Top Tax Benefits of Incorporating Your Farm in Canada

In the ever-evolving landscape of Canadian agriculture, farmers are constantly seeking ways to optimize their operations and maximize financial benefits. One strategy that has gained significant traction is the incorporation of farm businesses. The tax benefits of incorporating a farm in Canada can have a profound impact on a farm’s financial health, offering opportunities for tax savings, strategic planning, and long-term growth. This approach is reshaping the way agricultural enterprises manage their finances and plan for the future.

For Canadian farmers considering this option, it’s crucial to understand the various advantages that incorporation can bring. From lower corporate tax rates to enhanced possibilities for income splitting, the benefits are far-reaching. Incorporation also opens doors to capital gains exemptions, provides flexibility in compensation structures, and can play a vital role in succession and estate planning. Moreover, it offers avenues to improve retirement planning strategies, potentially leading to a more secure financial future for farm owners and their families.

Lower Corporate Tax Rates

One of the most significant advantages of incorporating a farm in Canada is the access to lower corporate tax rates. This benefit has a substantial impact on the farm’s financial health and growth potential. In 2023, the combined federal and provincial tax rate for incorporated small businesses in Ontario is 12.2%, with the federal rate at 9% and the provincial rate at 3.2%. This reduced rate applies to farm operations with an income of CAD 694,000.08 or less, making it particularly beneficial for small to moderate-sized farms.

Small Business Deduction

The Small Business Deduction (SBD) is a key factor in reducing the corporate tax burden for qualifying Canadian-controlled private corporations (CCPCs). This deduction lowers both federal and provincial taxes on active business income up to the small business limit. In most provinces and territories, this limit is set at CAD 694,000.08, with Saskatchewan being an exception at CAD 832,800.10.

It’s important to note that there are restrictions on accessing the SBD. For larger CCPCs, the deduction may be reduced based on the corporation’s taxable capital in Canada. If a corporation’s taxable capital exceeds CAD 13.88 million, it faces at least a partial reduction of its small business limit in the following year. For taxation years beginning on or after April 7, 2022, access to the SBD is eliminated once taxable capital in Canada surpasses CAD 69.40 million.

Tax Deferral Opportunities

Incorporating a farm opens up valuable tax deferral opportunities. The lower corporate tax rate allows farmers to keep more money within the corporation, which can be reinvested in the business or used to pay down debt faster. This deferral can be particularly beneficial for farmers with significant debt loads, as it provides more after-tax cash to repay their obligations more quickly.

One strategy to take advantage of tax deferral is through the use of bonuses. For farm corporations using the accrual method of accounting, declaring a bonus at the end of the fiscal year can be deducted in the current year but not taxed personally until the following calendar year. This creates a short-term deferral opportunity, as the bonus is deductible to the corporation if paid within 180 days of the corporation’s year-end.

Reinvesting Profits

The lower tax rate on corporate income provides farmers with more funds to reinvest in their operations. This reinvestment can take various forms, such as purchasing new equipment, expanding operations, or improving existing infrastructure. The ability to reinvest profits at a lower tax rate can significantly enhance a farm’s growth potential and long-term sustainability.

For example, the federal government introduced an accelerated capital cost allowance opportunity in November 2018. This allows farmers to deduct one and a half times the normal amount of capital cost allowance for equipment purchased after that date. This accelerated depreciation can help offset tax deferrals and facilitate the transition from a personally owned farm to a corporately owned one.

It’s crucial to remember that while the lower corporate tax rate offers substantial benefits, it’s essentially a tax deferral. Eventually, when funds are withdrawn from the corporation for personal use, additional personal taxes will be due. However, this deferral can provide significant advantages in terms of cash flow management and strategic reinvestment in the farm business.

In conclusion, the lower corporate tax rates available through incorporation offer Canadian farmers a powerful tool to improve their financial position. By taking advantage of the Small Business Deduction, exploring tax deferral opportunities, and strategically reinvesting profits, farmers can enhance their operations’ efficiency and profitability. However, it’s essential to work closely with a tax professional to navigate the complex rules and restrictions surrounding these benefits and to ensure that the incorporation strategy aligns with the farm’s long-term goals and succession plans.

Income Splitting Possibilities

Incorporating a farm in Canada opens up valuable opportunities for income splitting, which can lead to significant tax benefits for farm owners and their families. This strategy allows for the redistribution of income within a family group, taking advantage of lower tax brackets, deductions, and credits available to each family member. By effectively splitting income, farm corporations can potentially reduce the overall tax burden on the family unit.

