PLEASE NOTE: THIS INFORMATION WAS ORIGINALLY SUBMITTED BY COOPERS & LYBRAND, CANADA
Management fees paid by residents of Canada to non-residents are generally subject to 25% Canadian non-resident withholding tax. This domestic non-resident withholding tax is not required on management fees that are payments for specific expenses incurred for the benefit of the Canadian resident payor. This may be a tax effective method of returning funds to a non-resident parent company. In addition, it may also reduce the foreign company's exposure to disputes with their local taxation authorities because they will recover on expenditures that were not incurred to earn income in that country.
Charging for services requires an analysis of the services and costs incurred, in order to support the amount of any management fees that can escape Canadian withholding tax. Revenue Canada considers centralized management fees in the following three categories.
1.Expenses incurred by the parent company in its custodial capacity as a shareholder. For Canadian tax purposes these expenses are not deductible to the Canadian operations, and any payment of such an allocation would likely be treated as a deemed dividend subject to non-resident withholding tax.
2.Expenses of training, and similar activities which represent specific identifiable services. These expenditures can usually be considered reimbursements of specific expenses, and are deductible for Canadian tax purposes.
3.Centralized expenses incurred for the benefit of a number of companies. These expenses present an allocation problem and require a review of the services being performed and an acceptable allocation basis to be determined.
Items 2 and 3 indicate that there may be charged to the Canadian company from its non-resident parent amounts for specifically identifiable and centralized costs incurred for the benefit of the Canadian company. The term "specific expense" applies to a particular expense item or a portion thereof, a sum of several expense items, or a portion of a composite of various distinct expenses such as overhead expense including rent, power, heat, salaries, fringe benefits and other business expenses. A specific expense does not include depreciation, capital costs, reserves or amounts not vouched. A specific expense is net, after all applicable credits or refunds have been deducted, and is without any mark-up or profit element to the non-resident.
Proper documentation for these items must be maintained to support a tax-free management fee.
It must also be noted that only items charged which are deductible under the Canadian Income Tax Act can be claimed by the Canadian company in computing its taxable income. In addition, the amounts charged must not be a duplication of costs already being incurred by the Canadian operation, and must be incurred for the purpose of gaining or producing income from the Canadian company's business. That is, the Canadian company must be deriving a real benefit from the expenditures.
Management or administration fees generally include the functions of planning, direction, control, co-ordination, systems or other functions at a managerial level. These functions may include services for various departments of a business such as accounting, financial, legal, electronic data processing, employee relations, management consultation, labour negotiations, taxation, etc. relating to the management or administration of the business.
Charges whether subject to withholding or not, must not be in excess of "reasonable" amounts in order to be deductible by the Canadian company. Generally, Revenue Canada disallows a profit element in costs charged to Canadian subsidiaries. However, the tax authorities have accepted a reasonable mark-up where there is sufficient support that the amount represents the market value of the services provided. Accordingly, "reasonable" amounts would not be recharacterized as dividend distributions subject to withholding tax.
The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.
While every effort has been made to ensure the information provided herein is accurate and timely, no decision should be made or action taken on the basis of this information without first consulting a Coopers & Lybrand professional. Should you have any questions concerning the information provided herein or require specific advice, please contact your Coopers & Lybrand advisor, or:
David W. Steele
145 King Street West
Toronto, Ontario M5H 1V8
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Over the past year, we have watched the Canadian dollar drop relative to its U.S. counterpoint impacting Canadian businesses. U.S. goods and services are now more expensive, U.S. sales make a premium and errors when recording foreign exchange transactions can cost you more money.
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