They aren’t going to work on every farm. Joint ventures are common in industries such as natural resources, energy and property development, but they haven’t yet found a real home in agriculture, and certainly not as a farm transition tool.
With the price of farm assets such as land and equipment soaring, though, and with the next generation of farmers facing more and more challenges to access the capital and build the equity they need, joint ventures may offer a very adaptable solution to some very tough issues.
But be forewarned. For a joint venture to work as part of a transition plan, the parties entering into it must be open-minded and flexible, and they must also be willing and able to review, negotiate and tweak the plan on an ongoing basis.
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In our February 2022 issue, Country Guide brought readers a detailed case study of a Saskatchewan joint venture being used to transition Doyle Wiebe’s farm to a non-family successor, Mark Thompson.
In this article, we explore some of the technical challenges, and their opportunities.
The essentials
Here’s where you need to start. “One of the biggest differences with a joint venture versus other business structures is that the parties are agreeing to come together and engage in some sort of business activity that they all hope to profit from, but they’re not agreeing to carry on a single business together,” says Aaron Haight, a lawyer with MLT Aikins LLP in Saskatoon.
“It usually is temporary in that fashion, often a co-ordinating of efforts, or a pooling of resources for a specific time, purpose or project, rather than an ongoing business partnership.”
This will become clearer as you look at the advantages of using a joint venture for, say, farm transition.
First, a joint venture is a fluid and flexible process that can be customized to suit different farming situations and changing circumstances over time.
“It’s a way of starting the transition process without implementing an entirely new business structure that has everyone and everything joined at the hip,” Haight says. “The participants can work together for a particular time period under terms that they have set out that they think will work for them. Then, they can reassess where they are after that. It’s the flexibility that a joint venture provides that can really provide an advantage for producers.”
The parties can maintain independent operations and even compete with each other. They are only bound to the terms set out in the actual joint venture agreement.
Another potential benefit of a joint venture is the fact that the parties earn business income rather than passive income from renting of land or equipment, which can provide potential tax benefits.
“Our tax structure is set up in a way that, especially for Canadian controlled private corporations (CCPCs), there is a heavy tax load if you’re earning passive investment income through a company,” Haight says. “The intention is to avoid people deferring tax forever by just holding their passive investments corporately, and encouraging the payment of dividends which are then taxed at the personal level.”
In this context, a joint venture is a business undertaking with an expectation of profit from its activities, so the income derived from the joint venture is business income. This avoids the specified partnership income rules, which limit the availability of a small business deduction when you have a partnership involved.
“Every CCPC has their own small business limit of $500,000 of income that’s taxed at low corporate rates, nine to 13 per cent depending on the province,” Haight says. “If you’re in a partnership, the rules allocate that $500,000 business limit among the partners.”
By contrast, each joint venture participant may be eligible for their own $500,000 small business limit, which may allow the joint venture participant to pay a lower corporate tax rate than if the participant was a member of a partnership.
Must assume risk
With a joint venture, an entering producer will start earning business income for their contribution to the farm. This can help them build their equity profile to show the bank. Meanwhile, at the other end, a producer who is downsizing may retain active business status for a period of time rather than just going from full-out active farming to completely passive landlord status.
But in order to have active business income, you must assume a certain amount of risk, Haight says. That’s where a joint venture is a good solution, because the parties agree upfront to pay a pre-decided percentage of the costs associated with the joint venture activities, and they also receive an agreed percentage of the profits.
To be able to claim active business status, Canada Revenue Agency requires proof of two things; first, that both parties have an amount of risk (i.e. responsibility for costs with a corresponding entitlement to share in revenues) and second, that both participate in the management of the business, which often suits the retiring farmer’s situation if he or she isn’t quite ready to slip the reins to the next generation.
“The farmer doesn’t have to be riding the tractor, but he or she does need to be actively involved in making farming decisions,” Haight says.
Where do joint ventures fit?
There are many scenarios where a joint venture could work well for farm transition.