Paying Salaries to Family Members

One of the most straightforward methods of income splitting is paying reasonable salaries to family members for their contributions to the farming business. This approach has several advantages:

1. Lower Tax Brackets: By paying salaries to family members in lower tax brackets, the farm can reduce its overall tax liability. This is particularly beneficial when adult children or a spouse are involved in the business but have lower personal income levels.
2. RRSP Contribution Room: Paying salaries to family members allows them to generate Registered Retirement Savings Plan (RRSP) contribution room. This can be an effective way to enhance retirement planning for the entire family.
3. Tax Deductibility: The farm corporation can claim a deduction for reasonable salaries paid to family members, reducing its taxable income.
4. Canada Pension Plan (CPP) or Quebec Pension Plan (QPP) Participation: Paying salaries allows family members to participate in these pension plans, potentially improving their long-term financial security.

To make the most of this strategy, it’s crucial to ensure that the salaries paid are reasonable for the work performed and the age of the family members involved. The Canada Revenue Agency (CRA) has no issues with this approach as long as two key conditions are met: the work was necessary for earning income, and the payment was reasonable for the type of work done.

Dividend Distributions

Another income splitting possibility for incorporated farms is the distribution of dividends to family members who are shareholders. However, it’s important to note that recent changes to tax laws have introduced some limitations:

1. Tax on Split Income (TOSI) Rules: These rules, expanded in 2018, apply to certain adult family members and additional types of income. They specifically target private corporations and have significantly reduced opportunities to split income through dividends with family members who are not active participants in the business.
2. Eligible vs. Non-Eligible Dividends: Incorporated farms need to be aware of the distinction between eligible and non-eligible dividends. Eligible dividends are taxed at a lower personal income tax rate, recognizing that they are paid from corporate income taxed at full corporate rates. Non-eligible dividends, on the other hand, are taxed at a higher rate as they are considered to be paid from income that has benefited from preferential tax treatment at the corporate level, such as the small business deduction.
3. General Rate Income Pool (GRIP) and Low Rate Income Pool (LRIP): These accounts track amounts that can be designated as eligible dividends (GRIP) or must be paid as non-eligible dividends (LRIP). Understanding and managing these pools is crucial for optimizing dividend distributions.

While the TOSI rules have limited some income splitting opportunities, there may still be benefits to allowing family members to own shares in the farm corporation, especially if the shares could qualify for the capital gains exemption in the future.

In conclusion, while income splitting through incorporation offers significant tax benefits, it’s a complex area of tax planning. Farm owners should work closely with tax professionals to navigate these rules effectively and ensure compliance with CRA regulations. By carefully structuring salaries and dividends, incorporated farms can still achieve substantial tax savings while providing financial benefits to family members involved in the business.

Capital Gains Exemption

One of the most significant tax benefits of incorporating your farm in Canada is the Lifetime Capital Gains Exemption (LCGE). This exemption allows farmers to shelter up to CAD 1.39 million of capital gains from taxation when selling qualified farm property. This provision has a substantial impact on succession planning and retirement planning for farm owners.

Qualifying Farm Property

To take advantage of the LCGE, the property being sold must meet the criteria for qualified farm property. This includes:

1. Real or immovable property used in farming, such as land and buildings
2. Shares of a family farm corporation
3. Interests in a family farm partnership
4. Certain intangible capital property, like production quotas

For property to be considered qualified farm property, it must generally be owned by the individual, their spouse, child, or parent for at least 24 months immediately prior to disposition. Additionally, the property must have been used principally (more than 50%) in the course of carrying on a farming business in Canada.

The usage requirements vary depending on when the property was acquired. For property purchased after June 17, 1987, there are additional criteria related to gross revenue and active engagement in the farming business. These requirements ensure that the LCGE benefits genuine farming operations rather than passive investments.

It’s important to note that if a farm is leased to tenants or involved in a sharecropping arrangement, it may be considered rental income rather than farming income, potentially disqualifying it from the LCGE. Farm owners should be cautious about such arrangements and consult with tax professionals to ensure they maintain eligibility for the exemption.

Multiplying the Exemption

One of the key advantages of incorporating a farm is the potential to multiply the LCGE across family members. This strategy can significantly increase the total tax savings when selling farm assets. Here are some ways to multiply the exemption:

1. Family Partnerships: Setting up a valid family farm partnership allows partners to split capital gains and each use their own LCGE. However, the partnership must exist for at least two years prior to disposition, and income allocations must be reasonable in relation to capital invested or work performed.
2. Family Farm Corporations: Properly structured family farm corporations allow multiple family members to own shares. When these shares are sold, each shareholder may be eligible to use their own LCGE, effectively multiplying the total exemption available to the family.
3. Family Trusts: A well-structured family trust can allow for the multiplication of the LCGE among beneficiaries, including spouses, children, and grandchildren. This can be particularly effective for sheltering large capital gains from taxation.
4. Intergenerational Transfers: In some cases, farm property can be transferred to children at cost, allowing them to sell the property and access their own LCGE. However, care must be taken to avoid triggering immediate capital gains if there’s a plan to sell within three years of the transfer.

