Current Income Tax Issues for Agriculture Presented by Vern H. Peters, CPA, CA Tax Partner (2016/01/26) Current Income Tax Issues > Incorporation > Succession > Exit 1
Incorporation Incorporation > In Saskatchewan, a Canadian-controlled private corporation pays income tax at a rate of 12.5% on the first $500,000 of active taxable income The tax rate will decrease by ½% per calendar year to 11% by 2019 2
Incorporation > Individuals (including those with partnership income) pay tax at graduated rates. The following are for 2015: First $44,000 26% Next $44,000 35% Over $138,587 44% > Starting in 2016 the mid bracket decreases from 35% to 33.5%. A new bracket is added for income over $200,000 48%. Incorporation > Likely many grain producers have already incorporated > In 2015 we are incorporating cattle producers May not have been taxable in prior years - May still have been deducting optional inventory adjustments from prior years Optional inventory adjustments may have been utilized in 2014 Cattle prices remain reasonably strong 3
Partnership to Corporation > Lifetime capital gains deduction (CGD) limit on qualified farm property currently at $1 million > What is included in qualified farm property? Farmland An interest in a family farm partnership A share of the capital stock of a family farm corporation Partnership to Corporation > A partner does not own the assets of the partnership > A partner owns the an interest in the partnership (similar to owning a share of a company) The value of the interest is essentially that partner s percentage of the fair market value of the assets less liabilities 4
Partnership to Corporation > Some of you may have operated your ranch as a partnership for at least 2 years Transferring farming or ranching partnerships to a company can create significant income tax benefits > Can transfer ranching partnership interests to a company and utilize the capital gains deduction to eliminate tax at the individual level Partnership to Corporation > The transfer of the partnership interest could create a significant shareholder s loan This loan can be repaid without tax at the individual level > Can save up to $349,000 if utilizing the full lifetime capital gains deduction of $1 million > If currently operating as a proprietorship should consider having a partnership for 2 years prior to incorporating 5
Proprietorship to Corporation > Income may be too high in the current year to wait for 2 years to incorporate after having a partnership > Transferring debt on cattle will require planning > May need to plan for income deferred into the next year Proprietorship to Corporation > Can gain access to income tax deferral Have larger after tax dollars to reinvest in the operation > Provides opportunity to split income with spouse and other family members > May provide an opportunity to exit ranching and reduce income taxes 6
Shareholder s Loan Market Tax Value Cost Partner Proprietor Inventory $ 750,000 $ - $ 750,000 $ - Deferred 250,000-250,000 - Equipment 500,000 200,000 500,000 200,000 Loans (150,000) N/A (150,000) (150,000) Shareholder's loan $ 1,350,000 $ 50,000 Potential savings $ 453,830 Farm Succession 7
Farm Succession > Becoming more prevalent as the baby boomers near retirement That generation seems less willing to continue to work until age 80 > Estate planning becomes an important subset of succession planning Succession may occur due to death Intergenerational Rollover > Shares of a family farm corporation can be transferred to the next generation without income tax consequences > Particularly important on the death of a shareholder and the shares are bequeathed to a child > Will also be important if wanting to gift shares during one s lifetime one can plan in advance for this 8
Intergenerational Rollover > At death, deemed to have disposed of assets > If shares bequeathed to a spouse automatic transfer at cost unless you elect out > If shares to someone else deemed disposed at fair market value If the shares are shares of a family farm corporation, the shares can transfer at any value between cost and fair market value Family Farm Corporation > Can only transfer without income tax consequences to the next generation if the shares meet the definition of a share of the capital stock of a family farm corporation > Must not have inactive assets, e.g., cash and investments that exceed 10% of the fair market value of the assets of the company 9
Purification > Should keep cash and investments below 10% of the fair market value of the assets > Simple methods Pay a dividend to remove the inactive assets Pay off debt Transfer in a productive asset, e.g., farmland, to remove the cash Purification > More complex methods Establish a sister investment company to hold the inactive assets - Allows for continued deferral of income tax at the individual level - Creates opportunity to bequeath investments to non-farming children Establish a family trust with an investment company as a beneficiary 10
Purification Example FARMCO Fair Market Value Active assets $ 7,653,559 Inactive assets 2,507,571 AgriInvest 101,703 $ 10,262,833 Current Structure Joe Farmer 100 common Farmer Farms Ltd. Active $7,653,559 Inactive $2,507,571 11
