Magazine article CMA - the Management Accounting Magazine

Tax Aspects of Management Fees

Magazine article CMA - the Management Accounting Magazine

Tax Aspects of Management Fees

Article excerpt

A management fee charged by a non-resident to its Canadian subsidiary is a common occurrence where the parent company provides services to its Canadian subsidiary. The exemption of such fees from withholding tax in certain of Canada's tax treaties (see, for example, the Canada-U.S. Income Tax Convention) encourages the use of these fees as a means of reducing effective Canadian income tax rates and extracting tax-free cash from Canada.

For a management fee to be deductible from a Canadian taxpayer's income, it must be both a reasonable charge for services received, and those services must relate to and be of benefit to the Canadian taxpayer's business.

Revenue Canada's views on the deductibility of such services are summarized in Information Circular 37-2. Central management or administrative expenses incurred by a non-resident parent company are divided into three categories: a) Expenses incurred by the parent in its "custodial" capacity (cost of Board of Directors' meetings, for example). These are viewed as parent company costs only, as they relate to the management of its investment. b) Expenses that are clearly allocable to the Canadian subsidiary (for example, accounting costs where all accounting is done at head office). Such costs are deductible by the Canadian operation. c) Expenses that are not easily allocated, as they are incurred for the benefit of a number of companies in the multi-national group as a whole (for example, the cost of centralized world-wide insurance that provides insurance coverage for all members of the corporate group).

Only the last category presents an allocation problem. When allocating expenses that are for the benefit of more than one company, the method of allocation must be carefully documented and maintained on file to support the reasonableness of the allocation to the Canadian subsidiary. The method of allocation should correspond to the benefits enjoyed by the Canadian subsidiary and be reviewed and updated regularly. Management fees that are based on the ratio of Canadian sales to total group sales or Canadian assets to total group assets may be difficult to defend when audited by Revenue Canada. If such allocation methods are not rejected outright, Revenue Canada will want proof that such an allocation is reasonable. They will require a comprehensive review of the basis for the allocation, including a review of such factors as time records, documents supporting expenses incurred, internal memoranda, the duties performed by Canadian or non-Canadian management, etc. …

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