As the current generation of farmers heads into retirement, we are more commonly seeing family farms being sold to third parties instead of transferred to the next generation.
Aside from determining the purchase price, the most important decision in a sale is how it should be structured.
The two main options are a share sale and an asset sale. To differentiate the two, picture your corporation as a box, and your business assets as being inside that box, such as land, equipment and inventory.
If you complete a share sale, you are selling the whole box. If you complete an asset sale, you keep the box but sell some or all of the assets inside.
There is also a third option, which is a hybrid share sale and asset sale. I will briefly touch on each of these.
I would note this article pre-supposes that the farm being sold is incorporated. However, if you are a sole proprietor and would like to reap the benefits of a share sale, there is an ability to incorporate your business on a tax-deferred basis to do so.
Let’s start with a share sale because it is typically the preferred method for the seller.
Selling shares gives rise to one level of taxation at the shareholder level. Specifically, a shareholder will realize a capital gain equal to the difference between the purchase price and adjusted cost base (ACB) of their shares.
In most circumstances, the ACB will be equal to the amount paid for the shares, subject to some adjustments. At current tax and inclusion rates, capital gains are taxed at roughly 25 percent. This tax varies by province.
While a 25 percent tax rate is relatively reasonable, the benefits of a share sale multiply when a seller can avail themselves of the lifetime capital gains exemption.
Each individual resident in Canada has an exemption limit of $1 million when disposing of qualifying property, such as shares of a family farming corporation. That means that each individual shareholder can shelter capital gains of $1 million on a share sale, which is tax savings in the realm of $250,000. (Note that alternative minimum tax may apply.) However, with proper planning, this amount is refundable.
Not all farming corporations meet the requirements for the capital gains exemption. As such, it is important to engage your professional advisers to determine whether your corporation qualifies, or if you can make it qualify.
A share sale also has a few upsides for a purchaser. If the farm includes real property, the purchaser will avoid paying land transfer fees. (Land transfer fees vary by province. In Saskatchewan, the fee is equal to 0.3 percent of the fair market value of the real property sold.) Further, a share sale avoids the need to consider provincial and federal sales taxes, which are typically borne by the purchaser.
The majority of downsides of a share sale are borne by the purchaser. When a purchaser “buys the whole box,” they get everything that comes with it, including any pre-existing liabilities, whether they are known at the time or not.
Note, however, that a properly drafted share purchase agreement can mitigate the risk exposure of a purchaser in a share deal. In addition, the purchaser will inherit the assets owned by the farming corporation at their historic tax cost. As such, the purchaser will not be able to benefit from depreciating the assets from their original purchase price.
From the perspective of a purchaser, an asset sale is typically the preferred route. Not only can the purchaser select which assets to buy (assuming the seller is agreeable), but the tax cost of those assets will be bumped up to the purchase price in accordance with the price allocation agreed upon by the parties, allowing the purchaser to claim depreciation.
Further, the purchaser will generally only have exposure to liabilities of the seller that it expressly assumes under the asset purchase agreement.
From the seller’s perspective, an asset sale will typically result in a higher tax bill. It gives rise to two levels of taxation: one at the corporate level and another at the shareholder level.
The corporate level tax will arise when the assets are sold, and the quantum will be dependent on several factors such as the type of assets being sold and the tax cost of those assets. The shareholders will then need to pay tax when they extract the sale proceeds from the corporation, which typically takes place by way of dividends.
A hybrid sale is essentially the best of both worlds: the purchaser gets the benefits of an asset sale, and the seller gets to benefit from capital gains treatment.
This begs the question: why doesn’t everyone do a hybrid sale? Well, it comes with a price tag.
Completing a hybrid sale involves relatively complex tax planning, which can incur significant professional fees. Because of these additional fees, a hybrid sale makes sense only when the quantum of the sale is significant enough that the tax savings realized outweigh the additional fees.
Stephanie Maszko is a lawyer with Stevenson Hood Thornton Beaubier LLP in Saskatoon. She can be contacted at firstname.lastname@example.org. 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.