Associated corporations in Canada: 5 tests, one $500,000 limit

The five association tests in s.256(1)

Two corporations are associated in a taxation year if any one of five tests is met at any time in that year laws-lois.justice.gc.ca. One moment of overlap is enough, so a share transfer in November can associate two companies for their whole year.

The 25% tests in (c), (d) and (e) ignore shares of a specified class under s.256(1.1). Those are shares that carry no votes, cannot be converted, pay a capped dividend and redeem for no more than the consideration paid plus unpaid dividends. A spouse who holds only that kind of preferred share does not trip the 25% test.

Under s.256(1.5), a person who owns shares in two corporations is treated as related to themselves. That's why Dana in row (d) counts as related to every member of the Bco group, herself included laws-lois.justice.gc.ca.

Control: de jure, deemed, and in fact

De jure control generally means owning enough voting shares to elect a majority of the board canada.ca. Votes are not the only route. Under s.256(1.2)(c), a person or group that owns shares worth more than 50% of the fair market value of all issued shares, or of all issued common shares, is deemed to control the corporation even with no votes at all laws-lois.justice.gc.ca.

Under s.256(1.2)(a), a group is any two or more persons who own shares of the same corporation laws-lois.justice.gc.ca. A corporation can be controlled by more than one person or group at the same time, so one company can be controlled by Dana alone and also by Dana and Raj as a group.

The words "directly or indirectly in any manner whatever" in paragraphs (a) to (e) bring in control in fact. Section 256(5.1) says a corporation is controlled by anyone with direct or indirect influence that, if exercised, would give control in fact laws-lois.justice.gc.ca. A minority shareholder who holds the company's key loans, contracts or know how may meet that test. The one carve out: an arm's length franchise, licence, lease, distribution, supply or management agreement whose main purpose is to govern how the business runs does not, by itself, create control.

Who counts as related for the 25% tests

Related persons come from s.251(2). Individuals are related when they're connected by blood, marriage, common law partnership or adoption canada.ca.

The CRA's own examples follow the same line: corporations controlled by related individuals are associated only when one individual owns at least 25% of the shares of both, and drop below 25% in one of them and the association falls away canada.ca. Cousins can each run a company and own pieces of each other's without association under (c), because they aren't related at all.

Deemed ownership: options, minor children and look through

Section 256 counts shares your client doesn't hold on paper. Under s.256(1.4), a right under a contract, in equity or otherwise to acquire shares, now or in the future, is treated as if exercised. A right to make the corporation redeem or cancel other shareholders' shares is treated the same way laws-lois.justice.gc.ca. A buy option in a shareholder agreement can create association on the day it's signed. Rights that only become exercisable on a death, bankruptcy or permanent disability are excluded.

Under s.256(1.3), shares owned by a child under 18 are deemed owned by each parent. The exception is narrow: it applies only where the child manages the business without a significant degree of parental influence. Shares put in a 12 year old's name are counted as the parents' unless the child really runs the business.

Shares held through other entities are pushed out to the owners. Under s.256(1.2)(d) a holding corporation's shares go to its shareholders in proportion to the fair market value of their shares. Under (e) partnership shares go to partners by their share of partnership income. Under (f) a discretionary trust beneficiary is deemed to own all the trust's shares, and a s.75(2) trust's shares go to the person who contributed the property.

Section 256(2.1) sits behind all of this. If one of the main reasons two or more corporations exist separately in a year is to reduce tax, they are deemed associated for that year, whatever the share register says.

The third corporation rule and the Schedule 28 election

Under s.256(2), two corporations that aren't otherwise associated are deemed associated if each one is associated with the same third corporation laws-lois.justice.gc.ca. Example: Dana controls Aco and her brother Raj controls Bco, and neither owns shares of the other's company. They each own 50% of Cco. Aco is associated with Cco under (d), and so is Bco, so Aco and Bco become associated with each other through Cco.

For the small business deduction there's a way out. If the third corporation is not a CCPC, the other two are deemed not associated for s.125. If it is a CCPC, it can elect on Schedule 28, Election not to be Associated Through a Third Corporation canada.ca. The price is that the third corporation's business limit for that year is deemed nil, so the election only makes sense when Cco earns little or no active business income, such as a company that holds a building or a portfolio.

The election is narrow. The T2 guide notes that Aco and Bco remain associated with Cco and must still include Cco's taxable capital in their own calculations canada.ca.

What association costs, with a worked example for spouses

A CCPC that isn't associated gets a $500,000 business limit. Associated CCPCs share one $500,000 by assigning percentages on Schedule 23, and the percentages can't total more than 100% canada.ca. If they don't file the agreement within 30 days of a written CRA request, the Minister allocates the limit under s.125(4) laws-lois.justice.gc.ca. Each corporation also reports its related and associated corporations on Schedule 9 canada.ca, and the agreement itself is Schedule 23 canada.ca.

Priya owns 100% of Aco, a consulting company with $400,000 of active business income. Her husband Marc owns 100% of Bco, a renovation company with $300,000. Priya owns no Bco shares and Marc owns no Aco shares, so (c) doesn't apply and the two are not associated. Then Bco is reorganized so that Priya holds 25 of its 100 issued common shares and Marc holds the other 75. Marc still controls Bco, Priya controls Aco, they're related, and Priya now owns at least 25% of a class of each, so the companies are associated under s.256(1)(c). At the federal net rates of 9% on income eligible for the small business deduction and 15% general canada.ca, here is the cost, as of October 2026:

The table is federal only. If Priya's 25 Bco shares were specified class preferred shares instead of common, the 25% test would not be met, but s.256(2.1) can still apply if saving tax was a main reason for the structure. And if the couple's 15 year old held Bco shares, or Priya held an option to buy Marc's shares, those shares would be counted as hers.

Association also pools the two grinds that shrink the limit canada.ca. The taxable capital grind uses the combined taxable capital employed in Canada of the whole group for the last years ending in the preceding calendar year, cutting the limit on a straight line between $10 million and $50 million. At $30 million combined, the formula in s.125(5.1)(a) works out to 0.225% × $20 million = $45,000, divided by $90,000, so half the limit is gone laws-lois.justice.gc.ca. The passive income grind takes the group's combined adjusted aggregate investment income and removes $5 of limit for every $1 above $50,000, reaching nil at $150,000. If Aco's portfolio earned $80,000 in its year ending in 2025, the group's shared limit drops by 5 × $30,000 = $150,000, to $350,000. The limit is reduced by the larger of the two grinds, not both. More on both in the small business deduction for 2026 and the passive income grind.