Should you incorporate your farm? It’s a decision with many moving parts, combining tax planning with growth strategies. And it’s a decision more and more farmers are making. The 2016 census showed about half of all Canadian farms were sole proprietorships, 23 per cent were partnerships and about a quarter were corporations.
Successful farms depend on smart, strategic thinking no matter what the structure. However, incorporating forces the use of accrual, not only cash-basis, financial statements and also allows you to bring in additional owners as shareholders and a written shareholders’ agreement.
Also, not all business assets have to be part of the farm corporation. If it makes sense for you, your farm corporation can be an operating company, with assets held personally outside of the corporation. Whatever you do, make sure the legal structure is professionally created with your family’s needs and goals in mind and in consultation with your accountant.
Although there are setup costs and it’ll likely cost you more for your annual tax filing and financial statements, the corporate tax rate is much lower than personal income tax rate in Canada. Depending on your farm’s income and personal draws, the income tax savings of having an incorporated farm can be significant. When you incorporate your farm, you only pay the higher personal income taxes on the income that you withdraw.
As in most farm decisions, it really comes down to cash flow and timing. In general, if you use all the profits from your farm to pay yourself or have an off-farm job that supplements the farm income, it might not make sense to incorporate yet. However, if you have money left over at the end of every year that you want to reinvest in your farm, or have successors in the wings, there are some strong tax reasons to consider incorporating.
The following example shows the tax benefits of incorporating a farm in Alberta, but each province has different tax rates so check with your accountant.In Alberta, if your farm makes an average of $100,000 each year, your personal income tax will be about $28,000. However, if your farm was incorporated and you only need to withdraw $50,000 per year, you would pay $12,500 of personal income tax and the farm corporation would incur income tax at Alberta’s small-business tax rate of 11 per cent, which is $5,500.
David Den Uyl, Tax Senior at BDO Calgary says the funds that would otherwise be used to pay tax (about $10,000 in this example), can be used instead to pay down debt or reinvest in your farm corporation.
Furthermore, as your farm grows and income levels increase, these tax deferrals become more substantial. More income will be taxed at the corporate rate of 11 per cent rather than at personal tax rates which, in Alberta, reaches 48 per cent. “The 11 per cent corporate tax rate applies to the first $500,000 of farm income, so an incorporated farm can grow to a significant size and still pay tax at the low corporate tax rate,” says Den Uyl.
With the corporate tax rates lower than personal tax rates, being incorporated can help shift the mindset from year-end reactive tax avoidance to consistent longer-term business and growth planning. Since farming can be taxed on a cash basis, farmers often pre-buy inputs and assets and defer sales to decrease the amount of personal income that will be taxed that year. Farm corporations can do this as well.
Furthermore, buying and paying back with money that has been taxed at a lower rate helps expand your farm’s capacity for reinvestment and expansion.
Many farms incorporate as part of their succession planning process, allowing for multiple shareholders and flexibility, including incremental ownership and assigning different types of shares to non-farming or retiring owners. “If you expect you will be transitioning your farm to your children, certain income tax provisions make it easier to transfer the shares of your farm corporation to the next generation than the actual assets themselves,” says Den Uyl. “A farm corporation can also allow you the ability to transition ownership of the farm to the next generation in a tax efficient manner or to simplify your estate for income tax purposes.”
For example, if inventory (such as livestock, feed or crops on hand) is used to operate your farm and is owned personally and you want to transfer it to your children, Canada Revenue Agency requires it to be sold at fair market value and you as the seller will have to pay the resulting income taxes. “If the inventory is in a corporation,” says Den Uyl, “its value is included in the corporate shares which can be transferred to your children at any value between zero and fair market value.”
For more detail, see Incorporating Your Farm Business at bdo.ca. For specific or other tax questions contact BDO’s Agricultural tax trusted advisor Dave Den Uyl at [email protected]. Maggie Van Camp is BDO national agriculture practice development lead, co-founder of Loft32 and CEO of Redcrest Farms Ltd.