Many farmers are aware that there are “tax rollover” rules in the Income Tax Act (Canada) (the “Act”) that allow for their farmland and shares of their farming corporation to be transferred to their children without tax. However, these rules have many conditions that can catch people by surprise.
First, some background. Property that can create a capital gain or loss is referred to as capital property. Whenever a person transfers capital property to someone with whom they are related, the Act deems that transfer to occur at fair market value (regardless of the actual sale price). A similar rule states that whenever a person dies, that person is deemed to have disposed of all capital property at fair market value. These rules are designed to trigger all capital gains that have accrued on the property so that the government can tax those capital gains upon the transfer or death.
Farmers have the unique advantage of being able to transfer the shares of their farming corporation and their farmland to their children without triggering these capital gains taxes. However, the specific parcel of farmland and the shares of the corporation must qualify for the “farm rollover rules”. Unfortunately, these rules have many conditions. If even one of these conditions is not met, you can lose the rollover completely – and fall into a tax trap!
For farmland that is personally owned, one condition that must be met for these rules to apply is that the land must have been used principally in the business of farming. This means that the land must have been used in farming for more years than it was not.
What if you start to rent out your land? In that case (even though the renter is another farmer), the land is now being used by you for rental income, not farming. The best way to determine if this is a problem is to write down how long you have farmed each parcel of land. You can then compare this to how long you have rented the land out. You want to make sure you have farmed the land more years than you have rented it. There may be some parcels of land that you have acquired more recently and have less farming history. Those parcels of land could be a problem.
For shares of a corporation, the tests are even more complicated. The main test that causes people a problem is the “90% asset test”. The rule requires that “all or substantially all” (which the Canada Revenue Agency views to be 90% or more) of the fair market value of the assets owned by the corporation must be attributable to assets used in farming. Therefore, if the corporation has assets that are not used in farming, the shares might not qualify for the farming rollover. Some common problems are: assets used for a non-farming business (e.g. construction or oil servicing) or assets used for investment (e.g. rental property, investments or GICs). If the value of these “non-farming” assets exceeds 10% of the value of all the assets owned by the corporation, then you have a problem.
One asset that can be an especially sneaky trap is cash. Farmers may have extra cash on hand for an operating cushion or to fund equipment or land purchases. However, the CRA generally wants to see all of the cash in a business used at some point in the operating season. If the cash balance does not hit zero at some point, the CRA may view the “excess” to be a “non-farming” asset.
If a corporation has too much value in “non-farming” assets, the shares of the corporation will cease to qualify for the farm rollovers. This means that when the shares of the corporation are transferred to the children (either when both parents die or as part of a succession plan), the full capital gains on those shares will be triggered and tax will need to be paid. To make matters worse, because the shares of the corporation do not qualify under these rules, the farmland that is owned personally (and farmed by this corporation) may also fail to qualify.
If your farmland or farming corporation may not qualify under these rules, there is often planning that can be done to rectify the situation. Also, a properly planned corporate structure can be implemented to avoid these problems. This could involve creating an additional corporation to own the “non-farming” assets. A family trust can also be a useful tool in managing these issues. These are critical topics to consider when succession planning for your farm. The last thing that anyone wants (except perhaps the CRA!) is for unexpected and unnecessary tax to be triggered when parents pass their farming assets to their children.
Michael J. Deobald
STEVENSON HOOD THORNTON BEAUBIER LLP
500 – 123 2nd Avenue South, Saskatoon, SK S7K 7E6
The information in this guide is not legal advice. We encourage you
to consult with your legal advisor for specific advice.
This article was originally published in The Western Producer. Michael Deobald is a lawyer and partner with Stevenson Hood Thornton Beaubier LLP in Saskatoon.