One of the significant tax preferences is the small business deduction, which lowers the rate of tax on active business income of up to $500,000 per year. If your Canadian-controlled private corporation (CCPC) is associated with one or more other CCPCs in a taxation year, the $500,000 limit for the small business deduction must be shared and allocated amongst the corporations for that taxation year (in other words, the small business deduction cannot be doubled up, tripled up, and so on).
For example, if two associated CCPCs had active business income of $400,000 each, they could claim a total small business deduction between them based on $500,000 of income rather than $800,000. The corporations must file an agreement setting out their allocation of the small business deduction between them. If they do not, the Canada Revenue Agency (CRA) will make the allocation for them.
Meaning of “Associated”
So when are corporations associated with each other? The rules in this regard can be quite complex. However, some of the main circumstances in which they are associated can be illustrated as follows.
For example, Corporation A is associated with Corporation B if:
- A controls B, or B controls A;
- A and B are controlled by the same person or group of persons; or
- A and B are each controlled by a person and the two persons are related, and one of the persons owns at least 25% of the shares of any class of both corporations. (There are similar rules where Corporation A and / or Corporation B are controlled by a related group of persons.)
A group of persons means two or more persons who own shares in the corporation.
Significantly, the associated corporation rules do not normally apply when you and a related person each control a corporation, as long as neither of you meets the 25% threshold. For example, you control corporation A and your spouse controls Corporation B, and neither of you owns 25% or more of a class of the shares of both A and B, the corporations are not associated. As such, both A and B can qualify for the full small business deduction in respect of each corporation’s active business income. (However, there is an anti-avoidance rule: if the CRA concludes that one of the main reasons you set up two corporations was to save tax, the corporations can be deemed to be associated.)
Extended Meaning of “control”
For most income tax purposes, including the associated-corporation rules, the concept of control of a corporation by a shareholder or group of shareholders is de jure (legal) control. This generally means the ownership of shares in the corporation entitling the shareholder or group to more than 50% of the votes of all shares.
In addition, for the purposes of the associated corporation rules, other rules can apply, including the following:
- Control includes de facto control or control “in fact”, such as where a shareholder that does not have de jure control nonetheless has influence that could result in the shareholder controlling the corporation as a matter of fact.
- A corporation is deemed to be controlled by a person or group of persons if the person or group owns shares in the corporation whose value exceeds 50% of the value of all of the shares in the corporation, or common shares in the corporation whose value exceeds 50% of the value of all of the common shares in the corporation.
- Where a child under the age of 18 owns shares in a corporation, and another corporation is controlled by a parent of the child or a group of persons that includes the parent, the parent is deemed to own the shares owned by the child. (This rule does not apply if it can reasonably be considered that the child manages the business and affairs of the first corporation and does so without a significant degree of influence by the parent.)
The concept of “associated corporations” is relevant for various purposes under the Income Tax Act, most of which relate to beneficial tax preferences that would otherwise apply to the corporations.
You and your 16-year-old son each own 30% of the common shares of Corporation A, based on the value of the shares. You own more than 50% of the common shares of Corporation B. Your child does not manage the business and affairs of A. You will be deemed to own 60% of the common shares of A, meaning that A and B will be associated.
Meaning of “Related”
As noted above, the concept of “related persons” is relevant in determining whether corporations are associated. Again, the determination of related persons can be quite complex. Having said that, the following are some typical examples where persons are related.
- Individuals are related for income tax purposes if they are related by blood, marriage, or adoption. For example, you are related to your lineal descendants and ascendants (children, grandchildren, parents, grandparents, etc.), your siblings, your spouse, and most of your in-laws.
- A corporation is related to a person who controls the corporation, or to each member of a related group of persons that controls the corporation; and
- Two corporations are related if they are each controlled by the same person or group of persons, or each is controlled by a person and the two persons are related. (There are similar combinations of related persons controlling corporations that can lead to the corporations being related.)