Pembroke Realtors Ltd. is a closely held Canadian-controlled private corporation. At the end of 20X2, during which it earned an unusually high profit, the corporation paid additional salaries of $200,000 to its officers, who are also the shareholders. The salaries were paid in proportion to each shareholder’s holdings in the corporation. After reviewing the transaction, the CRA proposed to disallow $60,000 of the $200,000 salaries as an expense for tax purposes.
Required:
1. On what basis may the CRA justify such a proposal?
2. If the $60,000 is properly disallowed, what impact will it have on the shareholders who received the salary? Explain.