2006 Ruling 2006-0201601R3 - Whether a bonus is reasonable in the circumstances

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether a bonus to be paid out of proceeds of disposition of business property, including goodwill, will be reasonable in the circumstances.

Position: Yes, based on the facts provided.

Reasons: The issue of the reasonableness of the amount of a bonus payment is a question of fact. In this ruling, all of the relevant facts are known.

XXXXXXXXXX 2006-0020160

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Corporation") BN XXXXXXXXXX

We are writing in response to your letter dated XXXXXXXXXX, requesting an advance income tax ruling on behalf of the Corporation and the Key Employees (as defined below). We also acknowledge the information provided in your various emails and in our telephone conversations (Gibbons/XXXXXXXXXX).

To the best of your knowledge and that of the Corporation and the Key Employees (collectively the "Taxpayers"), none of the issues involved in the ruling request is:

i. in an earlier return of one of the Taxpayers or a related person;

ii. being considered by a tax services office or a tax centre in connection with a tax return already filed by one of the Taxpayers or a related person;

iii. under objection by one of the Taxpayers or a related person;

iv. before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; and

v. the subject of a ruling previously issued by the Directorate to one of the Taxpayers or a related person.

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 definitions unless otherwise indicated.

Our understanding of the facts, the proposed transactions and the purpose of the proposed transactions is as follows:

Definitions

In this letter, the following terms have the meanings specified:

(a) "active business carried on by a corporation" has the meaning set forth in subsection 125(7) of the Act;

(b) "Assets" means all of the assets of the Business, including goodwill;

(c) "Business" means the business carried on by the Corporation immediately before the Sale of such business, as described below;

(d) "business limit" has the meaning set forth in subsection 125(2) of the Act;

(e) "Canadian-controlled private corporation" has the meaning set forth in subsection 125(7) of the Act;

(f) "CRA" means the Canada Revenue Agency;

(g) "KE1" means XXXXXXXXXX residing at XXXXXXXXXX;

(h) "KE2" means XXXXXXXXXX residing at XXXXXXXXXX;

(i) "KE3" means XXXXXXXXXX residing at XXXXXXXXXX;

(j) "KE4" means XXXXXXXXXX residing at XXXXXXXXXX;

(k) "Taxation Year" is the taxation year of the Corporation that commenced on XXXXXXXXXX, and will end on XXXXXXXXXX; and

(l) "Key Employee(s)" means KE1, KE2, KE3 and KE4, either singularly or collectively.

Facts

1. The Corporation is a Canadian-controlled private corporation, resident in Canada for the purposes of the Act. Its principal place of business and head office, prior to the Sale of the Business (defined below), was XXXXXXXXXX.

2. The Corporation was formed as the result of an amalgamation (the "Amalgamation") between XXXXXXXXXX ("Predecessor 1") and XXXXXXXXXX (Predecessor 2) on XXXXXXXXXX, under the (XXXXXXXXXX) Business Corporations Act. "). Predecessors 1 and 2 were incorporated on XXXXXXXXXX, and XXXXXXXXXX, respectively.

3. Pursuant to an Agreement of Purchase and Sale between the Corporation and XXXXXXXXXX (the "Purchaser"), a division of XXXXXXXXXX, a sale of the Assets (the "Sale of Assets") was made by the Corporation to the Purchaser, effective XXXXXXXXXX, for consideration of $XXXXXXXXXX. A portion of the purchase price equal to $XXXXXXXXXX was payable in cash on the effective date, and the remaining $XXXXXXXXXX was payable on a graduated scale on or before XXXXXXXXXX, based on the Purchaser attaining certain objectives with respect to the Assets on or before XXXXXXXXXX.

4. The purchase price for the Sale of Assets was allocated to as follows:

	Asset 			Purchase Price Allocation
	Inventory 			$ XXXXXXXXXX
	Royalty Advances 		$ XXXXXXXXXX
	Plate 			$ XXXXXXXXXX
	Fixed Assets 		$ XXXXXXXXXX
	Goodwill 			$ XXXXXXXXXX
	TOTAL 			$ XXXXXXXXXX

5. The Corporation anticipates its net income for the Taxation Year attributable to the Sale of Assets will be $XXXXXXXXXX, before payment of any bonuses to the Key Employees, and will be comprised entirely of income from the sale of eligible capital property (i.e. goodwill) of $XXXXXXXXXX, included in income under subsection 14(1) of the Act. The net income from carrying on the Business will be negligible, as the relevant taxation year commenced on XXXXXXXXXX and the Assets were sold on XXXXXXXXXX.

6. The Business, as well as the businesses of the Predecessors 1 and 2, were at all times active businesses carried on by the particular corporations exclusively in Canada. They generally involved the XXXXXXXXXX.

