PROPERTY TRANSFERS AND THEIR USE IN AGRICULTURAL TAX PLANNING TABLE OF CONTENTS IV. THE ROLLOVER 2

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1 PROPERTY TRANSFERS AND THEIR USE IN AGRICULTURAL TAX PLANNING TABLE OF CONTENTS I. THE SCOPE OF THIS PAPER 1 II. GETTING STARTED 1 III. THE FIRST INTERVIEW 2 IV. THE ROLLOVER 2 V. SHOULD THE CAPITAL GAINS EXEMPTION BE CRYSTALLIZED? 5 A. WHAT IS THE CAPITAL GAINS EXEMPTION? 5 B. WHY CRYSTALLIZE THE CAPITAL GAINS EXEMPTION? 6 1. Sale to a Spouse Sale to Children Pitfalls in Crystallizing the Capital 8 Gains Exemption 10 VI. CREATING LIFE ESTATES 11 VII. OTHER CONSIDERATIONS 12 APPENDIXES

2 PROPERTY TRANSFERS AND THEIR USE IN AGRICULTURAL TAX PLANNING I. THE SCOPE OF THIS PAPER Due to time constraints, I will present this paper based on the assumption that you are acting for the parents, rather than the children. I am also making the assumption that your male client is the farmer and that he is a sole proprietor when carrying out his farm business. II. GETTING STARTED The information you get from your client in getting started is crucial. When a client telephones to express an interest in utilizing the mechanism of property transfers to accomplish estate planning objectives, ask your client to bring the following information to your first meeting: (i Income tax returns for 1972 (if available, as well as the past 2 taxation years. (ii Notice of Assessment affecting all farmland for 1972 and the most recent year for which a Tax Notice exists. (iii A Net Worth Statement. The last one filed with the client's bank is appropriate, if one exists. Otherwise, have the client do his/her Net Worth Statement making sure to list all assets and liabilities. Ask your client to indicate whether buildings were acquired before or after Pre 1972 buildings are Part XVII assets and are treated differently for recapture purposes than are buildings acquired after 1972 (Part XI buildings.

3 2 I always recommend that the husband and wife come in together for the first interview. Later on, if appropriate, the parents may want the children to attend at your office to review the estate plan to determine if the children also deem it appropriate. III. THE FIRST INTERVIEW Find out the history of the farm. generation? Is it first, second or third Are any children involved in the farming operation with the parents? What do the other children do for a living. Where do they reside? Have the parents helped them out with loans, education, etc.? Have the parents complete the "Personal Income Schedule" and "Personal Spending Schedule" which is attached as Appendix "A" and "B" respectively to this paper. Determine the age of your clients. This is important when taking into account the "Age amount" tax credit and the Old Age Security Clawback. My assumption is that your male client is a sole proprietor. If he leases some land to a farming child or farms in a Joint Venture with his farming child, you may need to make some modifications when giving advice. This would include determining the obligations created under the Lease or Joint Venture Agreement. IV. THE ROLLOVER I will then assume that, based on all the information you have received from your clients, it is clear that they want to transfer

4 3 farmland and buildings to the farming child. "rollover provisions" with them. You should review the To help guide you through the analysis of whether to use a rollover or trigger a capital gains exemption, I have attached a "Farm Transfer Road Map" as Appendix "C". As you probably know, SSe 73(3 of the Income Tax Act provides for a rollover of qualified farm property to a child during the lifetime of the parent. The previous wording of this section provided that the farm property must have been used in farm business by the taxpayer, the taxpayer's spouse or children immediately before the transfer. Due to a recent amendment to the Income Tax Act, the word "immediately" has been deleted and the word "before" left intact. The addition of the phrase "principally in the business of farming" has been added. So now, the criteria is that the property was " before the transfer, used principally in the business of farming " The meaning of this amendment is not clear. However, discussions with the Department of Finance (as reported by the CBA/CICA Joint Committee on Taxation indicate that: " the amendments are intended to alleviate the requirement that the property be used in the business of farming immediately before the disposition by a family member and to facilitate a smoother transfer of farming properties between generations." "The Department of Finance used the example that if the real property had been farmed actively by father for 15 years, rented on a crop-share basis for 2 years and then transferred to his son who would actively farm the real property, the amendment would permit a rollover of the farm property. However, if father had farmed the property for 10 years, had rented the property out on a crop-share basis for 20 years and then transferred the property to his son who would actively farm the property, the rollover treatment would not be available."

