Dear Sirs:
Re: Owner/Manager Remuneration
This is in reply to your letter of December 19, 1990, wherein you requested clarification of Revenue Canada's administrative position concerning the remuneration of owners\managers. You have described a hypothetical situation and have asked for our views regarding the deductibility of the bonuses.
The facts regarding your hypothetical enquiry are as follows:
1. Opco is a Canadian-Controlled private corporation, the shares of which are owned 60% by Mr. A and 40% by Mr. B (both of whom are Canadian residents). These individuals are key employees of Opco and are highly active in its business.
2. Lendco is a Canadian-Controlled private corporation whose shares are owned by Mr. A and Mr. B in the same proportions (60/40). Lendco is therefore associated with Opco. Mr. A and Mr. B are the sole officers and directors of Lendco.
3. Lendco's only activity is the earning of interest on a significant debt obligation issued by Opco. Lendco expects to earn interest income well in excess of $200,000 per year from this debt, which income will be deemed by paragraph 129(6)(b) of the Act to be active business income.
4. Lendco and Opco will file an election under subsection 125(3) of the Act to be allocated between them the $200,000 business limit provided for in subsection 125(2) of the Act.
5. Mr. A and Mr. B would like to have Lendco and Opco pay salaries and bonuses to them sufficient to reduce the aggregate taxable income of the two corporations to the $200,000 small business deduction limit.
You are concerned as to whether the Department's position with respect to shareholder-employee bonuses as set out in Revenue Canada's response to Round Table Question 42 of the 1981 Canadian Tax Foundation Conference report and as further discussed at the 1984 Conference, can be extended to the salaries and bonuses paid by Lendco to Mr. A and Mr.B.
Our Comments
Although you have asked for a technical interpretation, it would appear that a proposed transaction by a particular taxpayer is involved. Thus this matter would appear to be more appropriately the subject of an Advance Income Tax Ruling. We are, however, prepared to provide some general comments.
In our opinion, provided the bonus expenditures were made or incurred for business purposes, are reasonable in the circumstances and are paid on or before the day that is 180 days after the end of the taxation year in which the expense was incurred, the bonuses will generally be deductible in the year of accrual. We note that Round Table Question 42 in 1981 was concerned with a private corporation earning substantially all its income from property.
As you are aware the reasonableness of a salary or bonus is a question of fact which can only be determined by a thorough review of the circumstances of each particular situation. This type of review is generally performed by the local District Taxation Office. In accordance with the answer to Question 82 of the 1984 Round Table Discussion, the Department will generally give recognition to a corporation's practice of distributing its profits to shareholder employees in the form of bonuses, or to a corporation's policy of recompensing its shareholder-managers for profits that are attributable to their special knowledge, skills, or other contributions. We are therefore unable to provide specific confirmation as to the deductibility of the bonuses mentioned in your example but would suggest you take these factors into consideration in deciding on the amount of bonuses to be charged to Lendco and Opco's operations.
Where the individuals are not employee/shareholders of a corporation and do not render any services to that corporation, it is our view that the deduction would not be allowable. It is, however, a question of fact whether, in your example, Mr. A and Mr. B are employees of Lendco and render any services to it.
The above comments are only expressions of opinion on the application of the Income Tax Act to the above hypothetical situation and as such should not be construed as advance income tax rulings, nor are they binding on the Department. Should you require an advance ruling with respect to the specific situation please follow the procedure described in Information Circular IC 70-6R2.
We trust our comments are of assistance to you.
Yours truly,
for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch