If you pay your spouse, partner or kids a salary for assisting you in your business, you can almost guarantee that one day the Canada Revenue Agency may ask you to justify that amounts being paid to them are "reasonable."
Take the most recent case decided this month involving New Brunswick lawyer Michael Noel. In 2002, when two senior legal assistants decided not to return to work after their maternity leaves, he was unable to hire a senior legal assistant and settled for two junior legal assistants directly out of secretarial school.
His wife, Connie, was hired to be the office manager, overseeing the firm's financial matters, including billing and collection, payroll deduction remittances and management of the law firm's trust account.
Prior to joining her husband's law firm, Ms. Noel worked in various administrative and secretarial positions for Royal Bank of Canada for about 25 years before her position was eliminated in a reorganization in 2000.
The Noels agreed on a salary in the $40,000-to-$45,000 range for full-time employment. In 2004, Ms. Noel received fixed draws of $200 a week for 41 weeks for a total of $8,200, with the balance paid in additional "sporadic cheques" totalling $34,000.
Upon audit, the CRA was prepared to allow the weekly $200 cheques paid as a deduction but said the sporadic payments can't be deducted because the expenses "have not been incurred to earn income from [Mr. Noel's] professional practice." To support this position, the CRA argued they were not based on a formal employment contract or rate of pay nor were they based on hours worked or completion of specific tasks or projects. Rather "she was paid what [Mr. Noel] thought her contribution was worth."
Since the additional amounts were paid at random, the CRA felt this was merely an income-splitting scheme or a means of diverting a portion of Mr. Noel's income to his wife.
Fortunately for the Noels, the judge disagreed. Nowhere in the Tax Act is it required that salary be paid on a regular basis, he wrote, explaining: "A spouse may agree to be paid on an irregular basis because she has a greater interest in the family-owned business than an unrelated employee."
The judge elaborated by explaining that in essence, Mr. Noel paid his wife when he had the cash to do so. Requiring him to use his line of credit to meet a weekly payroll could have resulted weekly in unnecessary interest charges.
The case came down to whether Ms. Noel worked at the law firm and was paid a reasonable wage for her services. Since it's clear Ms. Noel played an important role in the operation of the firm, and was paid a competitive wage, the judge ruled this was not an income-splitting arrangement and therefore the wages paid were a legitimate deductible salary expense.