5 4 The other considerations you must review with your client if s/he wants to use the rollover provisions are: (i the child (transferee must be a resident of Canada (ii the GST implications. If the property is being rolled over to a child who will use the property in the business of farming or will lease the farmland, self-assessment of GST can occur and the transferee can file a GST 60 form. If the child was not registered for GST prior to the transfer and will either be farming the land himself or herself or will be renting out the land, the child should register and obtain a GST number prior to the transfer. A GST 60 form can also be completed in these circumstances. If the child will not be deriving any income from the property after it is transferred, the child will not be eligible to register for GST. GST would not have to be paid by the child if the land is being transferred into the joint names of the parent and the child. Refer to Appendix "0" attached to this paper. (iii the cost base of the land after it is transferred to the child will be the parent's a.c.b. (iv the parent does not need to worry about losing the age amount tax credit or having old age security clawed back. (v the parent does not need to worry about the 2.2% provincial flat tax (vi the parent does not need to worry about the Cumulative Net Investment Loss Account

6 v. SHOULD THE CAPITAL GAINS EXEMPTION BE CRYSTALLIZED? A. WHAT IS THE CAPITAL GAINS EXEMPTION? 5 The February 22, 1994 budget did not make any immediate changes to the capital gains exemption of $500, which is allowed to farmers in certain situations. However, you should note that the government has struck a Committee to study possible amendments to the capital gains exemption and has been asked to make recommendations for change in October, For the time being, the $500, capital gains exemption remains available on "qualified farm property". "Qualified Farm Property" includes: - land and buildings used in the course of carrying on a farming business in Canada by: - an individual - if the individual is a personal trust, by a beneficiary of the trust - the spouse, child or parent of the individual - the family farm corportion/partnership - If the property was acquired after June 17, 1987: - during the 24 months preceding the transfer the property must have been owned by the farming individual, spouse, child, parent or family farm partnership and - the gross revenue from farming must have exceeded the income from all other sources for 2 years of the period of ownership or the property must have been used by a family farm corporation or family farm partnership throughout a 24 month period during which time the individual farmer was actively engaged in farming

7 6 - If the land and buildings were acquired before June 18, 1987, they must be: - used in the course of carrying on a farming business in Canada in the year of disposal or - used in the course of carrying on a farming business in any five years during the period when it was owned by the individual, spouse, child, parent or family farm partnership NOTE: The definition of "Qualified Farm Property" for the determination of eligibility for the Capital Gains Exemption is different than the requirements contained in SSe 73(3 for rollover purposes. Make sure to consult The Income Tax Act in all cases to ensure your client falls within the prescribed class of transferors. B. WHY CRYSTALLIZE THE CAPITAL GAINS EXEMPTION? The main benefit of crystallizing the Capital Gains Exemption is to take advantage of the ability to increase the cost base of the land in case there is a sale in future. The second benefit would be to take advantage of the present benefit conferred by utilizing this provision now, rather than hoping that this tax provision will not be changed in the future. I will now review the provisions as they apply on a sale to a spouse and secondly on a sale to children. 1. Sale to a Spouse Many farm clients are crystallizing their capital gains exemptions by transferring a joint interest in their farm property to their spouse. For example, assume the husband has eight quarters of farmland registered in his name. If he transfers a joint interest

