Many farms that incorporate do so for tax purposes. After all, there are definite tax advantages available to a corporation and its shareholders that are not available to individuals or partnerships.
But farm businesses should be careful that they don’t let the tax tail wag the dog, says Jerry Lupkowski, a senior partner with MNP at its Portage la Prairie, Man. office.
“Tax is hugely important, but there are many more reasons to incorporate a business, such as protecting assets,” Lupkowski says. “We encourage our clients to take a look at the whole picture and make sure they’re not only getting the tax advantages of incorporation but also the creditor-proofing advantages.”
#1 Keep personal and business assets separate
Personal and business assets should be kept separate, and owners must decide which assets will be moved into the corporation and which assets will remain outside of it. Advisers often suggest that farmers keep their land under personal ownership, or in a separate holding company, rather than end up with all their hard-earned eggs in one basket.
“If a farm is properly incorporated, assets such as equipment or farm buildings will be inside the company, but the land remains as a personal asset outside of the company,” says Lupkowski. “This means that if someone accidentally gets run through the combine, it’s the company that gets sued because it owns the combine. It doesn’t mean that the spouse can’t sue the individual who owns the land but the chances are she will not be successful. If the land is not owned by the company, it’s not exposed in the event of this kind of situation.”
One of the first things farm owners have to get their head around when they incorporate is that the corporation is an entity in its own right, and they have to ensure that any business dealings for that corporation are done under the correct, full, legal name.
“If a farmer has incorporated the farm, he or she needs to tell all the creditors, suppliers, the bank, and everybody he or she deals with the new operating name for that corporation,” says Lupkowski. “If a farmer has been dealing with the same fertilizer company forever, it’s easy to get too comfortable with saying it’s for Jerry’s Farm, but now it’s no longer Jerry’s Farm, it’s Jerry’s Farm Ltd. So that is the name the fertilizer bill should be made out to, or Jerry could find himself personally liable for that bill instead of the company.”
But it’s not just about credit-proofing, adds Lupkowski. “It affects income taxes too, because if Jerry bought the fertilizer, the company can’t get a deduction for it because it’s not a business expense. Similarly, if Jerry bought a pickup truck, and it’s really a corporate asset, the corporation could have claimed the GST back if it had purchased the vehicle, but Jerry can’t. So for many reasons farmers should make sure they’re operating in the proper legal setting.”
Farm business owners should never use personal credit cards or personal lines of credit for their business because even if they’ve done a great job of sheltering personal assets, if they run all their input purchases, for example, through a personal credit card, they’re exposing those assets, adds Lupkowski. “The credit card company comes after the individual whose name is on the credit card,” he says. “It doesn’t see the company, even though the farmer bought the fertilizer or chemicals for the company. The reward points aren’t worth losing your house for.”
#2 Protect against dangers beyond your control
Similarly, assets need to be protected as much as possible from unforeseen, catastrophic events — such as BSE, food scares or trade issues — that can devastate the industry. “You weren’t negligent, you didn’t do anything wrong, so you need to ensure you, your family and what you’ve earned over the years are safe should you encounter something beyond your control,” says Lupkowski.
There are legitimate tax advantages to being a director of the farm corporation. Commonly a spouse is made a director so he or she can be paid a director’s fee to split income. But that can expose personal assets to unnecessary risks.
“You can be an owner or shareholder without being a director,” explains Lupkowski.
“If your business doesn’t succeed and you have your spouse listed as a director, they’re liable to third-party creditors, and things such as unpaid employee wages, GST, PST or payroll deductions. If they have assets outside of the business, it’s maybe a good idea not to make them a director to safeguard those personal assets if things go wrong.”
#3 Have a shareholder’s agreement in place
Protecting assets from third-party creditors is one thing, but all too often the real threat to personal and business assets can come from within.
Farm businesses, especially those that only involve family members, can be far too complacent about their business relationships, which means they don’t plan ahead for a situation where things go sour because of a family dispute or marital breakup.
“When things are going well, that’s the time to get all your documents in place because everybody’s willing to work with you,” says Lupkowski. “When things are looking sketchy, it’s too late to fix it.”
“It’s a situation,” he adds, “that’s more common that we would like to see.”
