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Agriculture Businesses Caught in the Crossfire as Government Targets Large Tax Structures

07/11/2016


This article previously appeared in ​Western Producerand is republished with permission.

In most large farms in Canada today there is a corporate structure in place, and quite often multiple corporate structures, for example when parents and grown children and their families are farming together. This has allowed farmers to operate more efficiently, share costs, expenses and capital assets.

The current government was given the mandate to tax the wealthy and limit access to small business deduction. They have begun closing some of the loopholes and we will review a few of the changes here. While these changes are directed at business in general, note the government did not take into account the unique nature of business in agriculture or how it has changed in the past few decades.

The amendments to tax rules in 2016 could have significant implications to some of the corporate tax structures used in agricultural companies. Let’s take a look at a few of these.

Taxable Capital Threshold

The first amendment is the change to how the taxable capital limits are calculated, which start grinding the small business limit at $10 million, with the limit fully eliminated at $15 million. In the past, a corporate structures (for instance Mom and Dad’s business and the son and his family’s business) would be able to pool their assets in a third company but only include in their capital the prorated percentage of the assets held by the third company if the proper election were filed. This is no longer an option. Within the corporate group they now have to add their combined capital in the calculation. 
Let’s look at an example where parents and two grown children and their families have four companies set up in their corporate group.
Before the new rules went into effect, each company had their own taxable capital limit of $15 assuming proper elections. 
After the amendment and new rules, the whole corporate group will only be entitled to one taxable capital limit of $15 million leaving them with potentially substantial tax implications.

Specified corporate income

The government is also cracking down on profit shared between certain companies by defining a new type of income referred to as specified corporate income. These are costs that might be charged between two related groups such as rent of land or use of equipment. The income transferred through these charges are no longer eligible for the small business limit.

Farmers should work with their tax planner and educate themselves on specified corporate income and find out if any of their business arrangements are caught by this new regulation.

Established farmers reap some benefits

It is important to note that capital held inside the corporation, such as land and buildings, is included in the taxable capital limit while capital that is held outside the corporation, such as land purchased many years ago and personally owned, would not be part of the total capital calculation. This is more likely to benefit those who have owned the land for some time and be a detriment to new owners.

Another factor that favours the more established farmers is that the taxable capital limit is based on historical cost not fair market value. Though purchased a number of years ago, the land value at that time is used to calculate total capital value today. New owners who may have bought their land more recently will be using more up-to-date values, which will be significantly higher in most areas and bring them much closer to the taxable limit cap.

But the biggest issue is that the cap itself has not been re-evaluated or adjusted for inflation since 1994. The $10 - $15 million benchmarks for taxable capital limits would have been aimed at large businesses 22 years ago, but in today’s dollars they are impacting far more small-to-medium sized agricultural businesses. When adjusted for inflation, $10 million would likely be worth in excess of $20 million today.

The costs and values associated with farming continue to rise, while the exemption limits remain the same. It takes a lot less for farms to reach the capital threshold and lose their exemptions. In 1994 it might have taken $2 million to get started in farming for a new couple. Today it could take $10 million, which means many new farmers have already hit the first benchmark as they enter the industry.

Joint ventures, cost sharing and other options

The good news is that there are still a few tax structures that remain in place that could provide options for farmers looking to offset these changes.
A joint venture is an arrangement where two or more farmers farm together to benefit from economies of scale. Here’s an example:

One farmer has 3,000 acres and another has 7,000 acres. The first farmer might not be able to make the math work out for a new combine, and the second farmer might not be able to justify a second combine, but together they are farming 10,000 acres and now the equipment purchase makes sense for both of them.

A joint venture is not a partnership, which in this example would own the combine. In a joint venture, each company would own an interest equal to their share; shares in the combine would be split 70-30 in this example. As well, the farmers pool their results – so on the 10,000 acres, the profit would be split 70-30.

In a cost sharing arrangement, everyone owns their own equipment etc. but they pool their resources to farm more efficiently. For example one company might own the combine and the other might own the seeder or sprayer. In the cost-sharing model, each company tracks their own results and they only pool expenses, not revenue, as they would in a joint venture.

Multiple partnerships occur when a farm is effectively working in different divisions such as grain and cattle. These divisions can be split into two separate partnerships where they potentially retain their own small business limits. There must be valid business reasons for creating these kinds of structures however.
There is an attack on the small business limit so one of the options to consider would be to not farm with your family or partners. Tax planning shouldn’t outweigh other cost benefits of working together but it could be part of the decision, given the current tax environment.

This issue is impacting more and more farm businesses every year. As that $10-15 million cap remains at 1994 levels, every year more businesses are being added to the issue because they keep growing and their value keeps growing so the impact of this regulation to agricultural businesses becomes greater every year.

Ron Friesen, CPA, CA, is a Business Advisor, Taxation Services with MNP. He can be reached at 306.664.8324 or email [email protected]