A farm’s overall success in the short and long term has a number of factors, chief among them being the blood, sweat, and tears of the men and women who operate them.
Many farms are in the middle of or preparing for a transition to the next generation. The legal structure of the farm (proprietorship, partnership, corporation, joint venture) can help, or hinder, this transition.
One structure that is often not given enough consideration, but which can be of great use in the right circumstances, is the joint venture.
A joint venture is an arrangement where two or more persons (including corporations) contribute the use of their assets to work together and split the revenues and expenses of that operation among themselves. It is a contractual arrangement between the parties.
The key legal difference between a joint venture and other structures, such as a single corporation or partnership, is that the joint venture does not own anything. The property used in the operation is owned directly by the participants to the joint venture, not a commonly owned entity.
To put this into a stereotypical farming situation, instead of having individuals own a corporation, which owns the farming assets, each individual could own their own corporation, which in turn owns a portion of the farming property and earns a portion of the overall farm’s revenue.
A joint venture can provide a number of benefits to farms. First, depending on the situation, there are certain tax advantages, including greater access to the small business deduction so long as one of the main reasons for the existence of multiple corporations is not to multiply the small business deduction.
A second advantage is that a joint venture provides greater flexibility when a farm’s ownership is being transitioned. Often, where a farm is being transitioned over a period of years from one generation to the next, there is tension as to who should own the shares of the corporation going forward.
The parents have built the business and often don’t want to give up ownership prematurely. However, they want the next generation to have a sense of ownership and be committed. The next generation often wants ownership so they can share in the value their efforts create.
While shares in a corporation can be transitioned over time, a significant amount of legal and accounting work is required to change the share ownership structure, especially if this is going to change frequently.
For example, let’s say the child owns 25 percent and the parents want to increase this to 50 percent of the future growth. This reallocation of share ownership typically requires a valuation of the farm and a number of legal documents. With a joint venture, they could simply amend the joint venture agreement to allocate 50 percent of the revenues and 50 percent of the expenses of the farm to the child’s corporation on a go-forward basis.
A third advantage is flexibility for financial and business planning. Continuing our example, imagine that the overall farm earns $500,000 in one year. If the farm is a single corporation and one of the owners wants to take their share of the profits to spend on personal items, but the other wishes to invest their money in the corporation on a new piece of land, there is a conflict as the two are tied to each other.
Instead, in a joint venture, each would have their own corporation. They can independently choose how to manage their own share of the profits. It allows for people with different objectives or who are at different life phases to each accomplish what they want.
However, there are always drawbacks to any plan. The biggest obstacle to operating a joint venture is that it can be more complex. Often it requires going from a single corporation to several, which in turn requires more annual returns and accounting effort.
It also requires that the ownership of the assets of the farm be appropriately tracked so there is a record of who owns what and in what proportions.
However, with proper systems, this does not need to be overwhelming and in the right circumstances the benefits can far outweigh this drawback.
Another risk that exists with a joint venture is that it could be construed by the Canada Revenue Agency to be a partnership and not a joint venture. This has the potential to cause tax problems. However, this can be guarded against if a proper joint venture agreement is prepared and the parties operate consistent with the joint venture concept. Also, for this reason, if a farm is already operating as a joint venture, it should ensure that it has in place a formal joint venture agreement.
Any farm that is looking to expand or transition its ownership group or that is looking to gain more flexibility should consider a joint venture and whether or not it is the right fit. In the right situations, a joint venture is the perfect fit to balance all of the parties’ objectives.
Thomas Fransoo is a lawyer with Stevenson Hood Thornton Beaubier LLP in Saskatoon. Contact: email@example.com. This article is provided for general informational purposes only and does not constitute legal or other professional advice and does not replace independent legal or tax advice.