DO YOU HAVE DOCUMENTATION FOR YOUR MANAGEMENT FEES?
Do you use more than one corporation (or other entities such as trusts or partnerships) for business purposes? Do you use management fees to bill central management expenses to these entities or to bill other entities for services performed? If you do, not only must the fees you charge be reasonable, but it is critical that you can prove the fees are truly management fees with the proper documentation should a Canada Revenue Agency (CRA) auditor ask for details of the fees charged.
In a recent Tax Court of Canada case, Les Entreprises Rejéan Goyette Inc., the judge disallowed the deduction of management fees because the taxpayer was unable to prove the fees were true management fees. In this case, an individual was the sole shareholder of a holding company with two wholly-owned subsidiaries (let’s refer to them as X Co and Y Co) whose intercorporate management fees were at issue. X Co was a corporation that operated a residential housing construction business. Y Co was in the business of purchasing land for urban development and for preparing the lots for X Co. Y Co paid for the usual development costs of the land, while X Co paid for any “out of the ordinary” development work.
X Co paid intercorporate management fees to Y Co which offset non-capital losses of Y Co for the taxation years in question. However, the deduction of the fees was disallowed. The planning itself was not unacceptable had the fees in fact been true management fees, but this is where the case was lost for X Co. There was no agreement in place for the provision of management services or the payment of management fees by X Co to Y Co nor were there any corporate resolutions authorizing such services or payments. The only evidence in respect of the fees given to the courts was two invoices, which showed only the total amount of the fees and the period to which they related (each covered an entire year). There was no information regarding the services provided such as the nature of the services, the hours of service or who provided the services. X Co argued that the fees were related to “out of the ordinary” development work including the supervision of this work and were management services to be charged by Y Co. However, this explanation was inconsistent with the financial records of Y Co. In addition, similar fees were not charged by other land development corporations that operated within the corporate group. In the end, the Court concluded that Y Co was not in the business of providing management services and the fees were paid as a “tax planning scheme” put in place to make use of the non-capital losses of Y Co.
This case serves as a reminder that where intercorporate management fees are used, there must be a legal obligation to pay management fees and proper documentation is critical. The amount charged must also be reasonable when compared to the work performed. The CRA will generally be looking for the following as evidence of true management fees:
General corporate information:
- The names of shareholders as well as the number of shares held by each.
A listing of management fees paid, including:
- Names of recipients and their business/social insurance number,
- The amount paid and the date of payment,
- Whether the amount was paid by cheque or journal entry, and
- The relationship between the corporation and the recipients.
Details of the services provided, including:
- A description of the work performed,
- The amount of time spent, and
- Details on how often the services were provided.
The CRA will also likely want to see a copy of the contract of services between the parties. Although you would generally have used the above information when you set the amount of your management fees, you should keep the information available in case the CRA requests it (rather than having to track it down later).
It is also important to resist the urge to charge a reasonable fee based on general information and estimates. The CRA will be looking for specific proof of how your management fees were determined. You should consider retaining back-up copies of time records of the employees performing the work and a detailed description of the work performed for the other company. The important 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.
If you have questions concerning management fee documentation, contact your BDO advisor. They can help you determine whether your management fees are properly documented.
Next section: New Rules for Dispositions of Canadian Corporations by Non-Residents
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