Management fees and other bruises

by Arthur Athanasiou, CTA

The accruing of expenses solely for the purpose of artificially reducing profits is not just dangerous, it can be downright criminal!

Recently, a good friend of mine who practises as a principal of a small accounting firm rang me to ask a question, knowing full well what my response would be. The dialogue went something like this:

Friend: What are your thoughts on accruing management fees at year end?

Me: Tell me more…

Friend: Client has two companies, one with profits, the other with losses, and he wants to charge a fee to the first company to suck up the loss in the second.

Me: It won’t work for many reasons. Time doesn’t permit a proper discussion, but do your client a favour and don’t bother.

Friend: I thought so. I just wanted to sound you out. Ciao!

And at that same time, my thoughts wandered back to the time when I started out in accountancy in the mid-80s. The accrual of management fees in the profit and loss accounts of closely held corporate entities, and claiming them as an allowable deduction, were commonplace in a non-tax consolidated world.

Ostensibly, the charge reflected the value of the services allegedly provided by a service provider to a recipient entity. Invariably, no identifiable services were provided under any contractual arrangement at any time. The reality was that the entry was nothing more than a flagrant, even clumsy, attempt to shift profits from one entity to another.

The journal entries reflected no-cash transactions via loan accounts only.

On the service recipient side:

  • Dr – management fees (expense); and
  • Cr – loan account.

While, on the service provider side:

  • Dr – loan account; and
  • Cr – management fees (receipt).

A casual reader may ask: What’s the problem with accruing management fees and claiming them as an allowable deduction on the basis that they were necessarily incurred in the course of carrying on a business, for the purpose of producing assessable income?

The answer to that question is best illustrated in two different hypothetical scenarios.

Scenario 1
mark controls two private companies. Company A runs a very successful business and is profitable. Company B is dormant and has deductible carry forward losses which could be utilised as it presently passes the continuity of ownership test.

Jeff is Mark’s long-time accountant and tax agent, and suggests that since cashflow issues usually dominate Mark’s thinking, and the saving of the payment of income tax is a prized goal, it is easily achievable by charging a management fee to Company A by Company B.

No services are provided by Company B and the payment of cash by Company A to Company B never occurs. In fact, the amount of the journal entry is generally the entire amount of Company A’s annual profit.

Scenario 2

The same facts as above, but Jeff suggests that Mark see Nick, a long-time promoter of “tax effective” schemes.1

After consulting with Nick, a suggestion is made that Nick can arrange a situation where Company A pays a management fee to an unrelated third party entity. Since an unrelated third party is involved and real cash is paid, Nick was confident that the ATO wouldn’t question it, and he also promised that he would ensure that all other issues, such as tax invoices, etc, would also be taken care of.

All Nick asked is that Jeff attend to the recording and documentation of the transaction. At that time, Jeff didn’t seem too concerned because Mark was a long standing and valued high wealth client who always paid his bills on time.

Mark agreed that of the management fee of $1m as at year end in Company A’s income tax return.

The Commissioner is now looking at both scenarios.

Let’s go through the scenarios and assess them on the most likely basis.

In scenario 1, there is no contractual basis on which any services could be provided or accrued. Furthermore, there was no indication or reference to any internal documents or correspondence that would deal with:

  • the nature of the services provided;
  • the extent to which any identifiable services were provided;
  • the basis on which the value of the services could be provided; and
  • no objective evidence of services being provided other than the production of a tax invoice, with a generic narration about the provision of management services.

Accordingly, as there was no expenditure incurred, nor physically paid, there is nothing on which to ground a deduction against assessable income, because although there may be a business being carried on, the expenditure was not incurred, let alone necessarily incurred.

To the extent that the deduction is claimed in a tax return that is lodged, and an input tax return that is lodged, and an input tax claimed for the accrual of a management charge in a business activity statement (BAS), both Jeff as tax agent and Mark are exposed to the possibility of serious consequences.

Focusing on Jeff as accountant and tax agent only, the Tax Agent Services Act 2009 (Cth) (TASA) places an onus on Jeff to ensure that he observes, at least, the following relevant requirements:

  • acting with honesty and with integrity; 2
  • providing a competent tax agent service; 3 and
  • taking reasonable care in ascertaining a client’s state of affairs, to the extent that ascertaining the state of those affairs is relevant to a statement made on behalf of the client.4

The Board would, rightly so, send a show cause notice to Jeff if the matter were to be referred to the Board by the Commissioner.

It would also be difficult for Jeff to show that he was professionally negligent on suggesting the accrual of management expense to Mark and making statements to the Commissioner on that basis by lodging the income tax return and BAS. Under these circumstances, Jeff would have engaged in deliberate and reckless conduct bordering on dishonesty.5 This conduct would also give an insurer good cause for denying any indemnity to Jeff in the event that Mark’s solicitors made a claim against Jeff’s professional indemnity policy.

