1 March 1982 Income Tax Severed Letter

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.

DECISION SUMMARY CORPORATE REORGANIZATIONS SECTION

R2-5 R.D. Weil March 1, 1982

Reference: Section 67

Subject: Reasonableness of an Expense - Bonus

Problem: Should we rule or provide an opinion in respect of the reasonableness of an expense where, for example, a large bonus will be paid to a taxpayer so that the payor corporation will not exceed its small business limit.

Position: No. The reasonableness of a salary or bonus is one of fact, the determination of which is the responsibility of the Compliance Directorate. The taxpayer should be referred to the District Office for a decision.

Comments

The District office has sufficient policy direction from the Compliance Directorate (80-2) and from the publicly announced position of the Department at the 1981 Canadian Tax Foundation Conference (Round-Table Discussion).

Corporate Reorganizations Section Specialty Corporations Division Corporate Rulings Directorate

QUESTION: What are the Department's views of the case of Holmes v The Queen, 74 DTC 6143, in connection with its assessing practices of "management companies" which apparently ignore that case.

ANSWER: The Department continues to accept that where a management corporation, legally incorporated, does in fact render management or administrative services, through its employees to a professional, that arrangement is acceptable.

However, the amount of the fees paid by the professional to the management corporation must be reasonable in the circumstances and laid out for the purpose of earning income. Generally, a management fee based on a mark up of 15% of the costs incurred by the corporation to provide its services to the professional is not considered to be unreasonable.

Reasonableness of Salaries or Bonuses

(a) Can Revenue Canada provide their guidelines with respect to the "reasonableness" of salaries paid to employees/shareholders where a private company earns substantially all of its income from property?

(b) We have seen a situation where an inactive or partially inactive shareholder has had his remuneration questioned as to its reasonableness. In this case, it was "suggested" that salary/ bonus in excess of $25,000 in a year may be unreasonable. Could you please comment?

(c) Large bonuses are often paid in order to reduce the taxable income of a CCPC to $150,000. These bonuses are then reviewed in the light of section 67. Could you please comment?

Department's Position

(a) No specific guidelines have been established to determine the reasonableness of salaries paid to employees/shareholders where a private company earns substantially all of its income from property. 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 or not 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:

(1) the duties performed by the employee and the time expended in carrying out these duties,

(2) the remuneration of other employees of the same business who have similar types of responsibilities, experience and skills,

(3) the remuneration paid by other businesses of a similar size to employees who render services corresponding to those of the employee concerned.

(b) The determination of a reasonable amount for salaries paid to employees/shareholders must be based on the facts of each particular 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. 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.

(c) 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 determine a mix of salary and dividend that he considers appropriate. Where there is more than one principal shareholder/ manager, the creation of separate classes of shares solely to achieve dividend flexibility would usually lead to a presumption of artificiality.

In general, the Department will not challenge the reasonableness of salaries and bonuses paid to the principal shareholders/ managers of a corporation when

(i) 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

(ii) the company has adopted a policy of declaring bonuses to the shareholders to remunerate them for the profits the company has earned which are in fact attributable to the special know how, connections or entrepreneurial skills of the shareholders.

Bonuses paid to shareholders other than the principal shareholders/ managers will be subject to the normal test of reasonableness that is set out in (a) above.