Reducing a Corporation’s Taxable Income through Bonuses to Shareholder vs. Management fees to a Holding Company

As a general rule, the amount of salary and fees must be reasonable in relation to the value of the services performed.  However, the CRA appears to be fairly lenient with respect to the reasonableness of a large salary or bonus that is paid to an active owner-manager from active business income.  In the Income Tax Technical News no. 22, the CRA stated that the conditions that were described in their response to a question posed at the 1981 round table are still applicable.  The 1981 response was as follows:

“In general, the Department will not challenge the reasonableness of salaries and bonuses paid to the principal shareholders-managers of a corporation when:

1. The general practice of the corporation is to distribute the profits of the company to its shareholders-managers in the form of bonuses or additional salaries; or
2. The company has adopted a policy of declaring bonuses to the shareholders to remunerate them for the profits the company has earned that are, in fact, attributable to special know-how, connections, or entrepreneurial skills of the shareholders.”

If a taxpayer is an employee of an interposed holding corporation, the administrative practices regarding the deductibility of bonuses also applies to bonuses paid by the holding company but NOT to intercorporate management fees that are paid by the operating corporation to the holding company.  Management fees must be reasonable of the services that are provided by the holding company through its employees in order to be fully deductible by the operating corporation[1].  In the Burrows case, management fees were found to be unreasonable because no services were performed and therefore not deductible.  Similarly in the Bessette case, the management fees were disallowed as there was no evidence that the corporation rendered the services.

The CRA has generally accepted management fees paid to a related corporation as reasonable, up to a 15 percent markup over the expenses that the company handles.  It should be noted that when a deduction is denied, the recipient is still taxed, thereby creating an element of double taxation.

[1] CRA document no. 9641607, April 2, 1997

This article is intended for general information purposes only and does not constitute professional advice.  Income tax law and regulation change frequently and the content on this article may no longer reflect the current state of the law. If you have any specific questions, you should consult a professional services advisor or email us for further advice.