The Blunt Bean Counter: management fees

Showing posts with label management fees. Show all posts

Monday, March 19, 2018

CRA Information Requests – 2018 Update

In December 2016, I wrote a blog post titled CRA Information Requests - 2016 Update in which I discussed that corporate clients had been receiving information requests from the CRA to support their equipment (capital cost additions) and/or had received information requests to support professional fees that had been claimed.

On the personal side, I noted that taxpayers were receiving information requests to provide support for Interest deduction expense claims, foreign tax credit claims and matching income requests.

Today, I provide a quick update on what I am seeing.

Beware if You are Receiving or Paying Management Fees

Lately, I have seen the CRA issue information requests to support management fees paid. The requests appear to relate more specifically to intercompany management fees, but these requests can directly or indirectly lead to information about management fees paid to owner-managers.

As detailed in this guest post by Howard Kazdan last year on Management Fees, it is important to have proper support for the payment of these fees. This support is often lacking for both intercompany payments and payments to shareholders who consider themselves independent contractors.

It should be noted that management fees paid to owner-managers as independent contractors can be problematic in the first place, as detailed in this 2015 blog post.

The CRA information requests essentially ask for all the information Howard suggested you document or maintain in his blog post, including some of the following:

1. The name and Business or SIN# of the corporation or individual receiving the management or administration fees

2. If the fee was paid to a related party

3. Copy of the contract for services

4. Description of the services provided and log if available

5. Invoices for the services provided

I would suggest many corporations and shareholders have been lax in ensuring there is proper documentation and that the remuneration for the services is fair-market value. If you do not have your act in order, in respect of documenting the payment of management or administration services, I suggest you make this a high urgency task.

Individual Taxpayers

From an individual taxpayer perspective, we are still receiving information requests to provide support for interest deduction expense claims, foreign tax credit claims and income matching requests (technically a separate program). In addition, I have seen several requests to support alimony payments.

I have also seen information requests for individuals that are owner-managers of corporations and have claimed employment expense based on a T2200 form signed by their related company. If you want to read an excellent summary about deducting expenses as an employee, this tax bulletin by BDO Canada LLP titled “Deducting Expenses as an Employee”, is very exhaustive.

For those not aware, a T2200 form must be completed by employers for their employees to deduct employment expenses from their income. Many people receive these forms from their employers each tax season, so they can claim their auto expenses related to their job, however, other people use the form to claim a home office expense or various other employment expenses related to their job.

The CRA requests have been specifically for those individuals who are shareholders of the corporation issuing the T2200; we have not seen a general review of employment expenses for employees (although I do see these occasionally).

In reviewing corporate shareholders employment expenses (most notably auto and home office expenses) the CRA had been disallowing these expenses in many cases, based on a lower court case decision.

However, it is my understanding the CRA is considering reversing these re-assessments and will set forth new criteria for owner-managers in respect to claiming employment expenses going forward. If you have been re-assessed or are in the middle of objecting, speak to your accountant about this issue, there may be positive news forthcoming.

If you have claimed any of the expenses that are leading to the information requests I detail above, you may want to review your records to ensure you have your documentation readily available in case you receive an information request.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Monday, March 20, 2017

What Small Business Owners Need to Know - Management Fees - The Importance of Having Proper Support

Management fees may be used to reduce taxes amongst a corporate group and/or to gain access to a greater small business deduction (i.e.: a company with taxable income pays a management fee to reduce its taxable income to a related company with losses that can absorb the management fee income and not pay taxes).

In other cases, management fees are used by an owner-manager as a “lazy” way to pay salaries to the owner.

Sometimes these fees are well thought out and supported with documentation. However, I also see these fees paid recklessly. In either case, the use of management fees have some risk associated with them, as they are often challenged by the Canada Revenue Agency ("CRA") where they are not considered reasonable and justifiable.

Today, Howard Kazdan, a tax expert with BDO Canada LLP, discusses management fees and what kind of support is suggested to strengthen the payer’s case for deducting such fees.

I thank Howard for his excellent post

Management Fees – The Importance Of Having Proper Support

By Howard Kazdan

As noted above, management fees are often used as a tax planning tool. Of course, to be effective, the fees must be deductible to the payer.

The criteria that are required for the management fees to be considered deductible, were established by the courts many years ago:

1. The expense must have been incurred (either actually paid or subject to a legal liability to pay);

2. The fees must have been incurred for the purpose of income from a business and

3. The fees must be reasonable in the circumstances.

In order to make a determination of whether the fees are deductible, the courts may:

1. Require documentation to support the expense, for example an intercompany agreement and/or invoices for work done.

Where the only documentation for intercompany fees is an accounting journal entry, the courts have concluded that such entries are not sufficient to establish that the amount was incurred during the year and represent a true liability at year end.

2. Require evidence from the corporation describing what services were provided and how incurring the expense contributed to the process of earning income.

3. Require evidence of the basis for the amount of fee, since a bona fide fee for service should be based on services performed and not profit. If a payment is based on profit (which may not be known until after year end) the CRA may argue that the payment is a distribution of profit and not a deductible expense.

The CRA has administratively allowed corporations to bonus down to the small business limit and considered such bonuses as reasonable when paid as salary to owner-managers. This administrative position is not available when such amounts are paid as management fees. In the latter case, the CRA will look at the nature of services performed, the time spent to perform those services and whether the fees paid are similar to what would be paid to other arm’s length sources.

Taking the above into consideration, successful claims of management fees that have been subject to CRA review and the courts have the following similarities:

(a) written management fee agreements/service arrangements be in place describing services, fees, responsibilities

(b) documentation of a bona-fide business purpose for the intercompany fee (for example, use of a management corporation to keep compensation of key management confidential).

(c) adequate records to keep track of services provided (time sheets)

(d) periodic invoicing rather than only once at the end of the year

(e) company rendering the servicing invoice should have the staff and ability to provide the services.

(f) the fee should be based on services provided, not profit.

Claims which have not been as successful generally lack the above noted characteristics (for example, there is no agreement; could not provide details of services provided; company earning the income did not have the ability to provide the services; general lack of documentation other than journal entries).

In reviewing management fees, the CRA may send a questionnaire. It is possible that even if the deduction is disallowed in one entity, the company including the fees as income will still be taxed (effectively double taxation). This is why you will want clear documentation that fees are bona-fide management fees and treated consistently each year.

Don’t forget that such fees may be subject to GST/HST unless the entities qualify for the closely related exception and the Form RC4616 has been properly filed.

In addition to the criteria already discussed, an additional reason to issue invoices is GST/HST. An invoice will provide clarity on timing of when GST/HST is payable (i.e. when fee becomes legally enforceable) and ensure there is adequate documentation for the company incurring the expense, in support of any ITCs claimed.

If you or your related companies use management fees as a tax planning tool, ensure you review the criteria noted above with your accountant.

Howard Kazdan is a Senior Tax Manager with BDO Canada LLP. If you would like to engage Howard for tax planning, he can be reached at 905-946-5459 or by email at hkazdan@bdo.ca

Monday, May 18, 2015

Can a Shareholder Be an Independent Contractor to Their Own Company?

If you perform services for a business, it is extremely important to determine whether you are an employee, a self-employed individual (i.e. independent contractor) or a Personal Service Business (if you contract through your own corporation).

I have discussed these controversial income tax issues a couple of times in “I am a Contractor Unless the CRA Says Otherwise” [see the second part of this post updating employee/contractor status] and in “Is Your Corporation a Personal Service Business”.

However, how about the situation where a shareholder of a corporation (whom you would typically consider to be an employee) wishes to treat themselves as an independent contractor and pay themselves a consulting/management fee instead of a salary? As I have been asked this question several times by readers, today, I will discuss a 2012 court case that "sort of" addressed the issue.

Pluri Vox Media Corp

In the 2012 court case, Pluri Vox Media Corp.v The Queen, 2012 FCA 295, the sole shareholder of Pluri Vox took the position that he was an independent contractor (not an employee) to his own company for the following reasons:

1. He was not paid a predetermined salary, but was paid a fee between $3,000 and $8,000 per month based on the commercial activity Pluri Vox undertook.
2. The company asserted that the varying compensation was indicative of the financial risk the shareholder undertook.
3. The shareholder was not directed on how to perform his duties and was able to hire assistants without Pluri Vox’s consent.

Nonetheless, the court ruled the shareholder's status to be that of an employee. As a result of this, the company was liable for payroll source deductions that were not remitted in the past.

This ruling was founded in part on the finding that there was no contract between Pluri Vox and the shareholder and that the shareholder did not invoice Pluri Vox for his services and did not charge GST (despite being registered for GST with the CRA).

However, Justice Webb made an important comment in respect of whether a shareholder can be a contractor to their own company. He stated:

"It would also seem to me that, while this would be unusual, an individual could enter into more than one contract with his or her own company and therefore could provide services in different capacities. It follows that the simple fact that an individual is a director or an officer of a company does not, in and of itself, exclude the possibility that other services may be provided by that individual as an independent contractor. When that occurs, it will be necessary ..... to apportion the amounts paid between the services performed in one capacity and the other."

Thus, the court provided for the possibility a shareholder could be an independent contractor to their own company in certain circumstances.

Justice Webb also commented that where applying the "control" test often used by the courts, “[t]he importance lies in the corporation's legal power to control the employees, not whether the employees feel subject to that control”.

Unfortunately, while the court actually addressed two important concepts, it failed to provide clarity for employee/contractor situations involving a shareholder of a company. Thus, if you own your own corporation and pay yourself as a contractor or through management fees, understand the CRA may come knocking at your door.

Employee vs Contractor

The link above to "I am a Contractor Unless the CRA Says Otherwise" is now almost four and a half years old. I may update this topic in the future, but until then, it should be noted a 2013 Federal Court of Appeal hearing, 1392644 Ontario Inc. (Connor Homes) v. Canada (National Revenue), 2013 FCA 85, has placed a new strong emphasis on the role of “intent” in the determination of whether you are an employee or contractor. In the case the judge applied a two-step approach:

1.The intent of the parties

2. Does the actual reality of the working relationship confirm the intent of the parties?

To reach a definitive conclusion, both steps must be consistent. In examining intent, the courts will examine the contractual relationship or the behavior of the parties, such as were invoices issued and whether or not the worker registered for GST/HST purposes and made various other filings as an independent contractor. The second step will involve a review of the same tests applied in the Weibe Doors and Sagaz Industries cases I note in the "I am a Contractor" post.