Intercorporate management fees are used commonly to facilitate the transfer of losses within corporate groups or to gain access to additional small business deductions. However, there are risks to using such management fees. Most significantly, they are often challenged and denied by the Canada Revenue Agency where the fees were not incurred to earn income and were not reasonable in the circumstances. The denial of the deduction could lead to a one-sided adjustment, as the recipient corporation may still be required to include the fee in income.
Two recent Tax Court cases have focused on the deductibility of management fees between related companies. These cases provide useful guidelines in assessing the reasonableness of management fees. In addition, they serve as a reminder to ensure there is a legal obligation to pay management fees, and that adequate documentation is in place to support the fee.
In Nielsen Development Co. v. R. (2009 TCC 160), the Tax Court of Canada considered the reasonableness of management fees paid between corporations owned indirectly by a husband and wife. In assessing the reasonableness of the fees, the Court considered the following factors:
- the nature of the management services;
- management on site;
- the efficiency of operations in comparison to similar operations in similar markets;
- the effort of management;
- profitability;
- the existence of a management contract; and
- experience and special qualifications.
In this case, the Court held that the management fees were reasonable in the circumstances and were adequately supported by a management services contract.
In contrast, in Entreprises Rejean Goyette Inc. v. R. (2009 TCC 351), the Tax Court of Canada denied management fees paid between two subsidiary corporations. Here, the taxpayer was unable to prove that the management fees were in fact true management fees. There was no agreement between the companies, no corporate resolutions authorizing the provision of services, and no payment of the management fee. The only evidence was invoices between the companies that did not contain details of the services rendered. The Court held that there was no legal obligation to pay the fees and denied the deduction.
It is thus important that all management fee arrangements have a properly drafted management agreement that contains bona fide commercial terms. Supporting documentation should include the preparation of invoices on a regular basis with an adequate description of the services provided, remitting the HST portion of the invoice, issuing payments on a timely basis, and ensuring the accounting records are up to date. Most importantly, the amount of the management fee should be representative of the value of the services provided.
Where there is a key person providing services, an employment contract should also be prepared between the provider corporation and the individual in question. This will help to further solidify the basis for charging the management fee. §
Guy A. Desmarais, B. Com., LL.B., TEP, is a partner in Collins Barrow's Sudbury-Nipissing member firm and can be reached at gudesmarais@collinsbarrow.com. Tony Alberton is a CA and a senior tax manager at Collins Barrow Sudbury-Nipissing and may be reached at 705-560-5599 ext.295.