Generally, management fees are required by wealth managers to manage assets for their clients. These assets can include stocks, bonds and other valuable items that generate value for investors. Since wealth managers or investment advisor cherry pick the best stocks or valuables for their investors, they charge a certain fee for their services. i.e. “management fee”.
In the recent past, Canadian corporations have started using this concept in acquiring tax benefits. As a result, management fee has come under scrutiny by Canadian Revenue Agency to mitigate any risk of tax fraud on their end. Hence, it is vital to gain a detailed understanding of this fee to avoid an audit by the CRA.
How corporations have used this concept in the past
Consider a service provider that is based out of Ontario. The organization has recently discovered the potential of building a client base in Alberta. The firm decides to open a branch office in Alberta, to facilitate its clients in the central region. It decides to keep a few sales officers at the new location while managing operations from Ontario.
At the end of the reporting period, the service provider realizes huge tax losses in Ontario. The firm charges a management fee to its subsidiary in Alberta to minimize this tax loss. This helps the parent company to reduce its tax losses while keeping all documents available for audit. This is one of the many ways in which corporations are using the concept of management for their own benefits.
Some shareholders establish a management company of their own to avoid or defer their taxes. Consider a shareholder who is allowed to take income from their company in the form of salaries or dividends. To avoid their income tax, shareholders can establish their own management company. This management company will charge the parent firm for contracts they receive from it.
During financial reporting to auditors, shareholders can charge additional expenses to the parent firm to minimize their tax losses.
Realized Income Benefits
In most of the Canadian provinces, professionals other than accountants and lawyers are not allowed to realize their income with their client firm. Professionals who cannot realize their income with their partner organizations pay as much as 3 times the taxes paid by those that can.
One strategy to help these unincorporated professionals gain tax credit is to establish a management company that is dedicated to managing their operations. If a real estate agent is providing property management services to an organization and they make huge profits in a fiscal year, They can form a management company that can reduce their tax loss. Income that is realized with a corporation is taxed at the rate of 15% while the one that is not is taxed at 45%.
Whether You Should Take The Management Fee or Not?
Charging a management fee to your client has multiple benefits. Reduction in tax loss is one of the primary examples why businesses in Canada have been utilizing it for many years. However, the government is devising strategies to differentiate management fee from ‘tax advantage.’ Corporations and Individuals who use management fee to gain tax breaks should do a considerable amount of homework before putting it on their profit and loss accounts.
One of the significant implications of using management fee is that CRA can treat it as past salary. As a result, it will not only treat it as taxable income but also enforce penalties on the amount earned.
Tax Experts generally suggest that if you want to use management fee for the service that you provide to your clients, you need to put appropriate documents in place. These could include:
1. The legal agreement between you and your employer with the terms and conditions specified in the contract.
2. Prepare invoice on a monthly basis for the services that you provide to the organization.
3. Each invoice that is generated by the management company should have a proof of financial transaction in the designated bank account.
If you want to use a management fee to charge for your service to your clients, you should make sure that you document it accurately. Otherwise, CRA may charge you with tax arrears and penalties that will offset all your financial gains.
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- Written by: Jag Bath