23 January 1991 External T.I. 903595 F - Reasonableness of Salary/Bonus 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.

Dear Sirs:

Re:  Reasonableness of Salary/Bonus Payments

This is in response to you letter dated December 4, 1990, requesting our comments concerning the reasonableness of large salary or bonus payments to shareholder managers.

Our position remains unchanged from that stated in the 1981 Canadian Tax Foundation Conference Report (Q.42) and is reproduced below;

"1)       No specific guidelines have been established to determine the reasonableness of salaries paid to employee-shareholders where a private company earns substantially all its income from property. The amount, if any, that is considered to be reasonable must be based on the facts of each particular case."..." In making this evaluation the following information is usually obtained:

a)     the duties performed by the employee and the time expended in carrying out these duties,

b)     the remuneration of other employees of the same business who have similar types of responsibilities, experience, and skills,

c)     the remuneration paid by other businesses of a similar size to employees who render services corresponding to those of the employee concerned.

2)     The determination of a reasonable amount for salaries paid to employees-shareholders must be based on the facts of each particular case.  Generally, the services performed by an inactive or partially inactive shareholder are substantially less than the services performed by a shareholder involved in the day to day operations of an active business and, therefore, the value of the services would be substantially less.  It would not be considered reasonable for a shareholder who provides no services to the corporation in which he holds shares to receive a salary.

3)     Subject to the bounds of reasonableness with respect to both the level of salary and bonuses for services performed and the rate of return on investment in shares the Department generally accepts that a principal shareholder-manager is entitled to determine a mix of salary and dividend that he considers appropriate.  Where there is more than one principal shareholder manager, the creation of separate classes of shares solely to achieve dividend flexibility would usually lead to a presumption of artificiality.

      In general, the Department will not challenge the reasonableness of salaries and bonuses paid to the principal shareholders-managers of a corporation when

a)        the general practice of the corporation is to distribute the profits of the company to its shareholder-managers in the form of bonuses or additional salaries; or

b)        the company has adopted a policy of declaring bonuses to shareholders of remunerate them for the profits the company has earned that are in fact, attributable to the special know-how, connections, or entrepreneurial skills of the shareholders."

     The comments stated above were made in response to a question concerning the reasonableness of salaries paid to employees-shareholders where a private company earns substantially all its income from property.  The situation you have described involves a sole shareholder-manager of a corporation earning investment income and either business income or capital gains on the disposition of assets.  You asked whether Revenue Canada would question the reasonableness of a bonus payment sufficient to reduce the company's income to nil where the shareholder may have preference to being taxed personally.

It is not possible to determine whether the Departmental guidelines have been met in the scenario you have presented.  This is a matter to be based upon all the relevant facts.  It is the taxpayer's responsibility to establish the reasonableness of amounts paid.

We trust that these comments will be of assistance to you.

Yours truly,

for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch