Ag operations caught in crossfire of business tax changes

Large Canadian farms often have multiple corporate structures, such as when parents and grown children and their families are farming together.

This has allowed farmers to operate more efficiently and share costs, expenses and capital assets.

However, the federal government is amending business tax rules that could affect farm business corporations. Although directed at business in general, the changes did not take into account the unique nature of farms and how they have changed in the past few decades.

Taxable capital threshold

This amendment changes how the taxable capital limits are calculated, which start affecting the small business limit at $10 million and fully eliminates it at $15 million.

In the past, corporate structures such as Mom and Dad’s business and the son and his family’s business could pool their assets in a third company but only include in their capital the pro-rated percentage of the assets held by the third company if the proper election was filed.

This is no longer an option. Within the corporate group, they now have to add their combined capital in the calculation.

Let’s say parents and two grown children and their families have four companies in their corporate group.

Before the new rules went into effect, each company had its own taxable capital limit of $15 million, assuming proper elections.

After the amendment and new rules, the whole corporate group will be entitled to only one taxable capital limit of $15 million.

Specified corporate income

The government is also cracking down on profit shared between certain companies by defining a new type of income called specified corporate income.

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These are costs that might be charged between two related groups such as rent of land or use of equipment. The income transferred through these charges is no longer eligible for the small business limit.

Farmers should work with their tax planner and educate themselves on specified corporate income and find out if their business arrangements are caught by this new regulation.

Capital held inside the corporation, such as land and buildings, is included in the taxable capital limit, while capital held outside the corporation, such as land bought many years ago and personally owned, would not be part of the total capital calculation.

This could benefit those who have owned the land for some time and be a detriment to new owners.

Basing the taxable capital limit on historical cost rather than fair market value also favours more established farmers.

The land might have been bought a number of years ago, but its value at that time is still used to calculate total capital value today.

New owners who bought land recently will use more up-to-date values, which will be significantly higher in most areas and bring them much closer to the taxable limit cap.

However, the biggest issue is that the cap itself has not been re-evaluated or adjusted for inflation since 1994.

The $10 to $15 million benchmarks for taxable capital limits were large businesses 22 years ago, but they now affect far more small-to-medium sized agricultural businesses.

When adjusted for inflation, $10 million in 1994 would likely be worth more than $20 million today.

The costs and values associated with farming continue to rise, while the exemption limits remain the same. It takes a lot less for farms to reach the capital threshold and lose their exemptions.

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It might have taken a new couple $2 million to get started in farming in 1994, but today it could take $10 million, which means many new farmers have hit the first benchmark as they enter the industry.

The good news is that there are still a few tax structures that could provide options for farmers looking to offset these changes.

A joint venture is an arrangement in which two or more producers farm together to benefit from economies of scale. Here’s an example:

One farmer has 3,000 acres and another has 7,000. The first farmer might not be able to make the math work for a new combine, and the second farmer might not be able to justify a second combine, but together they are farming 10,000 acres and now the equipment purchase makes sense for both of them.

A joint venture is not a partnership, which in this example would own the combine.

In a joint venture, each company would own an interest equal to their share. In this example, shares in the combine would be split 70-30.

As well, the farmers pool their results, so the profit would be split 70-30 on the 10,000 acres.

In a cost sharing arrangement, each farmer owns their own equipment but they pool their resources to farm more efficiently. For example, one company might own the combine and the other the seeder or sprayer. In the cost-sharing model, each company tracks its own results and the participants pool only expenses, and not revenue, as they would in a joint venture.

Multiple partnerships occur when a farm is effectively working in different divisions, such as grain and cattle. These divisions can be split into two separate partnerships with each potentially retaining its own small business limits.

However, there must be valid business reasons for creating these kinds of structures.

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Ron Friesen, CPA, CA, is a Business Advisor, Taxation Services with MNP. He can be reached at 306.664.8324 or email ron.friesen@mnp.ca.

About the author

Ron Friesen — Ron Friesen, CPA, CA, is a Business Advisor, Taxation Services, with MNP. He can be reached at 306.664.8324 or email ron.friesen@mnp.ca.

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