8 7 in the farmland to his wife, he can crystallize the capital gains exemption on the value of a one-half interest in the eight quarters. You have to determine whether the goal of the couple is to split income in addition to crystallizing the capital gain. If the goal is simply to crystallize the capital gain, have the farmer sign a transfer whereby his wife receives a joint interest in the land as a gift from the husband. The farmer then elects under SSe 73 (1 to have the transfer occur at fair market value in the year of the transfer. (Note: There is no specific form to accomplish this election. This triggers a capital gain. If this route is taken, then all future income and capital gains will attribute back to the transferor spouse. If the goal is to split income, then the wife should pay fair market value for the joint interest she is receiving. This works well if the wife has cash on hand from her own savings or an inheritance. If she has no cash on hand, then the husband could take back a note from the wife. If the note is not payable on demand, then the husband can create a reserve. In addition, this may help minimize the Old Age security clawback and alternative minimum tax. If the note bears interest at commercial rates and interest is actually paid in full in each year, or within 30 days of year end then, in addition to the previously mentioned benefits of taking a note, there is also no attribution of income or capital gains. You must consider the GST implications. Refer to the letter from the Regina District Excise Office which is attached as Appendix "0". If the farming spouse simply creates a joint tenancy, there will not be any GST implications if the following conditions are met: (i The related person(s are not involved in the farming

9 8 business independently on their own account or as members of a partnership (herein referred to as the "non-farming joint tenants". (ii The non-farming joint tenants do not independently receive any proceeds from the farming business which is treated as income on their own account. (iii The non-farming joint tenant(s are not currently registered for GST or required to register as a result of being involved in a farming operation. They may be registered for reasons unrelated to the farming business. (iv The consideration paid by the non-farming joint tenant(s for their joint tenancy interest is nil or a nominal amount such as a dollar. If the spouse is going to give an interest bearing note back to her husband, then she should register for GST. As she will be using the land in a commercial activity, whether by actively farming it herself or leasing it, she will be eligible for self-assessment of the GST triggered on the sale through the filing of a GST 60 form. 2. Sale to Children The first question to ask when you are helping your client decide whether to crystallize the capital gains exemption when selling to children is: Will the child use the land in the business of farming? If the child will use the land in the business of the child's farming, there will not be attribution of the income back to the parent. If the child will lease out the land, the rental income will attribute back to the parent unless the child pays fair market value for the land and any indebtedness in favor of the parent bears interest at commercial rates and interest is paid in full during the year or by 30 days following the year end.

10 In either situation, any capital gain on a future sale by the child will not attribute back to the parent. 9 The Vendor parent may need to receive some payment from the child in order to meet the income needs of the parent. Or it may be the case that the parent does not actually require any income, but the parties wish to crystallize the capital gains. In either case, an Agreement for Sale should be drawn up to reflect the amount being charged by the parent. The parent can charge any amount up to fair market value. The parent can therefore trigger a crystallization of all of the gain or only a portion. The parent (or surv1v1ng parent can forgive some or all of the indebtedness in his or her Will. In order to prevent an "outlawing of the debt" there should be some sort of payment at least every 9 years. (Debts under an Agreement for Sale become outlawed if payments are not made for 10 consecutive years. If the parent is going to forgive all of the debt in his Will, or this is to be done in the will of his spouse, I would suggest that the Agreement for Sale provide that the payment is made every Christmas or on the parent's birthday so that the child remembers to make it. Be careful about the forgiveness of debt owed by the child. If a note is forgiven during the lifetime of the parent, section 80 of The Income Tax Act would be applicable to the forgiveness. This section deems the child to have received income equivalent to the amount of the forgiveness of debt. This deeming provision does not apply if the forgiveness occurs by bequest in a will. The only uncertainty for the child in this scenario is that the parents may change their wills at some future date and eliminate the provision that the debt is forgiven. As well, many of you have no doubt utilized the crossing of cheques to eliminate the child's debt. In other words, it has been the practice among many of us to have the parent make a gift to the

