There has been much discussion recently in light of the Federal Liberal government’s plans to increase income taxes on “split income”. Split income is broadly understood to mean sharing income amongst family members who may not be actively involved with a business. An example would be a daughter of the owner who is away at university but still on the payroll. The new rules require that a family member spend at least 20 hours per week working for the company. The next hurdle would be the rate of pay. Section 67 of the Income Tax Act requires that an expenditure be “reasonable in the circumstances” in order to be deductible. It would appear, therefore, that a family member should have a salary similar to other employees to be considered “reasonable”.
However, there is a case that provides us with some guidance in this area. In Gabco Limited v. MNR (68 DTC 5210 (Ex. Ct.)) the reasonableness test was considered, and there was a conclusion that a wide range of salaries could satisfy. This case is important since may become the new frontier for income splitting in private corporations. In Gabco, the president of a corporation hired his 19-year-old son with the long-term intention of grooming him to move into upper management (second in command). The son was paid a substantial salary and bonus, and the corporation took a deduction in respect of the amount paid, even though the son did not yet have executive responsibilities.
The court took into account the son’s future role with the company and the benefit that the company would derive from his employment; it found that the amount paid to the son was reasonable, and it allowed the deduction in respect of his wages. The fact that the son was young and had a poor academic record did not affect the court’s finding.