Tax Trap: Corporation Associations Rules

The biggest advantage of incorporating a small business (generally known as CCPC) is that it qualifies for a lower tax rate. However, if you control more than one corporation, beware that reduced tax rates will apply to the first $500,000 income from all corporations collectively under your control (associated corporation) as per the CRA's rules. Therefore, it is critical to understand tax implications if you become a shareholder in multiple corporations, especially with your family members.

If you are an owner of a corporation, you need to understand the corporation association rules. Why?

One of the most important benefits of incorporation is that a Canadian-controlled private corporation (CCPC), a corporation controlled by a Canadian resident, qualifies for a small business deduction. Simply speaking a Canadian-controlled private corporation pays tax @ 12.2% (in Ontario) on its active business income up to $500,000, as compared to other corporations that pay tax @ 26.5% (depending upon province).

But this small business deduction limit of $500,000 is shared by the associated corporations. In plain words, if you own and control more than one corporation, a lower tax rate will be applicable up to $500,000 income of all corporations collectively, instead of each corporation individually. Furthermore, there are more tax implications for related and associated corporations.

For corporations to be related to individuals and other corporations, the concept of control is important. Control refers to owning more than 50% of the voting shares of the corporation.

As per income tax law, the following can be related:

Individuals. Related individuals include spouses, parents, siblings, parents-in-law, etc. But uncles, aunts, nieces, nephews, and cousins are not considered related.
Individuals and corporations. An individual can be related to a corporation. For example, if an individual controls the corporation that individual and corporation are related.
Corporations. One corporation can be related to another corporation, if both are controlled by the same person.

“Association” is a technical term defined under subsections 256(1) of the Income Act which determines whether corporations are associated. There are 5 tests to determine association under section 256(1). Let’s discuss them briefly for basic understanding, otherwise, association rules are very complex.

256(1)(a), two corporations are associated if one corporation controls the other. For example, if one corporation owns more than 50% of the voting shares of another corporation, then both are associated.
256(1)(b), two corporations are associated if both corporations are controlled by the same person or group of persons. If Mr. A fully owns corporation ABC and owns a 51% share of corporation XYZ, then ABC and XYZ corporations are associated.
256(1)(c), two corporations are associated if one of two related persons, who together control both corporations, has at least a 25% share of one of the corporations. For example, Mr. A 100% owns the corporation ABC while his spouse controls the corporation XYZ (by owning 51% shares or more). If Mr. A owns a 25% share of XYZ corporation, both corporations are associated.
256(1)(d), two corporations are associated if a person who controls one of the corporations, and who is related to each member of a group of persons who together control the other corporation, has at least a 25% share of that group’s corporation. For example, Mr. A owns the corporation ABC and his family (spouse and children) controls the corporation XYZ. If Mr. A owns a 25% share of XYZ corporation, both corporations are associated.
256(1)(e), two corporations are associated if at least one of the persons of a group of persons, who are all related to each other and who together control one of the corporations, has at least a 25% share of a corporation controlled by another group of persons each member of which is related to each other and to every member of the first group.

For example, a spousal couple together controlled a corporation ABC, and their three children each held a 25% share of corporation XYZ. The two corporations would be associated under paragraph 256(1)(e) if one of the spouses held the remaining 25% share of the children’s corporation. But on the other hand, if the couple has four children with each holding 20% shareholding of the corporation XYZ and one of the spouses holds the remaining 20% shareholding. Then corporations will not be associated, as the minimum requirement of 25% shareholding is not met.

As we mentioned before that association rules are very complicated and may have significant implications on your tax planning. It is important to have a clear understanding of the association’s rules and their potential implications. If you have any questions, please contact us for professional advice. The Source Accounting team is ready to help you in this journey.

If you have any questions or any other tax and accounting issues, please feel free to reach out to Source Accounting Professional Corporation (CPA). Source Accounting is a full-service accounting firm in Mississauga, dedicated to individuals, small and medium-sized businesses, providing tax preparation, corporate tax filing, accounting, bookkeeping services, payroll solutions, etc. If you are looking for an accountant near me (Mississauga, Brampton, Toronto, GTA) or an accountancy firm, you are in the right place. Please call for consultation or send us an email. And if you find this post helpful, please let us know in your comments.

Disclaimer: The above contents are provided for general guidance only, based on information believed to be accurate and complete, but we cannot guarantee its accuracy or completeness. It does not provide legal advice, nor can it or should it be relied upon. Please contact/consult a qualified tax professional specific to your case.