Putting aside the usual offences under the Criminal Code Act 1995 (Cth), there are also other offences relevant to Jeff that he should be aware of which are found in the Taxation Administration Act 1953 (Cth) (TAA). These are:

  • recklessly making false or misleading statements; 6
  • recklessly incorrectly keeping records etc; 7 and
  • incorrectly keeping records with the intention of deceiving or misleading etc.8

The penalties for offences that are proven under ss 8N and 8Q TAA include both monetary fines and imprisonment for a period not exceeding 12 months,9 whereas the penalty for contravening s 8T TAA is effectively doubled.10

Scenario 2 is different to scenario 1 in that while the penalties in the latter are potentially criminal in nature, the penalties in scenario 2 are criminal.

It also opens up novel issues if Mark was to sue Jeff for allegedly causing him loss, including deceptive and misleading conduct11 and breach of contract.

The facts in scenario 2 are taken from a NSW Supreme Court decision in R v Meares. 12 The author remembers this case for two different reasons.

The first reason is to do with the accruing of management fees, and how it all went wrong. Briefly, the facts in Meares were as follows.

Meares (Mark) owned a shopping centre and complained to Chesterton (Jeff) about a “tax problem”. Chesterton devised a scheme to have a non-related party give the benefit of revenue losses for tax purposes in return for a payment.13

Chesterton then engaged in two cardinal sins in accountancy:

  • he took it upon himself to draft a “management agreement”, purportedly between Meares and the non-related party, by which the former ostensibly provided management services to the latter. Perhaps Chesterton should have considered the statutory prohibition against engaging in unqualified legal practice;14 and
  • the agreement was signed between the parties but backdated by around two years. A really big “no-no”!15

The fees were paid and claimed as a deduction by Meares. The non-related party retained a small promotion of the fees and returned the balance to Meares. The fees paid in July 1993 were a total of $110,000 and accounted for as follows:

  • 1991/1992: $40,000;
  • 1992/1993: $45,000; and
  • 1993/1994: $25,000.

Needless to say, the scheme was a sham and no management services were provided. Meares was charged with conspiracy to defraud the Commonwealth. He responded in his defence by saying that he knew nothing about the criminal aspects of the scheme but had acted on the advice of Chesterton. That appears to be around the time when Chesterton pleaded guilty, while Meares was ultimately convicted and served six months in prison! Another commentator puts it a little more eloquently: 16

“Whilst Meares went to jail Chesterton got off fairly lightly and escaped actually serving time because he helped the authorities (by dobbing in his client) and put in a very early plea of guilty.”

So, for the claiming of an allowable deduction of relatively minor annual amounts, Meares was imprisoned. Had he not received the financial benefit, presumably he would not have been imprisoned.

No word seems to have been heard about Chesterton since, but in 2014, it is virtually impossible that he would not be vigorously pursued by the Tax Practitioners Board.

The second reason why the decision in Meares is memorable is because of Gleeson CJ (as he then was17) and his concise explanation of the difference between tax avoidance and tax evasion:

“It is important to bear in mind that although the appellant sough to defend the case against him upon the basis that he honestly believed that all that was involved in this transaction was a technically legitimate, if factually somewhat devious, scheme of tax avoidance, the charge against him was a charge of conspiracy to defraud the Commonwealth.

Although on occasion, it suits people, for argumentative purposes, to blur the difference, or pretend that there is no difference, between tax avoidance and tax evasion, the difference between the two is simple and clear. Tax avoidance involves using, or attempting to use, lawful means to reduce tax obligations. Tax evasion involves using unlawful means to escape payment of tax.

Tax avoidance is lawful and tax evasion is unlawful.

…it is sometimes said that the difference may be difficult to recognise in practice. I would suggest the in most cases there is a simple practical test that can be applied. If the parties to a scheme believe that its possibility of success is entirely dependent upon the revenue authorities never finding out the true facts, it is likely to be a scheme of tax evasion, not tax avoidance.”

This is a really good description of the so-called “smell-test” in Pt IVA of the Income Tax Assessment Act 1936 (Cth) that accountants often refer to in hushed tones!

Arthur Athanasiou, CTA


1 ignoring the application of the promoter penalty provisions in Div 290 (the promoter penalty laws) and  Subdiv 298-B (the civil penalty procedural provisions) of Sch 1 to the Taxation Administration Act 1953 (Cth) (TAA).

2 S 30-10 item 1 TASA.

3 S 30-10 item 7 TASA.

4 S 30-10 item 9 TASA.

5 For example, see Hart v FCT [2003] FCAFC 105.

6 S 8N TAA.

7 S 8Q TAA.

8 S 8T TAA.

9 S 8R TAA.

10 S 8V TAA.

11 Under the Competition and Consumer Act 2010 (Cth).

12 Regina v Colin Meares Cca 60468/97 [1997] NSWSC 458 (3 October 1997).

13 These payments are known as “subvention” payments. A subvention payment is made in respect of the transfer of a loss deduction. In other words, it represents the value of a deduction when a deductible loss is acquired. See TR 98/12 and ID 2003/537.

14 See, for example, s 2.2.2 of the Legal Profession Act (Vic) 2004 (Vic).

15 Apart from being a sham and therefore void, the backdating of a document in itself could be the commission of a criminal offence under the CCA.

16 See Eric Walters available at

17 Gleeson CJ was elevated from his position as Chief Justice of the Supreme Court of New South Wales to Chief Justice of the High Court of Australia in May 1998.

Call us today (03) 9600 1000
[contact-form-7 404 "Not Found"]