Management fees are used by corporate groups and small businesses when tax planning. In the case of small businesses, they can be an effective tool for gaining access to a higher small business deduction, while corporations use this strategy to reduce taxes.
While management fees are a legitimate tax planning tool, they must be logical and supported, as the Canada Revenue Agency often challenges them. This is likely due to the number of companies who use them thoughtlessly or dishonestly.
When deducting management fees, there are four requirements.
- The amount of the management fees must be reasonable – in amount and circumstances. When considering this, the CRA will look at the nature of the services for which the fee was incurred, as well as the time it took to perform those services. They will often consider the cost of obtaining a similar service from a third party.
- Management fees must be incurred to earn income for business purposes – the CRA will question how the management fees created income for the company.
- The fee must be for specific services and be paid within the year they are incurred, or payable as per an agreement.
- The fee cannot be discretionary – they cannot be based on results or performance.
Supporting Documentation
As mentioned before, the CRA often challenges management fees. As such, it is imperative that your company be able to authenticate these fees with supporting documentation, to be able to claim them as a deduction.
Failing to properly substantiate your management fees could result in the CRA disallowing your deduction.
If the CRA does review your management fees, the following information and documentation will help you substantiate them:
1. Corporate information:- Names of Shareholders; and
- Number of Shares held by each
2. Recipient Information:
- Names of Recipients; and
- Business Numbers or Social Insurance Numbers
- Relationship between fee recipient and the company
- Intercompany agreements or Invoice for work completed; and
- Management fee amount and payment date
- Method of payment – cheque or journal entry
Courts have deemed that journal entries, on their own, are not sufficient enough.
4. Services Provided:
- Details of the work performed
- Time spent performing the work
- Frequency of the services
- Details of how the service contributed to business earnings
Characteristics of a Successful Claim
Many cases, regarding management fees, have been reviewed by the CRA or brought to court. While the following is not an all-inclusive list, successful claims have had multiple similarities.
The companies, in question, have provided written management fee/service agreements and these documents contained information detailing fees to be paid, services to be performed, and responsibilities. If the fees were intercompany management fees, companies provided documentation outlining the business purpose of the services.
Successful claims also included time tracking records, such as time cards.
In addition to these documents, fees were based on services provided and the company performing the work had the skills and resources needed to perform the service. Also, companies with periodic invoicing, versus year-end invoicing, were often more successful.
If you are looking for more information on this tax planning tool, please feel free to contact us. We would be happy to determine whether or not it will be advantageous for your specific situation and if it should be included in your comprehensive estate plan.
