Tax II Chapter 3
Spring 2013
Notes
Chapter 3 Lecture Notes
Special Rate for Active Business
Income of a CCPC
David Christian
Spring Term 2013
Thorsteinssons LLP
UBC Faculty of Law
______________________________________________________________________________
Notes
… taxpayers can arrange their affairs in a particular way for the sole purpose of
deliberately availing themselves of tax reduction devices in the Income Tax Act
…
Iacobucci, J. (SCC 1998)
The Small Business Tax Rate
1.
The traditional “gross-up” (1/4 of the dividend) and “dividend tax credit”
(83.67% of the grossed-up amount of the dividend) system for dividends
received by an individual shareholder from a corporation resident in
Canada is premised in tax policy terms on a total (federal and provincial)
corporate tax rate of 20%. The gross-up amount (1/4 of the dividend)
equates to 20% of the assumed income earned by the corporation before a
20% tax on that income – i.e. $100 of income in the corporation, less $20
dollars of assumed corporate tax at a 20% tax rates leaves an $80
dividend. The gross-up is 1/4 of the $80 dividend, which equates to the
$20 of assumed corporate tax.
2.
We saw in Chapter 1 that the “base rate” of corporate tax is 25%.
However, where:


1
"active business income" up to $500,0001
is earned by a CCPC (defined in Chapter 2) and all associated
corporations (defined below)
This is the Federal “business limit” (see subsection 125(2)), which is the maximum amount of corporate income
that is subject to the low rate of taxation. The provincial business limit is sometimes different than the federal
business limit; only in 2010 was the British Columbia business limit increased to $500,000.
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the corporate tax rate is below this assumed 20% - subject to other
important limits as outlined in this Chapter. This rate is sometimes
referred to as the “small business rate”, which is arrived at through
entitlement to the “small business deduction”.
3.
The small business corporate tax rate is “built” by applying a number of
sections in the Federal Act and the Provincial Act.
The Federal Act:
Notes
%
Sections
start with the 38% rate
38
123(1)(a)
and 123.2
apply the general rate reduction
0
123.42
deduct the provincial abatement
10
124
deduct the “small business deduction
rate"
17
125(1.1)
net federal “small business rate”
11
Thus, the provincial abatement applies, but there is no entitlement to the
13% general rate reduction, which applied in Chapter 1 under section
123.4. This is because the general rate reduction applies only to “full rate
taxable income” as defined in section 123.4, and income eligible for the
small business deduction is excluded by paragraph (b) of that definition.
The only Federal Act corporate tax rate reduction in this context is in
section 125.
The Provincial Act (section 16):
small business rate
2
2.5% of the same “active business
income” up to $500,000 earned by
a CCPC
Read paragraph (b)(ii) of the definition of “full-rate taxable income” in section 123.4,
which backs out of the income qualifying for the general rate reduction income that
qualifies for the “small business deduction” in section 125. The latter is the focus of this
Chapter.
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That is, the 2.5% provincial corporate tax rate applies to active business
income that qualifies for the federal 17% rate reduction in section 125 as
discussed in this Chapter.
The total federal and provincial corporate tax rate is:
… the combined “small business corporate tax rate” is:
%
11.00
2.50
13.50
The combined federal and provincial small business corporate tax rate, for
the type of small business income explored in this Chapter, has hovered
around 20% from year-to-year. At present, the small business rate in
British Columbia is 13.5%. The small business rate in other provinces and
territories will of course depend on the small business rate in the income
tax statutes of those jurisdictions.
4.
Remember Chapter 1? The combined base case corporate rate was 25%.
We discussed the integration theory at a corporate rate of 20%, and that
certain companies with certain income were intended to get this rate. Now
assume the corporation has $100 of net taxable income that qualifies for
the combined small business rate of 13.5%.
$
Ind’l SH
Ltd
Income
qualifying income
100.00
combined corporate tax (13.5%)
13.50
after-tax dividend
86.50
gross-up (¼ of the dividend)
21.63
shareholder’s income
108.13
shareholder tax (43.7%)
47.25
dividend tax credit (83.67% of gross-up)
18.10
net shareholder tax
29.15
The total tax paid is $42.65 (13.50 + 29.15), or an effective tax rate on the
$100 of 42.65%. This is very close to the top individual tax rate of 43.7%.
Thus, integration is achieved and there is neutrality. Notice also that there
is both an absolute advantage of 1.05% to earning active business income
through a corporation and receiving after-tax income as dividends (as less
tax is paid overall than if the income had been earned directly) and a
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“deferral” advantage if the individual shareholder retains the after-tax
profits in the company. If you compare what the deferral advantage is to a
situation where the individual operates the small business as a
proprietorship, the advantage in percentage terms is 30.2% (43.7 – 13.5).
The advantage in dollar terms is $151,000 (the difference in the amount of
tax paid at 43.7% and 13.5%) This advantage is quite material if, for
example, the business has to borrow money in the early years. Why?
Corporate Income that Qualifies for the Small Business Rate
5.
The federal small business rate is available for up to a maximum $500,000
of net income from an active business carried on in Canada of a
corporation that was, throughout the year, a CCPC. Read paragraphs
125(1)(a) and (c) together with subsections 125(1.1) and (2). Thus, any
active business income of a CCPC over $500,000 is subject to the base
case corporate tax rate in Chapter 1 (25%). The maximum annual dollar
deferral for corporate tax is thus $57,500 ($500,000 at 11.5%, which is the
difference between the general corporate tax rate of 25% and the small
business rate of 13.5%).
6.
In years prior to 2006, the double taxation resulting from active business
income over $500,000 made it a common practice to pay increased salary
to shareholders active in the business. If:


the general practice is to distribute this business income as part of
the salary paid to the shareholder-manager; and
the company has adopted this as its policy,
The CRA will not scrutinize the “reasonableness” (s.67) or the purpose
(paragraph 18(1)(a)) of paying the extra salary to the shareholder as an
employee of the corporation. The extra salary is deductible to the
corporation as a business expense, and included in the employee’s income
as employment income. Consider a corporation that has $600,000 of
taxable income before additional salary of $100,000 to shareholderemployee. No corporate tax is payable on the $100,000 amount and
individual tax (assuming top rate) is payable at 43.7% on the additional
employment income.
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Notes
7.
The active business must be carried on “in Canada”. This is usually not a
difficult test. The threshold is quite low. There is no requirement that the
business be carried on “entirely” or even “primarily” in Canada.
8.
What is an "active business"? Read the definition for “active business
carried on by a corporation” in subsection 125(7). “Any business” will
qualify, including an “adventure in the nature of trade”, “other than” a:


"specified investment business"; or
"personal services business".
Both of these are “businesses” - but are specifically carved-out of what
constitutes an “active business” for purposes of the 13.5% small business
rate.
9.
"Specified investment business" is defined in subsection 125(7). The
elements are:

a business

the principal purpose of which

is to earn "income from property" including




interest (lending)
dividends (investing in stocks)
rents (holding real estate)
royalties (holding copyrights, patents)
except:

a business that is leasing property other than real property (such as,
for example, car rentals or computer rentals), or

a business where the corporation employs in the business
throughout the year more than 5 full-time employees, or any other
corporation “associated with” (as defined below) the corporation
provides, in the course of carrying on an active business,
managerial, administrative, financial, maintenance or other similar
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services to the corporation in the year and the corporation could
reasonably be expected to require more than 5 full-time employees
if those services had not been provided.
(Thus, the latter two activities may qualify as an “active business”
because they are not specified investment business.)
10.
"Personal service business" is defined in subsection 125(7). The elements
are:

a business

of providing services

where the individual who performs the services (or a person
“related” to that individual as defined below) is a "specified
shareholder" of the corporation, and

the individual who performs the service could reasonably be
regarded as an employee of the person who receives the services if
you were to ignore the existence of the corporation
except:

a business where the corporation employs in the business
throughout the year more than five full-time employees, or

