16 May 1994 External T.I. 9404565 - COURT ORDERED CORPORATE DISTRIBUTION

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 ‚mis,

peut ne pas repr‚senter la position actuelle du ministŠre.

Principal Issues:

characterization of a specific payment to a shareholder

Position TAKEN:

question of fact as to whether the amount was salary,
dividend or 15(1) but it was most likely 15(1)

Reasons FOR POSITION TAKEN:

court ordered payment did not have the attributes of a
dividend (pro-rata distribution to shareholders of that
class) nor was it likely salary since the shareholder in
question was inactive

A. Humenuk
XXXXXXXXXX 940456

Attention: XXXXXXXXXX

May 16, 1994

Dear Sirs:

Re: Court-Ordered Corporate Distribution to a Shareholder

We are replying to your letter of February 21, 1994 concerning a 1993 payment by a corporation to one of its
shareholders in accordance with the judgement of the Ontario Court (General Division).

You submitted a partial copy of the court judgment which ordered the payment and have asked for our opinion as to the correct characterization of said payment. Please note that any enquiry relating to an actual taxpayer, or a factual
situation involving completed transactions should be submitted along with all relevant facts and documentation to the local District Taxation office for their views in this regard. However, we would like to provide you with the following general comments which may assist you in determining the appropriate tax consequences.

As stated in paragraph 1 of Interpretation Bulletin IT-432R "Appropriation of Property to Shareholders", subsection 15(1) of the Act requires the value of any distribution of corporate property to a shareholder which would not otherwise be included in income and which cannot properly be considered as a return of capital or as having been received in the shareholder's capacity as an employee to be included in that shareholder's income in the year.

The Department's position on what constitutes a reasonable amount for salary or management fees was stated at the 1981, 1990 and 1991 Revenue Canada Round Tables. No specific guidelines have been established to determine the reasonableness of salaries paid to employees-shareholders.

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 salaries paid to employees-shareholders 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 the employee and the time expended in carrying out these duties,

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

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. It would not be considered reasonable for a shareholder who provides no services to the corporation in which he holds shares to receive a salary or management fees.

From what we can gather from the partial document submitted, the court ordered the corporation to pay a "dividend" to the
inactive shareholder in order to compensate him for the undue depletion of the corporation's equity caused by excessive management fees paid to the other shareholders in previous years. Notwithstanding the court's use of the word "dividend", it is our view that such a payment would not be included in income under section 82 of the Act as a dividend unless it represented a dividend duly declared by the Board of Directors to be payable on a pro rata basis to the owners of the shares of a particular class of stock.

To the extent that the payment in question is not salary, a dividend or a reduction in paid-up capital, it is our view that the amount should be included in the shareholder's income under subsection 15(1) of the Act. Prejudgment interest awarded by the court in respect of such amounts is included in income under paragraph 12(1)(c) of the Act.

We trust our comments will be of assistance to you.

Yours truly,

P.D. Fuoco
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch