Many small business owners incorporate their business to avail themselves of the Small Business Deduction (SBD) that can significantly reduce their taxes. However, every tax benefit comes with complex rules to prevent small business owners from misusing the deduction. And the small business deduction has associated corporation rules for the same. Let us first understand the small business deduction.

A business incorporated as a Canadian Controlled Private Corporation (CCPC), with less than $15 Million of taxable capital employed, might qualify for the SBD. The Income Tax Act allows CCPCs to pay a reduced federal corporate income tax of 9% instead of 38% on the first $500,000 of active business income. It also allows you to pay reduced provincial tax.

Associated Corporations Rule

The tax benefit is attractive, and business owners can misuse the deduction. For instance, a Banana Corporation with a business income of $1.25 million can create a Grape Corporation and transfer $500,000 in income and a Jelly Corporation with another $250,000 in income. The intent is to multiply the small business deduction benefit and pay lower tax on $1.25 million income.

To prevent this, associated corporation rules were created, under which all corporations owned by the same person or group share the SBD. Banana, Grape, and Jelly Corporation will share the same $500,000 SBD in the above scenario. It is up to the owner how he/she distributes the $500,000, either as $200,000, $200,000, or $100,000, or gives it all to Banna Corporation. The only condition is the combined limit of all three corporations should not exceed $500,000.

How to Identify Associated Corporations

The key in SBD is determining whether two corporations are associated. The CRA has set five rules determining whether two or more corporations are associated.

• Two or more corporations are controlled by the same person or group of persons. For instance, Corporations 1 and 2 both are controlled by John and his wife Kelly.
• Corporation 1 controls Corporation 2, or Corporation 3 controls both Corporation 1 and 2, thereby making 1 and 2 associated corporations.
• Corporation 1 is controlled by John, and Corporation 2 by Kelly. Both John and Kelly are related, and one of them owns at least 25% of any class shares of both corporations.
• Corporation 1 is controlled by John. He is related to Kelly and Jack who control Corporation 2, and John also has at least 25% of any class of shares of Corporation 2. 
• Related groups of persons control one corporation each and have at least 25% of the shares of any class of each corporation. John, Kelly, and their parents own six corporations and they own 25% shares in each other’s corporations.

Scenarios of Associated Corporations

The definition of associated corporations might look confusing, but here’s how you can simplify it. Three things common in the five points are:

• “Control” – which means a person or group of persons own more than 50% of the voting shares in the corporation.  
• “Related” – Two persons or a group of persons can be related as a spouse, parent, or children. “Related group” is when each member of the group is associated with every other member.
• “Associated” – For corporations to be associated, one should own at least 25% of the shares of the other corporation.

One must control a corporation. The second corporation must be controlled by the same person or a related person and there should be an association through at least 25% share ownership whether it is equity or preferred share. Let’s understand this with a scenario and see how the five points apply.

Kelly owns 75% common shares of Garden Corporation. Her spouse John owns 75% of Fruit Corporation, and her daughter Janet owns 25% of both Garden and Fruit Corporation and 70% of Berry Corporation, of which 30% is owned by Kelly and John combined.

• Janet, Kelly, and John are related.
• Janet owns at least 25% of both corporations creating an association.
• Kelly and John is a group of related persons owning at least a 25% stake in Berry Corporation.

Thus, all three are associated corporations and can avail themselves of a combined SBD of $500,000. 

Complications in the Associated Companies Rule

There are some complications in the associated corporation rules as well. The straightforward definition of control is owning over 50% voting shares in the corporation. However, the association rules include de facto or “deemed” control provisions. Here are two such provisions:

• A person or group is deemed to control a corporation if they own shares representing over 50% of the fair market value of all shares.
• A parent controls Corporation 1, and their child under 18 owns shares of Corporation 2. Here, the parent owns the child’s shares in Corporation 2.

Another complication is the difference between “related” and “associated”.

John owns 100% of Corporation 1, and Kelly 100% of Corporation 2. Both spouses are independently running their businesses and do not have any stake in each other’s business. While related persons run the two corporations, they are not associated (25% stake), making John and Kelly eligible for a $500,000 SBD each. However, the CRA could consider the two corporations associated under the anti-avoidance rule if they have grounds to believe that the second corporation was set up to multiply the SBD.

Contact Ford Keast LLP in London to Help You with Tax Planning

Long story short, tax laws are complicated, and one law is interlinked with the other law. A professional tax consultant is updated, well-versed, and experienced in dealing with tax laws and their complexities. At Ford Keast LLP, our tax consultants can provide tax planning services such as compliance and tax filing. To learn more about how Ford Keast LLP can provide you with the best tax planning expertise, contact us online or call us at 519-679-9330.