4 March 2011 External T.I. 2011-0393551E5 - Rental Properties

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 the taxpayer to the corporation he owns are deductible.

Position: It is a question of fact if the management fees are reasonable and laid out to earn income from business or property.

Reasons: The management fees must meet the general criteria required for a deduction from income from a business or property.

XXXXXXXXXX 					2011-039355
						Rita Ferguson
						519-645-5261

March 4, 2011

Dear XXXXXXXXXX :

Re: Technical Interpretation Request - Rental Properties

This is in response to your letter of January 21, 2011 asking whether an individual taxpayer may claim a deduction from rental income for management fees paid to a corporation of which he is the sole shareholder. The corporation provides property management services to other unrelated property owners and the fee charged to the shareholder will be based on the fair market value of the services provided and as charged to the unrelated landlords.

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 a request for an advance income tax ruling submitted in the manner set out in Information Circular 70-6R5, "Advanced Income Tax Rulings", dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the internet at http://www.cra-arc.gc.ca. Where the particular transactions are complete, the inquiry should be addressed to the relevant tax services office, a list of which is available on the "Contact Us" page of the CRA website. Although we cannot comment on your specific situation, we are prepared to provide the following comments in respect of the issues that you raised. Please note, however, that these comments are of a general nature only and are not binding on the CRA.

Broadly speaking, for an expense to be deductible it must be deductible in computing profit, using generally accepted accounting methods, from a source of income that is a business or property under subsection 9(1) of the Income Tax Act (the "Act"). In addition, it must be incurred for the purpose of gaining or producing income from that source in accordance with paragraph 18(1)(a) of the Act, and not be otherwise prohibited by a specific provision in the Act. Section 67 of the Act provides that an expense is only deductible to the extent that it is reasonable in the circumstances.

In determining whether a source of income that is a business or property exists, the CRA relies on the principles established by the Supreme Court of Canada in a case called Stewart v the Queen (2002 SCC 46). In Stewart, the court recommended a two-stage approach to determining whether a taxpayer's activities constitute a source of income under the Act. The first stage is to determine whether a taxpayer's activity is undertaken in pursuit of profit that results in a source of income under the Act, or is a personal endeavour. This first stage is only relevant where there is some personal or hobby element to the activity. The venture will be considered a source of income only if it is undertaken in a sufficiently commercial manner. The Court decided that in evaluating commerciality, the reasonable expectation of profit of the venture was a significant factor. In the second stage, pursuit of profit has been established and the taxpayer's activity is clearly commercial in nature. It then becomes a matter of determining whether the source of the income is from business or property for purposes of the Act. Additional information about the application of this two step test can be found in Income Tax Technical News "Issue No 25". The criteria for determining whether a rental operation carried on by an individual is a source of business income or of property income and the income tax consequences resulting from that classification are discussed in Interpretation Bulletin IT-434R, "Rental of Real Property by Individual" and the Special Release IT-434RSR.

The determination of whether an expense is incurred to earn income from a source that is business or property, and whether it is reasonable, can only be made after reviewing all of the facts and documentation of the specific situation. Based on the few facts provided, we are unable to comment on your situation except to note that there are no specific provisions in the Act that would prohibit the deduction. The determination of whether the amount paid is reasonable in this case would include reviewing the nature and extent of the services actually provided by the management company and then comparing the compensation amount to industry standards for similar services.

We trust that these comments have been of assistance.

Yours truly,

Renée Shields
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch