7 November 1990 Income Tax Severed Letter 188

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Dear Sirs:

This is in reply to your letter of October 3, 1990, concerning management service corporations and the related medical and dental practitioners.

You indicate that these corporations are responsible for the administration of the medical or dental practice. These corporations would normally lease the space in which the medical or dental services are rendered, pay for all overhead, and pay wages to non-medical or dental personnel (e.g. receptionists and secretaries). These corporations have charged a management fee equal to 15% of the costs incurred on behalf of the respective professional practice. The income of these corporations was treated as active business income eligible for the small business deduction provided under subsection 125(1) of the Income Tax Act (the Act).

You request our views regarding various alternative to the above situation:

Our Views

Our position remains as stated in answer to question 18 of the Thirty-Seventh Canadian Tax Foundation Conference, 1985 Revenue Canada Round Table Questions & Answers (a copy is enclosed for your convenience). The Department may, however, question whether a management service corporation, in any of the situations you describe, is in fact carrying on a business. This will be the case where the management service corporation charges a fee to the professional practice and there are not enough management service company employees to perform the functions in respect of which the professional practice is being billed. Examples would include the purchase of supplies, ordered and handled by the employees of the professional practice, or general and laboratory services that have been performed by employees of the professional practice. A 15% mark-up by the management service corporation in such situations would, in our view, be unreasonably.

The issue, in our opinion, is whether or not management services are provided by a bona fide management service corporation to a related professional practice. This is a question of fact to be determined on a case-by-case basis. If such services are in fact provided, the usual test of reasonableness and fair market value on charges claimed by the professional practice will apply. In addition, the services supplied to the professional practice must also be those usually and customarily required by the professional practice.

Finally, changing the nature of the contractual arrangement between the management company and the professional practice to an agency agreement would not necessarily affect the amount of the management service fees which would be considered reasonable. Management service fees can only be charged for the services performed by the management company. Duties performed or services rendered by employees of the professional practice would not be considered services performed by the management company.

The foregoing is an expression of opinion only and is not binding on the Department.

We trust our comments are of assistance.