Association Rules
Estate freezes create association problems that split one small business deduction across multiple operating companies. Custom-written for CPAs.
Matthew Cho
Learn when corporations are associated under the five tests in subsection 256(1), how discretionary trusts extend association scope to all beneficiaries, and when shares of specified class prevent association. You will understand control concepts including group control, common share value tests, and the third corporation transitivity rule that associates companies through common ownership.
You review the corporate structure and see three successful operating companies. Each child owns one business. Revenue totals well over $1.5 million. The T2s show one small business deduction shared across all three companies.
The companies are associated. You look closer. Five years ago the father did an estate freeze creating a discretionary trust that owns common shares of the parent company. The three children are beneficiaries. Each beneficiary is deemed to own all shares held by the trust. Every child therefore controls the parent company. Since each child also owns their own operating business, the parent company associates with every child's operating company. Through the third corporation transitivity rule, all three children's companies associate with each other. The family unknowingly shared one small business deduction limit across four companies for five years. This is a common trap. Estate freezes using discretionary trusts extend association scope dramatically because all beneficiaries are deemed to own all trust shares. The deeming rules transform simple structures into association nightmares.
This session shows you when corporations are associated and how to structure relationships to avoid unintended association:
- Five association tests: direct control, common person/group control, related persons with 25% cross-ownership, person and related group control, related groups with cross-ownership
- Shares of specified class ignored for association (non-voting, non-convertible, fixed dividend debt-like preferred shares)
- Control by owning over 50% of common shares by value even if shares non-voting or worthless
- Group means any two or more persons, need not be related (different from related group control)
- Discretionary trust beneficiaries deemed to own all shares held by trust, each beneficiary controls corporation
- Parents deemed to own shares held by children under 18, unless child manages business independently
- Third corporation rule: if A associated with C and B associated with C, then A associated with B (can elect out for SBD only)
You need to identify association before filing returns. Clients set up holding companies to own rental properties that earn interest and rental income from their operating businesses. The holding company and operating company are owned by husband and wife separately. They think the companies are not associated because different people own them. But rent and interest income is property income taxed at high rates. If the companies were associated, subsection 129(6) would deem the holding company income active, taxed at lower rates, and not counted toward the passive income grind. You can make companies associated deliberately by having each spouse own one percent of the other's company. Common group control creates association with no anti-avoidance rule preventing it. Sometimes association is exactly what you want.
The material walks through real structures showing what creates association and what breaks it.
Seminar Snapshot
This program will help you understand the association rules, identify when corporations are associated, and advise on structures that avoid unintended association. Learn at your own pace with instant access.
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Association Rules
Course Syllabus
Association Concepts and Why Association Matters
Understanding related versus associated and the implications of association
Related, Affiliated, and Associated Distinctions
- People confuse these three concepts; each is different
- Related: basis for association rules, 25% share ownership by related persons triggers association
- Affiliated: narrower concept (common control or spouse control), main purpose denying losses, not relevant to association
- Association builds on the concept of related but has specific, more targeted rules
Related Persons and Related Groups
- Related persons: parents, spouse, children, siblings, grandchildren/grandparents, in-laws by marriage or common-law
- Child includes adopted child
- Related corporations: controlled by related persons or related group
- Different from associated, which has narrower, more targeted rules
Why Association Matters for the Small Business Deduction
- Access to small business deduction shared across associated group
- Combining taxable capital and passive income of associated group
- Property income deemed active when received from associated corporation (subsection 129(6))
- Rental property deemed active can make shares eligible for capital gains exemption
- Exception to personal services business rules when income from associated corporation
Other Implications of Association
- Specified investment business exception where associated management company has over 5 full-time employees
- SR&ED $3M expenditure limit shared among associated group
- Capitalization of carrying charges on vacant land ($1M loan deduction limit) shared
- Ontario CMT implications, Part VI.I tax
- RUTT reporting exemption threshold ($50M assets) combined for associated corporations
- Large corporation threshold ($10M taxable capital) for notice of objection and tax payment requirements
- EIFEL rules exemption for CCPC ($50M taxable capital limit) combined across group
The Five Association Tests Under Subsection 256(1)
Learning when corporations are associated
Test (a): Direct Control
- One corporation controls the other directly or indirectly
- Simple and very common situation
- Example: parent owns 100% of subsidiary
Test (b): Common Person or Group Control
- Both corporations controlled by same person, or
- Both corporations controlled by same group (any two or more persons, need not be related)
- Group control more expansive than related group control
Test (c): Related Persons Each Control with 25% Cross-Ownership
- Each corporation controlled by a person
- Person controlling one corporation related to person controlling other
- Either person owns 25% or more of shares (excluding specified class) in each corporation
- Can avoid association by reducing cross-ownership below 25% or using specified class shares
Test (d): Person Controls One, Related Group Controls Other with 25% Ownership
- One corporation controlled by person
- Other corporation controlled by group of persons
- Person related to each member of group controlling second corporation
- Person owns 25% or more of second corporation (excluding specified class shares)
Test (e): Related Groups Control Each with Cross-Ownership
- Each corporation controlled by related group
- Each member of one group related to all members of other group
- One or more persons who are members of both groups own 25% or more of each corporation (excluding specified class)
- Can avoid by reducing cross-ownership below 25%
Shares of Specified Class and Control Concepts
Understanding when shares are ignored and how control is determined
Shares of Specified Class Definition
- Ignored for association as if shares do not exist
- Non-convertible and non-exchangeable
- Non-voting
- Dividends fixed in amount or fixed percentage of FMV of consideration paid
- Annual dividend rate cannot exceed prescribed rate at time shares issued
- Redemption proceeds cannot exceed FMV of consideration paid plus unpaid dividends
- Basically debt-like fixed value non-voting preferred shares
Control Under Association Rules
- Group means any two or more persons even if no common link (different from related group)
- Multiple groups can control same corporation
- Person or group deemed to control if: over 50% of FMV of all shares, or over 50% of common shares by FMV (even if worthless or non-voting)
- Shares of specified class ignored when determining control
Deeming Rules That Extend Association Scope
Recharacterizing structures based on indirect ownership and trust rules
Indirect Holdings Deemed Direct
- Shares held through holding companies deemed held directly
- Number of shares deemed owned proportionate to FMV (specified class shares deemed not issued when calculating FMV)
- Allows looking through corporate structures to determine ultimate ownership
Partnership Look-Through Rules
- Shares held through partnership deemed held by partners
- Proportionate to income allocation for partnership's previous fiscal period
- Can change year to year if income allocation ratios change
Discretionary Trust Deeming Rules
- Each beneficiary of discretionary trust deemed to own all shares owned by trust
- Means people can collectively own more than 100% of corporation for association purposes
- Major problem extending association scope dramatically
- Common trap in estate planning structures
Minor Child Attribution to Parents
- Each parent deemed to own all shares owned or deemed owned by child under 18
- Exception if minor child manages business affairs without significant influence from parent (unlikely in practice)
- Operates together with trust rules to create extensive deemed ownership
Third Corporation Rule and Estate Freeze Complications
Transitivity and common association traps
Transitivity (Third Corporation Rule)
- If A associated with C, and B associated with C, then A associated with B (subsection 256(2))
- Transitive association often missed in practice
- C can elect to break A and B association for section 125 only by having business limit of nil
- Election only impacts small business deduction, not other association provisions like subsection 129(6)
- Corporations associated throughout year if associated at any time in year
Estate Freeze Creating Association
- Before freeze: father owns A Co, son owns B Co (not associated)
- After freeze: trust with son as beneficiary owns A Co common shares, father holds preferred
- Son deemed to own all common shares of A Co through trust
- A Co and B Co now associated because son controls both
- Even non-voting common shares deemed to create control (over 50% by value)
Multiple Beneficiaries Trap
- Trust owns A Co, three children as discretionary beneficiaries
- Each child deemed to own 100% of A Co (controls it)
- Each child owns separate operating business (C1 Co, C2 Co, C3 Co)
- All companies associated due to A Co and trust
- C1 Co, C2 Co, and C3 Co all associated with each other through transitivity
- Can elect out making A Co business limit nil
De Jure and De Facto Control
Understanding voting control versus effective control
De Jure Control Basics
- Legal control based on voting shares (majority votes to elect board of directors)
- Buckerfield's case established control means 50% plus 1 vote
- Duha Printers case: can refute presumption using governing statute, share register, constating documents, unanimous shareholder agreements
- For groups, must have sufficient common connection (voting agreement, act in concert, business/family relationships)
De Jure Control CRA Positions
- CRA view: two arm's length 50/50 shareholders presumed to act in concert controlling jointly
- Courts rejected this view (Lenester Sales case)
- Ultimately question of fact based on parties' conduct
De Facto Control Expansion
- Direct or indirect influence that if exercised would result in control in fact
- 2017 federal budget expanded de facto control for taxation years beginning after March 22, 2017
- Overturned McGillivray case limiting de facto control
- All factors can now be considered, even factors without legally enforceable right to change board
- Not necessary to own any shares to have de facto control
- Factors: large debt payable on demand, retractable preferred shares, shareholder agreements, economic dependence
De Facto Control Case Law
- Silicon Graphics set high threshold (pre-2017 budget): must have clear right to effect change in board or influence shareholders
- Mimetix: non-resident 50% shareholder had de facto control through controlling daily operations and strategic decisions
- 9044-2807 Quebec: de facto control possible even when de jure control exists
- Lenester Sales: franchise agreement economic control not de facto control (franchise exception in 256(5.1))
