Related and Associated Corporations
By Eeva Harrop, CPA, CA, TEP, MSc.
September 28, 2020
Assessing whether or not corporations are related and associated is important as this can result in various tax consequences to consider such as how to share the small business deduction on the T2. The purpose of this memo is to highlight what these terms mean and how to assess if companies are associated /related.
Definitions and why we care:
Related person – used to determine if a person is dealing at arm’s length or not. This is important when considering the tax consequences on various transactions such as: loans, sales of property, allowable business investment losses, shareholder loans, acquisition of control and foreign affiliates
Affiliated person – used when considering a variety of stop-loss rules such as superficial loss rules. The stop -loss rules prevent transfers of property with unrealized losses by suspending the loss in the transfers hands until the property is no longer owned by an affiliate person.
Associated corporations – used to limit a corporation’s ability to benefit from certain deductions, credits and incentives including the small business deduction. The small business deduction must be shares among associate Canadian Controlled Private Corporations (“CCPC”).
Related Corporations are:
- A person who control the corporation, if controlled by one person
- Person is a member of a related group that controls the corporation,
- One of the corporations is controlled by one person, and that person is related to any member of a related group that controls the other corporation
- One of the corporations is controlled by one person, and that person is related to each member of an unrelated group that controls the other corporation
- Any member of a related group that controls one of the corporations is related to each member of an unrelated group that controls the other corporation, or
- Each member of an unrelated group that controls one of the corporations is related to at least one member of an unrelated group that controls the other corporation.
Related Persons and Arm’s Length
If two persons are related for purposes of the Income Tax Act, they are deemed not to deal with each other at arm’s length. If two persons are not related to each other, then it is a question of fact whether they are at a particular time dealing with each other at arm’s length.
Examples of related individuals are:
- blood relationship, marriage, common law partnership, step-children, adopted children, siblings and siblings-in-law.
- beneficial interest in a personal trust
With a group, where each member of the group is related to each other this is called a” related group.” Any other group, where the members are not related, is call an “unrelated group.” There is a presumption that unrelated shareholders of a closely held corporation act together to control the corporation if no one is in a position of de jure control (control in fact and not just control because of shareholdings) to control the corporation. For unrelated shareholders to act together to exert control over a corporation, there must be evidence of control.
Control is key
The concept of control is critical for purposes of applying the rules in the Act concerning association. There are 3 types of control: de jure control, de facto control and deemed control.
- De jure control is defined in the Act, and is the right of control that depends on a person owning enough shares of a corporation to give that person a majority of the voting power.
- De facto control occurs when a corporation is subject to any direct or indirect influence that, if exercise, would result in actual control being exerted. This is not defined in the Act.
- Deemed control is when there is a specific rule in the Act that deems control to exist
De facto control – a corporation is considered to be “controlled, directly or indirectly in any manner whatever” where the controller has any direct or indirect influence that, if exercise, would result in control in fact of the corporation. In determining if a taxpayer has control in fact of a corporation is determined when considering all factors and should not be limited to whether the taxpayer has a legally enforceable right or ability to effect a change in the board of directors of the corporation, or the board’s power, or to exercise influence over the shareholder(s) who have that right or ability.
We often see the CRA ask about related and associated corporations and how the small business deduction has been claimed. With any group of companies, working through the details can be complex but it is important to go through the shareholdings to avoid tax surprises.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. © 2020 Shajani LLP