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What are the SR&ED implications of "Associated" vs. "Related" vs. "Connected" corporations?

The table below (from MEUK Newsletter 2001-1) outlines some critical issues, definitions and implications of corporate structures:

CriteriaUnder "common control"Controlled by related person(s) (RP's)>10% of FMV of issued & voting shares
ITA references:ITA 256(1)ITA 251(2)ITA 186(4)
General tax implicationsShare business limits for income & capital tax + intercorporate rent = active incomeDisclose RP transactions & use "fair market value"Tax free intercompany dividends
ITA references:ITA 125(3-5) & ITA 129(6)ITA 69(1)ITA 186(1)
SR&ED implicationsShare expenditure limits for enhanced creditsEmployees controlling >=10% are "specified employees"
Election to claim or transfer eligible costs - no mark-ups
ITA references:ITA 127(10.2-4)ITA 127(9) & (13-22)ITA 248(1)

The Income Tax Act generally deems that where a shareholder owns greater than 50% of the fair market value of the capital of a company it will be deemed to control it (per ITA 256(1.2)(c)(i)). If a person owns more than one company in this fashion the companies will be "associated" for taxation purposes. This "association" umbrella can be extended wherever "related persons" each control corporations and there is a 25% cross-ownership of shares in either direction (per ITA 256(1)(c to e)). "Associated" companies are required to share the expenditure limits for enhanced SR&ED incentives. (Note: a shareholder may own less than 50% of the fair market value of a corporation and still be said to control it - see What are "de facto" vs. "de jure" control?)

Related persons include "individuals connected by blood relationship, marriage or adoption (...) and any two corporations [controlled by related persons]", per ITA 251(2)(a & c). The term blood relationship generally includes parents, grandparents, brothers, sisters and in-laws, however it does not specifically include cousins, nieces and nephews.

The SR&ED claim requires that you distinguish between "arm's length" contractors and "non-arm's length" contractors. In general terms, "non-arm's length" contractors are those who are controlled by the same "person" or "related group of persons" as described above (i.e., from "associated" or "related" corporations). Expenditures you incur for SR&ED performed on your behalf by a non-arm's length contractor are not immediately qualified expenditures for ITC purposes (per ITA 127(9)(f)). However, the performer can elect to claim or transfer the actual qualified expenditures incurred (per ITA subsection 127(13)). This prevents the company from unfairly marking up the costs on non-arm's length transactions.

Typically corporations will be "connected" when one owns >10% of the fair market value of the shares in another (per ITA 186(4)). This will result in an ability to pay inter-company dividends in a tax-free manner. Though there are no other significant SR&ED tax implications resulting from corporations having "connected" status, further analysis of such entities may uncover the existence of "specified employees". Generally this is any employee who (directly or indirectly) owns 10% or more of any class of stock of the company. Please see What is a 'specified employee'? for further information.)

Further discussion on the SR&ED tax credit implications of corporate ownership structures can be found in MEUK Newsletter 2001-1. Potentially inadvertent corporate association through the use of family trusts is discussed in MEUK Newsletter 2001-2. Association through groups of investors including venture capitalists is discussed in MEUK Newsletter 2004-2.