Structuring your farm operations as a partnership of two or more individuals before incorporation can result in a significant tax benefit after incorporation. Here is how it works:
The capital gains deduction (CGD) can be used to offset the capital gain income from certain farm assets including land, farm corporation shares and farm partnership interests. The CGD however can not be used to offset income such as the sales of grain or recapture of depreciation from the sale of equipment.
The grain and equipment can be transferred from a sole proprietor to a partnership by utilizing a tax free rollover election (‘rollover’). The partners then would each own a percentage of the partnership, i.e., they directly own a partnership interest and the partnership owns the farm assets such as the grain and equipment. These partnership interests can be sold to the corporation which may result in a capital gain which can be offset with the CGD if the partnership has existed for at least 2 years. The net result is that the grain and equipment still reside in a corporation on a tax free basis and the partners now have a shareholder loan owing to them by the corporation. This shareholder loan can be used to withdraw cash from the corporation on a tax free basis.
- Grain value $200,000, cost for tax purposes is $0
- Equipment value $200,000, cost for tax purposes is $50,000 (undepreciated portion)
- Partnership interests value $400,000 after tax discounts
If the grain and equipment went directly into a corporation on a rollover basis, a $50,000 shareholder loan would result.
If a partnership was used first the shareholder loan would be $400,000, an additional $350,000 resulting from the use of the CGD. This would save you up to $124,000 in income taxes over time. The savings would have to be weighed against the additional costs and complexities discussed below.
Although the benefits can be significant, the following issues should be considered:
- The partnership has to be farming for at least 2 years before incorporation; therefore the low corporate tax rate is unavailable for that period.
- This uses up some of the CGD which has a $1 million lifetime limit for qualified farm property
- The partnership, and the rollover of the assets to it, should be set up and documented properly which will result in additional professional fees.
- The partnership should have its own Goods and Services Tax (GST) number.
- Some complexities can arise with bookkeeping, farm programs, etc., where the structure changes from one operator to partnership and then to corporation.
Should you require additional information please contact your Chartered Professional Accountant.