10 April 2000 External T.I. 2000-0013085 - REASONABLENESS OF MANAGER 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.

Principal Issues: Whether the audit policy set out in our answer to question 42 at the Revenue Canada Roundtable at the 1981 Canadian Tax Foundation's Annual Conference will apply to managers who own their shares through a holding company. In our answer to question 42 we stated that, in general, we 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 the shareholders.

Position: No, the normal test of reasonableness will apply.

Reasons: The policy in question 42 applies to "principal shareholder-managers" only.

XXXXXXXXXX 						J. Gibbons
							2000-001308
Attention: XXXXXXXXXX 

April 10, 2000

Dear XXXXXXXXXX:

Your letter of March 6, 2000, was forwarded to us by the Winnipeg Tax Services Office for reply. In your letter, you requested further clarification of the Agency's policy concerning the reasonableness of management bonuses, which was set out in our answer to question 42 of the Revenue Canada Roundtable at the 1981 Canadian Tax Foundation's Annual Conference ("the 1981 CTF").

As requested, we provided some comments below. However, we will not confirm the tax implications of particular transactions unless the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R3. Thus, our comments are of a general nature only.

In our answer to question 42 at the 1981 CTF, we stated that, in general, we 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 the shareholders.

We also stated that bonuses paid to shareholders other than the principal shareholders-managers will be subject to the normal test of reasonableness.

You wish to know if our administrative policy concerning the payment of bonuses would apply in a situation containing the following hypothetical facts:

• the corporation is a CCPC which is ultimately controlled by three individuals;
• one of the shareholders ("A") of the corporation in not active in the business, and A's equity in the earnings of the corporation is distributed to A only by way of dividend (paid on a separate class of shares);
• the other two shareholders are corporations which are themselves owned by family trusts. The income beneficiaries of each family trust are the spouse and children of an individual who is actively engaged full-time in the business carried on by the corporation. The capital beneficiaries of each trust are that individual and his or her spouse;
• the two individuals ("B" and "C") receive annual bonuses for their services equal to their families interest in the earnings of the corporation.

Our views

Our answer to question 42 at the 1981 CTF continues to reflect the Agency's general views. However, unlike the situation addressed in that question, the managers in the situation described in your letter are not shareholders so that the audit position set out in our response to question 42 will not apply. Therefore, the bonuses paid to B and C will be subject to the normal test of reasonableness. This determination can only be made after a review of the specific facts of each particular case. Such a determination requires a consideration of the duties performed by the individual, as well as the time spent in carrying out those duties. In this regard, comparisons should be made with the remuneration paid to employees who perform similar services for corporations of similar size in similar businesses and in similar circumstances. These determinations are not such that they can be made with certainty on a prospective basis.

We trust that our comments will be of assistance.

Yours truly,

John Oulton
for Director
Business and Publications Division
Income Tax Rulings Directorate

c.c. H. Zerbin, Winnipeg Tax Services Office