29 July 1998 External T.I. 9816445 - BONUS TO SHAREHOLDER/EMPLOYEE

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: Reasonableness of bonuses paid to shareholder/employee.

Position: Generally, the services performed by an 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.

Subject to the bounds of reasonableness with respect to both the level of salary and bonuses for the services performed and the rate of return on investment in shares, the Department generally accepts that a principal shareholder-manager is entitled to a mix of salary and dividend that he considers appropriate.

Reasons: The Department's administrative position as stated in question 42 of the 1981 Revenue Canada Round Table.

XXXXXXXXXX . 981644

Wm. P. Guglich

Attention: XXXXXXXXXX

July 29, 1998

Dear Sir:

Re: Bonus Out of Rental Income

This is in reply to your letter of June 16, 1998, concerning the deductibility of bonuses paid by a corporation to a shareholder whose activity in the corporation is limited. You are requesting clarification on comments made in our letter to you of May 26, 1998, (our reference # 980574) in regard to the fact that bonuses paid should relate to the expertise, skills and services provided to the corporation.

You stated that a fairly common situation is where Individual A owns 100% of Holdco and Holdco owns 100% of Opco. Holdco earns rental income from property leased to Opco and used by Opco in carrying on its active business. Because the two corporations are associated, the rental income is deemed, under the provisions of the Income Tax Act, to be active business income of Holdco. Individual A is active in Opco but has limited activity in Holdco since there is very little to be done in Holdco. You requested our opinion whether bonuses paid by Holdco to Individual A would be deductible.

Our Comments

In general terms the bonuses paid may be deductible to the extent they were incurred to earn or produce income and were reasonable in the circumstances. As noted in our May 26, 1998 letter, the Department’s general administrative position regarding the reasonableness of salaries or bonuses paid where a private company earns substantially all its income from property was stated in reply to question 42 of the 1981 Canadian Tax Foundation Conference Round Table. The following comments in our reply may be of assistance in your 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. ... 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 a mix of salary and dividend that he considers appropriate.”

In any particular case, the amount of bonuses considered reasonable must be based on the specific facts of that case. In the situation you have described it is our view that the services performed by Individual A for Opco would not be relevant in determining the reasonableness of the bonus paid by Holdco to the that individual. The services performed by Individual A for Opco would only be relevant in determining the reasonableness of any bonus paid by Opco to Individual A.

We trust our comments will be of assistance to you.

Yours truly,

J.F. Oulton, CA
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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