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Your farm and the proposed tax changes

Two of the greatest impacts are the ability of a business to income split with related family members – not including aunts, uncles, nieces or nephews – and inter-generational transfers of farm property – such as land, shares of family farm corporations (FFCs) or an interest in a family farm partnership.

Tax on split income
Income splitting, or sprinkling, is the process of redirecting taxable income between family members to lower tax burden. Based on the draft legislation, split income is subject to the tax on split income (TOSI), which has now been extended to adults.

TOSI applies the highest tax rate to that income, which generally includes:

• Dividends and shareholder benefits from a private company
• Income received from a partnership or trust where the income is derived from a related business
• Interest on certain debt obligations (e.g. interest on loans to a related business)
• Income or capital gains from the disposition of certain property associated with a related business.

Related business will generally be a business carried on by a related individual, or by a partnership, corporation or trust where the related individual is actively engaged on a regular basis; a business of a partnership where a related individual has partnership interest; or a business of  corporation where a related individual owns shares of the corporation (or property deriving all or part of its fair market value from the shares of the corporation) with a fair market value equal to or greater than 10 per cent of the fair market value of all the issued and outstanding shares.

“So all our family-owned-and-operated farm operations will be considered a related business for the related family members, spouses, siblings, parents, grandparents, children, grandchildren and so on,” explains Kurt Oelschlagel, a chartered professional accountant with BDO Canada LLP.

TOSI exclusions
There are a number of exclusions, or safe harbours, from the TOSI rules.

One very important exclusion for farmers is that any capital gains from qualified farm property, which is farm property eligible for the lifetime capital gains exemption, or capital gains on death, are excluded and not subject to the TOSI. Income to spouses of business owners over age 65 is also excluded as long as it would have been an excluded amount for the business owner.

There is also a safe harbour for income or gains earned directly or indirectly by a person from an excluded business, generally a related business where the individual is actively engaged in the business. To determine this, the government has developed a “bright-line” test.

“If an individual works at least an average of 20 hours per week during the portion of the year the business operates, or in any of the five prior years, then the individual is considered actively engaged on a regular and substantial basis,” Oelschlagel says. “If this test is not met then it will depend on the facts and circumstances.”

This test is one area farmers have concerns. “We haven’t seen what the test is yet,” says Hall. “We are asking that it not be subjective.”

Seek professional advice
Oelschlagel says the changes are significant and recommends that farmers seek tax advice regarding their specific situation to see if changes are necessary. “The rules are very specific and complicated, so a one-size-fits-all solution is not possible. The solution must be tailored to each client and their specific situation.”

“With farm corporations, extra diligence will be needed to determine if one of the safe harbour exclusions can apply to each shareholder,” Oelschlagel says. “Family members who are actively engaged and fulfil the excluded business requirement should not have any issues.”

However, family members who own shares of the family farm corporation and are not active in the farm operation will be at risk. Planning will need to be undertaken to ensure to determine if they can take advantage of another exclusion, such as holding excluded shares.

“Share of the family farm corporation that are owned by another company, such as a holding company, or held by a family trust will be an issue and any producers with that type of structure should review it with their tax advisor,” Oelschlagel says.

Succession planning
As for succession planning, there should be no impact when farm operations are transferred to family members who will be active in the farm business. These family members will be able to receive income, such as dividends, and not be subject to the TOSI.

It will impact the ability to issue shares of the family farm corporation to family members who are not active in the business.  If they do not own excluded shares, then any dividend income will likely be subject to TOSI, Oelschlagel says.

“The capital gain on such shares will not be subject to TOSI as long as it is eligible for the lifetime capital gains exemption, but otherwise it will be,” he explains. “The definition of excluded shares has a lot of nuances right now. For example, shares of the family farm corporation held directly may qualify but shares held indirectly, say through a holding company or family trust, will not qualify.

“We need significantly more detailed guidance from the tax authorities on the interpretation of the various provisions.”

Oelschlagel points out that the proposed legislation is subject to interpretation in many areas.

“We have approached the government to get clarification and guidance, so things may change,” he says. “Unfortunately, the rules are complicated and expert advice will be needed.”

And there are more changes to come. Oelschlagel says the government is expected to introduce tax legislation in the 2018 federal budget that will affect corporations that hold passive investments. This may affect farmers who have built up other assets inside corporations, such as investment portfolios and rental properties.

The CFA agrees that producers need to seek qualified professional advice to understand the changes and how they will impact their family farms. “Farmers are a lot of things but we aren’t experts in tax,” Hall says.

MORE INFORMATION
Tax time can be confusing and stressful, and proposed tax changes can exacerbate the issue. Following is a list of links with information about Canada’s proposed tax changes:
 
Income splitting or sprinkling
www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/income-sprinkling/guidance-split-income-rules-adults.html
 
www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/income-sprinkling/frequently-asked-questions-income-sprinkling.html
 
Tax support for farming
www.fin.gc.ca/n17/data/17-100_1-eng.asp
 
General information
The Canadian Federation of Agriculture and BDO Canada websites also has more information: www.cfa-fca.ca/action-alert-ask-your-mp-to-rethink-tax-proposals
www.bdo.ca/en-ca/insights/industries/agriculture/how-the-proposed-tax-changes-will-impact-canadian-farmers/.

Provincial farm organizations also have information posted on their websites.

Be sure to seek qualified professional advice to understand the changes and how they will impact your family farm.