Principal Issues: Whether the proceeds from the sale of eligible capital property can be paid to the directors as a deductible bonus.
Position: Yes.
Reasons: Amount is reasonable and incurred for the purpose of earning business income.
XXXXXXXXXX 2005-016374
XXXXXXXXXX, 2006
Dear XXXXXXXXXX:
Re: Advance Income Tax Ruling Request
XXXXXXXXXX
This is in reply to your letter of XXXXXXXXXX, wherein 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 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.
Our understanding of the relevant facts, proposed transactions and the purpose of the proposed transactions are as follows:
Definitions
"Assets" means substantially all of the assets of the Company excluding the Goodwill.
"Asset Purchase Agreement" means the agreement for the purchase and sale of the Assets and the Goodwill of the Company dated XXXXXXXXXX.
"Company" means XXXXXXXXXX
"Employee 1" refers to XXXXXXXXXX
"Employee 2" refers to XXXXXXXXXX
"Employee 3" refers to XXXXXXXXXX
"Employee 4" refers to XXXXXXXXXX
"Employee 5" refers to XXXXXXXXXX
"Employee 6" refers to XXXXXXXXXX
Employee 1, Employee 2, Employee 3, Employee 4, Employee 5 and Employee 6 are collectively known as the "Shareholder/Managers".
"Goodwill" means the goodwill associated with the business of the Company.
Facts
1. The Company was incorporated under the laws of XXXXXXXXXX. The Company is a Canadian-controlled private corporation that files its tax returns at the XXXXXXXXXX Taxation Centre for audit by the XXXXXXXXXX Tax Services Office.
2. The shares of the Company are owned by three different holding companies: XXXXXXXXXX ("Aco"), XXXXXXXXXX ("Bco") and XXXXXXXXXX ("Cco"). Each of Aco, Bco, and Cco own one-third of every class of the issued shares in the Company.
3. Each of Aco, Bco, and Cco is a Canadian-controlled private corporation. The issued shares of Aco are held by Employee 5 and the XXXXXXXXXX ("Trust A"); the issued shares of Bco are held by Employee 1 and the XXXXXXXXXX ("Trust B"); and the issued shares of Cco are held by Employee 3 and the XXXXXXXXXX ("Trust C"). In each case, Employee 5, Employee 1 and Employee 3 hold the voting shares and certain preferred shares of Aco, Bco and Cco respectively, and Trust A, Trust B and Trust C hold common non-voting shares of Aco, Bco and Cco respectively. Each of Employee 5, Employee 1 and Employee 3 is a resident of XXXXXXXXXX, Canada.
4. Employee 6 is the wife of Employee 5 and a beneficiary of Trust A. Employee 2 is the wife of Employee 1 and a beneficiary of the Trust C. Employee 4 is the wife of Employee 3 and a beneficiary of the Trust C. Each of Employee 6, Employee 2 and Employee 4 is a resident of XXXXXXXXXX, Canada.
5. Each of the Shareholder/Managers is a director of the Company. As directors, each Shareholder/Manager has been and remains responsible for the strategic direction of the business of the Company, including the appointment of officers of the Company. In addition, Employee 5, Employee 1 and Employee 3 have been and remain responsible for the day-to-day management of the Company.
6. On XXXXXXXXXX, the Company sold the Goodwill and the Assets to arm's length purchasers, XXXXXXXXXX
7. The total proceeds of disposition from the sale of the Assets and Goodwill were $XXXXXXXXXX, of which $XXXXXXXXXX is allocated to Goodwill under the terms of the Asset Purchase Agreement. The Goodwill is an eligible capital property. Pursuant to subsection 14(5) of the Act, the Company's cumulative eligible capital balance prior to the sale was nil. As a result of the disposition of the Goodwill, the Company will have a negative balance in its eligible capital expenditure pool for the year ending XXXXXXXXXX.
8. The Company has a history and general practice of paying bonuses to its Shareholder/Managers in taxation years where its respective taxable income is in excess of the small business deduction. The Shareholder/Managers received the following salaries and bonuses in the past four taxation years of the Company:
Shareholder/Manager XXXXXXX XXXXXXX XXXXXXX XXXXXXX
Employee 1 XXXXXXX XXXXXXX XXXXXXX XXXXXXX Employee 2 XXXXXXX XXXXXXX XXXXXXX XXXXXXX Employee 3 XXXXXXX XXXXXXX XXXXXXX XXXXXXX Employee 4 XXXXXXX XXXXXXX XXXXXXX XXXXXXX Employee 5 XXXXXXX XXXXXXX XXXXXXX XXXXXXX Employee 6 XXXXXXX XXXXXXX XXXXXXX XXXXXXX
All the salaries and bonuses set out above were paid out of the operating profits of the Company. The XXXXXXXXXX salaries and bonuses were higher than prior years because certain bank financing of the Company was retired, which removed loan covenants restricting the remuneration that could be paid to the Shareholder/Managers.
Proposed Transaction
9. Before XXXXXXXXXX, the Company will declare the following bonuses to the Shareholder/Managers:
Shareholder/Manager XXXXXXX
Employee 1 XXXXXXX Employee 2 XXXXXXX Employee 3 XXXXXXX Employee 4 XXXXXXX Employee 5 XXXXXXX Employee 6 XXXXXXX
Purpose of the Proposed Transaction
10. The purposes of the proposed transactions are as follows:
(i) to compensate the Shareholder/Managers for their contribution to the successful management of the Company;
(ii) to allow the proceeds of disposition to be paid to the Shareholder/Managers in a tax effective manner.
Rulings Given
Provided that:
(a) the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and the purpose of the proposed transaction;
(b) the proposed transactions are completed in the manner described above;
(c) there are no other transactions that may be relevant to the ruling requested;
(d) the Company withholds source deductions from the amount of the bonus and salary paid to the Shareholder/Manager in accordance with the prescribed rules and remits the source deductions to the Receiver General within the prescribed time; and
(e) the Company pays the bonus to the Shareholder/Managers on or before the XXXXXXXXXX.
our rulings are as follows:
A. Paragraph 18(1)(a), section 67 and subsection 78(4) of the Act will not apply to prohibit the Company from deducting the amount of the bonuses described in paragraph 9 above in computing its business income for the year ending
XXXXXXXXXX.
B. Pursuant to subsection 5(1) of the Act, the amount of the bonuses described in paragraph 9 above paid to the Shareholder/Managers must be included in computing their employment income for the XXXXXXXXXX taxation year.
These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the Canada Revenue Agency ("CRA") on May 17, 2002, and are binding on the CRA provided the Proposed Transactions are carried out on or before the described dates.
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 and without restricting the generality of the foregoing, in no way implies the acceptance by the CRA of the allocation of the proceeds of disposition as described in paragraph 7 above.
Yours truly,
XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch