17 November 1994 External T.I. 9418455 - RCA FOR EMPLOYEE/SHAREHOLDER

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Whether position expressed in Q. 42 of 81 CTF applicable to amounts paid by CCPC to an RCA on behalf of shareholder-employees.

Position TAKEN:

Yes but reserved opinion whether amounts might be salary or wages and fund therefore is an SDA.

Reasons FOR POSITION TAKEN:

Criteria for reasonableness of amount of salaries/bonus equally applicable for reasonableness of amount of an RCA contribution; see 921803 re SDA or RCA determination.

XXXXXXXXXX 941845

Attention: XXXXXXXXXX

November 17, 1994

Dear Sirs:

Re: Contribution to Retirement Compensation Arrangement (RCA) on Behalf of Employee/Shareholder

This is in reply to your letter of July 12, 1994, in which you refer to the Department's position as set out in its response to Question 42 of the 1981 Canadian Tax Foundation Revenue Canada Round Table. You ask whether the position would also apply in the situation where, instead of paying a large bonus to the employee/shareholder, the corporation directs all or some of the amount to an RCA. We reproduce Question 42 and the response below and our comments follow thereafter. References to "the Act" are to the Income Tax Act.

Question

1)Can Revenue Canada provide guidelines with respect to the "reasonableness" of salaries paid to employees-shareholders where a private company earns substantially all its income from property?

2) We have seen a situation where an inactive or partially inactive shareholder has had his remuneration questioned as to its reasonableness. In this case, it was "suggested" that salary/bonus in excess of $25,000 in a year may be unreasonable. Could you please comment?

3) Large bonuses are often paid in order to reduce the taxable income of a CCPC to $150,000. These bonuses are then reviewed in light of section 67. Could you please comment?

Department's Position

1) No specific guidelines have been established to determine the reasonableness of salaries paid to employees-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 general, when determining whether salaries paid to employees-shareholders are reasonable, comparisons with like services performed in the same or similar businesses are required. 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 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 the 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 the 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 shareholders-managers in the form of bonuses or additional salaries; or

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

Bonuses paid to shareholders other that the principal shareholders-managers will be subject to the normal test of reasonableness that is set out in a) above.

In our view, the position as set out above would apply equally to the determination, for the purposes of section 67 of the Act, of the reasonableness of a contribution made by a company to an RCA in respect to benefits to be received by an employee-shareholder.

We note, however, that it is a question of fact whether the arrangement which the employer is funding is an RCA as defined in subsection 248(1) of the Act or a salary deferral arrangement as defined in the same subsection. Amounts which are payable as salary or wages will retain their identity as such even if paid after retirement. Consequently, if a fund contains these amounts, it may be a salary deferral arrangement if the right to the amounts arose in a year prior to their receipt, and one of the reasons they were not paid in that prior year was to defer taxation.

Although the foregoing comments are an expression of opinion only and are not binding on the Department, we trust they are helpful.

Yours truly,

for Director
Financial Industries Division
Rulings Directorate