Like any other business person, you have several options when it comes to choosing the legal business structure for your farm operation. In deciding which option will best suit your unique situation, the issues you will need to consider are: taxation, liability, ownership or management control, resources and exit strategies applicable to each type of organization.
In this article and the next two, we will discuss the pros and cons of the three most common farm business structures — proprietorships, general partnerships, and corporations. Beyond this discussion, there are still other structures you might consider, including joint ventures, trusts, co-operatives and limited partnerships.
The 2006 Statistics Canada Census of Agriculture, which has the most recent figures available, indicates that the number of farms in Canada has declined to approximately 230,000. The number of larger farms with gross farm receipts of $250,000 or more has increased by almost 14 per cent since 2001, while those with less than $250,000 in receipts declined by 10.5 per cent. Even with this growth in larger operations, about two-thirds of the farms in Canada still are at the lower end of the income scale, having less than $100,000 in total gross farm receipts each year. Many of these farm operators depend on off-farm income.
When it comes to the operating structures of Canada’s farms, the majority (57 per cent) are operated as sole proprietorships. Another 27 per cent are operated as partnerships and 14 per cent as family corporations. The remaining two per cent are operated as either non-family corporations or some other form of operating structure.
WHAT IS A SOLE PROPRIETORSHIP?
Under a sole proprietorship you are the sole owner of the farm operation; the business does not have a separate legal existence. You have legal title to the property, and you are self-employed. It does not matter how many people are working on the farm or whether they are family or non-family employees. You alone will collect the profits, pay the taxes, own the assets and incur any liabilities.
THE ADVANTAGES OF SOLE PROPRIETORSHIP
The main advantage of a sole proprietorship is that you have total management and ownership control of the operation. As well, you do not face the legal complications or extra expenses, such as accounting and legal costs, associated with other structures like corporations. No transfer of assets is required to the business. As well, no legal agreements or registration of a business name are needed for a sole proprietorship, so startup is simple.
While a sole proprietorship has these pluses, this type of business organization also has several drawbacks for you to consider.
THE DISADVANTAGES OF SOLE PROPRIETORSHIP
First is the issue of liabilities. If you operate as a sole proprietorship, you put both your business and personal assets at risk. You are liable for all payments or actions, whether incurred personally or through the business. If you are sued for a farm accident, whether involving yourself or an employee, your home and personal assets could be in jeopardy. If you farm only part-time and have off-farm income, you could be putting significant personal assets at risk for a part-time venture.
In addition, the resources available to the farm operation are limited by what you personally can bring to the business. This means that the efficiency of a farm family proprietorship typically will be inconsistent over the years. When you first start up, your efficiency may be low as you accumulate assets. As you grow your net worth and your ability to accept risk, your operation’s efficiency likely will increase as well. But then, when you start to think about retirement, you could become more conservative and less willing to accept risk — and your efficiency likely will decline again.
This cycle of varying farm efficiency can be avoided by transferring the farm during a time of peak efficiency. However, with a sole proprietorship such transfers do not often happen until the owner’s death.
And that raises one of the biggest potential negatives associated with the sole proprietorship structure: estate planning and transfer of assets can be difficult.
Upon the death of the sole proprietor, the income taxes are due in that year’s income. The tax rates could be very high, as much as 46.4 per cent in Ontario for example. Tax-effective sale of the farm assets could be a problem since having to sell in order to settle an estate rarely brings the best price for those assets. Nevertheless, because of the $750,000 capital gains exemption and the extensive rollover rules applying to farm capital properties transferred to spouse and/or children, a “deemed disposition” on the death of the proprietor will not usually result in a substantial tax liability for the estate.
Many of the farm operations in Canada that are operated as sole proprietorships would likely be better served by some other form of business structure. That’s true partly because of the unique rules that apply to agriculture, but also because a farm is more than a business. In making a decision regarding what form of business structure would best suit the goals you have for your farm operation, you should consult with all parties involved, including your tax and legal advisors. CG
This article was prepared by FBC tax analyst Larry Roche. FBC has specialized in farm tax matters for 55 years, and now serves 50,000 members from branches in British Columbia, Alberta, Saskatchewan, Manitoba and Ontario. You can visit the FBC website atwww.fbc.ca. If you have any questions about this article, please send an e-mail message to[email protected] or call 1-800-860-7011 tollfree.