Revisions to the Income Tax Act planned for Jan. 1 will change how intangible property, such as dairy and poultry quota, is taxed in Canada.
The former Conservative government initiated the changes to the act that deals with intangible property, known as Eligible Capital Property (ECP), and as of Jan. 1, the Liberal government is expected to put the changes into place.
Opinion is divided as to whether the revisions will fulfil the stated goal of simplifying this facet of the tax structure. They could definitely bump up income tax bills for producers selling quota after Dec. 31.
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Under the current system, intangible assets are held in an ECP account. On or before Dec. 31, they must be transferred into a Capital Cost Account (CCA) class for depreciable capital property.
For the producer, most of the impact will be felt in sales of quota that take place after Dec. 31, says David Inhaber, tax analyst at Farm Business Consultants in Calgary.
Jim Ross, who with his wife and two daughters runs a 200 cow dairy near Grenfell, Sask., concurs.
“It will not affect how I operate,” he says.
“It may affect succession planning or retirement, but that will be a burden on my estate or successors.”
Under the present tax regime, if the sale of quota results in capital gains, those capital gains are treated as business income and taxed at an income tax rate of 26 percent.
Under the new regulations, capital gains realized from quota sales will be classed as investment in-come. About half of the total amount will be taxable and at up to 24 percent more than under the present system.
For example, an imaginary couple named Steve and Carol have dairy quota worth $1 million. Unaware of the new rules, they are set to sell their quota in 2017. They paid $100,000 for it 20 years ago, so they are looking at capital gains of $900,000.
Under the new rules, half of that amount, or $450,000, will be taxable as investment income. That amount will be taxed, depending on the province, up to 24 percent more than under the present ECP rules. Learning this, Steve and Carol make an appointment with their accountant.
“Steve and Carol come to me and say, ‘OK, we want to sell quota,’ ” says Inhaber.
“My job is to go on their account and see if they’ve used the capital gains exemption of $1 million for qualified farm properties. And if the answer is, ‘no, they haven’t,’ then I can proudly tell them that this transaction, which was sold at a million bucks, will qualify for capital gains exemption and they don’t pay a nickel in tax.
“However, if they’ve used the capital gains exemption, I have a job to tell them, ‘here is the impact of your sale and make sure you carve out, I’ll say, 25 percent of a $100,000, and that’s probably the tax you’re going to pay. So make sure you put it in your bank account and you don’t spend it.’ ”
However, even if Steve and Carol have already used their lifetime capital gains exemption, there may be other tax strategies that could ease the pain, says Inhaber.
One option, if their quota is in a corporation, would be to sell it before the end of the year and realize significant tax savings. Or, they might consider keeping share ownership in the family but reorganizing it, possibly creating a second corporation.
Finally, quota can be passed to a spouse, children or grandchildren with few to no worries about capital gains taxes.
“Under current rules, you can transfer it at original cost or at fair market value,” says Inhaber.
“If you decide to do it at fair market value, some or all of it can be tax sheltered. If the fair market value is high and the executor does not want to generate a tax liability, then they’re going to move it over to cost, but if they’re OK with paying a little tax to bump up the fair market value, then they’ll pay an immaterial amount of tax and use the capital gains exemption.”
On the expenditure side, any expenditures before Jan. 1 will retain the present depreciation rate of seven percent until 2027. Expenditures after Jan. 1 will have a depreciation rate of five percent.
Intangibles such as quota now have 75 percent of their value put into a pool that depreciates at a rate of seven percent per year.
As of Jan. 1, that pool will be called the Class 14.1 pool and 100 percent of expenditures will be put into it. It will depreciate at a rate of five percent on a declining balance.
