11 September 1989 Internal T.I. 58469 F - Reasonableness of Shareholder-Manager Salaries

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.

September 11, 1989

Dear Sirs:

This is in reply to your letter of August 1, 1989, concerning the application of section 67 of the Income Tax Act (the "Act").

You described the following hypothetical situation:

Mr. A has owned 80% of the shares of a corporation up until the current year where he has purchased the other 20%, giving him 100% ownership.  In prior years, the corporation was very profitable and had taxable income well in excess of the $200,000 small business deduction limit.  The corporations' taxable income was not brought down to the small business deduction limit through salaries to the manager/shareholder as the two shareholders could not agree on a policy for this.

Mr. A feels he is the driving force behind the business and the corporations' high level of income reflects his efforts.  Now that he owns 100% of the outstanding shares, he would like to declare a bonus prior to his corporations' current fiscal year end such that the corporation will have a non-capital loss in the current year which will be taken back to the immediately preceding three years and used to reduce taxable income in those years to the level of small business deduction available.

Our Comments

The reasonableness of a salary or bonus is a question of fact which can only be determined by a through review of the circumstances of each particular situation.  This type of review is generally performed by the local District Office and we are therefore unable to provide specific confirmation as to the deductibility of the bonuses outlined in your letter.  However, the comments made by the Department on this subject at the 1981 and 1984 Canadian Tax Foundation continue to reflect the Department's position.

Generally, to determine the reasonableness of salaries paid to employees-shareholders comparisons with like services performed in similar businesses are required.  Information to be considered would include:  the duties performed by the employee and the time expended in carrying our these duties, and remuneration paid by other businesses of a similar size to employees who render services corresponding to those of the employee concerned.

In the case of principal shareholder-managers of a corporation, the Department generally will not consider their remuneration excessive in the following circumstances:  the corporation's normal practice is to distribute its profits to these individuals in the form of bonuses or additional salary, or the corporation has a policy of declaring bonuses to the shareholder - managers for corporate profits stemming from special knowledge, skills ar connections, etc. of that person.  It would not be considered reasonable for a shareholder who provides little or no services to the corporation to receive a large bonus.

There is no provision in the Act to permit the shareholder-manager to reduce the amount of salary received to the extent the expense was disallowed in the corporation.

Although we are unable to give you a definitive reply to your enquiry we trust that the above comments will be helpful.

Yours truly,

for DirectorSmall Business and General DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch