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 salary, promotion and travel ex are deductible to a corp which has as its sole activity the investment of capital in shares and other financial instruments
Position: a reasonable amount for salaries is deductible
promotion not deductible by reason of 18(1)(b)
travel to investigate investment opportunities not deductible by reason of 18(1)(b)
trave to train officers of corp - deductible, subject to s 67
Reasons: interaction of 18(1)(a),(b) and section 67
June 10, 1998
Toronto Centre Tax Services Office HEADQUARTERS
Verification and Enforcement Division A. Humenuk
Attention: Mary Cheng
This is in response to your memoranda of April 1 and 17, 1998, concerning the travel, promotion and salary expense claimed by the above-noted taxpayer in 1994 and 1995. We have also considered the comments made by the taxpayer’s representative, XXXXXXXXXX, in his letters of January 20, April 9 and May 13, 1998 (a copy of the May 13, 1998 letter to us is attached).
Summary of Relevant Facts
As a result of your audit, you propose to disallow the full amount of salary, travel, promotion and capital cost allowance deducted by the Corporation in 1994 and 1995, as well legal fees incurred in 1995 in respect of a lease. You also propose to recategorize the salary received by the various members of the XXXXXXXXXX family as other income, and also to include in the family member’s income, the amount incurred by them on account of travel and promotion, as other income. XXXXXXXXXX disagrees with your proposed assessment. However, it is our understanding from discussions with XXXXXXXXXX, that the taxpayer is prepared to concede that some, if not all, of the amount claimed for promotion is not deductible in computing the income of the Corporation. As you have not provided any details as to the basis for the proposed adjustment with respect to the legal fees incurred in respect of the lease or the claim for capital cost allowance, we assume that you do not require our views on these matters. The discussions you have had with XXXXXXXXXX have centred around the issue of whether the income earned by the Corporation is income from business or income from property.
In our view, the primary issue is not whether income earned by the Corporation is income from business or income from property, but whether the expenditures in question were incurred to earn income from business or property, whether they are capital or current in nature, and if so, whether they are reasonable in the circumstances. Except where specified (such as the restriction on capital cost allowance in subsection 1100(11) of the Regulations), the Act does not provide for a distinction between an expense incurred to earn income from business and an expense incurred to earn income from property.
Although no portion of the salary, travel or promotion expenses is deductible in computing the Corporation’s capital gains and capital losses, consideration must be given to whether these expenses are otherwise allowable in computing the amount to be included in the Corporation’s income under section 9 of the Act. In our view, the categorization of the income as income from an active business, a specified investment business or income from property is not necessary for the purpose of determining whether the limitations in paragraph 18(1)(a), paragraph 18(1)(b) or section 67 of the Act apply to the expenses which you propose to disallow. Rather, it is the connection between those expenses and the income earning process which is relevant for the purpose of paragraph 18(1)(a), and it is the nature of the expenses which is relevant for the purpose of paragraph 18(1)(b) of the Act. The limitation in section 67 of the Act relates to the reasonableness of the expenses.
In the Federal Court of Appeal decision in Firestone v. the Queen (87 DTC 5237), it was stated that “revenue derived from the ownership of corporate shares is generally regarded as income from property that does not normally require the exertion of much activity or energy on the part of the owner to produce the anticipated revenue.” In addition, revenue from the ownership of shares (i.e. dividends) does not normally require the owner of the shares to incur further expenditures for the purpose of earning income from those shares. Similarly, interest income is another form of passive income which, once the funds are invested, does not normally require the exertion of activity or any further expenditure of capital in order to produce income for the holder of the investment. However this does not preclude the possibility that expenses are incurred to earn income from such investments. Note that the distinction here is not between income from a business and income from property but between income from financial instruments, including shares, bonds and debentures, and income from other sources, including business and property income.
As stated in XXXXXXXXXX letter of January 20, 1998, income from rental of property often requires an outlay of expenses in order to produce income. However, the statement which follows that assertion, that expenses incurred by a corporation in managing its financial instruments should be accorded the same treatment as expenses incurred to earn income from rental property, is somewhat misleading. While the same provisions of the Act apply to each type of income, an investment in real estate usually requires more time, activity and capital to ensure an income source than does an investment in financial instruments. Thus, it is our view that the distinction between income from investments and other sources of income, merely affects the likelihood of an expenditure being incurred to earn income and not whether an actual expenditure is deductible in computing income.
If the deductibility of the expenses in question is not limited by reason of paragraph 18(1)(a), consideration must be given to whether paragraph 18(1)(b) or section 67 of the Act applies to deny or restrict the amount deductible in computing income. If the expenditures are capital in nature, paragraph 18(1)(b) of the Act will apply to deny the expense regardless of whether the expense relates to income from a business or income from property. Finally, if the expenses are otherwise deductible, section 67 of the Act applies to deny a deduction for any amount that is excess of a reasonable amount.