11 10 child in an amount equivalent to the purchase price or part of the purchase price. The child then takes this gifted amount and makes the payment for the land. There is uncertainty about whether Revenue Canada will view this as an avoidance transaction under SSe 245 (2. The better practice is likely to use the Agreement for Sale and specify payments to be made a minimum of every 9 years. Probably having even minimal payments, such as $ made once a year say, at Christmas, would be preferred so that the debt does not become outlawed by non-payment for 10 consecutive years. If the parent forgives the outstanding debt in his/her Will, Revenue Canada will not deem this to be avoidance. 3. Pitfalls in Crystallizing the Capital Gains Exemption Due to the fact that the taxable portion of the capital gain is included in the net income of the parent, items which are dependent on net income calculations can be affected. If the parent is over 65, the Old Age Security can be clawed back. Similarly, the parent could lose the Guaranteed Income Supplement. The "age amount" which is a tax credit of $3, could also be partially or totally clawed back. It is phased out at between approximately $25, and $49, of net taxable income. As the age amount is a tax credit and not a deduction, its actual after tax value is approximately $1, If the parent is receiving the Child Tax Benefit, this could be lost. If the parent has a Cumulative Net Investment Loss (CNIL account, this could prevent the parent from utilizing the capital gains exemption. This account has to be paid back first before the Capital Gains Exemption can be utilized.

12 11 In saskatchewan, the provincial government charges a 2.2% "Flat Tax" on net taxable income. To determine the amount of the flat tax, take the sale price, subtract the a.c.b., multiply that number by 75% and then multiply the resulting number by 2.2%. Eg. Land with a.c.b. of $20, and fair market value of $120,000. $100, $20, = $80, x 75%= 60, x 2.2% = $1, of flat tax. Minimum tax can also be triggered. To avoid this, you may want to create a reserve by having the purchaser provide a promissory note payable 30 days after demand. Make sure the GST issues are covered. If the spouse is receiving the interest in the property, in some cases, you will not want to have the spouse register. If the child is either purchasing or receiving the property as a gift, you will need to have the child registered unless the child will not be using the land in a commercial activity. In other words, if it is a transfer of legal titie only into j oint names, but the child is not going to be farming or leasing out the land, then the child need not register. Refer to Appendix "0". VI. CREATING LIFE ESTATES It may be that your client is prepared to have the land transferred to the child, but the parent requires some income each year to meet his living requirements. The parent and child are reluctant to commit to fixed payments. They would rather have the child pay over to the parent all or a portion of the crop grown on the land being transferred to the child. Under the Saskatchewan Land Titles Act, only a transfer creating a fee simple estate can be registered. A life estate cannot be created through the use of a transfer. However, a life estate can be registered by way of caveat. (Refer to s. 243 and 244 of The

13 Land Titles Act. 12 If the land qualifies as Qualified Farm Property and also qualifies for the rollover provisions as provided for in SSe 73(3, then the capital gains could be crystallized by having a sale take place at fair market value or any amount between the a.c.b. and fair market value. This is the case whether you elect to use the rollover or not. The issue is whether the rollover would apply. If the property does not meet the requirements set out in ss. 73 (3, then the fair market value of the life estate must be established. This is based on the life expectancy of the Vendor, interest rates and income which will be generated by the land. The fair market value of the life estate is deemed to be disposed of and then immediately reacquired by the Vendor. The remainder interest is the fair market value of the property less the value of the life estate. The question is whether the life estate is defined as Qualified Farm Property if the property would otherwise qualify as Qualified Farm Property. The answer to this question is not clear. VII. OTHER CONSIDERATIONS Always consider the impact of The Matrimonial Property Act when property is being transferred from parents to children. Is the child married? Should the child and his/her spouse enter into an Inter-Spousal Contract to provide for what will happen in the event their marriage ends. The February 22, 1994 Budget left the $100,000 capital gains exemption in place for Encourage your clients to trigger their $100,000 capital gains exemption on non-farm assets. Consider the impact of inter-vivos transfers on your clients' wills. Often carrying out this type of inter-vivos plan will result in changes being necessary in their wills.

