Excerpt from The Professional Corporation – What Are “Associated Companies”?
There are many things to be concerned about in relation to incorporating. When you’re working in a group situation make sure you don’t run into a problem with the associated company rules.
Definition: Companies can be associated, for tax purposes, where the same person, or group of individuals controls two or more companies directly, or indirectly.
When one Canadian-controlled private corporation is associated with other Canadian-controlled private corporations, these corporations must be treated as a group when applying the small business deduction on active business income.
For example, if you have a professional corporation and are the only shareholder, (as in diagram one on page 56) and you have an interest in another incorporated business in which you are a 50 per cent shareholder with your spouse, the professional corporation and the other company are associated for tax purposes and the two companies will only be able to claim the lower corporate tax rate on $500,000 between them. This situation can arise when there are two professionals in the same family. Each may have separate professional corporations, which are both eligible for the entire small business deduction if they are not associated.
However, companies can be associated in less obvious ways. One little-known tax trap can be found in a family trust. For example, if two members of a family are both incorporated professionals, and one of them decides to set up a family trust, and one of the beneficiaries of that trust happens to be a minor child of theirs, their professional corporations are associated on a de facto basis because parents of minor children are deemed to be 100 per cent owners of the trust property. If the trust assets are the shares of a professional corporation, then each parent is deemed to own 100 per cent of those shares. In the case above, even though each parent had their own professional corporation, they became associated for tax purposes by way of the family trust. Since it is the small business deduction along with the small business abatement that reduces tax rates to about 18 per cent on the first $500,000 of active business income, sharing it with other corporations can seriously diminish its tax efficiency.
In order to provide tax support to small businesses, a small business deduction is provided to Canadian-controlled private corporations on their active business income (up to specific income thresholds). For federal tax purposes, the small business deduction reduces the basic federal corporate income tax rate to approximately 13 per cent for the first $500,000 of active business income of Canadian-controlled private corporations. For provincial purposes most provinces and territories have increased their small business income limits over the past few years to provide further tax breaks for small businesses. The federal tax abatement is equal to 10 per cent of taxable income earned in the year in a Canadian province or territory, less exempt income.
Being married is not the only way that companies can be associated. If you have more than one professional working in the same place and sharing staff, and other practice-related costs, you could find yourself associated. This is because the CRA can argue you are carrying on a business as a professional partnership. It’s very important that you understand the potential danger of this situation. Don’t assume that your accountant or lawyer can give you a definitive answer. Ask them to check on your behalf and then write you a letter stating that they have reviewed the structure and are advising you that you do not have an “associated” companies issue.
By way of example, a few years ago I was working with a physician who worked in a clinic with three other doctors. All four were incorporated. Each had their own practice but they shared the same staff and office. They drew up an agreement amongst themselves, which detailed the responsibility of each partner, and each month they put an equal amount of money into the clinic to pay the bills. When I reviewed the agreement with a tax accountant he discovered the professional corporations were in fact associated, not because the doctors owned shares in each other’s professional corporations but because they had set up what amounted to a common business and were, in essence, carrying on as a professional partnership.