Not surprisingly, the national media focused on proposals like the new tax-free Canada Child Benefit program when the Justin Trudeau government presented its first federal budget back in March.
Buried underneath all the feel-good news, however, were some potentially painful changes to Eligible Capital Property (ECP) tax rules for incorporated businesses.
Common examples of ECP include incorporation expenses, customer lists, franchise rights… and farm quota.
For supply-managed farmers who want to sell quota that is held in a corporation, these changes will impose an extra tax burden on the gain in value, and the change is going to happen soon.
Starting on January 1, 2017, the capital gains arising from the sale of farm quota will be treated in a new way, with potentially costly implications for famers.
“The new federal budget will result in a significant increase in the upfront income taxes you’ll pay when selling quota that is owned by your farm corporation,” says Lisa Kemp, chartered accountant and partner with BDO Canada in Lindsay, Ont.
In general, the idea is to move away from ECP to a new property class under a Capital Cost Allowance (CCA) account. All businesses with an ECP account at December 31, 2016 will have to transfer these assets to a CCA account.
That may not seem important, until you go to sell those assets.
Currently, these capital gains are treated as normal business income with a maximum income tax rate of about 26 per cent. However, starting in 2017, capital gains from quota sales will be treated as investment income with an initial tax rate of about 50 per cent.
For example, consider broiler quota that was bought 20 years ago for $30 per unit and put into a farm corporation with a current value of $130 a unit. The capital gain is $100 per unit so if the farmer sells 50,000 units, half of the gain ($50 per unit, which totals $2.5 million) under the new rules will be taxed as investment income. That gain will be taxed up to 24 per cent more than under the current system, so potentially, in this case, $600,000 more will go to pay taxes.
That’s on top of the $650,000 currently being paid.
One mitigating factor is that the taxed portion of the gain can be distributed to shareholders as an ineligible dividend. Although this is subject to a potential partial tax recovery when taxable dividends are paid, it could still be a big hit for many farmers wanting to retire.
The bottom line is that next year, business owners’ exit strategies will become much less tax-effective than was possible under the phased-out ECP. “Income tax estimates that producers may have previously had done regarding a potential quota sale will no longer be valid for quota sales after 2016,” says Kemp.
The official government statement was that this change is intended to simplify ECP under CCA rules, something that was initiated in 2014. However, if that’s the case, it raises a question as to why depreciation was set only at seven per cent (and then descends) for those assets.
The resulting message to small business is to penalize the use of smart business structures.
For farmers, is it simply a grab at some of the proceeds from lucrative quota sales, or a tax warning to address the high value of quota?
As part of this package, the 2016 budget also now allows small balances of ECP to be carried over to the new CCA class to be deducted more quickly. Under the current ECP regime, 75 per cent of an eligible capital expenditure is added to the new CCA account and is deductible at seven per cent per year on a declining-balance basis.
As a result, if you are planning to buy quota, you might want to talk to your accountant about buying it soon to maximize the depreciation. The changes also allow up to $3,000 in incorporation costs to be deducted as a current expense, so about 80 per cent of newly incorporated businesses will be able to deduct the full amount of the incorporation expenses in their initial year.
However, the big impact is on a sale of quota. If your quota is in a corporation, it might be a good time to look at your tax liability situation on the sale of that quota. Beyond outright selling it before the end of the year, some farmers might consider doing a share freeze and reorganization of quota ownership within the same family, perhaps through the use of a second corporation. “While this will result in prepaying income taxes before a third-party quota sale, the objective would be to pay the quota tax under the old rules at more favourable income tax rates,” says Kemp.
Should you undertake a corporate reorganization or a non-arm’s-length transaction to crystallize the gains before the end of the year?
This might not be wise for all situations, but in some circumstances it may be worth considering.
Kemp says if you’re thinking of selling corporate-owned quota soon and want to keep and re-invest the money in your corporate business, there may be motivation to do so before December 31. Also, some planning might help someone who is looking to get money outside of their corporation and take out corporate surplus tax efficiently.