4 June 2004 External T.I. 2004-0070121E5 - Management Fees Paid To A Personal Serv. Business

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.

Principal Issues: Whether management fees paid by an operating company to a personal services business are reasonable by reason of the CRA's policy on when shareholder/manager remuneration will be considered reasonable for purposes of section 67 of the Income Tax Act.

Position: No.

Reasons: The determination of the reasonableness of an amount for purposes of section 67 of the Act will always be a question of fact. The CRA's administrative policy of not challenging the reasonableness of shareholder/manager remuneration under section 67 of the Act is outlined in Income Tax Technical News No. 22. As noted in our response to Question 6 under the topic "Shareholder/Manager Remuneration", the policy is "limited to salaries and bonuses paid directly to individuals resident in Canada who are active shareholder/managers of a CCPC. We therefore reserve the right to challenge the reasonableness of any inter-corporate management fees." As a result, this situation would not fall within the scope of the policy.

XXXXXXXXXX Randy Hewlett, B. Comm.

2004-007012
June 4, 2004

Dear XXXXXXXXXX:

Re: Management Fees Paid To A "Personal Services Business"

We are writing in response to your letter of March 29, 2004, wherein you requested our opinion on the above-noted issue, as it pertains to the policy of the Canada Revenue Agency ("CRA") on when shareholder/manager remuneration will be considered reasonable for purposes of section 67 of the Income Tax Act (the "Act").

Your letter described a situation in which an operating company that is carrying on an active business in Canada ("OPCO") proposes to pay management fees to a personal services business ("PSBCO"). PSBCO is owned and operated by the same shareholder/manager who owns and operates OPCO. The management fees will be based on the services provided by the shareholder/manager to OPCO on behalf of PSBCO. All of PSBCO's income remaining after the application of paragraph 18(1)(p) of the Act and applicable income taxes will be paid to the shareholder/manager. You asked a number of questions related to your main concern of whether the management fees paid by OPCO to PSBCO would be reasonable for purposes of section 67 of the Act. In your view, the management fees should be considered reasonable under the CRA's policy since the basis of the relationship between PSBCO and OPCO amounts to "what would otherwise be an employment relationship."

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to offer the following comments.

The determination of the reasonableness of an amount for purposes of section 67 of the Act will always be a question of fact. The CRA's administrative policy of not challenging the reasonableness of shareholder/manager remuneration under section 67 of the Act is outlined in Income Tax Technical News No. 22. As noted in our response to Question 6 under the topic "Shareholder/Manager Remuneration", the policy is "limited to salaries and bonuses paid directly to individuals resident in Canada who are active shareholder/managers of a CCPC. We therefore reserve the right to challenge the reasonableness of any inter-corporate management fees." As a result, the situation described in your letter would not fall within the scope of the policy.

While the situation described above may not be within the scope of the policy, this does not mean that the management fees will not be considered reasonable for purposes of section 67 of the Act. However, such a determination can only be made with a complete knowledge of all the facts and circumstances surrounding a particular situation. We would, therefore, be prepared to consider your request in the context of an advance income tax ruling.

On a final note, you mentioned in your letter that PSBCO has a different year-end than OPCO and may enjoy a tax benefit by deferring inclusion of the management fees in its income. We presume the deferral you refer to is a result of the difference in timing of when OPCO will deduct the management fees and PSBCO will report the amounts as income. In our opinion, subsection 9(1) of the Act would require PSBCO to report the management fees as income when the amounts are earned. This means that PSBCO would have to accrue the management fees as income commencing with the period it first performs management services for OPCO. Consequently, we are of the view that PSBCO would not have a "deferral", but would be required to report the management fees as they are earned.

We trust our comments are of assistance.

Yours truly,

Randy Hewlett, B.Comm.

for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch