Management Fees are not a 'gimme'

October 15, 2015

The days of trading in your personal name are long gone. Whether trading occurs through a company or multiple companies, either way, the utilisation of special purpose entities is common. Because of the common control that exists in these situations, it is all too easy for transactions between entities to be poorly documented. A recent Taxation Review Authority (TRA) decision reminds us all of the need to do better.

The TRA decision related to whether a tax payer was entitled to a tax deduction, $1,116,000, for a management fee that had been charged by a related entity. The problem was that there was no evidence that management services had actually been provided and the deduction was disallowed.

The tax payer relied on the decision in Lockwood Buildings Ltd V C of IR (1996) 17 NZTC 12,483 (Lockwood), which made it clear that an arbitrary allocation of management expenses is acceptable. In Lockwood a holding company took over the management services for its multiple subsidiary companies and received a combined management fee of $1,901,821. The High Court upheld the deduction for management services.

However, the TRA found the facts in Lockwood were distinguishable from the present case as the costs were clear and properly documented. This was in contrast to the tax payer’s case where the fee was not fixed by reference to its costs but simply by reference to the tax payer’s total income and the charge could not be supported by any written management agreement, invoices or company resolutions.

Not only was the $1,116,000 deduction denied, but the Court also ruled that it was a tax avoidance arrangement, lacking commercial reality. This decision was reached once the TRA had concluded it was not Parliament’s intention for a company’s loss to be transferred to the tax payer, which was the effect of the management fee. The TRA stated that the management fee served no commercial purpose. A shortfall penalty of $184,000 was imposed for taking an abusive tax position (reduced by 50% for previous behaviour).

This case brings about a strong reminder – transactions between commonly controlled entities should be approached no differently than if it was a transaction between third parties.

Add a comment1 Comment

Reply Valinda | May 24th, 2016 at 4:24am
Life is short, and this article saved vabllaue time on this Earth.

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