A shareholder’s agreement will help protect everybody when things aren’t going according to plan. “Often, when I advise clients that they should have a shareholder’s agreement in place they’ll say, but why? It’s just me and my spouse,” says Lupkowski.
“But if the marriage goes sideways,” he explains, “chances are they’re not thinking to their best business abilities. Emotions are clouding judgment. An agreement sets out how they will work through the situation from a business standpoint.”
Such an agreement will cost money to cover having it drawn up properly, and hopefully the agreement will never have to be used, Lupkowski tells clients, “but it’s worth its weight in gold if they ever have to.”
#4 Negotiate a limited personal guarantee
Borrowing money is a fact of life for most businesses, and it’s not uncommon for a bank to request a personal guarantee to secure a loan or line of credit. But that doesn’t mean anyone needs to feel pressured or obligated to sign on the dotted line.
“All too often people are fearful of the bank, and I really think they need to take a different view of it,” Lupkowski says. “The bank is a partner in the business, and owners need to talk to them when times are good, not only when times are tough.
“Just because they put a personal guarantee in front of you doesn’t mean you have to sign it,”
he adds. “If you’re a well-run operation, you’ve got good information, and you’ve got good people on your team, you’ll be attractive to many banks, and you may be able to negotiate a limited personal guarantee up to a certain dollar amount.”
For example, if both you and your business partner have limited personal guarantees on both sides, the bank may agree to have one partner be good for half the debt, and the other partner can be good for the other half.
#5 Treat cash an an asset, and protect it
Cash is an asset that most people don’t treat like one. If the business is successful and cash accumulates, that’s good, but it’s not always best to just let it sit there.
“That cash is the shareholders’ equity, so if you’ve got lots of retained earnings you should strip that equity out into a separate entity, perhaps a holding company, so it’s not at risk should the business not continue to be successful,” says Lupkowski.
It might be necessary to lend some money back to the business once in a while, but if that happens, security for the loan should be properly registered to make sure you don’t end up behind a lineup of unsecured creditors, such as suppliers, if something goes wrong.
“People will say, it’s my company, I control it, I can take the money out whenever I want, and that’s true when times are good. But when times get tough, if you have registered proper security against the assets of your business because you’ve lent it money, it puts you in front of non-registered creditors,” says Lupkowski. “The banks are usually going to be in front of you, but at least you’ve got claim against the assets versus just being lumped into the pool of unsecured creditors. It’ll be the best insurance you’ve ever bought, if you need it.”
There should also be activity on the loan from time to time, such as charging interest or taking a small repayment, because loans that sit for more than seven years with no activity are not required by law to be repaid.
The same applies for assets that are transferred into the business. “If you transfer the combine which you own, and which the business has not paid you for, to the business, you should register a General Business Security Agreement on it, which means the serial number of the property is recorded and properly registered,” says Lupkowski.
Parking cash into investments is a good idea, but they also have to be chosen carefully. “From a creditor-proofing standpoint, Registered Retirement Savings Plans are secure and safe, but Tax-Free Savings Accounts are not, which is one more thing to consider when you’re making your investments,” says Lupkowski.
#6 Don’t go to Hawaii on the business
At the same time, a business owner can’t treat corporate cash as his or her own unless it’s paid out as wages or directors fees, which are taxable. “You may own the company but the company owns the cash in the bank,” says Lupkowski. “People can easily get into trouble from a tax standpoint because if they borrow money from the company to buy a personal asset — say to buy a boat, take a holiday, or to build an extension on their house — that is a taxable transaction.
“You have to make sure all your suppliers, creditors, and everybody knows whether you’re dealing with them on behalf of yourself, or on behalf of the company, so that any assets you have outside the company aren’t inadvertently put at risk because they thought they were dealing with the individual, rather than the company.”
Make sure the business has adequate insurance to cover any accidents involving business owners or employees, whether they occur on or off the farm, and be cognizant of environmental and health-and-safety issues.
“One thing to remember is that you don’t even need to be at fault,” says Lupkowski. Also recognize that if someone decides to sue you, the legal costs can become significant.
“Running a business is risky, so spend the time now to look at potential liabilities and get some professional advice to help lower your risks.”