Purifying your farm corporation
Purified farm corporations have access to some major tax advantages, including the lifetime capital gains exemption and the ability to transfer assets to the next generation at cost. In order to qualify for these opportunities, 90 per cent of your farm corporation’s assets need to be active farming assets. If non-farming assets exceed 10 per cent, you will no longer qualify unless you remove some of these assets. This article will take a closer look at the tax opportunities available to purified farming corporations and the steps you can take to ensure you have access to them.
The lifetime capital gains exemption
Each individual farmer has access to a lifetime capital gains exemption of $1 million. When you sell your farm corporation’s shares, you can use that $1 million exemption against the capital gains realized on those shares. While many other business owners would be forced to pay tax in this situation, you would be sheltered. However, if your farm corporation is not purified, you have to pay tax on the entire taxable capital gain, whether it’s from a sale or a transfer within the family.
Transferring assets at cost
Purified farm corporations also have the ability to transfer value to the next generation at cost. In any other business, this transfer of shares has to be done at fair market value, resulting in a capital gain, whether you’re alive or the transfer happens upon death through your will. The government allows these special rules for farmers to compensate for the unusually high cost of assets in their industry versus others. However, if your farm corporation is not purified, it will not qualify for the special tax treatment farming corporations receive.
Farming or non-farming assets?
You have to look closely at each asset to determine whether it qualifies as a farming or non-farming asset, but this is more complicated than it seems. Some farmers have assets they mistakenly believe to be farming assets, including short-term investments and farm elevators. In addition, any assets associated with a secondary business related to a farming business would not qualify as farm assets, even if they are dealing with farm commodities. For example, some farm corporations have a second “division” (e.g., a trucking business) operating in the same company as their farming activity.
When farming assets become non-farming assets
We frequently encounter confusion surrounding trucking businesses because they own trucks and use them to transport feed or other commodities, but they don't qualify as farming assets if the business uses them primarily for additional trucking. Similarly, it might seem obvious to classify a tractor as a farming asset, but if you use this vehicle to do custom work for other farmers more than half the time, it won't qualify.
One way to prevent these types of non-farming assets from exceeding 10 per cent in your corporation is to establish a second company. Once you have two corporations, you can assign farming assets to one and non-farming assets to the other.
Managing money
The most common non-farming asset in a corporation is cash. In a case where a company owns multiple farms and one of them is sold for $1 million, the company has this cash, while continuing all other farming activity. Since this cash is a substantial non-farming asset, it is likely to bring your percentage of farming assets below the required 90 per cent. There are several ways you can solve this problem. You could take this money out (subject to tax, depending on your situation), invest it in a new farm or farming assets, transfer it to a different corporation or set it up as another corporation. However, simply loaning the money to one of your non-farm companies is insufficient because this leaves you with a loan receivable, which is still an asset – and that asset may cause you to exceed the non-farming asset limit of 10 per cent. Fortunately, with some special tax work, you can bring your total back down to 10 per cent or less.
Risks and rewards
If you fail to speak to an advisor and adequately understand the issues related to purifying your farm corporation, the consequences could be disastrous. For example, if a company worth $10 million has non-farming assets in excess of 10 per cent, it needs to pay tax on a gain of several million dollars, rather than just making a transfer to the next generation at cost. In this example, you might have to sell other farms or assets simply to pay the tax bill. As for the capital gains exemption, you can save roughly $250,000 in taxes if you use your full $1-million exemption. If your spouse is also involved in the operations, the tax savings could exceed $500,000. To make the most of these opportunities, be sure to consult with an advisor and ensure you have a viable estate plan in place.
Luc Joye
The drawbacks of deferring taxes
Luc Joye