Investco Joe Farmer Joe Farmer 100 common 7,942,429 pref 100 common 2,057,571 pref Farmer Farms Ltd. Active $7,653,559 Inactive $650,000 Inactive $2,057,671 Investco Investco With a Trust Joe Farmer 100 common 2,057,571 pref Investco Joe Farmer Trustee Joe Farmer & Family Beneficiary Trust Beneficiaries 7,942,429 pref Farmer Farms Ltd. 100 common 12
Share Freeze > A share freeze is one of the more common methods to transition the farming operation to the next generation > Share sales with the seller utilizing the capital gains deduction are not usually preferred The next generation needs to pay for the shares at the individual level creates higher income taxes to obtain cash required to pay for the share purchase Share Freeze > Share sales (continued) The next generation is unlikely to sell the shares to an outside party - Most purchasers want farmland and do not want an operating company - The next generation would be unable to take advantage of the high cost base on the shares 13
Share Freeze > Typically all of the value of the common shares is frozen into fixed value preferred shares > Allows the next generation to obtain new common shares at nominal value > Future growth will accrue to the next generation > Mom and dad gradually redeem the preferred shares in future years Share Freeze > Redemption of preferred shares create taxable dividends for mom and dad > Cash for the redemption comes from future after tax income generated in the company > Provides protection for matrimonial issues with the next generation as long as mom and dad continue to have significant value in their preferred shares 14
Share Freeze > Allows for gifting of some or all of the preferred shares to the next generation at an appropriate time Shares need to meet the definition of a share of the capital stock of a family farm corporation Farm Exit 15
Farm Exit > Similar to cattle producers, grain producers who operate as a proprietorship may want to consider incorporation prior to the sale of grain and equipment Likely minimal expenses to offset the income Pay tax at 12.5% Gradually withdraw funds over future years to have dividends taxed at lower rates Farm Exit > Those with corporations will want to plan the timing of auction sales and commodity (grain and cattle) sales to maximize use of the low tax rates on the first $500,000 of taxable income 16
Companies with Land > Becoming more common to sell shares of a company that only contains farmland to another company Would need to remove other assets > The seller can access the capital gains deduction on the sale of shares > The purchasing company will receive a bump in the value of the land when the companies are amalgamated Companies With Land > It may make sense for many situations to have land owned by a sister company separate from the operating company Will allow for succession of the operating company to the farming child. Non-farming children could be included in the succession for Landco. Easier to sell the shares of Landco without having to remove assets of Opco 17
Companies With Land > May want to sell some land and retain some in the company Could use a hybrid sale Sell some land to a new company at fair market value Transfer some shares of Opco to Landco and utilize the capital gains deduction Sell these shares to the purchaser Companies With Land > If retaining some land in the company, will need to consider future arrangements for income from that land > Issues revolve around the taxation of that income and maintaining access to the intergenerational rollover rules and capital gains deduction 18
Land Income > Cash rent will be initially taxed in the company at a rate of 51%. The rate reduces to 20% as dividends are paid to individual shareholders. > Crop share likely would be subject to income tax at a rate of 12.5%. The Canada Revenue Agency has stated that they would treat crop share the same as cash rent. > A joint venture or custom farming arrangement should qualify for taxation at 12.5%. Land Income > If cash renting land in a company to someone outside of your family, you will lose access to intergenerational rollover and the capital gains deduction (CGD) for the shares if the land is cash rented for longer than it was used actively by family members > Cash rent is not active use of the land. Crop share likely is not active enough for rollover and CGD purposes. 19
Land Income > A joint venture arrangement likely would constitute active enough involvement in farming > A custom farming arrangement would be active enough Succession and Exit > Three of our senior partners are starting to transition more into consulting for succession and exit Tax Advisory addresses the income tax issues where these are the main factor The other partners would address soft issues and items such as cash flows required by parents and next generation Soft issues would include items such as the possibility of future matrimonial issues 20
Current Income Tax Issues > If you would like to have more information on topics included in this presentation, we can provide handouts to you on request Corporations Farm Partnership to a Corporation Purification of Companies Share Freeze Current Income Tax Issues > To request handouts: Call (306) 773-7285 and ask for Ashley Email abelon@starkmarsh.com 21