14 Appendix nan RAME: DATE PREPARED: PERSONAL INCOKE SCHEDULE (HUSBAND AND WIFE TO EACH PREPARE ORE SCHEDULE EXPECTED DATE OF RETIREMENT: SOURCE OF INCOME Old Age Security Pension Guaranteed Income Supplement Canada Pension Plan Retirement Income (RRSP Proceeds Other Pensions Net Income Stabilization Account Interest and Dividends Farm Income Rents (Farm Payments on Accounts Receivable Interest Principal Annuity Payments Capital Portion Income Portion Insurance Benefits Salaries and Wages Others (Specify TOTAL INCOME CURRENT INCOKE $----- $----- PROJECTED INCOKE AT RETIREKENT $----- $-----

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16 Appendix "B" PERSONAL SPENDING SCHEDULE NAME: DATE PREPARED: EXPECTED DATE or RETIRDENT: Food Restaurant Meals Housing (or Rent - Property Taxes - Repairs &Maintenance - Insurance - Appliances & Furnishings - Cable Vision - Telephone - Electricity - Water & Sewer - Heating Clothing Entertainment Recreation Major Travel Medical &Hospital Education, Books & Newspapers Charitable Donations Automobile - Fuel & Oil - Repairs - Insurance - Replacement Allowance Interest Payments Principal Payments Life &Disability Insurance Premiums Savings & Investments Pension Contributions Business Expenses (Farm,Rentals,etc Capital Purchases Family Gifts Miscellaneous Expenses SUB TOTAL INCOME TAX & CANADA PENSION PLAN TOTAL EXPENSES (INCL INCOME TAX CURREHT SPENDING PROJECTED SPENDING AT RETIREMENT $----- $-----

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18 Appendix "e" FARM TRANSFER ROAD MAP FARM TRANSFERRED GST GST MINIMUM TAX usm IN IIJSINI:SS OF FABMIrG

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20 Revenue Canada Customs and Excise Revenu Canada Douanes et Accise Appendix no" Duncan Financial Management nd Avenue Regina, Saskatchewan S4R 1A6 A~~en~ion: Dear Mr. Re: Howard Duncan Duncan: Your lile Our life File #:Rl CN-3G0437 Misc. Tax Treatment of Joint Tenancy in Farmland Votre reference Notre reference District Excise Office 5th Floor, Avord Tower 2002 Victoria Avenue P.O. Box 557 Regina, Saskatchewan S4P 3A4 January 11, 1993 Thank you for your letter, dated December 29, 1992, requesting clarification of the application of the Goods ~nd Services Tax (GST on the transfer of farm property to a joint tenancy interest with a person related to the owner of the farm' property. It is the administrative policy of Revenue Canada-Excise/GST that the transfer of an interest in farm property from individuals who operate a farm into a joint tenancy with themselves and one or more related persons (such as a spouse, children or siblings will not have any immediate GST consequences if all the conditions outlined below are met: 1. The related persons(s are not involved in the farming business independently on their account or as members of a partnership (herein referred to as the "non-farming joint tenants". 2. The non-farming joint tenants do not independently receive any proceeds from the farming business which is treated as income on their own account. 3. The non-farming joint tenants are not currently registered for GST or required to register as a result of being involved in a farming operation. They may be registered for reasons unrelated to the farming business. 4. The consideration paid by the non-farming joint tenants for their joint tenancy interest is nil or a nominal amount such as a dollar. Canada Department of National Revenue (Customs and Excise Min',slere du Revenu national (Douanes et Acclse

21 If all these conditions are met, the non-farming joint tenants will not be required to pay tax on the supply of the joint tenancy or ~o register for the GS~. Based on the facts presented and the information provided, it appears that the transfer of the farm property into joint tenancy would satisfy the requirements noted above. Accordingly, the transfer of the property into joint tenancy would not be subject to GST. These interpretations are based on our current interpretation of the Excise Tax Act and regulations thereunder in their present form and do not take into account.the effects of any proposed or future amendments thereto or future changes in the interpretation. Further, while we trust that our comments are of assistance to you, we would advise you that they do not constitute a GST ruling and are, therefore, not binding on the Department in respect of any particular factual situation. If you require further information or have any other questions regarding the Goods and Services Tax, please do not hesitate to contact our office at YOR~1S='~~ Ron MacDonald Interpretation Officer Excise/GST