“In the case of a farmer with no next generation of family to take over, there is always the question of when to pull the plug and have the auction sale,” Haight says. “By entering into a joint venture for a period of time, it can help him or her ease out of that process, both from a financial perspective, in terms of selling off assets and so on, and from a personal perspective of being able to take a gradual step back.”
Joint ventures can also help with challenges in a family transition. Questions can arise such as whether the kids become shareholders in the parents’ company, or do they try to run their own operation on the side but using the home farm’s equipment?
“The joint venture more closely matches practical realities, so the parents don’t have to commit to giving a share of the company to the kids, or them having to buy a share of their company,” Haight says. “Instead, the kids buy the inputs and rent the equipment from them and carry on a joint venture that way.”
Haight says he has also seen a joint venture work well in family situations where Mom and Dad are going to pass the farm down to their children, but the kids have not decided whether they want to farm together long-term.
“Rather than getting everybody into a single corporation and having to go through a lot of headaches to split everything up, they can enter into a kind of trial period with a joint venture, where they make changes in how they organize the farm, and split it up into multiple entities that may choose to work together for a few years or may choose to go separate ways,” Haight says.
The joint venture is a good way to trial a new farming arrangement without having to commit to a longer-term agreement that can be tricky and costly to change later, especially if assets and shares are divided up according to a rigid structure.
Why to get it in writing
“Taxpayers have the right to order their legal affairs to achieve certain tax treatments and, generally, our courts and the Income Tax Act respect the arrangements that people have put in place,” Haight says. “But, if someone runs into the question of is it a partnership, or a joint venture, absent a written agreement, you’re going to have a really tough time establishing some of those elements that distinguish between the two.”
It’s also important from a strategic business standpoint.
“The nice thing with a joint venture is you are not marrying everybody together forever,” Haight says. But get it in writing to ensure you tackle key questions. “What is the deal? Is it fair to all parties? Have all parties actually agreed to what’s going on? Do we have a plan for when or if we decide to go our separate ways? What does that look like? You can cover all those things in a joint venture context.”
Scenarios for joint ventures as a transition tool
The following fictional scenarios were developed by Aaron Haight and Erin Bokshowan, lawyers at MLT Aikins LLP in Saskatoon, for their recent presentation about joint ventures for the Canadian Association of Farm Advisors’ online tax and legal update.
One: A family transition
Parents are nearing retirement and want to pass the farm on to their children. They decide they are willing to transfer the operating assets to their children, but want to retain ownership of the farmland. The parents also want to participate in the management of the farm for a period of time, and the children want to use their own corporations to carry on the farming business.
“This scenario is ripe for the potential use of a joint venture,” Bokshowan says, with the following hypothetical structure.
The parents retain the farmland in their company, but move operating assets out to the companies that are controlled by their two children. Each of these three companies enter into a written joint venture agreement in respect of the operation of the farm. The parents contribute their land, some time and expertise to the joint venture, and the two children contribute any assets they own as well as their labour and expertise. The assets are employed in furtherance of the joint venture project.
Each of the three companies gets an allocation of gross revenues, and an allocation of expenses in respect of the farming joint venture and may realize some tax advantages, including the possibility of each being eligible for the small business deduction on their own business income.
As time goes on, the parties can review the parent company’s allocation of gross revenues and expenses, and the participation in the joint venture, and make adjustments regarding the contributions made, and the risks assumed by each of the parties.
Two: An arm’s-length transition
This scenario involves two neighbours. One is nearing retirement and wants to wind down the farming activities, but has no family to take over. This person owns the farmland and other assets and depreciable property used in the farm business.
The second neighbour is a young farmer who would like to grow and expand his or her operation and wants to take over the first neighbour’s business, but because of the size, they aren’t in a position to do that right away.
In this case, an immediate sale of all the assets might not be the best scenario for either party. Under a joint venture agreement, neighbour one brings the assets (such as land, buildings and equipment) to the venture, remains involved in the management, and assumes some of the risk of the operation. Neighbour two can immediately access the assets needed to expand his or her operation.