where the amount paid or payable to the corporation in the year for
the services is received or receivable by it from another
corporation with which the corporation was “associated” in the
year.
(Thus, income arising in these latter two cases may qualify as an
“active business”.)
11.
A "specified shareholder" is defined in subsection 248(1) to mean
ownership, directly or indirectly, of 10% or more of any class of the issued
shares of the corporation.
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12.
In schematic terms, the idea is this:
Specified Shareholder
Third Party (not
“associated” with
Corp)
Contract
for Services
Corp
This or a “related” person provides the services
and it is “reasonable to regard” the person as an
“employee” of the third party if you ignored the
corporation
13.
There are two principal consequences where the business is a personal
services business:
(a)
First, the expenses of that business are severely constrained – read
paragraph 18(1)(p).
(b)
Second, a different corporate tax rate applies. Specifically, the
general rate reduction percentage cannot be deducted from income
from a personal services business. This leads to a corporate tax rate
of 38% in British Columbia, which is built as follows:
Tax rate to be applied to the
corporation’s taxable income
to arrive at the tax owing by
the corporation
%
Section references and notes
start with (historical) federal tax
rate
38
123(1)(a) - base federal rate
subtract the federal “general rate
reduction percentage”
0
123.4(2) – for taxation years commencing
after October 31, 2011, income from a
personal services business is not “full rate
taxable” income
subtract the “provincial
abatement”
10
124(1) – this gives us the net current federal
rate of 28% where the corporation’s income
is subject to provincial or territorial tax
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add the base case provincial tax
rate on the corporation’s income
earned in the province
thus, the total tax “base case” tax
rate on the corporation’s taxable
income from a personal services
business in Canada is
14.
10
the provincial rate here is the base rate of
10% in subsection 14(2) Income Tax Act
(British Columbia)
38
the base corporate tax will vary across
Canada as provinces and territories impose
tax a rates different from British Columbia
Remember chapter 1? What happens when the corporate tax rate increases
without a corresponding increase in the gross-up and dividend tax credit?
Disintegration. This is shown below. Note that income from a personal
services business is still “full rate corporate income” and therefore will be
added to GRIP, from which the corporation may pay eligible dividends.
Shareholder
Ltd
the corporation’s tax on the $100 at the
personal services rate of 38% is
$38.00
the actual dividend paid to the shareholder,
being the $100 less the $38.00 is
$62.00
“gross-up” the dividend by 38% of the
actual dividend, or $23.56, for a total
amount included in the shareholder’s
income of
shareholder tax at the top
provincial tax rate of 43.7%
$100 of Taxable Income
Earned
$85.56
federal$37.39
deduct the “enhanced dividend tax credit”,
which is equal to 89.99% of the gross-up,
or
$21.20
net shareholder tax
$16.19
the total $54.19 of tax on $100 of income
translates to an effective tax rate of
54.19%, or rounded to
54%
15.
The result: while there is a deferral of 5.7% of tax on corporate income,
this comes with a significant distribution penalty: 10.49%.
16.
There are specific rules for “partnerships”. Consider:
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Mr. X
Mr. Y
50%
50%
Ltd
business A
small business
rate
Mr. Y
Mr. X
X Co
Y Co
active
income
partnership
business A
Do X Co and Y Co each get $500,000 so together they get $1,000,000?
X Co and Y Co as partners of a partnership (defined in law as carrying on
business in common with a view to profit) must "share" one $500,000
limit of the partnership's active business income. Read subparagraphs
125(1)(a)(i) & (ii), and the definition of “specified partnership income” in
subsection 125(7).
And consider this:
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Non-resident or
public corporation
Mr. X
X Co
(CCPC)
income
factual control
partnership
active business
Does the CCPC get the low rate on its share of active business from the
partnership? Read subsections 125(6.2) and 125(6.3). In tax policy terms,
the structure is viewed as:
Non-resident, or
public corporation
Mr. X
factual control
Non-CCPC
active business
17.
"Income of the corporation for the year from an active business” is defined
in subsection 125(7) to include any income for the year “pertaining to or
incident to that business” other than income for the year from a source in
Canada that is a property (within the meaning assigned by subsection
129(4)). We come back to examine this test in Chapter 4, where the
taxation of “income from property” or “investment income” is contrasted
with income from an active business. For now, consider the following:

