June 2016 Newsletter

High management fees to owners’ companies were reasonable

6051944 Canada Inc. v. The Queen, 2015 TCC 180, was a GST appeal, on an issue that is relevant to both income tax and GST. It was an appeal of denied input tax credits (ITCs) on management fees paid by a company to its parent holding companies.

For GST purposes, a business can normally claim ITCs for all GST it pays as inputs to making taxable sales. However the costs in question must be “reasonable”.

The company in question was in the residential construction business. It was run by its two owners, father and son. Each one held his shares in the company through a holding company (Holdco). The two Holdcos each held 50 % of the company’s shares.

Over 2008-2010, the company paid management fees ranging from $1 million to $1.8 million per year to the Holdcos, essentially “bonusing out” its profits, which was advantageous for creditor-proofing purposes — getting the money out of the company while still keeping the funds at the corporate level to benefit from income tax deferral. It also meant a small deferral of corporate tax, as the company had a December 31 year-end and the Holdcos had January 31 year-ends.

Each Holdco collected and remitted GST on the fees it charged the company.

The Canada Revenue Agency did not disallow the company’s deduction of the management fees for income tax purposes. However, Revenu Québec (RQ), which administers the GST in Quebec, denied $41,000 of the company’s ITC claim for 2009, taking the position that the level of management fees was not “reasonable” as required. The company appealed to the Tax Court of Canada.

The Tax Court judge allowed the appeal. On the evidence, the father and son were wholly responsible for the company’s profits, and it could not operate without them. Thus, it was not unreasonable for it to pay the management fees.

The Court’s decision is a sensible one. Payment of management fees to a holding company is a legitimate way to extract corporate profits. After all, the holding company pays income tax on the fees and remits all GST it collects from the operating company, so there is no loss to the government.

The Court’s decision is consistent with the 2000 decision under the Income Tax Act, in Safety Boss Ltd., where a $3 million bonus to a company’s owner was held to be “reasonable” because the company’s profits were all attributable to his work.

Last modified on June 14, 2016 12:00 am
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