It is generally accepted that a corporation requires officers to manage the company and that they ordinarily receive compensation for those duties of employment. The issue then, is whether the salary paid to the officers of a corporation is reasonable in the circumstances, given the duties, skills and experience of the officers in question. Our position with respect to salaries paid to employee-shareholders of a corporation earning investment income was set out at the 1981 Canadian Tax Foundation Conference and confirmed at the 1990 and 1991 conferences (clarification on the subject generally was also provided at the 1984 and 1993 conferences). The reasonableness of salaries paid to employee-shareholders out of investment income is based on the facts of each particular case and is made with reference to the duties, experience and skills of the employee-shareholder in question. Although it is not reasonable for a shareholder (or a person related to the shareholder) who provides little or no services to the corporation to receive a large salary or bonus, we have not been provided with the details of the extent of the services provided to the Corporation by its officers, and thus cannot comment on the extent to which the salary and benefits paid are reasonable in relation to those services.
Regardless of whether the salaries are reasonable or not, it is our view that the actual amount paid to the officers as salary is properly included in their income under section 5 of the Act, and is not included in their income under subsection 246(1) of the Act. With respect to any personal expenses paid by the Corporation, please refer to our comments on travel and promotion below.
Jurisprudence relating to costs associated with the acquisition of investments has centred on paragraph 18(1)(b) of the Act. In Firestone and the Queen v. Young (89 DTC 5234), it was established that the cost of investigating investment opportunities and the cost of investment publications were not deductible by reason of 18(1)(b) of the Act. The fact that a taxpayer does not in fact acquire the investment for which the expenditure was incurred does not alter the application of paragraph 18(1)(b) of the Act to such an expenditure. Based on the information in XXXXXXXXXX letter of May 13, 1998, the travel expenses to XXXXXXXXXX were incurred for the purpose of investigating the possibility of acquiring an investment (a specific investment in the case of XXXXXXXXXX, and in the case of XXXXXXXXXX, a more general assessment of the investment opportunities). Accordingly, it is our view that these travel costs are not deductible by reason of paragraph 18(1)(b) of the Act. As noted above, our view in this regard would not be any different if it could be established that the Corporation was in the business of holding investments. However, to the extent that the sole purpose of the trips to XXXXXXXXXX related to the investigation of these investment opportunities and the employee who incurred the travel expenses did not incorporate a vacation into the trip, it is our view that the employee would not be required to include an amount in income on account of the cost of such trips.
In our conversation of April 22, 1998 (Cheng\Humenuk), you advised that the balance of the claim for travel expenses relates to seminars and courses taken by senior officers of the Corporation to enhance their skills in assessing investment opportunities. Unless it can be established that these costs were part of training provided to the members of the XXXXXXXXXX family by reason of their non-arm’s length relationship to the Corporation and not by reason of their employment with the Corporation, a reasonable amount in respect of training costs incurred by the Corporation is likely deductible in computing its income, whether or not such training results in a taxable benefit to the employee-shareholders. The new guidelines found in Technical News No. 13 for determining whether employer-provided training results in a taxable benefit to the employee, do not necessarily apply to shareholders of the company or persons related to the shareholders. As a result, the issue of whether a taxable benefit applies in respect of such training will depend on whether the training was primarily of benefit to the employees or to the Corporation.
In summary, with respect to any travel undertaken by the officers which is disallowed as an expense to the Corporation, the value of such travel is unlikely to be considered a taxable benefit unless a personal element to the travel is established. If the travel is established to be a taxable benefit received by virtue of employment and forms part of a reasonable compensation package for the services so rendered, the amount would presumably be deductible to the Corporation as an expense for salary and benefits. However, if the cost of personal travel for the family members was paid by the Corporation by reason of their non-arm’s length relationship with the Corporation, or the expense, when added to the remuneration otherwise payable to a particular employee, forms an excessive amount of remuneration, the expense would not be deductible to the Corporation.
With respect to the amount deducted on account of promotion, based on the information available to us, there is nothing to suggest that any of these costs were incurred to earn income from business or property, since the Corporation does not appear to be engaged in the promotion of any product, service or investment. However, as noted above in respect of travel expenses, the amount of any expenditure disallowed as an expense to the Corporation does not necessarily result in a taxable benefit to the employee who incurred the expense on behalf of the Corporation. It is our understanding that a large part of the expenses claimed as “promotion” relate to business lunches attended by various employees of the Corporation and of the Corporation’s bank and advisors. Notwithstanding the element of personal consumption involved in a business lunch generally, no amount is normally required to be included in the income of an employee attending a business lunch (TOM 36(13) provides further guidance on this issue). If employees attending a business lunch on behalf of their employer were to be routinely assessed a benefit for the personal element of the lunch, there would not be any need for subsection 67.1(1) since the exception in paragraph 67.1(2)(d) would eliminate any reduction otherwise imposed by section 67.1 of the Act.
To the extent that an amount claimed for promotion results in a taxable benefit to an employee and forms part of a reasonable compensation package for the services rendered by that employee, the amount would be deductible to the Corporation. However, to the extent that a particular expense relates to benefits conferred on the family members by reason of their non-arm’s length relationship with the Corporation, or that the expense, when added to the remuneration otherwise payable to a particular employee forms an excessive amount of remuneration, the expense would not be deductible to the Corporation.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Department’s mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at 613 957-0682. The severed copy will be sent to you for delivery to the client.
J.F. Oulton, CA
Business, Property and Employment Section III
Business and Publications Division
Income Tax Rulings and
Policy and Legislation Branch
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