| 24(1) | 903321 |
| A.W. Larochelle | |
| (613) 957-2140 |
19(1)
December 31, 1990
Dear Sirs:
Re: Owner/Manager Remuneration
This is in reply to your letter of November 21, 1990 wherein you requested clarification of Revenue Canada's administrative position concerning the remuneration of owners\managers. You have described four hypothetical situations and have asked for our views regarding the deductibility of the bonuses in each case.
The facts regarding your hypothetical enquiry are as follows:
1. Holdco is a Canadian-Controlled private corporation, the shares of which are owned 60% by Mr. X and 40% by Mr. Y (both of whom are Canadian residents).
2. Holdco's only asset is all of the issued and outstanding shares of Opco, a Canadian corporation which carries on a active business in Canada.
3. Messrs. X and Y are key contributors to the business carried on by Opco, and were direct shareholders of Opco prior to the formation of Holdco. Holdco was created to allow Opco to transfer its available surplus and thereby minimize exposure to the liabilities of Opco's business.
4. Opco's business is profitable and Messrs. X and Y wish to have Opco pay salaries/bonuses sufficient to reduce its taxable income 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 following hypothetical cases.
Situation 1
Mr. X and Mr. Y are employees of Opco and Opco pays salaries/bonuses directly to these individuals.
Provided the amounts allocated to the employees meet the guidelines stated by the Department on this subject at the 1981 and 1984 Canadian Tax Foundation it is likely that these amounts would be deductible in computing Opco's business income. 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 Opco's operations.
Situation 2
Mr. X and Mr. Y are employees of Holdco which provides management services to Opco in exchange for fees and bonuses under a management agreement. Bonuses are paid to Holdco which immediately pays the full amount as bonuses to its employees, Mr. X and Mr. Y.
This situation appears similar to the Technical Interpretation quoted in your letter. As discussed in that interpretation the Department's stated policy referred to above and as discussed in your letter can not be extended to management fees paid to corporate shareholder managers. In your example you refer to the remuneration to be paid to Holdco as fees and bonuses whereas in the Technical Interpretation quoted referred to the amount simply as management fees. We believe there is no basic difference and the result would be the same notwithstanding the description used to describe the amount expenses. Accordingly, any fees and/or bonuses paid to corporate shareholder managers by Opco as stated in your example must be reasonable in the light of the services actually rendered by Holdco through its employees to be fully deductible. However, Revenue's administrative policy would be applicable to bonuses paid by Holdco to its qualifying shareholder-employees.
Situation 3
As in situation 2, but bonuses are paid by Opco directly to the employees of Holdco, Mr. X and Mr. Y.
We do not believe that the hypothetical situation which you described is the same as the example set forth in the Round Table question and answer discussed above. In the latter the individuals were employees/shareholders of the same corporation that was paying the bonuses whereas in your example while not stated it appears the employees in question are strictly employees/shareholders of Holdco. Should this be the situation then no deduction would be permitted to Opco for wages/bonuses as Mr. X and Mr. Y are not employees of that company and apparently have not rendered any services to it.
Situation 4
As in, situation 2, but the amount of the bonuses paid to Mr. X and Mr. Y from Holdco is less than the bonus received by Holdco from Opco. The balance is retained by Holdco and will be subject to tax at a rate not less than that applicable to Opco.
The Department's 1984 Round Table administrative position would not appear to apply to a hypothetical situation such as you have described above. Our comments in reply to your question 2 above would also (in most cases) be applicable to this question. See especially our comments regarding reasonableness.
The above comments are only expressions of opinion on the application of the Income Tax Act to the above hypothetical situations 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 a specific situation please follow the procedure described in the enclosed 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