Management Fees Between Related Companies: What Makes Them Deductible and What Gets Them Denied

Two corporations with common ownership, one invoicing the other for “management fees”. It is one of the most common entries in Canadian small business bookkeeping, and one of the most reliably challenged on audit.

The fee itself is not the problem. Related corporations genuinely provide services to one another: an owner-manager’s time, shared administration, premises, bookkeeping, IT. Charging for those services is ordinary commercial practice. The problem is that the entry is often made for a tax reason and supported by nothing, and the CRA knows exactly what that looks like.

The two tests every fee has to pass

It must be incurred to earn income. The payer must have received something of value in the course of earning business income. Paragraph 18(1)(a) denies a deduction otherwise.

It must be reasonable. Section 67 denies a deduction to the extent the amount is unreasonable in the circumstances. The CRA’s general position on the limitation is set out in the archived bulletin it no longer updates, IT-487, and in the related-party context it looks primarily at the amount of the fee in relation to the service performed and the benefit derived by the payer.

Reasonableness is assessed on facts, not on intention. A fee equal to whatever was needed to bring taxable income to a target number is the classic failure.

The consequence nobody expects: the same dollar taxed twice

This is the part worth understanding before charging anything.

If the CRA disallows the fee in the paying corporation, the deduction goes away. The income does not automatically come out of the recipient corporation. There is no self-executing corresponding adjustment between two Canadian corporations the way there is under a treaty in the cross-border context.

So the payer loses the deduction and pays tax on the amount, and the recipient has already paid tax on the same amount. Relief may be available on request, but it is discretionary and it is negotiated after the fact, from a weak position.

A management fee that fails is therefore not a neutral adjustment. It is roughly double the cost of never having charged it.

What separates a fee that survives from one that does not

The single most useful discipline is to decide the basis of the charge before the year begins and apply it consistently. A fee computed from hours, salaries, square footage or transaction volume can be explained. A fee computed from the tax result cannot.

The GST and HST problem

A management fee is consideration for a taxable supply. Unless an election applies, the provider must charge GST or HST on it, and it counts toward the provider’s registration threshold.

For two fully commercial corporations this is usually cash flow rather than cost, since the payer claims an input tax credit. It becomes a real cost where the payer makes exempt supplies, for example a medical or dental practice. There, the HST on an intercompany management fee is unrecoverable, and a structure designed to save income tax can lose more in unrecoverable HST than it gains.

Where the corporations are closely related members of a qualifying group and all of the conditions are met, an election under section 156 can treat certain supplies between them as made for nil consideration. It is filed on Form RC4616, and the conditions are set out in GST/HST Memorandum 14-5. The election is not automatic, it must be filed, and it does not apply to every supply. Confirm eligibility rather than assuming it. The general registration mechanics are in GST/HST registration.

What management fees will not do

They will not create a second small business deduction. Corporations under common control are generally associated and share one business limit, as associated corporations explains and as the CRA describes in its guidance on how relationships affect the small business deduction. Moving income between associated companies does not multiply the low rate. The specified corporate income rules also restrict access where a CCPC earns income from a non-arm’s length private corporation.

They will not turn a dividend into a deduction. Paying a fee to a corporation owned by a spouse, and then dividends out of it, does not sidestep the split income rules. If the spouse did not perform the services, the fee is unreasonable, and if they did, a salary may be simpler. See TOSI explained.

They will not clean up a shareholder loan. A fee charged to offset an overdrawn shareholder account, without services behind it, is a fee with no substance and a shareholder loan problem underneath it. Read shareholder loans.

Where the fee is genuinely the right answer

There are good reasons to charge one:

• A holding company employs the owner-manager and provides management to the operating company, keeping the employment relationship out of the operating entity. The structural reasoning is in holding companies
• Shared services across two operating businesses with different ownership percentages, where costs must be allocated fairly between shareholder groups
• Premises and administration provided by one entity to another, priced on a defensible basis
• Risk separation, where the operating company is deliberately kept thin

In each case the fee reflects something real. Document the something real.

The file to build

1. A services agreement, signed, describing what is provided and how the fee is computed
2. Invoices issued through the year, not one at year end
3. The allocation working paper showing the basis and the calculation
4. Evidence the services were performed: time records, payroll, contracts, correspondence
5. Settlement: payment, or an intercompany balance that is tracked and reconciled
6. GST/HST treatment documented, including any section 156 election on file

Audit exposure on intercompany charges is high enough that this file is worth building contemporaneously, alongside the general expense principles in business expenses the CRA allows.

If you are charging management fees between corporations you control, or considering starting, a review of the basis and the documentation before the fiscal year ends is worth considerably more than the same review during an audit.