Principal Issues: [TaxInterpretations translation] Can section 67 of the Income Tax Act apply to a situation where management fees are paid by a corporation to Trust A, which distributes the amounts to Trust B, and ultimately to the sole shareholder of the corporation, whether or not that shareholder is the sole beneficiary of Trust B?
Position: Question of fact. Section 67 of the Act may apply if compensation is paid to a trust. The administrative policy regarding the reasonableness of compensation to shareholders and managers contained in Income Tax Technical News No. 22 would not apply in this situation.
Reasons: Regardless of the ownership of the corporation, management fees and any bonuses in the particular situation are not paid directly to an individual who is resident in Canada and actively participates in the activities of the corporation.
February 1, 2010Compliance Programs Branch Income Tax Rulings Directorate Interprovincial Tax Avoidance Section Business and Partnerships Division Attention: Mr. Dan Rivet, CGA Lucie Allaire, Advocate, CGA., D. Fisc.
2010-035467
Reasonableness of management fees and premiums paid by a corporation
This is in response to the first question in your email of January 8, 2010 asking for our views on the application of section 67 of the Income Tax Act ("Act") to management fees and bonuses paid by a corporation.
Unless otherwise indicated, all legislative references herein are to the provisions of the Act.
You presented a situation (the "Particular Situation") where a sole shareholder of a corporation establishes a trust in a province other than Alberta (“Trust A”) and an agreement was entered into for the management of the corporation to be carried out by Trust A in consideration for a fixed monthly management fee to Trust A plus an additional bonus to be determined by the sole shareholder. The beneficiary of Trust A is another trust, formed in Alberta (“Trust B”). Without giving details as to the trustees of the two trusts, you indicated that the beneficiary of Trust B is the sole shareholder and/or his or her spouse and/or children.
Specifically, you indicated that significant amounts, representing management fees and bonuses, are paid by the Corporation to Trust A, which distributes the amounts received to Trust B. After reporting these amounts as income and paying federal and provincial taxes, Trust B ultimately distributes the remaining amounts to the beneficiary as a capital distribution.
Finally, you added that the bonus, which would be received by Trust A, would only be intended to reduce the corporation's taxable income to a level equal to or less than the small business deduction limit.
You therefore wish to know whether the Canada Revenue Agency ("CRA") would question the reasonableness of the amounts paid by the Corporation to Trust A, which amounts are then distributed to Trust B and ultimately to the sole shareholder of the Corporation. You also wish to know whether this position would be the same if the sole shareholder were not the sole beneficiary of Trust B.
Our Comments
First, we have assumed that the corporation is a Canadian-controlled private corporation (a "CCPC") as defined in subsection 125(7).
Section 67 prevents the deduction of an otherwise deductible expense except to the extent that it is reasonable in the circumstances. Whether section 67 applies in the particular situation can only be determined after considering all the facts.
Under our policy as set out in Income Tax Technical News No. 22 dated January 11, 2002 and further clarified in Income Tax Technical News No. 30 dated May 21, 2004, the CRA would not challenge the reasonableness of compensation paid by a CCPC to an individual who is a shareholder of the corporation (whether directly or indirectly through a holding company), provided that the individual is actively engaged in the activities of the corporation and is resident in Canada. This policy is intended for simple cases where the above criteria are satisfied, and does not apply, for example, to inter-corporate management fees.
In light of the above, the CRA's policy applies only where salaries and bonuses are paid directly by the CCPC to individuals who are, directly or indirectly, shareholders of that CCPC. Consequently, the CRA would therefore reserve the right to challenge the reasonableness of the management fees that are paid to Trust A, which amounts are distributed to Trust B and ultimately to the sole shareholder of the corporation, whether or not that shareholder is the sole beneficiary of Trust B.
Access to Information
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We hope that these comments are of assistance.
François Bordeleau, Advocate
Manager
Business and Partnerships Section
Income Tax Rulings Directorate.