Sunday, August 6, 2006

Says CorpA to CorpB: Do not associate with me

These days, it is not uncommon for there to be more than one corporation in a family. For example, a husband and wife may both be busy professionals who do business through their own corporations. Or a father may operate a business through one corporation and his son may operate a business through a different corporation.

Whenever there is more than one corporation involved in a particular family, it is always important to turn one’s mind to the concept of associated corporations because association could result in paying a higher amount of tax.

For example, a private family corporation that carries on an active business pays an 18% tax rate on the first $300,000 of active business income. If two family corporations are NOT associated, each has a separate $300,000 limit. If the two corporations are associated, however, they have to share that $300,000 limit. This means the higher rate of tax kicks in when the two family corporations have earned $300,000 of combined income. If there are three associated family corporations, then all three corporations would have to share the one $300,000 limit, thus further decreasing the amount of income any one of those corporations can earn before a higher rate of tax kicks in. (The $300,000 limit will be increased federally to $400,000 next year.)

The Income Tax Act provides a number of ways in which two corporations can be associated with each other. This article will focus on just a couple of those ways.

In the following example, wife owns all the shares of a corporation (WifeCo) that runs a paharmacy. The husband owns all the shares of another corporation (HusbandCo) that operates a bookstore. Since neither spouse owns shares in the corporation of the other spouse, neither corporation is associated with the other and each corporation pays tax at 18% on the first $300,000 of active business income. If either spouse owned 25% or more of the common shares of the other spouse’s corporation, however, the two corporations would have to share a single $300,000 limit.

Now let us move further in time to when the husband and wife are ready for some estate planning. They have been careful to keep their corporations completely separate and they now want to do an estate “freeze” of both their corporations using a discretionary family trust with the beneficiaries being their two children, daughter and son. An estate freeze would freeze or cap their respective interests in the corporations and allow future growth in each corporation to accrue to the discretionary family trust. However, daughter followed her mother’s footsteps and she too operates her own pharmacy through DaughterCo. Association could be a problem because each beneficiary of a discretionary trust is deemed to own all the shares owned by the trust. If the family trust owned all the common shares in both the parents’ corporations, HusbandCo, WifeCo and DaughterCo would all end up being associated with each other simply because daughter is a discretionary beneficiary of the family trust.

As soon as there is more than one corporation in a family, be sure to consider whether the corporations are associated. Sometimes parents do not want their children to associate with unsavory individuals. In this case, a family may not want their corporations to “associate” with each other, irrespective of the unsavory factor.

-- Devinder Sidhu

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The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.