The notion of control can be complex, particularly with recent jurisprudence where the courts have provided new interpretations in grey areas. Discussions with business owners often highlight that the fundamentals of control and association are not well-understood, but the implications are significant. Associated corporations must share one small business deduction, which means that only $500,000 of active business income across the entire group of associated corporations is subject to the low tax rate.
This article discusses the fundamental concepts of control and association.
There are two ways that control can exist – de facto control and de jure control. De jure control means control in law – holding sufficient shares to elect the majority of the directors of the corporation (i.e., more than 50 percent of the shares). De facto control means direct or indirect influence that, if exercised, would result in control of the corporation.
In general terms, case law has confirmed de facto control may exist even when there is no share ownership. Where circumstances exist for influence to occur, even if it is not actually exercised, this could be sufficient to result in de facto control.
De jure control can occur through a single person or a group of persons, where the term “person” includes individuals, corporations and trusts. If the same person or group of persons controls two companies, the two companies will be considered associated. The group of persons does not have to be related – the two groups must simply be made up of the same members. For instance, two companies each have three equal shareholders; if two shareholders are the same in both groups, then both companies are controlled by the same group of shareholders and would therefore be associated.
The Income Tax Act contains a set of rules with respect to who is “deemed to own” shares of a corporation; these rules are important to consider in the analysis of de jure control.
• Shares held in a discretionary trust are deemed to be held by each beneficiary of that trust. This creates duplication when analyzing shares held by a discretionary trust; the same share could be counted multiple times in analyzing votes.
Consider the situation of a discretionary family trust that holds all of the shares of the family corporation (Opco A). One of the beneficiaries (Maggie) is also a sole shareholder of another corporation that operates a veterinarian clinic (Opco B). Opco A and Opco B are deemed to be associated because Maggie is deemed to control Opco A and she actually controls Opco B.
When looking at a non-discretionary trust, there is no application of this deeming rule. Instead, shares held in a non-discretionary trust are deemed to be held by the beneficiary with entitlement to the shares.
• Shares held by minors are deemed to be held by the parents. This can be a surprise to some families and can become even more problematic with second marriages and common-law relationships because of the new relationships that are created.
An exception is available when it can be “reasonably” demonstrated that the of Opco to another individual (Ms. B, a non-shareholder), there may well be de facto control child, in fact, manages the business affairs through the corporation without significant influence from the parent. Application of this exception is generally quite rare.
• The above two deeming rules can be combined such that if a minor is deemed to own all the shares held by the discretionary trust, then the parent is deemed to own all of the shares that were deemed owned by the child. This can become a significant issue in estate freezes that use discretionary trusts where multiple businesses are owned across generations.
In terms of de facto control, consider the example of a family business that is financed by a large loan from a relative. The relative could be considered to have control of the corporation, if the loan is callable on demand. Many other types of “influence” also exist. In situations where a passive shareholder (Mr. A) concedes control of the business operations of Opco by Ms. B as she is effectively controlling the business. If Ms. B is a controlling shareholder of other corporations, Opco may be considered associated with these other corporations.
There is even a provision that can deem two corporations to be associated through a third corporation. If, for example, Corporations A and B are associated and Corporations A and C are associated, then because Corporations B and C are each associated with Corporation A, they too are “deemed” to be associated. This situation can arise in family business structures where family members each own independent corporations but the entire family owns a common (for example, real estate) corporation.
Control is an important concept in tax planning and can arise in situations where it is not readily apparent. An awareness of the concept of control and how it plays into the issue of association will help to minimize the element of surprise.
(Reprinted from Comment, edition 293, with permission of the Institute of Advanced Financial Education, Queens Quay West, Toronto, Ontario)