- Post-2017 budget: de facto control is real issue requiring careful analysis
Anti-Avoidance and Passive Income Rules
Deemed association rules and passive income complications
Deemed Association Anti-Avoidance
- Applies where main reason for separate existence is to reduce tax or increase refundable investment tax credit
- Year-by-year basis
- Defeated by strong business reason for separate existence
- Used rarely now because other rules are more effective (de facto control, deeming rules)
Passive Income Rule Basics
- $500,000 SBD limit reduced $5 for every $1 of passive income above $50,000
- $0 SBD if passive income exceeds $150,000
- Calculate for associated group
- Grind based on previous year's passive income (Adjusted Aggregate Investment Income or AAII)
- AAII includes: net taxable capital gains, rent/interest/royalties unless recharacterized active, dividends from non-connected corporations, specified investment business income
Passive Income Anti-Avoidance for Related Corporations
- Subsection 125(5.2): related but unassociated corporations deemed associated for passive income calculation if one corporation lends or transfers property to the other, and it is reasonable to conclude one of the reasons was to reduce passive income
- Very low threshold: "one of the reasons" not "main reason"
- Once rule applies it cannot be undone
- Deemed associated only for passive income rule, not other purposes
- Be very careful with any intercompany transactions
Disassociation Techniques and Practical Solutions
Breaking association through structure changes
Gifting Shares to Spouse
- Husband owns two operating companies (associated by common control)
- Husband gifts shares of one company to wife (tax-free rollover under subsection 73(1))
- Companies now disassociated
- Attribution rules apply to income and capital gains/losses
- Must ensure husband does not have de facto control of wife's company
Using Shares of Specified Class
- Husband freezes one company for specified class shares
- Wife subscribes to common shares with own funds
- Companies disassociated because specified class shares ignored
- Section 86 exchange does not result in tax to husband
- Corporate attribution rules (section 74.4) can apply when company not small business corporation
- Must ensure husband does not have de facto control
Breaking Common Group Control
- Two people each own 11% and 89% of two companies (associated by common group control)
- One person gifts shares to spouse creating different groups
- Companies no longer controlled by same group, therefore disassociated
Deliberate Association for Investment Income
- Operating company pays rent and interest to holding company (property income taxed at 50%)
- Making companies associated converts holding company income to active business income (subsection 129(6))
- Avoids passive income grind
- Shares of holding company may become eligible for capital gains exemption
- Can associate by having each spouse own 1% of other's company (common group control)
- No anti-avoidance rule preventing deliberate association
Practical Application and Common Traps
Analyzing structures and avoiding mistakes
Redrawing Structures for Analysis
- Collapse structure based on deeming rules
- Redraw showing deemed ownership and control
- Helps simplify analysis and get the right answer
- Example: voting control by preferred shares shows X controls, but Y owns 100% common so Y also controls
- Example: discretionary trust shows each beneficiary controlling company
Non-Voting Common Shares Do Not Solve Association
- Person holding over 50% of common shares (voting or non-voting) deemed to control
- With discretionary trust, all beneficiaries deemed to own trust shares
- Holder of shares with over 50% FMV deemed to control (except specified class)
- Major problem in estate freezes if children have their own corporations
Possible Solutions to Trust Problems
- Use shares of specified class (must be non-voting)
- Limit entitlement under trust to 24% or less per beneficiary (stays below 25% cross-ownership threshold)
- Set up separate trusts for each beneficiary (may not be practical or wise)
- Check impact of association rules before carrying out estate freeze
Schedule 15 and CRA Focus
- New trust reporting (Schedule 15) brings association issues into focus
- Possible CRA project given additional information now disclosed
- Better to identify and fix association issues proactively
- Statute-barred reassessments depend on whether misrepresentation attributable to carelessness, neglect, or willful default
Meet Your Presenters
Michael Cadesky
Michael Cadesky is the managing partner at Cadesky Tax and a committed contributor to the tax and accounting professions since 1980, earning the title of Fellow from CPA Ontario. He is a past governor of the Canadian Tax Foundation, past chair of STEP Canada and STEP Worldwide, and past chair of the CPA Canada Tax Committee for Small and Medium-Sized Enterprises. Michael is also the co-author of 11 books on tax subjects and the author or co-author of numerous papers and articles on Canadian and international taxation.
Matthew Cho
For years, Matthew has been guiding domestic and overseas clients through the ever-treacherous waters of the Canadian tax ocean. From individuals and high-net-worth families to foreign corporations, Matthew provides practical, no-fluff solutions to fulfill the needs of his clients. A firm believer in balance, Matthew does not merely provide for a tax solution, he provides a solution that works for his clients.
FAQ
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Immediately upon purchase. All course materials are available on-demand, allowing you to start learning right away.
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You have 1-year all-access to the course materials. Watch and review the content as many times as you need, at your own pace.
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Yes. Upon completion, you will receive a verifiable CPD certificate indicating all instructional learning hours and required details.
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Full video recording of the seminar, plus slides with detailed notes for your reference. Additional resources may be included.
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