Associated Corporations

Association is a tax concept, not a corporate law one: under the Ontario Business Corporations Act every corporation remains a separate legal person. Section 256 of the Income Tax Act does something narrower: it groups corporations under common or related control so they cannot multiply tax benefits that are meant to be claimed once.

The main consequence is the small business deduction. Associated Canadian-controlled private corporations share a single $500,000 business limit, which they allocate among themselves each year on Schedule 23 of the T2 return, and the taxable capital and passive income reductions to that limit are measured across the whole associated group.

Every association test turns on control, whether legal (de jure) or factual (de facto).

Two corporations are associated in a taxation year if, at any time in that year, any one of these is true:

1. One corporation controls the other, directly or indirectly in any manner whatever.
2. Both corporations are controlled by the same person or the same group of persons.
3. Each corporation is controlled by one person, the two controllers are related, and either of them owns at least 25% of the issued shares of any class of each corporation.
4. One corporation is controlled by a person who is related to each member of a group that controls the other, and that person owns at least 25% of the issued shares of any class of the other corporation.
5. Each corporation is controlled by a related group, each member of one group is related to every member of the other, and one or more people who belong to both groups own at least 25% of the issued shares of any class of each corporation.

The 25% tests ignore shares of a specified class: shares that are non-voting, not convertible or exchangeable, carry a fixed dividend capped at the prescribed rate when issued, and cannot be redeemed for more than the value received for them plus unpaid dividends. A group is any two or more shareholders, so two unrelated partners who each own 50% of two companies control both as the same group, and the companies are associated under the second test.

Section 256 also stretches ownership through deeming rules:

• Shares held by a corporation are treated as owned by its shareholders in proportion to their holdings.
• Where a beneficiary's share of a trust depends on someone's discretion, as in most family trusts, each beneficiary is deemed to own all the shares the trust holds.
• A parent is deemed to own shares held by a child under 18, unless the child manages the business without significant influence from the parent.
• A contractual right to acquire shares, such as an option, is generally treated as if the shares were already owned, except for rights that depend on death, bankruptcy or permanent disability.

De jure control is legal control: generally, owning shares that carry enough votes to elect a majority of the board. The share register is the starting point, but the articles and any unanimous shareholder agreement are read with it. Section 256 adds a value test: a person or group that owns shares worth more than 50% of the fair market value of all issued shares, or of all issued common shares, is deemed to control the corporation even without voting control.

De facto control is control in fact. Subsection 256(5.1) treats a person as controlling a corporation if they have any direct or indirect influence that, if exercised, would result in control in fact. In McGillivray Restaurant Ltd. v. The Queen, decided in 2016, the Federal Court of Appeal limited that test to a legally enforceable right and ability to change the board or to influence the shareholders who hold that right. Parliament then added subsection 256(5.11): the analysis must consider all relevant factors and is not limited to a legally enforceable right to change the board. Practical influence over the business can therefore count.

Ordinary commercial relationships are carved out. Influence that comes from a franchise, licence, lease, distribution, supply or management agreement with an arm's-length party, whose main purpose is to govern how the business is run, does not by itself create de facto control.

Holding company over an operating company. If you own a holding company that owns your operating company, the two are associated under the first test. A second company owned by the same holdco, or by you personally, is associated through common control.

Spouses with separate businesses. Spouses are related, so if each controls a corporation the third test is in play, but it applies only if one of them owns at least 25% of a non-specified class of shares of both companies. One spouse who owns 100% of a consulting company and another who owns 100% of a bakery are related but not associated, unless cross-ownership, a family trust, de facto control or the anti-avoidance rule links them.

Parents and children. Because of the minor-child rule, putting a new company in the name of a child under 18 does not separate it from the parent. Adult children are related to their parents, so the 25% cross-ownership tests apply.

Family trusts. Because each discretionary beneficiary is deemed to own all the shares the trust holds, a trust that controls an operating company can associate it with another corporation that a beneficiary controls.

Third-corporation rule. Two corporations that are each associated with the same third corporation are associated with each other. For small business deduction purposes, a third corporation that is a CCPC can elect so that the other two are not associated through it, but its own business limit then becomes nil.

Anti-avoidance. Subsection 256(2.1) deems corporations associated if one of the main reasons for their separate existence is to reduce tax. Splitting one business into several companies to multiply the business limit is a typical target.

Related and associated are different tests. Section 251 decides when corporations are related, which drives the non-arm's-length rules. Two corporations are related if the same person or group controls both, or if each is controlled by one person and those two people are related. Individuals are related if they are connected by blood (a descendant or a sibling), marriage, common-law partnership or adoption. Cousins, aunts, uncles, nieces and nephews are not related under section 251.

Before adding a corporation, holdco, trust or shareholder, map with your accountant who controls each company, who owns 25% of any class, who holds options and who the trust beneficiaries are. Association and the tax on split income use different tests, so a structure that avoids association can still expose family dividends to TOSI. Once the structure is settled, Lamba Law's free incorporation calculator compares Ontario and federal incorporation for the new company.

Daniel Okafor owns all the shares of Okafor Mechanical Ltd., a Mississauga HVAC contractor earning about $420,000 of active business income a year. His wife, Grace Mensah, owns all the shares of Bramalea Bakehouse Inc., which earns about $150,000. Daniel and Grace are related, but neither owns shares of the other's company, so the corporations are not associated and each can claim its own $500,000 business limit.

Grace needs $90,000 for new ovens, and their first idea is for Daniel to subscribe for 30% of the bakery's common shares. That would make Daniel a related controller who owns at least 25% of a class of shares of both companies, so the corporations would become associated under the third test. They would then share one $500,000 limit against combined income of $570,000, and about $70,000 a year would lose the small business rate.

Instead, Daniel lends the $90,000 to the bakery under a written loan at a commercial interest rate, and Grace keeps 100% of the shares and runs the bakery without him. Because the interest is a commercial return on capital Daniel actually contributed, their accountant expects it to qualify as a reasonable return under the split-income rules, and the two corporations each keep a full business limit.