90% of a building that is used in an active business and 10% is
used to earn rental income. Is the rental income "incident to" the
active business income and therefore itself active business income?
Is the rental income specified investment business income?
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
18.
Oil and gas royalties from land used mostly in a farming business
or ranching business. Is the royalty “income from property” or
income from an active business? Is the royalty “income from a
specified investment business”?
Certain income that you would not ordinarily regard as “active business
income” is deemed to be active business income in certain cases described
in subsection 129(6). We will review these cases when we look at the
special tax rates for “investment income” and “income from property” of a
CCPC in Chapter 4. For now, read subsection 129(6) and the “source
preservation rule” for associated companies.
Mr. X
“associated””
CCPC 1
CCPC 2
loan
active
business
interest
The interest income is deemed to be “active
business income” to CCPC 2
Mr. X
“associated”
CCPC 1
dental
business
CCPC 2
lease
building
rent
The rental income is deemed to be active
business of CCPC 2
income.
19.
Consider the “large capital” CCPC rule. The small business corporate rate
“phased out” for a CCPC that has debt and share capital employed in
Canada greater than $15 million. Read subsection 125(5.1).
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20.
Review two cases on income qualifying for the small business rate. The
first examines the “specified investment business” definition: Lerric
Investments Ltd. v. The Queen. The second examines the “personal
services business” definition: S & C Ross Enterprises Ltd. v The Queen.
Associated Corporations
21.
Some rules already discussed refer to “associated corporations”. In
addition, the $500,000 of active business income to which the small
business rate applies (i.e., the small business limit) must be shared among
“associated corporations”. Read subsections 125(2), (3) and (4).
22.
Read the basic rules in paragraphs 256(1)(a) to (e). One corporation is
associated with another if:

Paragraph (a): one corporation is controlled, “directly or indirectly
in any manner whatever” (i.e., legal or factual control), by the
other corporation;

Paragraph (b): both corporations are controlled, directly or
indirectly in any manner whatever, by the same person or “group
of persons”;
same
person or group
L or F
control
L or F
control
A Ltd
B Ltd
associated

Paragraph (c): each corporation is controlled, directly or indirectly
in any manner whatever, by a single person, the one person who so
controls the first corporation is “related” (as defined below under
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the heading Related Persons) to the person who controls the other
corporation AND either of these persons owns 25% or more or any
class of shares of the other corporation other than a “specified
class” (as defined below): discuss the daughter and father example;
Person 1
L or F
control
A Ltd
related
owns 25% or
more of a nonspecified class
of shares
Person 2
L or F
control
B Ltd
associated

Paragraph (d): one corporation is controlled, directly or indirectly
in any manner whatever, by one person, that person is “related” (as
defined below) to each member of a “group of persons” (as defined
below) that so controls the other corporation, AND the one person
who controls the first corporation owns 25% or more of a class of
shares of the other corporation other than a specified class (as
defined below): discuss the mother and two sons example;
Person
L or F
control
A Ltd
related to each
member
owns 25% or
more of a nonspecified class
of shares
Group of persons
L or F
control
B Ltd
associated

Paragraph (e): each corporation is controlled, directly or indirectly
in any manner whatever, by a “related group” (as defined below),
each member of first group is “related” (as defined below) to all
members of the second group, AND one or more persons who
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were member(s) of both groups, either alone or together, own 25%
or more of any class of shares of both corporations other than a
specified class: discuss the father, mother and daughter example;
each member of one group
“related” to all in the other
related group 1
related group 2
one or more who are members of both, either alone or together, own
25% or more of a non-specified class of each corporation
A Ltd
B Ltd
associated

