Kenco Restaurants was part of an intra-group cost-sharing arrangement and paid ‘management fees’ to a related service company.
Following an audit, the tax deductions for the fees were adjusted by the tax authorities as the method used to calculate the fees was not in line with the arm’s length principle.
Kenco Restaurants took the matter to court.
Judgment of the Court.
The Court upheld the decision of the tax authorities.
Excerpt
“We conclude that Petitioners’ allocations are not an arm’s-length charge because Petitioners provide no evidence of an independent transaction between unrelated parties in similar circumstances. Also, the facts support our conclusion that Petitioners were not dealing at arm’s length but were, instead, allocating their costs based on an ability to pay. Petitioners charged Wapak, a Restaurant Corporation, no management fee in 1990, but when its income increased in 1991 and 1992, so did its fees.5 GMK’s fees increased more than 900% between 1990 and 1992, and its share of the total fees increased by a factor of seven. However, no evidence was presented that there was a corresponding increase in Owner hours. In 1990, Kenco required special attention to rebuild the restaurant. Yet, in 1991, the fee allocated to it was higher than 1990. There is no claim that K-K required special attention in 1992, but its fee was higher in 1992 than in 1991. Perrysburg was charged $29,000 in 1990, $60,415 in 1991, and $42,700 in 1992, but Petitioners provided no explanation, in terms of services, that would account for these differences.”
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