Reasonableness of Shareholder/Manager Remuneration
At the 2001 Canadian Tax Foundation conference, you discussed the CCRA’s long-standing policy on when, for purposes of section 67 of the Income Tax Act (the Act), shareholder/manager remuneration will be considered reasonable. You indicated that the CCRA would not challenge the reasonableness of remuneration that was paid by a Canadian-controlled private corporation (CCPC) to an individual who is a shareholder of the corporation, provided the individual is active in the business operations and resident in Canada. You further indicated that this policy would not apply to inter-corporate management fees.
Since the conference, we understand that you have received a number of advance income tax ruling requests involving situations in which these criteria were met, but you were unable to rule favorably because there were other factors that indicated the remuneration was to be paid for reasons beyond the original intent of the policy.
Question 1
Can you discuss the intent of the policy on shareholder/manager remuneration?
Response 1
The general purpose of the policy is to provide flexibility to a CCPC and its active shareholder/managers to take advantage of marginal tax rates by reducing the corporation’s taxable income to or below the small business deduction limit through the payment of salaries and bonuses from income that is derived from normal business operations, and to provide certainty as to the taxable status of the transactions.
Question 2
When do you consider a particular situation to be within the intent of the policy in reviewing an advance income tax ruling request?
Response 2
In general terms, we consider any straightforward situation where the basic criteria noted above are met and the income that is used to pay the remuneration was earned from the ongoing, normal activities of the business, to be within the intent of the policy.
Question 3
The determination of the reasonableness of an amount is generally a question of fact. The Directorate has stated on numerous occasions that it will not rule on questions of fact. Why would you consider ruling on the reasonableness of shareholder/manager remuneration?
Response 3
We want to provide certainty to taxpayers as to the taxable status of transactions that are within the intent of this policy. As noted, we also want to provide flexibility to taxpayers in tax planning and allow them to take full advantage of marginal corporate and personal income tax rates and any integration provided for under the law.
Question 4
Can you give us some examples of situations that the CCRA would consider to be beyond the intent of the policy?
Response 4
Yes. We would consider a situation in which a CCPC pays the remuneration out of the proceeds generated from a major a sale of business assets, including the sale of the entire business assets or those of a large division, to be beyond the intent of the policy. This would encompass all sources of income triggered by the proceeds, including capital gains, recapture of capital cost allowance, and income arising from the disposition of eligible capital properties. We would not generally be concerned with situations where there is a sale of some of the assets, which is incidental to the normal business operations.
Question 5
Are there any other situations that you would consider to be beyond the intent of the policy?
Response 5
Yes. Also beyond the intent of this policy would be a situation in which the income of a CCPC is derived from management fees or dividends that have flowed through a complex corporate structure. In this situation, the income used to pay the remuneration is not derived from the normal business operations of the CCPC.
Question 6
Are you saying that the CCRA would consider the remuneration to be unreasonable or refuse to rule in situations that you consider to be beyond the intent of the policy?
Response 6
No. All we are saying is that the CCRA reserves the right to challenge the reasonableness of the remuneration or refuse to rule in these situations. We would like to re-emphasize that the policy is intended for straightforward situations where the criteria noted above are met. We will, however, consider any situation in the context of an advance income tax ruling where the facts demonstrate that there is no undue tax advantage resulting from the transactions.
Question 7
When requesting an advance income tax ruling on the reasonableness of shareholder/manager remuneration under section 67 of the Act, are there any important considerations that should be kept in mind?
Response 7
All advance income tax ruling requests should include a complete disclosure of all relevant facts, the purpose of the proposed transaction, and a discussion on why the request should be considered in the context of the relevant provisions of the Act, jurisprudence, and CCRA policy. In addition, where one of the purposes of the proposed transactions is to alleviate the tax consequences imposed under the law of a province that does not have a collection agreement with the CCRA, the ruling request should contain a copy of the ruling from the province with respect the proposed transactions or other documentation to that effect.
In terms of a ruling request on the reasonableness of shareholder/manager remuneration under section 67 of the Act, it may be helpful to provide a complete analysis of the tax impact of the proposed transactions, a valid business reason for payment of the remuneration, and a reasonable estimate of the amount of the remuneration.