Businesses are often related to each other in various ways, such as through ownership, partnership, affiliation, or collaboration. But what does it mean for businesses to be “related” in the legal and tax sense? And why does it matter?
In this article, we will explore the essential requirement for different businesses to be “related” according to the law and the implications of being related for tax purposes.
What is the Legal Definition of Related Businesses?
According to the law, related businesses are those that have a direct or indirect connection or influence over each other. This can be determined by various factors, such as:
- The percentage of ownership or control that one business has over another
- The degree of common management or direction that the businesses share
- The existence of intercompany transactions or agreements that affect the businesses’ operations or finances
- The nature and extent of the businesses’ activities and interests
The legal definition of related businesses may vary depending on the jurisdiction and the context. For example, in Canada, the Income Tax Act defines related persons as those who are connected by blood relationship, marriage, common-law partnership, or adoption, or those who deal with each other at non-arm’s length. In the United States, the Internal Revenue Code defines related persons as those who have a specified degree of familial or business relationship, such as parent and child, brother and sister, partner and partnership, corporation and shareholder, etc.
Why Does it Matter if Businesses are Related?
The main reason why it matters if businesses are related is because of the tax implications. Related businesses may be subject to different tax rules and rates than unrelated businesses. For example:
- Related businesses may be able to consolidate their income and expenses and file a joint tax return, which could reduce their overall tax liability or increase their tax credits
- Related businesses may be able to transfer assets or income between them without triggering tax consequences, such as capital gains or dividends
- Related businesses may be able to deduct losses or expenses incurred by one business from the income of another business, which could lower their taxable income
- Related businesses may be able to claim certain tax benefits or incentives that are available only to related parties, such as research and development credits or small business deductions
However, there are also some disadvantages or risks associated with being related businesses. For example:
- Related businesses may be subject to more scrutiny and audit by the tax authorities, who may challenge their transactions or arrangements as not being at arm’s length or not reflecting the fair market value
- Related businesses may be subject to anti-avoidance rules or penalties that aim to prevent tax evasion or abuse by related parties, such as transfer pricing rules or thin capitalization rules
- Related businesses may be subject to double taxation or withholding taxes if they operate across different jurisdictions or countries that have different tax laws or treaties
Therefore, it is important for businesses to determine whether they are related or not and to comply with the relevant tax rules and obligations that apply to them. It is also advisable for businesses to seek professional advice from a tax lawyer or accountant before entering into any transactions or agreements with related parties.