both corporations are associated with a third corporation, unless the
third corporation “elects out” of any entitlement to the small
business rate in section 125 (read subsection 256(2)): discuss the
husband and wife example.
related
Person 1
Person 2
A Ltd
B Ltd
50%
50%
C Ltd
associated
23.
associated
A “group of persons” in this context can be any two or more persons each
of whom own shares of the corporation (read paragraph 256(1.2)(a)). “For
greater certainty”, one group of persons can control a corporation,
notwithstanding another person or group of persons also controls the
corporation (paragraph 256(1.2)(b)).
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24.
In addition to legal and factual control of a corporation, there is a further
test of “control” for the associated corporation rules. Read paragraph
256(1.2)(c). A corporation is deemed to be controlled by a person or group
if the person or group: (i) owns shares of the corporation having a value of
more than 50% of the value of all the shares of the corporation, or (ii) owns
common shares of the corporation having a value of more than 50% of all
the common shares of the corporation. This is sometimes referred to as the
economic control test. However, shares of a “specified class” are ignored
in applying this test.
25.
Thus, a “specified class” of shares is ignored, or do not count, for the
purposes of the 25% or more cross-shareholding rule and the economic
control rule. Read subsection 256(1.1). To be a specified class of shares,
they must have the following characteristics:

they are not convertible or exchangeable;


they are not voting;
they carry a fixed dividend entitlement;

the annual rate of dividends on the shares expressed as a
percentage of the consideration for which the shares were issued,
cannot exceed the “prescribed rate of interest” at the time of
issuance (Regulation 4301(c)); and

the entitlement on redemption, cancellation or acquisition by the
corporation (or a person “not dealing at arm’s length” with the
corporation, as defined later in this course) is not greater than the
consideration for which shares were issued plus any declared and
unpaid dividends.
The rule permits persons to have their own separate corporations for the
small business rate, and yet still allow them to hold these special type of
preferred shares in the other corporations – which are analogous to debt without causing the two corporations to be associated corporations.
26.
When assessing who “owns shares” of a corporation for purposes of these
associated corporation rules, there are a number of deeming rules.
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
Shares owned by corporations are deemed to be owned by the persons
who own the shares of that corporation in proportion to the relative
value of their shares in that corporation (read paragraph 256(1.2)(d)).
The value of shares in all associated corporation rules is to be
determined assuming they were all non-voting (read paragraph
256(1.2)(g)).

Shares owned by a trust - which is a relationship that exists when one
person (the settlor) gives property to another (the trustee) to hold for
the benefit of others (the beneficiaries) - are deemed be owned by the
beneficiaries. Generally, where the trust is “discretionary” as to
distributions, each discretionary beneficiary is deemed to own all the
shares owned by the trust (clause 256(1.2)(f)(i)(A), and subparagraph
256(1.2)(f)(ii)).
Where the trust is not “discretionary” as to
distributions, each beneficiary is deemed to own the shares owned by
the trust in proportion to the relative value of the beneficiary’s interest
in the trust (clause 256(1.2)(f)(i)(B), and subparagraph 256(1.2)(f)(iii)).

Shares of a corporation that are owned by a partnership are deemed to
be owned by the partners in proportion to their relative share of the
income or loss of the partnership. Read paragraph 256(1.2)(e).

Shares of a corporation that are owned by a child under 18 are deemed
to be owned by the parent for the purpose of assessing whether that
corporation is associated with another corporation controlled (legally or
factually) by the parent or a group of which the parent is a member except where the child manages the business of the first corporation
without influence from the parent. Read subsection 256(1.3).

Where two corporations are not otherwise associated, a person can be
deemed to own shares or control voting rights where the person has an
option or a contingent right similar to those we saw in Chapter 2. Read
subsection 256(1.4). That is:

where a person has an absolute or contingent right to acquire
shares, (except on the death, bankruptcy or permanent
disability of an individual), that person is deemed to own those
shares in ascertaining whether two corporations are associated
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
where a person has an absolute or contingent right to acquire,
control votes (same exceptions), the votes are deemed to be so
controlled in ascertaining whether two corporations are
associated

Where a person has an absolute or contingent right to redeem,
acquire, or cancel shares (same exceptions), the shares are
deemed to be so redeemed, acquired, or cancelled in
ascertaining whether two corporations are associated
27.
Remember subsection 256(6) from Chapter 2 – legal or factual control of a
corporation that might otherwise exist is deemed not to exist where such
control arises from safeguarding certain loans and special share
arrangements of arm’s length parties (as defined in a later chapter). This
rule applies for the whole Act, not just the associated corporation rules.
28.
Finally, two corporations are deemed not to be associated where:

the association arises by reason only that the first corporation is a
trustee under a trust pursuant to which the second corporation is
controlled - unless, at any time in the year, the person that established
the trust (the settlor, by making the gift) controlled or is a member of a
related group that controlled the corporation that is the trustee under
the trust. This is sometimes referred to as the corporate trustee rule in
subsection 256(5).

both of the corporations are controlled by the same executor, liquidator
or trustee, and it is established that the executor, liquidator or trustee
did not acquire control of the corporations as a result of one or more
estates or trusts created by the same individual (or two or more
individuals not dealing with each other at arm's length), and that the
estate or trust under which the executor, liquidator or trustee acquired
control of each of the corporations arose only on the death of the
individual creating the estate or trust. This is sometimes referred to as
the “common executor” rule in subsection 256(4).
Related Persons
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29.
The associated corporation rules employ the term “related to” in
connection with two or more persons. We have already discussed some
examples: i.e., husband and wife, mother and child, brother and sister. It
is important to understand that this concept of related persons extends to
other sections of the Act - as we will see in later chapters of this course.
For this reason we look at all the related person rules right here, even
though - as a practical matter - only some of them typically apply in the
associated corporations context. Keep this in mind as we go through the
rules, which hopefully will minimize the (initial) confusion you may
experience. Read subsections 251(2) through (6).
30.
Two individuals are related if they are connected by (i) blood relationship,
(ii) marriage, (iii) common-law partnership, or (iv) adoption. Read
paragraph 251(2)(a). In this context:

Individuals are connected by blood relationship only if the one
individual is a child or other descendent of the other individual, or is
the brother or sister of the other individual.
Read paragraph
251(6)(a). For example, cousins are not related - in the tax sense.

Individuals are connected by marriage if one is married to the other, or
one is married to a person who is connected by a blood relationship to
the other person. Read paragraph 251(6)(b). These are the rules you
most often see in practice in the context of the associated corporation
rules.

connected by
marriage
connected by
marriage (inlaw)

connected by blood
relationship


Individuals are connected by common-law partnership if one is the
common-law partner of the other, or one is a common-law partner of a
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person who is connected by a blood relationship to the other person
(i.e., replace married above with the notion of common-law partner) and a “common law partner” is defined in subsection 248(1) as a
person who cohabits at that time in a conjugal relationship with the
other person (same or opposite sex), and (i) has so cohabited
throughout the twelve-month period that ends at that time, or (ii) is the
parent of a child of whom the other person is also a parent.

31.
Individuals are connected by adoption if one has been adopted (either
legally or in fact) as the child of the other. In addition, an individual
who is related by blood (except a brother or sister – i.e., only “vertical”
blood relation) to another individual will be related by adoption to that
person's adopted child. Therefore, individuals are connected by
adoption to their adoptive children, parents and grandparents.
(paragraph 251(6)(c)).
Read paragraph 251(2)(b). A corporation and one person are related in the
following circumstances.

The person “controls” the corporation (de jure control only, not factual
control - i.e., legal control is the only control test applicable in these
rules).

The person is a member of a “related group” (as defined below) that
controls the corporation.

The person is related to a person who is described in the two bullets
above.
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related (1)
Person
Person
Legal
control (2)
Thus,
related (3)
A Ltd
or
Person
related to one
member (1)
Thus,
related (3)
related group
of persons
Legal
control (2)
B Ltd
32.
Read paragraph 251(5)(c). Try not to confuse these with the “associated
corporation rules”, although they appear similar. Remember the notion of
“related corporations” will have relevance in other parts of this course, and
the concept is quite distinct from the concept of “associated corporations”.
Two corporations are related in the following circumstances.

