CRA indicates that the s. 256(2)(b)(ii) election busts s. 256(2)(a) transitivity but not association with the 3rd corporation

Three children each of whom wholly-owns a Childco are also, along with their parent, the discretionary beneficiaries of a family trust owning all the non-voting common shares of Parentco, whose voting shares are held by their parent.

Each Childco is associated with Parentco given that s. 256(1.2)(f)(ii) deems a discretionary beneficiary to own the trust shares for association purposes. Accordingly, under the “transitivity” rule in s. 256(2)(a), the Childcos are also associated with each other.

However, if Parentco elects under s. 256(2)(b)(ii) to have a nil business limit, it will be deemed to not be associated with the Childcos for purposes of applying the transitivity rule for s. 125 purposes. Accordingly, for small-business-deduction purposes, the Childcos will no longer be associated with each other - but will still be associated with Parentco for such (and other) purposes. If these elections are made, in computing the business limit reduction for a Childco under s. 125(5.1), the reduction must take into account the taxable capital employed in Canada of Parentco, but not of the other Childcos. Given that the business limit could be allocated away from Parentco by agreement under s. 125(3) even without the elections, this latter taxable capital point may be the more significant advantage of making the elections.

Neal Armstrong. Summaries of 14 September 2017 External T.I. 2017-0685121E5 F under s. 256(2)(b)(ii) and s. 125(5.1).