Principal Issues: The deductibility of shareholder/manger remuneration that is paid out of income triggered from the proceeds of a sale of business assets
Position: Remuneration is deductible.
Reasons: Amount is reasonable and incurred for the purpose of earning business income.
XXXXXXXXXX 2005-014603
XXXXXXXXXX, 2005
Dear XXXXXXXXXX:
Re: Advance Income Tax Ruling Request - XXXXXXXXXX
This is in reply to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling in respect of the above-noted company as it pertains to the deductibility of shareholder/manager remuneration. We also acknowledge the information provided in an XXXXXXXXXX telephone conversation in connection with your request (XXXXXXXXXX).
We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the ruling request:
(i) is in an earlier return of a taxpayer or a related person;
(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of a taxpayer or a related person;
(iii) is under objection by a taxpayer or a related person;
(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; and
(v) is the subject of a ruling previously issued by the Directorate.
Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.
Definitions
1. "Corporation" is XXXXXXXXXX.
2. "Shareholder A" is XXXXXXXXXX.
3. "Shareholder B" is XXXXXXXXXX.
4. "Shareholder C" is XXXXXXXXXX.
5. "Shareholder D" is XXXXXXXXXX.
6. "Corporation B" is XXXXXXXXXX.
7. "Corporation C" is XXXXXXXXXX.
Our understanding of the relevant facts, proposed transactions and the purpose of the proposed transactions is as follows:
Facts
8. The Corporation is a "Canadian-controlled private corporation" as defined in subsection 125(7) of the Act.
9. The Corporation has a fiscal year end of XXXXXXXXXX.
10. Shareholders A, B, C, and D are residents of XXXXXXXXXX for tax purposes.
11. The Corporation was incorporated under the name XXXXXXXXXX . and operated an active business of XXXXXXXXXX. The corporation changed its name to XXXXXXXXXX. effective XXXXXXXXXX.
12. The Corporation is primarily a family owned and managed business. The shareholdings of the Corporation are as follows:
Share Common % Preferred % Shareholders Class Shares Shares
Shareholder A Class A XXXXXX XXXXXXXX XXXXXXXXXX XXXXXXXXXX Class B XXXXXX XXXXXXXX XXXXXXXXXX XXXXXXXXXX
Shareholder B Class B XXXXXXXXXX XXXXXXXXXX Shareholder C Class A XXXXXX XXXXXXXX XXXXXXXXXX XXXXXXXXXX Class B XXXXXX XXXXXXXX XXXXXXXXXX XXXXXXXXXX
Shareholder D Class B XXXXXXXXXX XXXXXXXXXX
Total XXXXXX XXXXXXXX XXXXXXXXXX XXXXXXXXXX
13. Effective XXXXXXXXXX, the Corporation sold the majority of its business assets to XXXXXXXXXX.
14. In conjunction with the XXXXXXXXXX sale of business assets by the Corporation, its sister companies, Corporation B and Corporation C sold their business assets for $XXXXXXXXXX and $XXXXXXXXXX respectively.
15. The Corporation received $XXXXXXXXXX (hereafter referred to as the "Proceeds") in consideration for the sale of the Business. The Corporation's total gain for accounting purposes with respect to the sale of the Business is $XXXXXXXXXX, its capital gain for tax purposes is $XXXXXXXXXX and the recapture for tax purposes is $XXXXXXXXXX.
16. Shareholder A, and Shareholder C (hereafter referred to as the "Shareholder/Managers") were active in the day-to-day management of the operations of the Business prior to its sale, and are currently directors and officers of the Corporation.
17. The Shareholder/Managers are residents of Canada.
18. The Corporation is associated with the following Canadian Controlled Private Corporations:
Corporation B
Corporation C
XXXXXXXXXX
19. XXXXXXXXXX, the Corporation declared a bonus in the amount of $XXXXXXXX. It is intended that the bonus will be paid as follows:
Shareholder Amount
Shareholder A XXXXXXX Shareholder C XXXXXXX Key employees XXXXXXX Bonus Total XXXXXXX
23. The allocation between the employees and combined Shareholders A/C may change depending on employment negotiations with key employees who are in management positions.
24. The Bonus was unanimously authorized by the Corporation's Board of Directors and approved by its shareholders in a meeting on XXXXXXXXXX. The Corporation and the Shareholder/Managers are aware that the Canada Revenue Agency clarified its policy on when such remuneration would be considered reasonable for purposes of section 67 of the Act, and as a result, jointly decided that the Bonus would not be paid until such time as a favourable advance income tax ruling could be obtained on the income tax status of the Bonus and/or Plan allocation.
Proposed Transactions
25. The Corporation will pay the amount of the Bonus that is payable to the Shareholder/Managers from income from operations and Proceeds within 180 days of the year end of the Corporation.
Purpose of the Proposed Transactions
26. The purpose of the payment of the Bonus is to remunerate the Shareholder/Managers for their contribution towards the successful management of the Corporation.
Rulings Given
Provided that:
(a) The preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions;
(b) The proposed transactions are completed in the manner described above; and
(c) There are no other transactions, which may be relevant to the ruling requested,
our rulings are as follows:
A. Section 67 and paragraphs 18(1)(a) and 18(1)(e) of the Act will not apply to prohibit the Corporation from deducting the amount of the Bonus in computing its business income for the taxation year ended XXXXXXXXXX.
B. Provided the Bonus will be paid on or before XXXXXXXXXX, subsection 78(4) of the Act will not apply to prohibit the Corporation from deducting the amount in computing its business income for the taxation year ended XXXXXXXXXX.
C. The amount of the Bonus that will be paid by the Corporation to the Shareholder/Managers must be included in calculating their employment income in XXXXXXXXXX, pursuant to subsection 5(1) of the Act.
These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CRA on May 17, 2002, and are binding on the CRA provided the Proposed Transactions are carried out within the time frame described in paragraph 19 above.
These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.
Except as expressly stated, these rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions.
Yours truly,
XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch