By OptiVal Editorial Desk

Associated Corporations in Canada: When Two Companies Share One $500,000 Limit

Associated corporations in Canada do not each get a $500,000 business limit. They share one. That rule surprises owners who open a second company, then file both returns as if each corporation stood alone. The Canada Revenue Agency (CRA) treats the group as one business for the small business deduction, and it will reallocate the limit if the returns claim it twice.

What associated corporations in Canada actually share

A Canadian controlled private corporation, or CCPC, can claim the small business deduction on active business income up to its business limit. The CRA’s T2 guide puts the maximum at $500,000 for a corporation that is not associated with any other corporation. The deduction is worth 19 per cent of the lowest of active business income, taxable income and the business limit, which is what brings the federal rate on that income down to 9 per cent.

Association changes the arithmetic, not the rate. Associated CCPCs split that same $500,000 between them, in whatever proportions they agree on, as long as the total allocation is no more than 100 per cent. One company can take the whole limit and the other none, or they can split it 60 and 40. What they cannot do is each take $500,000. A short tax year shrinks it further: a year under 51 weeks is prorated by days divided by 365.

Take two associated companies earning $400,000 and $200,000 of active business income. Together, only $500,000 of the combined $600,000 qualifies at the small business rate, and $100,000 is taxed at general rates instead.

The six tests that make corporations associated

Association turns on control: direct or indirect, in any way, at any time in the tax year. It covers legal control, enough voting shares to command a majority, and factual control, real influence even without that majority. A person can be an individual or another corporation. Under section 256 of the Income Tax Act, two corporations are associated if any one of these six conditions applies:

• One corporation controls the other, including through a chain. A parent that owns a subsidiary, which in turn controls a third company, is associated with both.
• Both corporations are controlled by the same person or the same group of persons, even if the group members have no other connection to each other.
• Each corporation is controlled by one person, those two people are related, and one of them owns at least 25 per cent of any class of shares (other than a specified class) of each corporation. This is the rule that catches many spouses running separate companies with cross shareholdings.
• One corporation is controlled by a person related to every member of a group controlling the other, and that person owns at least 25 per cent of a class of shares of the other.
• Each corporation is controlled by a related group, all members of each group are related to all members of the other, and shared members own at least 25 per cent of a class of shares of each.
• Two corporations that are not otherwise associated are deemed associated if each is associated with the same third corporation. A special election on Schedule 28 can break this link for small business deduction purposes in some cases, though both companies stay associated with the third one.

Two points trip people up. First, related is a tax term, not a family feeling: spouses, parents, children and siblings are related, and a person is also related to a corporation they control. Second, the 25 per cent tests look at any class of shares, not only voting common shares. Preferred shares that look passive can still create association. The CRA works through each test, with examples, in Chapter 2 of the T2 Corporation Income Tax Guide.

Schedule 9 and Schedule 23: the paperwork that proves the split

Two schedules do the reporting. Schedule 9 lists every corporation the filer is related to or associated with. Schedule 23, the agreement among associated CCPCs to allocate the business limit, records the actual split: a percentage for each corporation, totalling no more than 100 per cent.

All associated CCPCs have to file Schedule 23, though only one corporation in the group needs to file it for a calendar year. The CRA guide warns that if none is on file when it assesses a return, it will ask for one. Filing returns that each claim a full limit, with no agreement on file, invites reassessment: the CRA reallocates, one company’s deduction shrinks, and tax plus interest follows.

Year ends add a wrinkle: if a group has more than one tax year ending in the same calendar year, special rules cap the later years at the lower of the amounts allocated for the first and later years.

Two grinds that shrink the shared limit first

Sharing is not the only reduction. The reduced business limit is the greater of two grinds, both calculated on the group as a whole, as the CRA sets out in Chapter 4 of the T2 guide.

The taxable capital grind hits larger groups. If the combined taxable capital employed in Canada of the corporation and its associated corporations is $50 million or more, there is no small business deduction at all. Between $10 million and $50 million, the limit falls on a straight line basis. Most small groups never reach $10 million.

The passive income grind hits smaller groups far more often. If the corporation and its associated corporations together earn more than $50,000 of adjusted aggregate investment income, meaning interest, rents, dividends and similar passive income, the business limit shrinks by $5 for every $1 of that income over $50,000. At $150,000 of combined passive income, the limit is gone entirely. Note the word combined: a holding company sitting on investments inside the group can eat the operating company’s limit, which is why the structure described in our guide to specified investment business rules in Canada needs the association picture checked alongside it.

What to check before you file either return

Ask four questions before the first return in the group is filed. Who controls each corporation, on paper and in practice, including through spouses? Does anyone hold 25 per cent or more of a share class in another group company? What is the group’s combined passive income and taxable capital? And does the Schedule 23 allocation put the limit on the income that needs it? Answering early is cheap. Answering after a reassessment is not.

If you run more than one corporation, OptiVal can map the association picture and prepare both returns so the limit is shared on purpose, not by reassessment. Our team is led by qualified professionals with more than 75 years of combined experience, PwC trained, with work at world leading multinationals in CFO level positions. Corporate tax returns start from $449 and bookkeeping from $199 a month, with the full rate card on our pricing page and service details on our services page. Book a free consultation and we will walk through your group structure before you file.