Are you using more than one corporation for business purposes? For example, do you use management fees to bill central management expenses to these entities? Or do you bill management fees to other entities for services performed? If you do, there are important considerations to ensure these fees are deductible for income tax purposes.
For management fees to be allowed as a deduction from taxable income, the following three criteria must be met:
- The amount of the fees charged must be reasonable.
- The fees must have been incurred for the purpose of earning income.
- There must be a legal obligation to pay the fees.
Where the Canada Revenue Agency (CRA) disallows the deduction of management fees in one entity, the law does not require any adjustment to fees in the receiving entity, effectively resulting in double taxation.
In general, the CRA will look closely at transactions between related or associated businesses. Therefore, if the CRA asks for details, you will need to be ready to prove your fees are bona fide management fees with the proper documentation.
Let’s look at the requirements for the deductibility of management fees in a little more detail.
In general, expenses must be reasonable in the circumstances to be deductible for income tax purposes. This means that the amount charged must be reasonable compared to the work performed. There have been several court cases specifically pertaining to charges for management fees between related organizations.
Purpose and legal obligation
Management fees must be paid for specific services performed and should not be based on the results of a business. The specific services should be identified in a management fee agreement between the parties involved.
Where the CRA has challenged fees, the tax courts have required taxpayers to prove how the payment of a specific fee generated revenue for the entity. Management fees must also be paid during the year or be payable under an agreement.
Proper documentation is critical to substantiate any management fees you have paid (or that are payable) to support a full deduction based on the above requirements.
The critical point to keep in mind here is that otherwise, reasonable fees could be denied if there is insufficient documentation to back up the fee charged.
Management fees are considered taxable services for GST/HST and QST purposes.
Reporting of inter-corporate management fees
Management fees paid to shareholders, other residents of Canada, and non-residents are all separately reportable on schedules that support the T2 Corporate income tax return. Management fees paid to non-residents are also subject to a non-resident reporting process separate from corporate tax return reporting.
If you have questions concerning the use of management fees or documentation, contact Scott Conner at the Huntsville office of BDO. Scott and his team can help you determine whether your management fees are properly documented to support their deduction for income tax purposes.
Scott Conner is an experienced tax practitioner and practical problem solver at BDO. As a partner specializing in Canadian income tax, Scott has particular specialties in private companies, planning for estates, trusts, and complex transactions. Scott works closely with his clients to understand their specific needs and adjust strategies accordingly. Scott and his team take a proactive, hands-on approach. They closely follow existing and proposed legislation to determine how it will affect individual financial goals, and provide ongoing guidance.