As advisors, we are often asked whether farmland should be held in a corporation or personally. The question arises often in the context of incorporating farming operations. Previous Farm Alerts discussed the merits of incorporating as a way of reducing taxes due to low corporate tax rates and deferral of personal income. It is important to consider the tax impact of current and future transactions involving the farmland to become comfortable in that decision.
Many family farm corporations will structure their operations such that the land is owned by the shareholders outside of the corporate structure. There are obvious benefits to these arrangements, such as access to the capital gain and principal residence exemptions, which are not available to corporations. Additionally, if a farmer operates multiple farms, owning the farmland personally may assist in future succession planning if there is more than one child involved in the farming operations and they decide to farm separately at a later date. Alternatively, the strategy may assist in equalizing estate assets between active and non-active farming children.
Shareholders should be cautious where corporations make improvements to personally owned farms. At times, a corporation may build a new barn or add drainage to a farm using lower corporate after-tax funds to purchase or finance the improvements. Section 15(1) of the Income Tax Act sets out rules specifically designed to confer a taxable benefit onto the shareholder if corporate funds are used for their benefit. In such cases, the shareholder would be taxed on the cost of the capital improvement.
The risk can be reduced where the corporation and shareholder enter into a leasing or sharecropping arrangement to rent the property from the shareholder. The terms of the arrangement should consider the useful life of the capital improvement. For example, if the corporation builds a new barn, the agreement at a minimum should be termed out over the useful life of the barn. In addition, the agreement should stipulate that, if the farm is sold at any time during the agreement, the shareholder is obligated to purchase the capital improvement at its fair market value at the time of the sale. Inclusion of lease or sharecropping terms and mandatory purchase will mitigate the risk of a taxable benefit being assessed.
It remains possible that the Canada Revenue Agency could assess a taxable benefit at the end of the agreement if it determines there is still a residual value in the capital improvement. Careful consideration is thus required in determining an adequate term.
It may become necessary for a shareholder to transfer farm property into a corporation. At that point, the shareholder may consider crystallizing their lifetime capital gains exemption. Other advantages may include the creation of shareholder loans, which can be paid back to the shareholder tax-free, and creating a more straightforward business structure that has all assets inside a corporation. In addition, if the farmland carries a mortgage, the debt may be paid off quicker inside a corporation using lower after-tax corporate dollars.
In such cases, it will be important to assess whether land transfer tax may apply. In Ontario, an exemption on the land transfer tax may be available if the shareholder was farming the land in their personal capacity prior to the conveyance. However, if the shareholder decides to transfer the farmland into the corporation a few years after incorporating the farming operations, land transfer tax may apply. If the shareholder was farming the land under direction of the corporation prior to the conveyance (i.e., income and expenses are on the corporation’s books before the transfer), the exemption may not apply.
Contact your Baker Tilly advisor for help in making wise decisions involving your farmland and for capital improvements made by a corporation to shareholder-owned farms.
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