If you use multiple entities (corporations, trusts, partnerships) for business purposes and bill central management fees between them, there are some important things you should know.
The CRA is aware that some corporations use intercorporate management fees to reduce (or eliminate) taxes by shifting income between related or associated businesses. This is not an uncommon practice. As a result, the CRA looks closely at transactions between connected entities and may challenge and deny the deduction of management fees from taxable income if they conclude the fees do not meet the following conditions:
- Is there a reason for the fees?
Intercorporate management fees must be incurred for specific services, and those services must be performed for the purpose of earning or producing business income. Meaning – there must be a legitimate reason for Company A to provide a service to Company B. For example, perhaps the CFO of Company A also serves as the CFO for a connected company – Company B. Company A pays the CFO’s salary, and then charges Company B a management fee for the CFO’s services.
Note: The decision to pay management fees cannot be discretionary or based on business results. There must be a legal obligation (such as a formal agreement or corporation resolution) to pay the fees and the fees must be paid within the year they are incurred.
- Are the fees reasonable?
What is the nature of the services being provided? How much time was involved in performing those services? The amount of management fees charged between connected entities must be reasonable for the services performed. When considering this, the CRA will often look at the amount of fees that would need to be paid to obtain similar services from a third-party, as well as the amount of salary (or dividends) that the service provider is receiving from the entity charging the fee.
Note: It is recommended that management fees be invoiced on a regular and consistent basis (monthly or yearly). A lump sum amount may appear to the CRA as being computed after the fact based on business performance or tax planning needs.
- Are the fees properly documented and reported?
Unlike many other corporate expenses, corporations are required to report intercorporate management fees as part of their income tax return on Form T2. It may also be necessary to provide documentation that supports the management fees and outlines the business purpose of the services provided. It is very important to have a written agreement that details the terms of the relationship and a proper audit trail of invoices, cheques, bank transfers etc. in case the CRA challenges the expense.
Note: A deduction for reasonable management fees may be denied if you have insufficient documentation them back it up.
Did you consider HST?
Management fees are considered taxable services for GST/HST and QST purposes. We have encountered situations in our practice where management fees have been paid or credited without sales tax considerations being fully taken into account. In Ontario, the recipient of a management fee will likely need to be registered for HST unless election form RC4616 (Election or Revocation of an Election for Closely Related Corporations and/or Canadian Partnerships to Treat Certain Taxable Supplies as Having Been Made for Nil Consideration for GST/HST Purposes) is filed with the CRA. If sales tax is charged, the payor of the management fee will likely wish to claim it as an input tax credit.
A word of caution
The CRA has a policy of not taxing the same amount twice, but … there is the potential for double taxation if they conclude management fees are not reasonable and deny a deduction. The law does not require them to make an adjustment to the recipient company if a management fee deduction is denied for a payor company. Technically in this case the recipient company would still need to include the management fees as taxable income. Usually, if the recipient company makes a written request to the CRA and refunds the disallowed fee amount to the payor, the CRA will allow an adjustment to offset the lost deduction. However, the CRA will not allow an adjustment if they suspect deception or abuse. If you are ever put in a position where you need to prove your management fees are legitimate, having proper documentation will be essential.
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