Income from farm partnership: computation and reporting by individuals

Farm partnership tends to be the preferred choice of operating arrangement for many farm operators that stop acting as sole proprietors. Many of these farm partnerships are operated by immediate family members. As we head into the individual income tax filing season, it is the ideal time to refresh some of the key principles on computation and reporting of farm partnership income by individuals.

Income computed at partnership level

Although a partnership is not a separate legal entity, the Income Tax Act (“the Act”) requires a partnership to compute income as if it were a separate person, who is a resident in Canada. Income computed at the farm partnership level is allocated to the partners who report it in their tax returns and pay tax accordingly. If you are registered with the AgriStability and AgriInvest programs, you will report your information of farm activities in form T1163. If you are not registered, you will report in form T2042.

The partnership is not required to file an income tax return, but you may have to file an annual information return (T5013). Under the Canada Revenue Agency’s (“the CRA”) administrative policy for the 2018 fiscal year, farm partnerships made up of individuals do not have to file a T5013 return¹. However, a farm partnership that includes a trust or a corporation still has to file a T5013 return. The CRA’s administrative policy for each year will be posted on its website.  

Cash method allowed and inventory adjustment to reduce losses

In computing the income from a farming business, the farm partnership may elect to use the “cash” method, which is helpful in aligning the tax situation to match the cash flow situation. However, if your farming operation results in a net loss, you may have to decrease your loss by inventory purchased and still owned at the end of the year². Any amount included in income due to this adjustment is deductible in the following year.

Allocation of income or loss among partners

Allocation of income or loss among partners has to be stated in the partnership agreement. Partners should be aware that the sharing of income among partners needs to be reasonable. Under the Act, where income is shared between non-arm’s length members of a partnership in a manner that is not reasonable – giving consideration to the capital contributed or work performed – the CRA may reallocate the income in a way that it deems reasonable. Keeping track of each partner’s working hours and/or capital contributions would assist in supporting a reasonable position to the CRA.

Claiming farm losses

The ability to claim farming losses is determined at the individual level and not the partnership level. Losses cannot be deducted if farming is not a business (i.e. hobby farmers). The deduction of the net farming losses of each partner whose chief source of income is neither farming nor a combination of farming and other source of income is restricted to the amount (up to $17,500) annually determined under the Act. Unused restricted farm losses can be carried back three years and forward 20 years, but only against farming income. Non-restricted farm losses are fully deductible against other income and can also be carried back three years and forward 20 years. For a detailed discussion of restricted farm losses, please see Farm Alert, Restricted Farm Losses Bulletin.

Investment tax credit and donations

Because the partnership does not pay tax, the Act provides that each partner is entitled to claim his or her reasonable share of the investment tax credit (ITC) that would have been available to the partnership. You can claim ITC on expenditures for scientific research and experimental developments, incurred by you or contributions made by you to an agricultural organization. An example on contributions made to an agricultural organization would be, if you are a dairy farmer operating in Ontario, you will receive a statement from Dairy Farmers of Ontario stating the amount of your qualifying expenditures for ITC purposes.

Charitable donations and political contributions paid by the partnership must be added back to the partnership income before it is allocated to the partners. As a partner, you may claim a credit for your share of charitable donations and political contributions made at the partner level to the extent that such deductions are permitted.

Salaries cannot be paid to the partners

Salaries paid by a partnership to its partners do not constitute a business expense, but they are considered a method of distributing income among partners. A farm partnership that employed your spouse or common law partner can deduct that person’s salary/wages, assuming it incurred the expense to earn farming income, the wages were reasonable and that person was not a partner.

Leasing assets and lending money to the partnership

The farm partnership may lease property (land, machinery, etc.) owned by a partner. The rent is an expense of the partnership and income of the partner. In addition, a partner may lend money to the partnership, which is not precluded from entering a lender-borrower relationship with a partner under which interest paid would be property income. Such property income would be recognized as such by the partner.

Capital assets

Purchase of capital assets must be capitalized by the partnership. The expenditures on depreciable assets (quota, machinery, equipment, building, etc.) will be eligible for capital cost allowance at the partnership level. The rates at which capital cost allowance may be claimed vary according to each asset. The partnership itself has the choice of claiming maximum capital cost allowance available to it each year.

Partners may own depreciable property that is used in the farming business but held outside the partnership.  Assets of one class owned by the partner personally are not in any way grouped or combined with assets of the same class owned by the partnership. Capital cost allowance for depreciable assets owned by a partner is calculated by the partner and claimed separately from the partnership income. 

When a partnership disposes of capital property, the taxable capital gain or allowable capital loss is allocated to the partners. A partner then includes such gains or losses on his/her tax return. If a partnership allocates a capital gain to a partner who is an individual, that gain may qualify for the lifetime capital gains exemption of each partner, but only if it arises from the sale of qualified farm property.

Your Baker Tilly farm tax advisor can help you understand these rules and determine the reporting requirements for your personal income tax return.