B.C. TRANSITION TOOLKIT FOR NON-FAMILY FARM TRANSFER – Stage 3
A corporation is a distinct legal entity, meaning it can do anything a person can, such as conduct business, buy, own and sell assets, hold debt, file tax returns, rent land and enter into contracts. However, a corporation does not have a finite lifespan, which opens up the possibility of continuity over multiple generations.
A farmer wanting to pass on their land to a non-relative could incorporate as a means to transition. This would usually mean turning a partnership or sole proprietorship into a corporation. A corporation can own the farm business, equipment, infrastructure, the land, or any combination of the above, depending on what’s best for the individuals involved.
Incorporation can provide a clearly defined timeline and mechanism for gradually transitioning ownership and management of a farm business to the entering farmer. For example, say the current farmer, George, has been operating a market garden as a sole proprietor for the last 20 years. To transition their farm business to an entering farmer, George will incorporate the farm business with the advice of an accountant and assistance of a lawyer. In the new structure, the farm corporation owns the business, and some infrastructure, such as a delivery truck and greenhouses. The business has been valued at $100,000. If the entering farmer, Lisa, bought into the company with savings of $20,000, she would then have a one-fifth stake in the corporation. As Lisa continues to work on the farm, she could take her earnings from the farm and put that back into the business, and over the course of two to three years become a 50% owner of the business, and eventually 100% owner as George completes his transition out of the farm business. That would give Lisa a controlling share in the company. Meanwhile, the corporation could be leasing the land and other infrastructure at an agreed upon rate from George, who still owns the land. This gives George income for retirement.
The intention to transition ownership of the land may or not be present. If an eventual purchase of the land by the entering farmer is not feasible, the farmer-landholder may decide that the corporation will inherit the land once they die, depending on the financial needs of the landholder’s family. However, because the landholder will be deemed to have sold the land at market value at the time of their death, consideration must be given to the ability to fund the estate’s resulting tax liability.
If a landholder’s family wants to continue to be involved in the farm, they could retain a stake by holding minority shares, or serving on a board of directors. Dividends from the business could potentially provide the current farmer’s heirs a financial benefit. Similarly, if the heirs are to be the landholders in the future, lease payments could provide a financial benefit. If the intention is for the entering farmer to eventually own the farm business but not the land, a registered lease can provide the farm business with the security and stability needed to justify the entering farmer’s time and investment.
Regardless of how the incorporation model is applied, a shareholder agreement is necessary. A detailed agreement outlining timelines, exit strategies, and financial considerations will ensure that the intentions of both parties can be effectively put into practice.
- What is a share? An indivisible unit of capital, expressing the ownership relationship between company and shareholder. A share is an easily quantifiable unit and makes for a very clear structure in ownership that can change over the course of the transition process: as the new farmer obtains more shares, they will have more control over how the business runs.
- What is a dividend? The portion of profit a shareholder receives from ownership of shares.
Considerations for Incorporation:
- When – and whether – to incorporate is a common question. There are many factors to consider:
- There is no magical numerical revenue threshold for incorporating, but a good benchmark may be looking at how much you’re earning and how much you need to live on. If your business is earning $100,000 and you only need $60,000 to live on, being incorporated would enable you to leave $40,000 in the corporation, and pay reduced income tax on that amount overall.
- An accountant can help you figure out if there are good business and financial reasons to incorporate, or if this step should be put off until it becomes advantageous.
- Limiting liability is often considered a sufficient reason to incorporate.
- Certain farm grants, loans and programs require incorporation.
- It’s important to have the trade name registered to the corporation, which costs an extra $50.
Taxes and Corporations:
- The corporate tax rate may be lower than personal income tax rates. For example, a B.C. corporation with a small business deduction currently pays corporate tax at 11% on farming income, which may be lower than the tax rate of an individual earning the same amount of farming income.
- There are unique tax benefits that farm operators may qualify for over their lifetime. It is not wise to merge the business of farming with other non-farming business in one corporation, as that will disqualify the corporation from accessing certain tax benefits only available to Family Farm Corporations.
- When farming is not the primary source of income for the operator, there are restrictions in place on the use of farm losses against non-farm income.
- If a property is currently personally owned, it is possible to transfer it to a company in a manner that does not result in current income tax. Additional planning and tax elections are required. However, once owned by a corporation, the property cannot come out of the company on a tax-deferred basis.
- Whether a property or shares of a corporation qualify for the capital gains exemption is an “all or nothing” test and can be difficult to apply in practical scenarios. A partial exemption is not available – the asset either qualifies or does not.
- The qualification for some of these tax provisions can become really complex really quickly, and some of it will be time based. (For example, should you farm the property, only to then rent it out later to an arm’s-length party).
Owning Land as a Corporation:
- If a corporation purchases land, the land can be bought using funds that have been taxed at the corporate level, meaning less pre-tax income needs to be earned to pay for the property.
- Property Transfer Tax must be paid every time that the ownership of property changes. It is quite common to put the land inside a corporation to ensure that should the farm/farm property be sold in the future; the shares can be sold without having to also incur Property Transfer Tax.
- The downside of having a company own the land is that this would require an additional step to ensure that the owner’s principal residence exemption is still available when the farm property is sold in the future. Tax planning is necessary to ensure that the ability to claim the principal residence exemption is maintained.
- If the residence is owned by the corporation, the shareholders need to pay fair market value rent to the company to avoid a taxable benefit.
- Land owned by a corporation must be leased to a related person or corporation that is using the land principally in a farming business in order to qualify for the Capital Gains exemption. If leased to another corporation, all or substantially all of the value of the corporation’s assets must relate to assets used in a farming business.
- If the land is owned by a corporation, it is the shares of the corporation that may qualify for Capital Gains exemptions, not the land itself. In other words, the shares need to be sold to utilize the Capital Gains exemption.
A joint venture is an agreement between two parties to work together towards common goals without legally entering into a business partnership, or merging operations. It allows individuals to combine resources but retain ownership of their respective businesses. Each party makes a contribution to the venture, which may include labour, investment, and depreciation, and shares a percentage of revenue and expenses based on their percentage contribution.
A joint venture is different from a partnership in that each individual party files taxes separately. A joint venture agreement should be individualized to meet the needs of both parties and allow collaboration and sharing of resources while retaining independence.
There are different types of joint ventures. An income joint venture may be a suitable type of interim solution for transition planning. In this type of joint venture, all expenses and revenue run through one bank account. Revenue is allocated to each member, according to their decisions around labour, roles and responsibilities. Infrastructure and equipment can be owned separately or together, but repairs, maintenance and operating costs are typically paid by the joint venture.
In a transition scenario, one party may have considerably more invested in equipment and land, but may contribute less and less labour as time goes on. Over time, the entering farmer may have more opportunity to pay for new equipment and other capital contributions.
Considerations for Forming a Joint Venture:
- Agree on values, goals and business strategy. Aligning the big picture vision is important and foundational for the rest of the process. For example, perhaps your agreed-upon value equation is to be a financially sustainable farm, a good employer and to maintain strong ecological stewardship practices. Define the terms.
- Agree on roles and responsibilities. If you have Standard Operating Procedures (SOPs), they will be very handy here! Work towards developing lists of common tasks and discuss who will do which tasks.
- Determine allocation of revenue and expenses based on agreed upon terms, e.g. 30% / 60% or based on hours with an agreed upon value.
- Determine when profits will be distributed.
- Designate on ‘Operator’ for the legal pieces, e.g. GST number.