“Neighbour one has potential for significant tax savings,” says Haight. If the farming has significant inventory and finishes farming at the end of a calendar year, they will still be selling grain inventory the next year. Without the joint venture, they wouldn’t be able to access the small business deduction, though, because they need to still be actively carrying on business in order to qualify.”
That means the corporate tax rate that would apply to that income earned when the inventory is being sold would be significantly higher.
For neighbour two, being able to implement a gradual buyout over several years, as he or she builds their own equity through having access to more land and production equipment, means they don’t have to have as much capital up front in order to finance the whole arrangement.
“The nice thing about a joint venture is that because you’re not entering into a partnership, because you’re not shareholders in the same company, there’s an extra level of flexibility for the participants,” Haight said. “They can look at it every year and say did that work? If not, how do we need to change things next year? In a worst-case scenario, both parties just say, you know what, we tried it, it didn’t work, we’re actually just going to separate and go our own ways. Other than that contractual tie and the economic interest that is associated with that particular crop cycle, there’s not a whole lot that ties the two parties together.”
Setting up a joint venture: The questions that need to be answered
When, they sit down with clients to develop a joint venture arrangement for transition of a farm, Aaron Haight and Erin Bokshowan, lawyers at MLT Aikins LLP in Saskatoon, go through a series of questions to ensure that it’s going to meet the needs of everyone involved. These questions are outlined below.
One: What’s the goal?
“What type of joint venture are we looking to come up with,” asks Haight. “Fundamental to this conversation is the purpose, the root goal that ultimately the parties are getting at. We need to work through the dynamics and have our eyes fixed on the outcomes the client is looking for.”
Two: What are the percentages?
There are two approaches for determining the percentage of revenues and expenses that each person in a joint venture will be allocated.
An uncomplicated approach is to have a percentage that would be similar to those typically seen in something like a crop share arrangement, where the parties determine what is a fair share of the revenues and expenses of a crop allocated to a landowner versus the person who’s primarily responsible for the day-to-day farming operations.
A more complicated process is to look at the value of the resources being brought to the table.
“What’s the value of the farmland and other assets being contributed, the value of the time and labour being spent, and the financial risk assumed in the form of guarantees or access to lines of credit and that sort of thing,” Haight says.
Three: How deep to those percentages go?
“We know we’re talking about gross revenues and gross costs, but what types of costs?” Haight asks. “Are we just looking at the variable input level: seed, feed, fertilizer and that sort of thing? Are we moving to all variable costs, such as utilities, fuel and insurance premiums? What about fixed costs? What do we do about maintenance on equipment? If somebody owns all the equipment, how do we deal with potential breakdowns that could arise?”
Four: Is there business risk?
Risk must be assumed by all participants in a joint venture to ensure they can maintain active business status and the related tax advantages.
“Do we have things like production insurance?” Haight says. “Are we covered off on the asset insurance level? If there is some sort of liability brought on to the joint venture participants, we need to have some indemnification to make sure that, if there is a lawsuit that’s filed, everybody is named in it.”
Five: Who makes which decisions?
Depending on the number of people involved, there may be some governance questions.
Says Haight: “Questions to ask include: how do we handle the larger, higher-level decisions in terms of capital investment versus the day-to-day? Who tells the hired labour where to go and which field to work in today?”
Six: Will property be co-owned?
There are questions around co-owned property.
“If the parties are going to own property in common,” Haight says, “do they need to have a co-ownership agreement that governs that?”
Seven: The aligning process
Depending on the complexity and the degree to which everybody is intertwined with each other’s economic interest, how would they separate all that out again?
“How do we do so in a way that gives people flexibility while still making sure that the business is really sustainable over time?” Haight asks. “Questions that come when we look at termination are everything from ‘How do we deal with inputs that have maybe been applied to the land as part of a current crop year when we’re terminating at the end of the calendar year?’ ‘How do we deal with leases for land that has been used in the joint venture when people go their separate ways? ‘Do parties for the joint venture have the option to purchase assets of other joint ventures so that they can at least try to hold together a core part of the business?’”
