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In past articles, we have discussed the capital gains deduction and the assets a farmer might own that qualify for the deduction. We also discussed the use of a partnership in a farming operation. In this article, we will discuss the potential use of the capital gains deduction on the incorporation of your farm partnership.
In order for the sale of a farm partnership interest to qualify for the deduction, the majority of the partnership property must have been used in the business of farming in Canada in which the individual selling the partnership interest, his or her spouse, one or more of their children, or one or more of their parents was actively engaged in any 24 month period before that time, and at the time of sale, virtually all of the property was so used. This definition should be reviewed in detail prior to undertaking the transactions described in the next paragraphs.
Assuming the definition is met, a farmer could decide to sell all or a portion of his or her partnership interests to a corporation. The value of the partnership interest is based on the value of the assets held by the partnership. This would generally be farm inventory, deferred sales, buildings and equipment. Note the key difference here, the sale of their partnership interest, not their inventory, buildings, equipment, etc. As a result, as consideration for the sale, a farmer is able to take back a shareholder loan from the company that is equal to the value of the partnership interest less the share capital received. Unlike certain other transactions dealing with related parties, at this point the Canada Revenue Agency (“CRA”) has not set up any roadblocks to completing the transaction in this manner.
For example, assume the partnership interest is worth $1,000,000 and it’s adjusted cost base is nominal. Should the farmer be willing to use his capital gains deduction on this transaction, he would be able to take back a $750,000 shareholder loan and $250,000 in shares. The shareholder loan could then be repaid to him/her from the excess cash generated by the corporation, likely over a longer time period. The repayment of the shares would be taxable as dividends, resulting in a maximum tax liability of approximately $78,000.
Had the farmer not been in a partnership, and wished to incorporate his farm, he/she would have been forced to take back share consideration for the entire $1,000,000. On the repayment of the shares, depending on the time frame in which the repayment took place, tax in excess of $300,000 could have been realized. Given the above example, a savings in excess of $220,000 would have been realized.
So, what have we accomplished? In reality, with proper planning and structuring, we have allowed the farmer to use his capital gains deduction on the transfer of his inventory, deferred sales, buildings, and equipment to the corporation. The goal now, assuming the total value of these assets is in excess of a single capital gains deduction, would be to maximize the number of capital gains deductions available on the transfer. This goal can be obtained through many different means, including ensuring the partnership structure is in place early in the farm’s life cycle, or possibly through the gifting of partnership interests.
Many other items need to be considered when contemplating the incorporation of your farm partnership. The right time for completing the transaction, planning for the capital gain on your farmland should your capital gains deduction have been used up on the partnership incorporation, planning for the partnership interest value in excess of your capital gains deduction, the impact on your agri-stability reference margin, to name a few. Your local MNP Tax advisor can help you through all of these considerations to allow you to realize the maximum benefit of your capital gains deduction.
For further information, please contact Jeff Henkelman, CA, Ron Friesen, CA or Jaymon Hill, CA at 306.665.6766.
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