It is common practice for some private corporations to accrue a bonus to a shareholder, who is also an employee, at year end and then pay the bonus in the following fiscal year. The expectation is that the corporation can claim the deduction in the year accrued and that the shareholder will report the employment income in the following year.
Consider the following example:
Muhamad is the sole shareholder of a private corporation whose fiscal year end is December 31, 2017. The corporation’s initial 2017 taxable income is $750,000. The corporation accrues a bonus to Muhamad of $250,000, claims the deduction and pays its corporate tax based upon $500,000 of taxable income. The corporation must pay the bonus within 180 days of December 31, 2017, being June 29, 2018. The bonus is taxed in Muhamad’s 2018 taxation year.
To achieve the corporate deduction, the bonus must be paid within a certain timeframe. ITA 78(4) requires the bonus to be paid within 180 days of the corporate year end. But what constitutes payment? Making a payment to the shareholder, as evidenced by a cancelled cheque or bank transfer, would clearly be a payment. But oftentimes there are cash constraints on the corporation that may deprive it of the ability to make the payment.
In a 2012 technical interpretation, the Canada Revenue Agency (“CRA”) stated that remittance of the payroll withholdings on time would evidence payment of the bonus. The technical interpretation did not go into any further detail as to what on time means. Does it mean that the source deductions must be remitted to CRA within the 180 day time frame required by ITA 78(4) or does it mean the remittance can be made by the regular source deduction deadline in the following month?
This has become a point of uncertainty. Many corporations are taking the position that the source deductions can be remitted by the remittance deadline the following month. During recent tax audits we have experienced CRA auditors taking the position that the withholdings should be remitted by the 180th day.
In the example above, the corporation’s 2017 income would be increased by $250,000 if the bonus was not paid within 180 days of year end. While it would obtain a deduction in the following year when payment occurred, CRA would assess interest on the unpaid tax. Assuming that the bonus was paid in 2018, Muhamad’s personal tax position would not be affected.
Given this uncertainty, we recommend that the deadlines for payment of bonuses be monitored very closely and that source deductions be paid within 180 days of the year end in which the bonus was accrued.