The federal finance department recently released a consultation paper focusing on owners of private companies in Canada.
The proposed rules are aimed at eliminating tax planning strategies that the finance department believes “inappropriately reduce personal taxes.” Because most farming corporations in Canada are private companies, these new rules could be applicable.
Under the current rules, many farming corporations pay family members such as adult children dividends as a way to use lower personal tax rates. Current rules have allowed this type of compensation to be allocated to children who are older than 18 and therefore do not fall under the “kiddie tax” rules.
The federal proposal aims to eliminate the payment of these dividends as a way of reducing personal taxes.
The new proposal expands on the split income rule by not allowing dividends to be paid to certain non-arm’s length individuals. No matter the age of the individual receiving the dividend, a reasonability test will be performed on the amount paid to the individual.
If the amount is deemed to be unreasonable, the dividends will be taxed at the highest marginal tax rates.
Additional factors will also be taken into consideration when determining if the dividend is reasonable. These factors include the amount of labour the individual has performed in the company, if they have made any capital contributions to the business and if they bear any risk from the business.
The finance department has indicated that these rules will be stricter for 18 to 24 year olds. If approved, these changes would take effect starting in the 2018 tax year.
So what does this mean for family farm businesses?
If a spouse, adult son or daughter or other non-arm’s length individual older than 18 is actively involved in the family farm, there may be no significant changes in the way dividends are paid to them or taxed in their hands. As long as the amount is deemed to be reasonable, lower personal tax rates could be used.
In some cases, the adult children attend a post-secondary school. As a way to help them fund school costs, dividends are paid to them to cover tuition and lodging. In this case, it may be argued that the child is no longer actively involved in the family farm and therefore would have to pay the highest rate of tax on those dividends.
Another example may be spouses who work full time at other jobs and receive dividends from the farming corporation.
In this case, it may be hard to argue that the spouse who also works off the farm is actively involved in the farm because they would not be dedicating as much time to the farm as the other spouse.
The consultation paper also proposes changing the ability to flow out capital gains to children and spouses through trusts and potentially reduce the capital gains exemption available on qualified farm property to related individuals not active in operations.
Be sure to consult with your professional advisers before the end of this year to determine what changes are enacted and how they will affect your farming operation planning and long-term objectives.
Brenton Marchuk, a chartered professional accountant in KPMG’s tax practice in Regina, contributed to this column.
Colin Miller is a chartered accountant and partner with KPMG’s tax practice in Lethbridge. Contact: firstname.lastname@example.org.