As a tax planning technique, a company is set up to operate the business (Opco) and another company is set up to hold the shares of the former (Holdco). In this structure, the business risk is under the Opco and the assets are held by the Holdco.
There are two main vehicles to move the income from the Opco to the Holdco: Dividends and Management fees. By declaring the management fee, the Opco is able to split the income with the Holdco.
However, the management fee deduction in the Opco may be disallowed by the CRA. CRA is always concerned with the reasonability of management fees between the related parties. In case that the CRA denies the deduction of the expenses from Opco, the Holdco still need to include the management fee in its income. The double taxation occurs.
To avoid this situation, certain steps should be undertaken as follows:
- A service contract or agreement outlining the services and fees provided from one party to another one must be signed between two parties.
- Both parties should keep recording the services when they are provided with the nature of services and amount time of work to be performed.
- The fee level is comparable to the fee paid to an unrelated party if the same kind of services were provided by the unrelated party.