2 April 1997 Internal T.I. 9641607 - MANAGEMENT FEES

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Are management fees to corporate shareholders deductible

Position:

Subject to the tests of reasonableness

Reasons:

section 67

			April 2, 1997

	TORONTO CENTRE TSO	HEADQUARTERS
	Audit Division		C. Tremblay
(613) 957-2744
	Attn: Paul Leblanc
	       Business Enquiries Group
	       443-6-6
			964160

XXXXXXXXXX

We are writing in response to your memorandum of December 12, 1996, wherein you request our opinion as to whether or not the management fees expensed by XXXXXXXXXX are deductible.

Facts as Given

1.XXXXXXXXXX are equal shareholders of XXXXXXXXXX.

2.All of the above mentioned corporations are Canadian controlled private corporations as defined in subsection 125(7) of the Act.

3. XXXXXXXXXX.

4. XXXXXXXXXX.

6.XXXXXXXXXX did not charge GST on the management fees as is required pursuant to section 123 of the Excise Tax Act.

7.XXXXXXXXXX have incurred substantial losses in a partnership called

XXXXXXXXXX.

Taxpayer's Position

The representatives have argued that there is no principal reason to distinguish the payment to an owner operator and to a controlling corporation that itself acts as an operator. They point that it would seem improper to treat essentially the same transaction in two different ways, where the only distinction is the type of ownership. They view the distinction as one without a difference.

XXXXXXXXXX

In their accountant's view, the decision in the De Salaberry Realties Limited v Her Majesty the Queen (78 DTC 6408) confirming that the character of a corporate activity of a corporate Joint Venture is determined by the intention and activities of its corporate shareholders is support for the argument that the purpose of the management fees are attributable for the efforts and expertise and is reasonable to what has been achieved. Their legal representatives have focused on the word "reasonable" and question the policy reason for the proposed reassessment. In their view, the service rendered by the corporate shareholders was essentially entrepreneurial, risk-taking and managerial in nature.

TSO's Position

The TSO intends to reassess XXXXXXXXXX pursuant to section 67 of the Act on the basis that most of the $XXXXXXXXXX is unreasonable. The TSO has relied upon comments made by the Department at various conferences sponsored by the Canadian Tax Foundation and in an opinion dated December 31, 1990 in taking this position. At the Revenue Canada Round Tables, it has been clearly stated that any fees and/or bonuses paid to corporate shareholders-managers by Opco must be reasonable in light of the services actually rendered by Holdco through its employees in order to be fully deductible.

Our Comments

The issue is whether the expenditures are considered reasonable in the circumstances.

In the 1991 Canadian Tax conference Round Table, the Department responded to questions concerning management fees and bonuses:

"The Department has a long standing practice not to challenge the reasonableness of salaries or bonuses paid to a principal shareholder who is active in the corporation's business and the corporation has either established a practice of distributing profits to such employee\shareholder in this manner or a policy of declaring bonuses to shareholders to remunerate them for the profits the corporation has earned that in fact are attributable to special know-how or skills of the shareholder. This position, however, does not extend to remuneration paid to spouses or other family members of the principal shareholder or to principal shareholders who are non-residents. This position was adopted largely for administrative ease and because the overall tax effect did not vary significantly whether the corporate profits were drawn out as salaries or as dividends. However, the Department is not prepared to extend this general administrative position to bonuses paid out of a corporation's investment income or to inter-corporate management fees since to do so could lead to inappropriate tax planning. The acceptance of excessive intercorporate management fees could, for example, enable taxpayers to multiply their access to the small business deduction or could facilitate intercorporate loss transfers."

In the Department's view any method used to transfer losses within a corporate group will only be effective provided that it complies with the provisions of the Act, including section 67 of the Act which requires that any amount deducted in computing income will only be allowable to the extent that the amount is reasonable. Consequently, the Department's general position is that in order for management fees paid from one corporation to another to be deductible, such fees must have been incurred by the payer for the purpose of earning income and the amount of such fees must be reasonable in the circumstances after considering the services rendered by the recipient or its employees.

The determination of whether an inter corporate management fee is reasonable can only be made on a case by case basis following a review of all of the facts of a particular case. Accordingly any portion of an expenditure denied by virtue of section 67 of the Income Tax Act ("the Act") will not be deductible to the payor, in this case XXXXXXXXXX.

For expenditures to be deductible under section 67 they must meet the following requirements:

1. Must be an outlay or expense made or incurred

2. Must be made or incurred for the purpose of gaining or producing income from a business or property.

3. Must be reasonable in the circumstances for the services actually provided.

The results of three fairly recent court decisions in light of the section 67 requirements may have a bearing upon the management issue now before you. These cases are Bronson Homes Ltd. v. MNR, 93 DTC 710(TCC), Panzer Scrap Metals Company Limited v. MNR, 91 DTC 1153(TCC), and Agricultural and Industrial Corporation and Brimstone Export Limited v. MNR, 91 DTC 1286 (TCC).

In our view, fees paid by a corporation to any corporation, whether a corporate shareholder or otherwise, would be subject to the tests of reasonableness. The reasonableness of any management fee paid is a question of fact that can only be determined in light of the services actually rendered. In determining the reasonableness of a fee the following should be considered:

a) the nature of the services rendered and time expended in performing those services; and

b) the fees which would be paid to obtain similar services from other sources.

Accordingly, as stated above, in order to be deductible, any fees paid to a corporation must be reasonable in light of the circumstances and such fees must be reasonable in light of the services actually rendered by the corporation through its employees.

The case referred to by the representative, De Salaberry Realties Limited v The Queen (74 DTC 6408) focuses on the fact that in the circumstances being considered in the case, the corporation must be considered a trader in land as it was but an instrument of its shareholder group of companies. In our view, one cannot conclude from that case that a management fee is reasonable if it is paid to a corporate shareholder who is also in the same activity as the paying corporation.

The legal representatives in their submission insist that the fees are reasonable, however they have provided no documentation to support their claims and have failed to explain the composition and rationale of the fees or how in fact they are calculated.

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch