28 July 1998 External T.I. 9807805 - ACTIVE BUSINESS INCOME

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: (1) Apportionment of employees among joint venturers in meeting "more than five full-time employee" requirement.

(2) Shareholder-Manager bonus policy

Position: (1) Where the sum of the allocated portions, based on ownership of each joint venture, exceeds 5, the requirement will have been met.

(2) Question of fact whether the situation meets the bonus policy.

Reasons: (1) Apportion share of employees of each joint venture on the basis of percentage of ownership of each joint venture and the sum of the allocated portions of full-time employees should exceed 5 as set out in paragraph 16 of IT-73R5.

XXXXXXXXXX 980780
A. M. Brake

Attention: XXXXXXXXXX

July 28, 1998

Dear Sirs:

Re: Active Business Income

This is in reply to your letter of March 23, 1998, relating to a Canadian-controlled private corporation (the "corporation") whose business is carried out through joint ventures with varied interest in several properties with other co-owners or venturers. The joint ventures are not partnerships. The corporation is the co-owner of the following real estate co-ownerships the income from which would otherwise be from a specified investment business.

Joint Venture
Ownership
Percentage
Number of
Full-time Employees
Allocation of
Full-time Employees
JV 1
25%
3
0.75
JV 2
50%
5
2.50
JV 3
50%
1
0.50
JV 4
50%
4
2.00
JV 5
30%
6
1.80
Total

7.55

You asked us to confirm the following:

1) That the corporation would have more than five full-time employees for purposes of the definition of "specified investment business" in subsection 125(7) of the Income Tax Act (the "Act").

2) That the income is from an "active business carried on by a corporation" as defined in subsection 125(7) of the Act and the income would qualify for the small business deduction.

3) That the Department's administrative position to allow corporations to declare bonuses to reduce taxable income down to the $200,000 small business limit would apply with respect to the above scenario where income of the corporation is deemed to be active business income.

Our Comments

On the assumption that the corporation would be considered to be carrying on only one business (see Interpretation Bulletin IT-206R, entitled "Separate Business"), we agree that the method you used in arriving at the 7.55 full-time employees is in accordance with paragraph 16 of Interpretation Bulletin IT-73R5, entitled "The Small Business Deduction." Accordingly, the corporation's business would not be a "specified investment business" within the meaning assigned to that term in subsection 125(7) of the Act. Such income would therefore be considered to be from an "active business carried on by a corporation" for purposes of section 125 of the Act.

The 1981 Canadian Tax Foundation Question 42 sets out the Department's position with respect to shareholder-manager bonuses:

"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 them for the profits the company has earned that are, in fact, attributable to the special know-how, connections, or entrepreneurial skills of shareholders.

Bonuses paid to shareholders other than the principal shareholders-managers will be subject to the normal test of reasonableness."

In response to Question 56 of the 1990 Canadian Tax Foundation Roundtable, the Department confirmed that large salaries/bonuses intended to reduce active business income of the corporation to the annual business limit will generally not be considered excessive when the conditions described in Question 42 of the 1981 Roundtable are met. The above publications still reflect the Department's current position on the issue.

The foregoing comments represent our general views with respect to the subject matter of your letter. As indicated in paragraph 22 of Information Circular 70-6R3, dated December 30, 1996, this is not an advance tax ruling and is therefore not binding on Revenue Canada.

We trust our comments will be of assistance to you.

Yours truly,

Jim Wilson
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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