There are various income tax rules that apply when two or more corporations are “associated” with each other. Unfortunately, the rules tend to be detrimental rather than beneficial, and the associated corporation rules must always be considered when dealing with closely-held corporate structures.
For example, associated corporations face the following restrictions or limitations:
- Most significantly, if two or more Canadian-controlled private corporations (CCPCs) are associated, they must share the small business deduction (SBD) that applies to the first $500,000 of active business income in a year. The SBD reduces corporate tax rates on business income to around 12-15%, depending on the province, compared to the regular corporate rates that range from around 25-31%.
For example, if two associated corporations each earn $400,000 of active business income, they can claim the SBD only on $500,000 of income between them, and not $400,000 of business income for each one. If, for instance, one corporation claimed the SBD for all $400,000 of its business income, the other can claim it for only $100,000 of its business income, leaving $300,000 of business income subject to the regular (high) corporate tax rates.
- In the 2018 Federal Budget, the government introduced restrictions on the amount of passive investment income that CCPCs can earn without adverse tax consequences (see our May 2018 Tax Letter for details). Basically, a CCPC can earn up to $50,000 of passive investment income per year without affecting the SBD. However, above that level, every dollar of additional investment income in a year reduces the limit of business income that qualifies for the SBD on a 5:1 basis ($5 business income for each excess $1 investment income). If CCPCs are associated, the rule applies to $50,000 of investment income earned by all the associated corporations. For example, if two associated corporations each earn $26,000 of investment income, they will be over the $50,000 limit and therefore subject to the SBD reduction, so their maximum business income eligible for the SBD will be $490,000 instead of $500,000 ($10,000 reduction, due to being $2,000 over the $50,000 threshold).
- CCPCs can earn refundable investment tax credits of up to 35% of expenditures on scientific research and experimental development. However, the credit is phased out if the combined taxable income of the CCPC and any associated corporations exceeds $500,000, or if the combined “taxable capital” of the CCPC and any associated corporations exceeds $10 million.
Meaning of “Associated Corporation”
The definition is quite complex. However, the following is a general description of the main situations under which corporations are associated.
Corporation A and Corporation B are associated if:
- Corporation A controls Corporation B, or vice versa.
- The same person or group of persons controls both Corporation A and Corporation B.
- Corporation A is controlled by one person (A) and corporation B is controlled by a person (B) that is related to person A; plus either A owns at least 25% of the shares of any class of Corporation B, or B owns at least 25% of the shares of any class of Corporation A.
For these purposes, “control” of a corporation includes the regular legal meaning, which says that a person or group controls a corporation if the person or group owns more than 50% of the voting shares in the corporation. However, for the purposes of the associated-corporation rules (and not for most other tax purposes), the concept of “control” is expanded.
- You are deemed to control a corporation if you own shares in the corporation whose fair market value (even without votes) is more than 50% of all of the shares in the corporation;
- De facto control is considered “control” for these rules; and even having “direct or indirect influence that, if exercised, would result in control in fact of the corporation” is sufficient in many cases.
In determining whether you control a corporation, any shares owned by your children under the age of 18 are deemed to be owned by you. For example, if you owned most of the voting shares of one corporation and your minor child owned most of the voting shares of another corporation, you are deemed to control both corporations and they will be associated. However, this rule does not apply “if it can reasonably be considered that your child manages the business and affairs of his or her corporation “without a significant degree of influence” by you.