The “associated corporation” rules in the Income Tax Act are relevant mainly for the purposes of limiting certain income tax preferences or benefits that apply to private corporations.
The most significant limitation relates to the small business deduction that applies to active business income of a Canadian-controlled private corporation (CCPC). The small business deduction results in the first $500,000 of a CCPC’s active business income being subject to a much lower rate of tax than applies to other corporations or other income. As a result of the deduction, the lower federal rate of tax is 11% and, depending on the province, the combined federal and provincial rate ranges from about 14% to 19%. The federal small business rate is being lowered further, to 10.5 % in 2016, 10% in 2017, 9.5% in 2018, and 9% in 2019.
In contrast, for business income above the $500,000 limit and for other corporations, the regular federal rate is 15% and the combined federal and provincial rates range from about 26% to 31%.
The associated corporation rules prevent you from incorporating two or more CCPCs and benefiting from the lower tax rate for more than $500,000 of active business income. For example, in the absence of the rules, you could own 3 corporations that each earned $500,000 or more of active business income. Your corporations would therefore benefit from the lower rate on up to $1.5 million of business income. However, the associated corporation rules prevent this result and allow the lower rate only for a maximum of $500,000 of business income, either for one corporation or to be shared by the corporations. You can designate the amounts that qualify for
each corporation, and if you do not, the Canada Revenue Agency (CRA) can designate the amounts for each corporation.
Associated corporations include the following:
- A corporation and another corporation that controls it;
- Two or more corporations controlled by the same person or group of persons;
- Two corporations if one is controlled by one person and the other is controlled by another person who is related to the first person, where either person owns at least 25% of the shares of any class of each corporation; and
- Two corporations if each is controlled by a related group of persons, where each of the persons in one related group is related to all of the persons in the other group, if a person in either group owns at least 25% of the shares of any class in each corporation.
For these purposes, “control” includes the ownership of shares with more than 50% of the corporate votes. It also includes de facto control or control “in fact”, such as where someone has influence that could result in the person controlling the corporation as a matter of fact.
Furthermore, there are various deeming rules that provide that a corporation will be deemed to be controlled by a person for the purposes of the associated-corporation rules. For example, there is deemed control by a person if the person owns shares of the corporation having a value of more than 50% of the value of all the shares of the corporation (with or without votes), or common shares of the corporation having a value of more than 50% of the value of all of the common shares of the corporation (with or without votes). 2
The rules do not normally prevent you and family members from each owning a CCPC and each claiming the small business deduction in respect of the first $500,000 of active business income. For example, if you control one CCPC and your spouse controls another CCPC, the two CCPCs will not automatically be associated, unless one of you owns 25% or more of the shares of a class of the other spouse’s CCPC. However, if “one of the main reasons for the separate existence” of the corporations is to save tax, the CRA can deem them to be associated.
Furthermore, for the purposes of the associated-corporation rules, you are deemed to own any shares of a corporation owned by any child of yours who is under age 18. Thus, for example, if you control one CCPC and your 16-year-old controls another CCPC, the two corporations will be associated and will be required to share the small business deduction. However, this deeming rule does not apply where it can reasonably be considered that your child manages the business and affairs of the corporation and does so “without a significant degree” of your influence.
Note that the associated corporation rules differ from the related and non-arm’s length rules and therefore require a separate examination of the rules.