Do you use more than one company for business purposes? For example, do you use management fees to charge central management fees to these entities? Or do you charge management fees to other entities for services rendered? 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 fees charged must be reasonable.
- The expenses must have been incurred for the purpose of earning income.
- There must be a legal obligation to pay the fees.
When the Canada Revenue Agency (CRA) denies the management fee deduction in an entity, the law does not require any fee adjustment in the receiving entity, effectively resulting in double taxation.
In general, the CRA will closely examine transactions between related or associated businesses. Therefore, if the CRA asks for details, you will need to be prepared to prove that your charges are genuine service charges with the proper documentation.
Let’s take a closer look at the conditions for the deductibility of management fees.
In general, expenses must be reasonable in the circumstances to be deductible for income tax purposes. This means that the amount billed must be reasonable in relation to the work performed. There have been several court cases dealing specifically with management fees between related organizations.
Purpose and legal obligation
Management fees should be paid for specific services rendered and should not be based on a company’s results. Specific services should be identified in a management fee agreement between the parties involved.
When the CRA challenged the charges, the tax courts required taxpayers to prove how paying a specific charge generated revenue for the entity. Management fees must also be paid during the year or be payable under an agreement.
Proper documentation is essential to substantiate the management fees you have paid (or are payable) to support a full deduction based on the above requirements.
The critical point to keep in mind here is that otherwise reasonable charges could be disallowed if there is insufficient documentation to back up the charges charged.
Management fees are considered taxable services for GST/HST and QST purposes.
Reporting of inter-company management fees
Management fees paid to shareholders, other residents of Canada and non-residents must all be reported separately on schedules that support the T2 corporation tax return. Management fees paid to non-residents are also subject to a non-resident reporting process separate from corporate income tax reporting.
If you have any questions regarding the use of management fees or documentation, contact Scott Conner at BDO’s Huntsville office. Scott and his team can help you determine if your management fees are properly documented to justify deducting them 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 business, estate planning, trusts and complex transactions. Scott works closely with clients to understand their specific needs and adjust strategies accordingly. Scott and his team take a proactive and hands-on approach. They closely monitor existing and proposed legislation to determine how it will affect individual financial goals and provide ongoing advice.