7 March 1995 External T.I. 9428355 - ACTIVE SHAREHOLDER BONUSES

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.

		942835
XXXXXXXXXX	A.M. Brake

Attention: XXXXXXXXXX

March 7, 1995

Dear Sirs:

Re: Reasonableness of Bonuses to Active Shareholders

This is in reply to your letter of November 1, 1994, wherein you posed certain questions in relation to a hypothetical fact situation involving the payment of substantial bonuses to seven active shareholders of a corporation whose general practice has been to reduce taxable income to $200,000 by paying bonuses to the shareholder-managers. In the fact situation presented, one shareholder holds 40% of the voting shares, while the remaining 6 shareholders each hold 10% of the voting shares.

Although you have asked for a technical interpretation, the situation presented appears to be an actual fact situation. Should this situation involve a proposed transaction, you may wish to submit all relevant facts and proposed transactions for a binding advance income tax ruling. However, should this situation involve actual taxpayers and completed transactions you may wish to submit all relevant facts and documentation (including company names and identification numbers) to the appropriate District Taxation Office for their comments. We are, however, prepared to provide some general comments.

Our comments

In order for any amount to qualify as a deduction in the computation of income, it must be considered to have been laid out to earn income from a business or property as is required by paragraph 18(1)(a) of the Act and must also meet the reasonableness test provided by section 67 of the Act. 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 amounts paid 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 that person and the time expended in carrying out these duties,

b)the remuneration of other persons 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 persons who render services corresponding to those of the employee concerned.

Revenue Canada's policy on the deduction of bonuses, as discussed at the 1981 Canadian Tax Foundation Conference, is that a bonus will not be considered unreasonable where the recipient is a principal shareholder-manager of the corporation and the corporation's general practice is to distribute its profits to shareholder-managers in the form of bonuses or the company has adopted a policy of declaring bonuses to shareholders to remunerate them for the profits the corporation has earned that are attributable to the special know-how, connections or entrepreneurial skills of the shareholders (1981 Roundtable, question 42).

It might be noted, for example, that amounts would not be considered reasonable if paid to a shareholder who provides no services to the corporation in which he holds shares. Hence, bonuses paid to shareholders other than principal shareholder-managers will be subject to the normal test of reasonableness set out in a) above. If, however, it can be demonstrated that salaries and bonuses paid to persons is to remunerate them for the profits the company has earned that are, in fact, attributable to the special know-how, connections, or entrepreneurial skills of those persons, the test will be considered to have been met.

You also asked whether our response would be different if Registered Retirement Savings Plans for each of the six employees are the beneficial owners of the shares, and the bonus is paid to the employees.

Our position would not be different and again we would like to reiterate that the bonuses should relate to the expertise, skills and services provided the corporation rather than their individual holdings in the corporation.

The foregoing comments are given in accordance with the practice of providing opinions referred to in paragraph 21 of Information Circular 170-6R2 dated September 28, 1990 and are not binding on Revenue Canada, Taxation.

We trust our comments will be of assistance to you.

Yours truly,

R. Albert
for Director
Business and General Division
Rulings Directorate
Policy and Legislation Branch