Depending on how the Canada Revenue Agency interprets your sales and purchase agreement, income from sales of gravel from your farm may be taxed as either income or capital gain. The latter interpretation is usually more beneficial to the producer because only half of the capital gain is taxable.
In 2003, the agency released an Advance Income Tax Ruling that said the sale of gravel from land owned by a farm corporation would not be considered income if it sold all the gravel for a lump sum. However, a CRA technical interpretation issued later that year for another taxpayer, indicated an amount received for shale extracted from the property was to be considered as income because it was based on the quantity of production.
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This ruling and subsequent interpretation mirror the administrative policy outlined in CRA Interpretation Bulletin IT-462, Payments based on production or use.
The key is in the wording of the purchase and sale agreement and how the contract terms of sale are described. Agreements based on production or use will be taxed as ordinary income.
There are a number of options that will generate a more favourable tax treatment for the seller.
The easiest and safest way to ensure the desired CRA capital gains treatment is to have the sale contract call for a fixed sum. In this case, the proceeds of the sale are not normally considered income. The contract also may allow some variance for timing of instalment payments based on production or use of the gravel. As long as the instalments are based on a fixed sum, the amount will not be treated as income. In this situation the price doesn’t vary, although the timing of payments might change based on production.
Another option is to set the contract price at a maximum amount equivalent to fair market value at the time of sale. This amount may be decreased without affecting the tax treatment as long as certain contract-stipulated conditions for production and use in the future are met.
Several other variations exist that will allow you to split the proceeds of such contracts between income and capital accounts. These may include pricing at a fixed amount with provision for additional payments based on production. The fixed amount will be considered capital while the additional amounts will be treated as income.
Because there are several options in structuring these contracts, we recommend farmers seek professional advice before proceeding with a transaction for the sale of gravel from their property.
Larry Roche is a tax analyst with farm taxation and planning specialists Farm Business Consultants Inc. He can be contacted at fbc@fbc.ca or call 800-860-7011.
