A connected corporation is a term used in Canadian tax law to describe a relationship between two corporations based on share ownership or control. This relationship plays a significant role in tax matters, such as the payment of dividends, allocation of the Small Business Deduction (SBD), and other inter-corporate transactions.
When Are Corporations Considered "Connected"?
Two corporations are considered "connected" if either of the following conditions is met:
1. Control:
One corporation controls the other, either directly or indirectly. "Control" typically means owning more than 50% of the voting shares.
Additionally, two companies are connected if the same person (or that person together with someone connected to them) controls both companies, or if a group of two or more persons controls each company and the group consists of the same individuals (or could be regarded as the same if one member is replaced by another connected person).
2. Share Ownership:
One corporation owns at least 10% of the voting shares of the other, and
It owns shares representing at least 10% of the fair market value of all issued shares of the other corporation.
Why Is This Important?
Understanding whether corporations are connected is crucial for several tax-related reasons:
Taxation of Dividends: Dividends paid between connected corporations are generally not subject to Part IV tax.
Small Business Deduction (SBD): Connected corporations may need to share the $500,000 SBD limit, affecting how much each corporation can claim.
Associated Corporation Rules: When corporations are connected, certain tax rules and benefits may change, impacting tax planning strategies.
Example 1
Scenario:
John owns 75% of the voting shares in Company A and 60% of the voting shares in Company B. Let's see how these two corporations are connected:
Control Test:
Since John controls more than 50% of the voting shares in both Company A and Company B, he effectively controls both companies.
Therefore, Company A and Company B are considered connected under the control test.
Example 2
Share Ownership Test:
Sarah's company, Company C, owns 15% of the voting shares in Company D and holds shares that represent 15% of the fair market value of all issued shares of Company D.
Since Company C owns at least 10% of the voting shares and at least 10% of the fair market value of Company D, Company C and Company D are connected based on the share ownership criteria.
For more information, please visit CRA at:
Canada Revenue Agency
