31 March 1998 Ruling 9802353 - resource loss, bonus

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.

                                                                         	980235
XXXXXXXXXX 					                                                      	Denise Dalphy

Attention: XXXXXXXXXX

March 31, 1998

Dear Sirs:

Re: Advance Income Tax Ruling Request

XXXXXXXXXX (“Mr. A.”)

XXXXXXXXXX

We are writing in reply to your letter dated March 26, 1998 and your telephone conversations with John Chan and Denise Dalphy concerning the above ruling request.

As we advised you on March 20 and 25, 1998, the Department will not rule on the fair market value of property or services and we therefore will not rule on the reasonableness of bonuses paid to Mr. A. or any employee-shareholder.

In your aforementioned letter you stated that your understanding is that the Directorate has not opined that “the proposed bonus described in the above ruling request is not being paid from active business income or that it is not reasonable in the circumstances”. This statement is not a complete and accurate description of the Department’s position. As we have advised you in telephone conversations, whether an amount will be classified as active business income is a question of fact and not an issue which requires an interpretation of the Income Tax Act (“the Act”). These types of determinations can only be made with certainty after all details that may relate to a transaction are available, and this may require an audit of the taxpayer on its completed transactions. Further, as we have advised you, the Department’s preliminary opinion on the payment of the proposed bonuses to Mr. A. is that they would not be reasonable expenses of XXXXXXXXXX within the meaning of section 67 of the Act, for we are not able to answer the question: “Would a reasonable business person have contracted to pay such amounts having only business considerations in mind?” in the affirmative. However, we cannot make a definitive factual determination on this issue. Although a company can certainly pay all of its income to a sole shareholder, such a payment may be in the nature of a distribution of profits or it may be an expense (reasonable or unreasonable) of the payer. In order to determine whether the payment of an expense would be reasonable, it would be necessary to conduct a review similar to that performed by a person valuing of the fair market value of a service.

It would be necessary to, inter alia, evaluate the services performed by Mr. A., to compare the employment income paid to Mr. A. with employment income paid to similar employees in similar industries and in similar circumstances, and to compare the income and expenses of XXXXXXXXXX to similar businesses. These determinations are not such that can be made with certainty on a prospective basis.

You have questioned whether the response to Question 42 at the 1981 Revenue Canada Round Table is still applicable. The Canadian Tax Foundation has published a number of the Department’s positions on the reasonableness of bonuses, including the Department’s response to Question 42 at the 1981 Revenue Canada Round Table. We are not aware of any changes to this audit position, however, the issue of reasonableness is a question of fact and as is stated in the response, this position is a general statement. Accordingly, it will not necessarily apply in all cases.

Finally, with respect to the proposed payment of the bonuses to Mr. A., although we would not rule on the issue of whether the bonuses would be reasonable expenses of XXXXXXXXXX, it is our view that the payment of the bonuses by XXXXXXXXXX to Mr. A. would reduce its adjusted resource profits and would result in a prescribed resource loss, the quantum of which would be determined upon audit of XXXXXXXXXX.

Yours truly,

R. Shultis
Director General
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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