Introduction to Canada Tax System – Corporate Association and Subsection 256 (2.1)
In Canada, the anti-avoidance provision provided in subsection 256(2.1) of the Income Tax Act (the “ITA”) deems two or more corporations to be associated with each other in a taxation year if one of the main reasons for the separate existence of the corporations is to reduce the amount of taxes that would otherwise be payable.
The application of subsection 256(2.1) was recently discussed in Nicole L. Tiessen Interior Design Ltd. v. The Queen, 2021 TCC 29, aff’d 2022 FCA 53 (“Nicole Tiessen”). In Nicole Tiessen, Justice Monaghan of the Tax Court of Canada determined that thirty corporations were deemed to be associated with each other for their 2012 and 2013 taxation years because the reason for their separate existences was to reduce taxes. The appeal to the Federal Court of Appeal was dismissed.
In Nicole Tiessen, the appellants undertook a reorganization of an architecture and interior design business from a corporate model to a corporate partnership model. The reorganization was intended to permit substantially more income to be taxed at the small business deduction (the “SBD”) rate. The SBD is a deduction that can be available to Canadian-controlled private corporations for a limited amount of active business income each year. A corporation’s maximum income eligible for the SBD (or, in other words, a corporation’s “business limit”) is $500,000. Such business limit, however, has to be shared with associated corporations.
Prior to the reorganization in Nicole Tiessen, the business was carried on through one corporation (the “Original Corporation”) whose shareholders were made up of fifteen professional employees and their spouses. This structure was replaced with a partnership structure which involved thirty different corporations: fifteen corporations that were partners of a single partnership (the “PartnerCos”) and fifteen corporations that were respectively each providing services to a PartnerCo (the “ServiceCos”) under a service agreement. Under each of such fifteen service agreements, each ServiceCo had to provide the services of one of the professional employees to its respective PartnerCo in order for such PartnerCo to perform its partnership duties. Each ServiceCo employed one of the professional employees of the business, and each professional employee controlled a pair of corporations, i.e., a PartnerCo and ServiceCo (hereinafter, a “Pair”). All Pairs together carried on the architecture and interior design business through the partnership.
Prior to the reorganization, only the Original Corporation had access to the SBD. After the reorganization, each Pair claimed the SBD as if they were not associated with the other Pairs. Had they been successful, the appellants would have effectively multiplied their access to the SBD.
In determining whether the anti-avoidance rule of subsection 256(2.1) ITA could apply, the Tax Court framed the issue as “whether saving taxes was a main goal or a side effect” of the separate existence of the corporations, and not whether saving taxes was the sole reason or the “sole main reason”. The Tax Court determined that a taxpayer contesting the applicability of the provision must provide “an objectively reasonable explanation that none of the main reasons was the reduction of taxes”.
The appellants submitted that the multiplication of the SBD was not one of the main reasons for the reorganization since they knew that the SBD might not be available. The Tax Court rejected this argument and determined that one of the main reasons for the reorganization was for each Pair to access the SBD, despite the other benefits of the reorganization identified by the appellants.
As a result, and seeing as the multiplication of the SBD was one of the main reasons for the reorganization, the Tax Court concluded that subsection 256(2.1) deemed the fifteen Pairs of corporations to be associated within the meaning of the ITA. The Tax Court decision was appealed to the Federal Court of Appeal and such appeal was dismissed.
Canadian income tax rules are complex and subject to change, and the information in our series of blogs is not intended to be comprehensive.
 Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.).
 Nicole Tiessen, 2022 FCA 53 para 5.
 ITA, subsections 125(2) and (3).
 Nicole Tiessen, 2021 TCC 29 para 32.
 Nicole Tiessen, 2021 TCC 29 para 42.
 Nicole Tiessen, 2021 TCC 29 para 43.
 Nicole Tiessen, 2021 TCC 29 para 89.
 Nicole Tiessen, 2021 TCC 29 para 91.
 Nicole Tiessen, 2021 TCC 29 para 153.