Under the Income Tax Act, there are various rules pertaining to relationships between taxpayers, including individuals, trusts, and corporations. For example, there are rules that apply to “related” persons, “non‑arm’s length” persons, “affiliated” persons, and “associated” corporations.
The rules are generally restrictive in nature, and the tax policy reasons for the rules are sometimes the same but sometimes different. Some of the rules intersect; for example, whether persons are related, or non‑arm’s length, may affect whether corporations are associated which is the topic of this article.
If corporations are associated, there are some significant limits on tax benefits that would normally be available to the corporations.
For example, if Canadian‑controlled private corporations (CCPCs) are associated, they must share the $500,000 small business deduction limit that normally applies to a single corporation. Under the small business deduction, the first $500,000 of active business income each year is normally subject to a much lower tax rate than the general corporate tax rate that applies to other corporate income.
As another example, associated CCPCs must share certain enhanced investment tax credits, (for scientific research and experimental development) which otherwise may be available in full to each corporation.
So when are corporations associated?
There are various ways that two or more corporations can be associated. Some of the main situations are summarized below.
- One corporation controls the other corporation. For these purposes, “control” usually means ownerships of more than 50% of the voting shares of the other corporation, although for the associated corporation rules, there is an extended meaning of control, discussed below.
This situation would apply, for example, where you have a holding corporation that in turn controls a lower subsidiary corporation. The corporations are associated.
- The corporations are controlled by the same person or group of persons. For these purposes, a group of persons simply means two or more persons. Persons include individuals, corporations and trusts.
In terms of group control, each member of the shareholder group does not have to own the same percentage of voting shares in each corporation.
For example, assume John owns 30% of the shares in Corp A and Bill owns 30% of the shares in Corp A. John owns 20% of the shares in Corp B and Bill owns 40% of the shares in Corp B. In this case, Corp A and Corp B will be associated because they are both controlled by John and Bill as a group.
- You control corporation Corp A and a person related to you controls another corporation Corp B. (The concept of related persons is discussed below.) Either you own 25% or more of the shares of Corp B or the related person owns 25% or more of the shares of Corp A. Corp A and Corp B will be associated.
This rule is sometimes called the “cross‑ownership rule”, because it applies only if one of the related persons owns at least 25% of the shares of the other person’s controlled corporation. It is a bright‑line test.
For example, if I control Corp A and my spouse controls Corp B (spouses are related), but I own only 10% of the shares of Corp B, the corporations are not necessarily associated (though they could be under a different rule, discussed further below).
Extended meaning of “control”
For many tax purposes, “control” means owning more than 50% of the voting shares of the corporation (which gives one the power to elect the board of directors, who then manage the corporation). This is sometimes called de jure or common law control, as it is the regular legal concept of control developed by the Canadian courts.
However, for purposes of the associated corporation rules, the meaning of “control” is extended by specific rules in the Income Tax Act.
For example, a special rule says that control of a corporation exists where a person or group of persons owns more than 50% of all of the shares on a fair market value basis, or more than 50% of the common shares on a fair market value basis, regardless of whether those shares carry more than 50% of the shareholder votes.
Under another rule, if your child under the age of 18 owns shares in one corporation and you own shares in another corporation, you are deemed to own the child’s shares. For example, if you control Corp A and your minor child controls Corp B, you are deemed to own their shares in Corp B, which will result in Corp A and Corp B being associated. There is an exception to this deeming rule: It does not apply if it can reasonably be considered that your child manages the business and affairs of Corp B and does so without a significant degree of influence by the parent (you).
There is also a de facto control rule (control in fact). This rule can apply regardless of the rules discussed above. Under this rule, you (called the “controller” under this rule) will have control of a corporation if you have “any direct or indirect influence that, if exercised, would result in control in fact of the corporation”. However, this rule does not apply if you and the corporation are dealing with each other at arm’s length and the influence is derived from a franchise, licence, lease, distribution, supply or management agreement or other similar agreement or arrangement, the main purpose of which is to govern your relationship with the corporation and the manner in which a business is carried on by the corporation.
Meaning of “related” persons
As discussed above, whether corporations are associated sometimes depends on whether persons, including corporations, are related.
In general terms, under the Income Tax Act the following persons are related. Note that the actual list is a bit more detailed.
- You and your parents, grandparents, great‑grand parents, and so on;
- You and your children, grandchildren, and so on
- You and your spouse or common‑law partner
- You and your siblings
- You and your in‑laws; e.g. sister‑in‑law, father‑in‑law, son‑in‑law
- You and a corporation that you control
- You and a corporation, if you are part of a related group that controls the corporation
- Two corporations if they are controlled by one person or by a group of persons