Having lots of cash is never a bad thing and can sometimes be hard to imagine after a very challenging year like 2021. However, for the purposes of the Income Tax Act (Canada), having too much cash inside of a farming corporation can be a problem and can result in the loss of certain tax benefits.
Individuals who hold shares of a family farm corporation (a “Qualifying Share”) are generally entitled to the following advantageous tax rules:
- Intergenerational Rollovers: In general, when a taxpayer transfers shares of a corporation to a non-arm’s length person (such as a family member) there will be a taxable gain (or loss) on the transfer equal to the difference between the cost of the shares to the taxpayer and the fair market value of the shares at the time of the transfer. However, Qualifying Shares can be passed from one generation to the next without triggering any immediate tax if the child or grandchild is a resident of Canada. This transfer can occur as a gift or a sale.
- Lifetime Capital Gains Exemption: Individuals resident in Canada may claim the lifetime capital gains exemption (“LCGE”) of up to $1,000,000 on the disposition of Qualifying Shares.
These rules are particularly important when planning to retire or transfer the farm to the next generation.
At a very high level, to be a Qualifying Share, (i) more than 50% of the fair market value of the assets of the corporation must be attributable to assets that were used at least 50% in the course of carrying on a farming business (“Active Assets”) throughout any previous 24-month period, and (ii) at least 90% of the fair market value of the corporation’s assets must be attributable to Active Assets at the time of the disposition.
If the corporation has too many assets that are not considered Active Assets, the shares will cease to qualify for these rules. This could result in the whole value of the farm being taxed (not just the inactive assets). Excess cash, financial investments, and assets used in businesses other than farming can all lead to this problem.
The Canada Revenue Agency (the “CRA”) has provided some general comments on the amount of cash or near cash (such as GICs or financial investments) that it would consider to be used in active business:
- Cash is considered active if its withdrawal would destabilize the business.
- Cash which is temporarily surplus to the needs of the business may be considered to be used actively in the business.
- Cash balances which accumulate and are then depleted in accordance with the annual seasonal fluctuations of an ongoing business will generally be considered to be used in the business, but a permanent balance in excess of the corporation’s reasonable working capital needs will generally not be considered to be so used as an active asset.
- The accumulation of funds in anticipation of the replacement or purchase of capital assets or the repayment of a long-term debt will not generally qualify the funds as active.
- Cash may be active if its retention fulfills a requirement which had to be met in order to do business, such as certificates of deposits required to be maintained by a supplier.
- Cash held to offset long-term liabilities will not generally be considered active.
In the farming context, there are some key items in the above list from the CRA to consider. First, cash balances that exist after selling grain but will be later depleted in funding next year’s inputs are likely active. Second, cash balances that are never utilized in the growing season are likely a problem. Third, cash that is being stockpiled to buy land or equipment or to pay off long-term debt is likely a problem.
The above commentary from the CRA should be kept in mind when determining whether excess cash is being built up inside of your farming corporation. The CRA’s view of “active cash” is much narrower than what most people would likely expect.
The good news is that if you find yourself in a situation where you have surplus cash or investments sitting inside of your farming corporation, there are ways to “purify” the corporation so that its shares can qualify for the intergenerational rollover and LCGE. There are often planning opportunities available to remove excess cash and/or investments from a corporation without triggering any taxes. Furthermore, planning can be undertaken to ensure that there is a tax efficient means of extracting surplus cash from your corporation on an ongoing basis.
It is especially important to consider this topic as part of the retirement and/or succession planning for your farm.
Michael J. Deobald
STEVENSON HOOD THORNTON BEAUBIER LLP
500 – 123 2nd Avenue South, Saskatoon, SK S7K 7E6
Telephone: 306-244-0132
Email: mdeobald@shtb-law.com
Garrett Leedahl
STEVENSON HOOD THORNTON BEAUBIER LLP
500 – 123 2nd Avenue South, Saskatoon, SK S7K 7E6
Telephone: 306-244-0132
Email: gleedahl@shtb-law.com
This article is provided for general informational purposes only and does not constitute legal or other professional advice and does not replace independent legal or tax advice.
This article was originally published in The Western Producer on November 4, 2021.