The two corporations are “controlled” (remember, legal control
only - in these rules) by the same person or a group of persons. A
“group of persons” is not defined in the context of related
corporations (as observed above, it is defined for associated
corporations). The most authoritative case summarizing how to
determine whether a “group of persons” have legal control in this
context is the Federal Court of Appeal’s decision in Silicon
Graphics Ltd. v. R where the Court said:
… simple ownership of a mathematical majority of shares by a
random aggregation of shareholders in a widely held
corporation with some common identifying feature (e.g. place
of residence) but without a common connection does not
constitute de jure control as that term has been defined in the
case law. I also agree with the appellant's submission that in
order for more than one person to be in a position to exercise
control it is necessary that there be a sufficient common
connection between the individual shareholders. The common
connection might include, inter alia, a voting agreement, an
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Tax II Chapter 3
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Notes
agreement to act in concert, or business or family relationships
…

Each corporation is controlled by one person, and the person who
controls one corporation is related to the person who controls the
other corporation. Discuss the husband and wife example – the
corporations are related but not associated because there is no
cross-shareholding.
Person
related
Person
Legal
control
Legal
control
A Ltd

related
one corporation is controlled by one person, and that one person is
related to any member of a “related group” (as defined below) that
controls the other corporation. Discuss the son, father and mother
example.
Person
related to any
member
Legal
control
A Ltd

B Ltd
related group
Legal
control
related
B Ltd
There are three more rules that can cause two corporations to be
related corporations.
Now that you have the idea, read
subparagraphs 251(2)(c)(iv), (v) and (vi) slowly and at least twice.
Then sketch your own drawings.
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Tax II Chapter 3
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Notes
33.
A “related group” is defined to mean a group of persons each member of
which is related to every other member. Read subsection 251(4). As you
might expect, an “unrelated group” is defined as a group of persons that is
not a related group.
34.
Read subsection 251(3). Two corporations that are related to the same
third corporation are deemed to be related to each other. Discuss the
example in CRA document AC58898, a copy of which is in these
materials.
35.
Read paragraphs 251(5)(a) and (c). If you can find a related group that is
in a position to control a corporation, then it is deemed to be a related
group that controls the corporation, period, whether or not it might be part
of a larger group by which the corporation is controlled. Thus, multiple
related groups could be seen as controlling a corporation. Also, where a
person owns shares in two or more corporations, that person is (as
shareholder of one of the corporations) deemed to be related to himself,
herself or itself as shareholder of each of the other corporations.
36.
Finally, read paragraph 251(5)(b) again. Recall we looked at this rule in
determining who had control of a corporation for purposes of the
definition of “Canadian-controlled private corporation”. This same rule
also applies in determining whether persons are “related” (read the
opening words of subsection 251(5)). Accordingly the following rules
apply.

Where a person has an absolute or contingent right to acquire
shares of a corporation (except on the death, bankruptcy or
permanent disability of an individual), that person is deemed to
have the same position in relation to the control of the corporation
as if the person owned the shares - for purposes of the related
person rules.

Where a person has an absolute or contingent right to acquire,
control or reduce votes in respect of shares of a corporation (same
exceptions), that person is deemed to have the same position in
relation to the control of the corporation as if the votes were so
controlled or reduced - for purposes of the related person rules.
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Tax II Chapter 3
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Notes

Where a person has an absolute or contingent right to redeem,
acquire, or cancel shares of a corporation (same exceptions), that
person is deemed to have the same position in relation to the
control of the corporation as if the shares were so redeemed,
acquired, or cancelled - for purposes of the related person rules.
Associated Corporations Revisited: Specific Anti-Avoidance Rule
37.
Read subsection 256(2.1). This is a targeted anti-avoidance rule. Two
corporations that are not otherwise associated can be deemed to be
associated where it can reasonably be considered that one of the main
reasons for the separate existence of the corporations is to reduce the
amount of taxes that would otherwise be payable under the Act.
38.
Discuss the decision in Hughes Homes Inc., a copy of which is included in
these materials.
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