7. At the commencement of the Proposed Transactions described below, all of the shareholders of the Corporation, and their respective shareholdings, are anticipated to be as follows:

	Key Employee 	Shareholding

	KE1 			XXXXXXX Class "A" Common Shares (XXXXXXX %);

	KE2 			XXXXXXX Class "A" Common Shares (XXXXXXX %);

	KE3 			XXXXXXX Class "A" Common Shares (XXXXXXX %);and

	KE4 			XXXXXXX Class "A" Common Shares (XXXXXXX %).

8. Prior to the Sale of Assets, each of the Key Employees had an employment agreement with the Corporation under which they were entitled to be paid remuneration that included additional compensation in the form of bonuses.

9. Prior to the Sale of Assets, each of the Key Employees was actively engaged in the day-to-day conduct of the Business and, through such active participation and leadership in strategic and in day-to-day operations, each of the Key Employees had made a significant contribution to the overall success of the Corporation. In particular, reference is made to the following:

(i) KE1, KE2 and KE3 worked jointly as the Executive Committee of the Corporation. They were jointly responsible for all strategic decisions, business management, and XXXXXXXXXX operations. Individually each also took lead responsibility for initiating, and managing to completion, XXXXXXXXXX.

(ii) KE1 was President of the Corporation and, before that, President and CEO of Predecessor 2.

(iii) KE2 was employed as XXXXXXXXXX of the Corporation and was a member of the Executive Committee since XXXXXXXXXX. He was also Secretary-Treasurer of the Corporation;

(iv) KE3 became an employee of the Corporation and a member of the Executive Committee in XXXXXXXXXX.

(v) Since XXXXXXXXXX, KE4 was employed by the Corporation as Operations Manager, responsible for all areas of business administration, including controller, payroll, ordering, accounting, inventory, payables and receivables, and office management. Prior to this employment, KE4 had been an employee of Predecessor 2 since XXXXXXXXXX.

10. The Corporation has historically declared and paid bonuses to the Key Employees to reduce its income down near the business limit.

11. At all material times, and specifically at the commencement of the Proposed Transaction described below, each of the Key Employees was, and will be, resident in Canada.

12. Each Key Employee is served by the XXXXXXXXXX Tax Centre and the XXXXXXXXXX Tax Services Office, except for KE1, who is served by the XXXXXXXXXX Tax Centre and the XXXXXXXXXX Tax Services Office.

Proposed Transactions

13. Prior to the end of the Taxation Year, the board of directors of the Corporation will declare bonuses (the "Bonuses") payable to the Key Employees in the amount of approximately $XXXXXXXXXX such that the Corporation will, at that time, have a legal obligation to pay the Bonuses.

14. The Bonuses will be allocated among the Key Employees as follows:

KE1: $XXXXXXXXXX
KE2: $XXXXXXXXXX
KE3: $XXXXXXXXXX
KE4: $XXXXXXXXXX
Total:$XXXXXXXXXX

15. The Corporation will pay the Bonuses no later than XXXXXXXXXX, being the XXXXXXXXXX day after the end of the Taxation Year.

Purpose of the Proposed Transactions

The purpose of the proposed transaction is to remunerate the Key Employees in a tax efficient manner for their contributions to the success of the Business and the Corporation.

Rulings Provided

Provided that

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, Proposed Transactions, and purpose of the Proposed Transactions;

(b) the Proposed Transactions are completed in the manner described above;

(c) there are no other transactions which may be relevant to the Rulings Provided; and

(d) the Corporation withholds source deductions from the Bonuses in accordance with the rules prescribed in the Act and the Income Tax Regulations and remits the source deduction to the Receiver General of Canada within the prescribed time;

we rule as follows:

A. Section 67, subsection 78(4) and paragraph 18(1)(a) of the Act will not apply to prohibit the Corporation from deducting the amount of the Bonuses in computing its income from an active business carried on by it in the Taxation Year.

B. Pursuant to subsection 5(1) of the Act, the amount paid to each Key Employee in respect of the Bonuses will be included in computing the employment of the respective Key Employee for the taxation year in which it is received.

Caveats

The above rulings are given subject to the general limitations and qualifications set out in Information Circular IC 70-6R5, dated May 17, 2002, and is binding on the CRA provided the proposed transactions are implemented before XXXXXXXXXX. These rulings are based on the Act in its present form and do not take into account any proposed amendments thereto.

Nothing in this letter should be construed as implying that the CRA has agreed to or accepted any of the tax consequences relating to the facts and proposed transactions described above, or any related transactions thereto, other than those tax consequences described in Rulings A and B, and, without restricting the generality of this statement, the CRA has not in any way agreed to or accepted:

(i) the accuracy of any amounts referred to this letter;

(ii) the implications of the goods and services tax; and

(iii) the allocation of the proceeds from the Sale of Assets.

XXXXXXXXXX

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch