Associated Corporations Rule
Associated corporations under ITA s.256 must share a single $500,000 Small Business Deduction limit and combine their passive income and taxable capital for the SBD grind tests.
Definition
Two corporations are associated under ITA s.256(1) when control or significant share ownership is common to both, either directly through a controlling shareholder, through a related group, or by common individual ownership of 25% or more of any class of shares. The associated-corporations rule prevents taxpayers from multiplying the Small Business Deduction by splitting a business into multiple corporations.
Key rules
- Five associated tests (ITA s.256(1)):
- One corporation controls the other.
- Both are controlled by the same person or group of persons.
- Each is controlled by a person, and the two controllers are related and one owns at least 25% of any class of shares of each corporation.
- 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 any class of each corporation.
- Each is controlled by a group, and each member of one group is related to each member of the other, with overlapping 25% share ownership.
- Related persons: spouses, common-law partners, parents, children, siblings, and corporations controlled by them (ITA s.251).
- Deeming rules (ITA s.256(1.2)): options and rights to acquire shares are treated as exercised; shares held by children under 18 are attributed to their parents.
- Anti-avoidance (ITA s.256(2.1)): if one of the main reasons for the separate existence of two or more corporations is to reduce tax, they are deemed associated.
- Election to be associated (ITA s.256(2)): a third corporation associated with two others that are not associated with each other can break the chain if the third corporation files a s.256(2) election, in which case only the third loses its SBD.
Consequences of association
| Item | Effect |
|---|---|
| Small Business Deduction limit | Share one $500,000 limit (ITA s.125(3)) via T2 Schedule 23 |
| Taxable capital | Combined across the group for the $10M–$50M grind |
| Passive income (AAII) | Combined across the group for the $50K–$150K grind |
| Refundable Part I tax | Separate per corporation, but RDTOH rules apply per entity |
| Capital cost allowance Class 10.1 | Separate $37,000 limit per corporation |
Example
Jin owns 100% of Alpha Co and 50% of Beta Co. Jin's spouse, Mia, owns the other 50% of Beta Co.
- Test 3: Jin controls Alpha Co; Jin and Mia together control Beta Co; Jin and Mia are related; Jin owns at least 25% of a class of shares of both. Alpha and Beta are associated.
- SBD sharing: the $500,000 business limit must be allocated between Alpha and Beta on T2 Schedule 23. If Alpha claims $300,000 and Beta claims $200,000, each corporation applies the 9% federal SBD rate only up to its allocation.
- Passive income: AAII from both corporations is added. If Alpha earned $30,000 and Beta earned $40,000 of AAII, combined AAII is $70,000, reducing the group's business limit by ($70,000 − $50,000) × 5 = $100,000 for the following year.
Common-law partnerships count as related under s.251. Two CCPCs owned by unmarried partners living together for at least 12 months are associated if the 25% cross-ownership threshold is met.
Common mistakes
- Forgetting children's shares. Shares owned by a child under 18 are attributed to the parent under s.256(1.3).
- Missing option-based deeming. A shareholder agreement granting a call option is treated as exercised for association purposes.
- Treating sister corporations as independent because no single person controls both. The related-group test catches siblings and spouses.
- Ignoring the s.256(2.1) anti-avoidance rule when using a holdco-opco-sisterco structure primarily to multiply the SBD.
- Allocating the business limit informally. The allocation must be filed on Schedule 23 and agreed by each associated corporation.
Related concepts
Authority
- Income Tax Act s.256
- Income Tax Act s.256(1)
- Income Tax Act s.256(1.2)
- Income Tax Act s.256(2)
- Income Tax Act s.125(3)
See also
Related entries
Small Business Deduction
The Small Business Deduction reduces federal corporate tax on the first $500,000 of active business income earned by a CCPC, dropping the federal rate from 15% to 9%.
CCPC Status
A Canadian-Controlled Private Corporation is a private corporation resident in Canada that is not controlled by non-residents or public corporations, and CCPC status unlocks the small business deduction, refundable tax mechanics, and the capital gains exemption.
Refundable Dividend Tax On Hand (RDTOH)
RDTOH is a refundable tax pool tracked by private corporations that returns a portion of federal tax on investment income when taxable dividends are paid to shareholders, split since 2019 into ERDTOH and NERDTOH.
This entry is for general reference. It does not constitute professional tax advice. Consult a qualified Canadian accountant for your specific situation.