2nd anniversary, new blogsite and private corporations and the use of management fees

Tomorrow marks the second anniversary of the establishment of Moodys LLP Tax Advisors!  While the last year has certainly provided economic challenges for our clients, we are extremely pleased with the services, clients and growth that our firm has had.  A special thank you to the Moodys’ teammates and Shea Nerland Calnan LLP (our fantastic legal partner).  A special thank you also to all of our great service providers.  Moodys has some exciting new plans and service offerings that we will share with you soon!

For those of you who enjoy reading our blogs, we are pleased to announce our new blogsite at www.taxandestateplanning.com which hosts all of our blogs and has a link to a whole host of other interesting blogs.  We encourage you to visit this website.

As a tax specialist firm, we work with many private corporations and their accounting and legal advisors. We see a lot of opportunities for planning and take great pleasure in working with the fabulous advisors that serve our clients.

Unfortunately, however, we often come across plans that could perhaps have been better thought out. One of the common strategies that we trip across is the use of “management fees” to reduce income of one corporation and increase the income of another corporation. Often times the payor corporation and the recipient corporation have different taxation year ends and therefore the plan is a loose attempt to try and get an income tax deferral.  In some cases, advisors will recommend the use of a disassociated “Management Co” (owned by a related person) to receive management fees in an attempt to multiply access to the small business deduction (with the result being lower income tax rates on retained profits).  There are a host of income tax issues that need to be considered with the use of management fees between related corporations. For example, are the management fees legitimate, are they reasonable, were they incurred for the purpose of earning from a business or property, are the management fees earned over the course of the year (and, if so, is the resulting deferral eliminated or reduced) and are GST issues  properly considered?

The recent case of Nielsen Development Company Limited (2009 TCC 160) highlights the problems when management fees are utilized. Very generally, Nielsen owned and operated a hotel in British Columbia. Nielson was owned by Mr. Jason Lo and he caused Nielsen to pay $275,000 of “management fees” to a company controlled by his wife. The Canada Revenue Agency (“CRA”) disallowed $223,330 of the fees as a deduction stating that the amount was unreasonable in the circumstances. The CRA similarly disallowed certain management fees as a deduction in a subsequent taxation year as well. After reviewing the facts, the Court found that the management fees were reasonable under the circumstances. WHEW! This was a good result given that the Court had the ability to deny the deduction of the management fees from the payor but still include the amount in income of the recipient corporation pursuant to section 67 of the Income Tax Act. This would result in double taxation. Our firm has written a paper on this subject and for practitioners who would like to explore this topic further we would refer you to our 2004 Canadian Tax Foundation paper.

Another common error that we trip across is the ownership of personal use property through a corporation.  This will be the subject of another blog shortly.