Farmers may be left wondering as they prepare for the coming production year why they have less cash in the bank.
One factor could be the result of new tax rules that came into effect March 21, 2016.
A number of farm corporations and partnerships have lost access to the small business deduction, resulting in higher income taxes being paid.
The small business deduction reduces the general tax rate to 10.5 percent from 15 percent on the first $500,000 of active business income for businesses that can take advantage of it.
Furthermore, in Alberta and Sask-atchewan it reduces the provincial income tax rate to two percent from 12 percent in 2017.
In Manitoba it lowers it to zero percent from 12 percent on the first $500,000 of income. That is tax savings of 14.5 to 16.5 percent, or about $75,000 on $500,000 of income per year.
The $500,000 limit is shared with associated corporations and phased out when the total asset value of associated corporations reaches $10 to $15 million.
This means all income earned by a single farm or an associated group of farms with a total asset value of more than $15 million cannot access the small business deduction.
Many farm operations have been structured in a way that allowed multiple corporations under the same group to obtain their own small business deduction, but these structures may be limited with the introduction of the new tax rules.
Corporation asset threshold
To illustrate the effect of the changes, take the situation of two brothers who farm together.
They have created a corporation called Farm Co. for the day-to-day farming operations. Each brother owns 50 percent of Farm Co., but each brother also has his own corporation: BrotherCorp One and BrotherCorp Two.
The three corporations have combined assets exceeding the $15 million threshold.
Farm Co. distributes all of its income and expenses equally to BrotherCorp One and BrotherCorp Two. Farm Co. elects out of the small business deduction, resulting in each BrotherCorp obtaining its own $500,000 business limit, or a total of $1 million.
The new tax rule changes state that all corporations are deemed to be associated, whether an election is filed or not, for the purposes of calculating the total assets threshold.
All three corporations will now have to share the total assets limit.
Given that the three corporations’ total assets exceed the threshold, none of them would have access to the small business deduction, resulting in all income being taxed at the higher rate.
Another common type of structure affected by these rules would be where two siblings are involved in a farming operation. A partnership structure has been created where each sibling is an equal partner.
Each sibling also owns his or her own corporation. The two corporations enter into an agreement to provide services to the partnership.
Under the old rules, these two corporations may not have been considered associated and would each have access to the full $500,000 small business deduction.
The new legislation has disallowed this type of transaction to occur between the partnership and corporations, thus denying them access to the small business deduction.
Farm owners who operate in these types of structure, should review them to determine whether there are opportunities to mitigate the adverse tax consequences associated with the legislation changes.
Riley Honess and Brenton Marchuk of KPMG contributed to this article.
Colin Miller is a chartered accountant and partner with KPMG’s tax practice in Lethbridge. Contact: firstname.lastname@example.org.