The federal finance department has already indicated that it is taking aim at family farm businesses structured as corporations and the way income removed from the corporations is treated for tax purposes.
Payouts to family members are usually most heavily taxed as straight income but to a lesser degree as dividends. The intent of the finance department is to measure the participation of each family member in the business and if they don’t meet considerable input tests, then income taken as dividends by those family members will automatically be treated as income and taxed at their individual highest marginal tax rate.
But it doesn’t end there. The Canada Revenue Agency also takes a close look at how the farm business accounts for its leasing expenses. Frequently, producers will lease equipment, thereby reducing their expenses and eliminating the risks and benefits of outright ownership. That is called an operating lease and is valid under generally accepted accounting principles as long as certain conditions are met.
As an operating lease, your lease payments can be deducted from your revenues, giving you the opportunity to reduce your taxes owed, sometimes considerably. CRA has seen and is alert to attempts to finance purchases of equipment under operating leases. In effect, the farmer still claims the expenses against revenues but takes ownership of the asset at the end of the lease.
In CRA’s eyes, that is not an operating lease but a capital lease and must be treated as a depreciable asset, which frequently takes a longer period of time to write off the asset.
The conditions mentioned earlier for operating leases include that the lease period can’t be greater than 70 percent of the equipment’s generally accepted lifespan, payments can’t be greater than 90 percent of the fair market value of the equipment and you can’t get ownership of the property at the end of the lease, whether at a bargain purchase price or not.
For example, individuals have been known to contract a lease for a $100,000 tractor with payment over five years and purchase of the property for $1 at lease end. Yet, they still claim their lease payments of $20,000 per year as operating expenses. That will be denied by CRA as an operating lease and treated as a capital lease instead. This example pretty much breaks every condition stated above for operating leases.
But a new curve is about to be thrown into the leasing process beginning Jan. 1. That is when Canada signs on to the International Financial Reporting Standards (IFRS). A feature of these standards is that virtually all leases must be shown on your balance sheet, wiping out the distinction between operating leases and capital leases. Classifying all your leases as assets and liabilities on your balance sheet could affect your financial ratios and your ability to raise capital.
We strongly suggest you seek advice from your tax or financial specialists on how this change will impact your finances.
Grant Diamond is a tax analyst in Saskatoon, SK., with FBC, a company that specializes in farm tax. Contact: email@example.com or 800-265-1002.