11 April 1980 Income Tax Severed Letter RCT-0438 F

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.

RE: Management Fees Paragraphs 212(1)(a)and 212(4)(b)

This is in reply to your memorandum of February 26, 1980 and your request for our views on the application of Part XIII tax to management fees paid by XXX to XXX which XXX claims are not taxable by virtue of paragraph 212(4)(b).

Your views as we understand them are that:

(a) the "residual costs" are management fees as contemplated by paragraph 212(1)(a) and are not "specific expenses" for purposes of paragraph 212(4)(b).

(b) to be excluded from the meaning of "management or administration fee or charge" expenses should be easily identifiable as benefitting the Canadian operations and be the type of expense that is deductible under Part I of the Act.

(c) You do not agree with XXX broad interpretation that the residual costs of XXX represent specific expenses, part of which, the allocated amount, were incurred by XXX for services that were for the benefit of XXX.

(d) a complete examination of the records of XXX is required to confirm that the accounts of XXX do contain reasonable charges for specific allowable services incurred for the benefit of XXX.

We understand from our telephone conversations with Messrs. Ley and Fellows of your office that you have a copy of the memorandum from W.T. Casey of Rulings Division to Mr. W. Kerwin of the Montreal District Office dated February 20, 1976 in connection with the XXX and this identical question of management fees (corporate charges).

We also understand from these telephone discussions that subsequent re-assessments on this issue were settled on Appeal when the taxpayer provided the Department with financial statements detailing XXX departmental operating costs along with an undertaking to provide similar schedules in the future. In addition it was agreed that XXX would attempt to be as accurate as possible in charging its operating subsidiaries by using actual service hours and other date to bill these companies directly and only then would it allocate and recover its "residual costs" using "capital employed" as the basis for allocation.

This matter of management fees has been the subject of many reviews by Head Office and District Office staff and it is safe to say that the attainment of a conclusive authoritative Departmental policy and approach in this area has been very elusive. The source that represents the most comprehensive coverage of current Departmental policy on management fees that we can refer you to is the information contained in TOM 10(24)(7.3).

We agree with you that the residual allocation to XXX is in the nature of "a management or administration fee or charge" as referred to in paragraph 212(1)(a) and as defined in TOM 10(24)(7.3)(1)(A).

As to item (a) above and the interpretation of the words "specific expenses", the taxpayer, as promised in 1976-77, provided you with the detailed expense account listings supporting the compilation of the total "residual costs" which were subject to the "capital employed" allocation. It is our view that this information satisfies the Department's position on the meaning of "specific expenses", which interpretation is discussed in TOM 10(24)(7.3)(2)(A) and (B).

The Department's position on the deductibility of expenses was set out on page 8 of the 1976 memorandum to the Montreal D.O. and we can only repeat this position which states in part that

"We are now of the opinion that non-allowable expenses are within the provisions of subsection 212(4) to the same extent as other components of the management fees. Similarly, they are properly deductible in Canada to the extent that they are reasonable. Their identity as club dues, pensions, donations, etc., is lost when they are properly part of a management fee."

Items (c) and (d) above represent your concerns that the specific expenses allocated were reasonable and were in fact incurred for the benefit of XXX. These concerns centre on the propriety of the basis of allocation, as well as whether or not the "residual costs" have been "purified" before allocation to exclude costs for services which were clearly not incurred for the benefit of the Canadian corporation. Whether or not you wish to invest the time and effort to investigate these two difficult areas -is entirely your decision to be based presumably on your calculation of the potential for recovery. In principle we certainly agree with you that these concerns warrant some review and TOM 10(24)(7.3)(2)(C), (D), (E) and (F) outlines the main areas to be investigated. In view of the fact that XXX files in Hamilton you may wish to consider the possibility of discussing this file with the case file manager in Hamilton with a view to a co-ordinated review of all the XXX.

We are enclosing for reference purposes material from our files which originated in the Toronto District Office. There they have a "management Fees Committee" which has not been too active recently. However, we understand it will be reactivated on April 1.

We trust the foregoing will be of some assistance to you.

PRINCIPAL ISSUES

Whether or not a "non-financial guarantee fee, paid by a Canadian resident corporation to a non-resident corporation to guarantee a performance obligation of the Canadian corporation, would:

•     constitute a management or administration fee or charge for the purposes of 212(1)(a).

•     be deemed to be a payment of interest pursuant to 214(15)(a).

The taxpayer defines a "non-financial guarantee as being a general guarantee of performance in contrast to a "financial guarantee" which the taxpayer defines as one in which financial instruments issued by the applicant are guaranteed.

POSITION TAKEN

Decline to comment. Information provided is insufficient to make a determination, particularly given that the taxpayer asking the questions (about a non-financial guarantee) is a financial institution i.e. a Cdn. bank, and it involves the guarantor analyzing the applicant's credit. (i.e. it is not beyond the realm of possibility that there is an underlying financing transaction). Situation not clear enough to express an opinion - appeared to be a XXX structure transactions to get around XXX.