Can You Pay Yourself a Management Fee Instead of Salary or Dividends?

Business Tax

Jul 8

As an incorporated business owner in Canada, one of the most important and pervasive questions (certainly from my point of view) you face is how to pay yourself from the corporation.

Generally speaking there are two primary options: salary or dividends.

There is also a third option which is management fees and is often bandied about as an easier alternative.

What is a Management Fee?

A management fee is simply a payment your corporation makes to you or your business in exchange for management or consulting services.

For example:
You invoice your own corporation for “management services,” and the corporation records it as a business expense.

It’s similar to paying yourself a salary, but works a little differently in practice.

Understanding Employee vs. Self-Employed Status

Since the recipient of management/consulting fees are essentially independent contractors (whether or not you own your corporation) , you should ensure that you understand the employee vs. self-employed criteria and take measures to support your self-employment status.

CRA applies specific tests to determine whether someone is truly an independent contractor or really an employee in disguise.

If CRA sees that the relationship is actually one of employment, they can reclassify the income as salary, requiring the payer to remit unpaid payroll deductions (including CPP and income tax) plus penalties and interest.

To help demonstrate self-employed status, you should:

Have a clear, written contract for services.
Invoice for services rendered, with detailed descriptions.
Maintain control over how and when work is performed.
Supply their own tools and equipment if applicable.
Offer similar services to other clients if possible.
Register and charge GST/HST if required.

Being aware of these criteria and keeping records to support your status can help avoid being classified as an employee.

How Does a Management Fee Work?

When your corporation pays you a management fee:

The corporation deducts it as an expense (lowers its taxable income).
You report the payment as self-employment income on your personal tax return.

You invoice the corporation, just like any consultant or contractor would.

Tax Treatment of Management Fees

If you pay yourself a management fee:

You report the income on the T2125 (Statement of Business Activities) on your personal tax return.
You pay income tax on it at your personal marginal rate.
You pay both employer and employee portions of CPP contributions, like any sole proprietor.
If you earn more than $30,000 in such fees, you’ll need to register for and charge GST/HST on your invoices.

How Are Management Fees Different from Salary?

When you pay yourself a salary:

Your corporation has to register and process the salary through payroll.
Your corporation withholds and remits income tax and both employer and employee portions of CPP.
You receive a T4 slip at year-end (and RL1 in Quebec).
No GST/HST registration is required on your personal side.
You are not required to pay employment insurance (EI) if you own more than 40% of the shares of your corporation

When you pay yourself a management fee:

You invoice your corporation for services.
No tax is withheld which means that you’re responsible for paying personal tax (often by instalments).
You report it as self-employment income on the T2125 form of your personal tax return (T1).
You pay both the employer and employee portions of CPP yourself.
If you earn over $30,000 in such fees, you must register for and charge GST/HST.
You are not required to pay employment insurance (EI) as an unincorporated sole proprietorship.

In other words, when you pay yourself a management fee, you are responsible for paying the income taxes and Canada Pension Plan (CPP) contributions while as an employee of your corporation, the corporation is required to remit these amounts on your behalf through payroll remittances and pay the employer portion of the CPP.

How Are Management Fees Different from Dividends?

When you pay yourself dividends:

Dividends are paid from your corporation’s after-tax profits.
The corporation cannot deduct dividends as an expense.
You must prepare a T5 slip to report the income.
You benefit from the dividend tax credit, which takes into account the fact that dividends are not tax deductible and lower your income tax on the personal side.
You don’t pay CPP on dividend income.
GST/HST doesn’t apply to dividends.
Considered passive income and therefore does not create RRSP contribution room.

By contrast, management fees:

Are deductible expenses for the corporation (they reduce its taxable income).
Are fully taxable to you as self-employment income.
Require you to pay CPP as a self-employed individual.
May require you to charge GST/HST if your total revenues exceed $30,000.
Considered to be earned income for creating RRSP contribution room.

Ensure Management Fees Are Reasonable

CRA is strict about reasonableness and might deny the expense (or reclassify it as salary) if they see it as scheme to avoid payroll taxes.

Make sure that management fees paid are:

Reasonable in amount relative to the services that you are charging for.
Paid for actual services performed
Properly documented with an invoice, contract and detailed description of services.

When Management Fees Make Sense

Management fees can be a good option when you genuinely provide separate consulting or management services to your corporation. This typically works best if:

You have a separate, active business (with other clients) that invoices your corporation for actual services provided.
The fees reflect fair market value for real work performed.
You maintain clear contracts and invoices.
You’re prepared to report the income as self-employment on your personal return and pay the amounts owing as well as instalments.
You ensure that you register for GST/HST if applicable.
You don’t want the administrative hassle of registering for payroll, but want to make sure that you contribute to CPP and create RRSP room.

Used properly, management fees can be a legitimate, flexible way to pay yourself as long as they are a reflection of the services that you provide and follow CRA guidelines.

Final Thoughts

As established, there are certain situations where it might make sense to take management fees instead of a salary or dividend. However, keep in mind, that by taking management fees you have de facto created a sole proprietorship (whether or not your are officially registered) that adds a level of complexity to their personal taxes.

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