subsection 56(2) of the Act when the amount in question is income to the recipient, it is the Department's position to apply subsection 56(2) of the Act where the four conditions listed in paragraph 1 of IT-335 are present whether or not the amount is income to the recipient, It is also the Department's practice, in these situations, not to assess the same income twice.  Accordingly, where the taxpayer agrees to the allocation, the recipient's income will be reduced.  Where the taxpayer does not agree, the Department will also reduce the recipient's income, without requiring a waiver, provided that at the time of the assessing action the recipient's return was not about to become statute-barred; in those cases the Department will seek a waiver. The above position appears on page 49:4 (Revenue Canada Round Table) of the Report of the Thirty-seventh Tax Conference, 1985.

If the payments in the above situation is the above situation were a salary or bonuses, our position would be the same.  However, if the recipient spouse was, in fact, an employee of the corporation and the amount of such salary or bonuses was reasonable in the circumstances, it is our view that subsection 56(2) of the Act would not apply.  On the other hand, if the recipient spouse was in fact, an employee of the corporation but the amount of such salary or bonuses was in excess of a reasonable amount, subsection 56(2) of the Act could apply to the excess.  In this latter situation, the corporation would assume the additional risk of a disallowance pursuant to section 67 of the Act.

B.W. DathDirectorSmall Business and General DivisionLegislative and IntergovernmentalAffairs Branch