Tax clinic: Another way to pay?
If you pay yourself a salary or bonus each year from your corporation, you generally don't have to worry about whether the amount you pay yourself is "reasonable" in order for the corporation to deduct that salary or bonus from its corporate taxable income. That's because the Canada Revenue Agency has a long-standing administrative policy that says it will not question the reasonableness of the payments, as long as the salaries and bonuses are paid to managers who meet three conditions: that they are shareholders of the Canadian- controlled private corporation (either directly or through a holding company); that they are Canadian residents; and that they are actively involved in the day-to-day operations of the company from which the remuneration is paid.
Paying a bonus is a common tax-planning technique to bring the corporation's income down to the $500,000 small-business limit, as active income below this amount is eligible for preferred small-business tax rates. But what if instead of paying yourself the bonus directly, the operating company pays a "management fee" to your holding corporation? The CRA has stated in the past that its administrative position of not challenging the reasonableness of remuneration was limited to salaries and bonuses paid directly to individuals - and not to inter-corporate management fees. And in a recent tax case, the CRA challenged just such a fee.
Jason Lo owned a corporation that owned and operated a hotel in Port Coquitlam, B.C. The hotel had a management agreement with a corporation owned by Lo's wife, Phoebe Lo. In 2003 and 2004, the company paid and deducted $275,000 and $300,000 respectively in management fees to run the hotel. The CRA disallowed the bulk of the fees, saying that they were "unreasonable in the circumstances" and shouldn't be greater than $50,000 or so each year. The evidence demonstrated that the hotel was extremely profitable, producing operating margins of about 40% annually. Regardless of the CRA's position, the judge ruled that the full management fees paid should be deductible to the corporation, presumably on the principle that these profits were primarily attributable to Ms. Lo's work. As the judge concluded, while the fees "are a lot of money to operate a hotel, Phoebe Lo is not your ordinary hotel manager. She is truly exceptional, and made money, and a lot of money ... in how she operated the hotel." While this case is fact-specific, it does help pave the way for other business owners who may be facing similar tax challenges.