Associated Corporations

Associated Corporations Explained: A Guide to an Important Canadian Tax Rule

In our previous article, we explained the rules for related persons. Now, we'll build on that by discussing a distinct and critical concept in Canadian tax law: associated corporations.

Understanding whether your corporations are associated is fundamental for accurate tax planning. These rules are in place to determine how certain tax limits and deductions are shared among a corporate group. For Canadian business owners, especially those with multiple companies or family members in business, knowing these rules is essential for ensuring compliance and proper financial planning.

"Related" vs. "Associated": A Crucial Distinction

While they sound similar, these terms have different meanings and applications under the Income Tax Act. It's a common point of confusion, so it's important to separate them.

  • Related Corporations: This concept is mainly used to determine if transactions between companies are conducted at "arm's length." The test for being related is based on de jure (legal) control.

  • Associated Corporations: These rules exist to ensure that groups of connected corporations share certain tax benefits, most notably the Small Business Deduction. The test for association is much broader and considers both de jure (legal) control and de facto (factual) control.

A key principle to remember is that related corporations are not necessarily associated, and associated corporations are not necessarily related. The two sets of rules must be considered independently.

How Corporations Become Associated

The Income Tax Act outlines several ways corporations can be associated. The determination often comes down to who controls the corporations and how they are related to each other. Here are a few common examples:

1. One Person Controls Both Corporations

This is the most direct scenario. If an individual controls two or more corporations, they are all associated with each other.

  • Example: You own 100% of the voting shares in your primary business, "Victoria Operations Inc.," and you also own 100% of a holding company, "BC Holdings Ltd." These two corporations are associated.

2. You and a Related Person Control Different Corporations

This is where the "related persons" rules intersect with the "associated" rules. If you control one corporation and a person related to you (such as a spouse, parent, child, or sibling) controls another, the two corporations can be deemed associated.

  • Example: You control "YourCo Inc." and your spouse controls "SpouseCo Ltd." If you also own at least 25% of any class of shares of SpouseCo Ltd. (or your spouse owns at least 25% of YourCo Inc.), the corporations are associated.

3. De Facto (Factual) Control

Association isn't just about share ownership. The CRA also looks at de facto control, which is the ability to exert influence and make decisions, regardless of who is on the share registry.

  • Example: A parent provides a significant loan to their child's new corporation. The terms of the loan give the parent the power to approve or reject major business decisions. Even if the parent owns zero shares, the CRA could determine they have de facto control, which could make the parent's corporation associated with the child's.

Consequences of Being Associated

When corporations are associated, they are required to share certain tax benefits.

The Shared Small Business Deduction (SBD)

This is the most important consequence. In British Columbia, the first $500,000 of active business income for a Canadian-controlled private corporation (CCPC) is taxed at a significantly lower rate. Associated corporations must share this single $500,000 limit.

  • Impact Example:

    • If Company A and Company B are not associated, and each earns $400,000 of income, both companies are fully eligible for the low tax rate.

    • If Company A and Company B are associated, they must share one $500,000 limit between them. If they allocate it 50/50, each only gets the low rate on its first $250,000 of income. The remaining $150,000 for each company would be taxed at the much higher general corporate rate.

Other Shared Tax Limits

The requirement to share also applies to other items, such as R&D tax credits and other investment tax credits.

Key Takeaways for Business OwnersReview Your Corporate Structure: Take into account all corporations you own, as well as those owned by your spouse, children, parents, and siblings.

  1. Consider Factual Control: Look beyond share ownership. Are there any agreements or financial dependencies that give someone else influence over your company?

  2. Ensure Correct Filing: Associated CCPCs are required to file Schedule 23 with their corporate tax returns to formally allocate the small business deduction among the group.

The rules for associated corporations are complex. A clear understanding is necessary for effective tax planning. If you have questions about your corporate structure, our Tax Planning & Compliance services can help provide clarity.

Please contact us today to schedule a professional review of your situation.