Incorporating your Farm or Ranch – Factors to Consider

In a previous column, we considered some of the legal implications involved in starting up a business. I promised that in this month’s column, we would discuss incorporating your farm or ranch, and what specific things you should consider.

I spoke to Barrie Broughton, a lawyer (and incorporated farmer) at North & Copmany LLP,  who has practiced in the area of farm, tax and succession planning for 27 years. Here are his comments:

“Family Farm Corporations have two main uses. The first is as a business tool to help the farm grow. The second is to allow family members, in a controlled manner, to participate in the farm, and to pay the least tax, as a family, to buy out the retiring parents and off-farm children. If you view a corporation as a tool, then it may or may not be the right tool for any particular family at that point in time. The families that use it for the right reasons accept both the costs and benefits and rarely complain. Those families that don’t use the corporation properly tend to blame the corporation for the farm’s woes. A family farm corporation is not for every family. Usually the family farm that plans to grow and continue as a viable operation will end up using a corporation as part of their business and succession strategy.”

Advantages

1. Small Business Tax Rate – easily the most important reason to incorporate – In Alberta, the tax rate for a Canadian Controlled Private Corporation is 16.12% on the first $300,000 of active business income each year. There is no cumulative limit. Between $300,001 and $400,000, the rate is 25.12%. Over that, it jumps to 33.62%. Active business income does not include investment income or capital gains. Because personal marginal tax rates are higher with even moderate levels of taxable income, it is possible to shelter earnings in a corporation and defer the payment of income tax to a later date. This is done by not paying out all the corporate earnings as dividends, wages, salaries or interest but by retaining a portion of the earnings in the corporation. This is referred to as retained earnings. This low tax rate promotes the growth of the farm, which is good for you and for your family.

2. Continuity of Operation – Being incorporated can provide a smooth means for succession planning, where a simple change in directorship and share transfer can replace a complicated property transfer to an heir or other beneficiary. Shares in a family farm corporation may be transferred from a parent to a child on a capital gain rollover thereby deferring tax liabilities on the shares to the succeeding generations. Corporate shares are easier and less costly to transfer to beneficiaries than is real and personal property such as cattle, grain, etc. It is easier to divide shares that are relatively low in value compared to say a quarter section of land with a much larger value. In layman’s terms, you can save tax and save complications.

3. Salary Paid to a Spouse, Children - A corporation is able to pay a wage or salary to an owner’s spouse and children, providing that the spouse and children did work for the business. Because of Canada's progressive tax system, total personal income tax payable is less to the extent that a husband, wife and children can split income between them rather than having all the income received by one spouse. The salary paid must be reasonable for the services performed (normally this would be the amount that you would be willing to pay someone not related, for the same work).

4. Limited Liability – Owners of a corporation enjoy some protection from creditors that is not available to owners of an unincorporated business. In a case where the farm economics begin turning for worse, the farmer may be able to avoid personal bankruptcy or other forms of personal liability. 

5. Employee Benefits for Owners – There can be a variety of further tax advantages for a farm corporation and its employees, including being able to deduct your employee’s expenses related to your business, including business use of vehicles. According to Technical News Bulletin No.22 from the Canada Revenue Agency, you can also pay for group and health benefits for your employees, without them incurring tax for those benefits. Here’s the really cool part: Your farm corporation can give two non-cash gifts per year per employee for special occasions where the cost to the employer is under $500 per year. You can also give up to two non-cash rewards per year per employee for recognition of special achievement not exceeding $500 per year. Both of these gifts are tax free to the employee and a business deduction to the farm corporation.

As you can see, there are a number of attractive aspects to incorporating as a farm or ranch, or any small business. Next month, I will put forward some disadvantages of incorporating, to help you decide if a corporation is right for you.