By strategically incorporating and structuring ownership of farm assets, families can optimize their use of the LCGE and potentially shelter millions of dollars in capital gains from taxation. This can have a profound impact on estate planning and the financial security of future generations involved in the farming business.

It’s crucial to work closely with tax professionals and legal advisors when implementing these strategies, as the rules surrounding the LCGE and farm incorporation are complex and subject to change. Proper planning can help ensure compliance with tax regulations while maximizing the benefits of incorporation for Canadian farm families.

Flexibility in Compensation

Incorporating your farm in Canada offers significant flexibility in how you structure compensation for yourself and your family members. This flexibility can lead to substantial tax benefits and improved financial planning. By carefully considering the various compensation options available, farm owners can optimize their tax position while ensuring compliance with Canada Revenue Agency (CRA) regulations.

Salary vs. Dividends

One of the key advantages of incorporation is the ability to choose between paying salaries and distributing dividends. This choice has important tax implications:

Salaries: Paying salaries to yourself and family members who work in the business allows you to take advantage of lower marginal tax rates. It also generates Registered Retirement Savings Plan (RRSP) contribution room and enables participation in the Canada Pension Plan (CPP) or Quebec Pension Plan (QPP). The corporation can claim a deduction for reasonable salaries paid, reducing its taxable income.

Dividends: Distributing dividends can be an effective way to split income among family members who are shareholders. However, it’s crucial to be aware of the Tax on Split Income (TOSI) rules, which have limited traditional income splitting opportunities since 2018. Dividends are taxed differently than salaries, with eligible dividends receiving more favorable tax treatment than non-eligible dividends.

The optimal mix of salary and dividends depends on various factors, including the corporation’s income level, personal tax brackets, and long-term financial goals. It’s no longer automatically beneficial to “bonus down” to the small business limit, as was common in the past. The tax integration cost – the difference between corporate and personal tax rates – has decreased, making it sometimes more advantageous to retain income within the corporation.

Bonuses and Other Benefits

Incorporating your farm also allows for strategic use of bonuses and other benefits:

Bonuses: For farm corporations using the accrual method of accounting, declaring a bonus at the end of the fiscal year can be deducted in the current year but not taxed personally until the following calendar year. This creates a short-term tax deferral opportunity, as the bonus is deductible to the corporation if paid within 180 days of the corporation’s year-end.

Employment Benefits: Corporations can provide certain benefits more efficiently from a tax perspective. For example:

1. Automobile leases: In some situations, it may be beneficial for the company to lease a vehicle used for both business and personal travel. The corporation can deduct lease payments up to certain limits, while only two-thirds of the amount is treated as a taxable benefit to the employee.
2. Health care premiums: Premiums paid by the corporation for private health insurance plans are generally deductible to the corporation and not a taxable benefit to the employee, effectively allowing these premiums to be paid with pre-tax corporate profits.
3. Individual Pension Plans: As an alternative to RRSPs, incorporated farm owners can consider setting up Individual Pension Plans, which may offer higher contribution limits and additional tax planning opportunities.

By leveraging these various compensation options, incorporated farms can achieve significant tax benefits while providing financial security for farm owners and their families. However, it’s crucial to work closely with tax professionals to navigate the complex rules surrounding compensation and to ensure that all arrangements comply with CRA regulations.

Enhanced Retirement Planning

Incorporating your farm in Canada opens up additional avenues for retirement planning, offering significant tax benefits and financial security. Two key strategies that can be particularly advantageous for incorporated farmers are Individual Pension Plans (IPPs) and Corporate-Owned Life Insurance.

Individual Pension Plans

An IPP is a defined benefit pension plan that a corporation, including an incorporated farm, can establish for its owner or key employees. This retirement planning tool is particularly beneficial for farmers over 50 years old who earn more than CAD 138,800.02 annually. IPPs allow for higher contribution limits compared to Registered Retirement Savings Plans (RRSPs), enabling farm owners to save more for retirement while enjoying tax advantages.

One of the primary benefits of an IPP is the predictable retirement income it provides. The annuity amount is calculated based on factors such as years of service and salary, with a maximum of 2% of the average of your three highest years of salary. This predictability can be especially valuable for farmers planning their succession and estate strategies.

IPPs also offer tax deferral opportunities. Contributions made by the farm corporation are tax-deductible, reducing the company’s taxable income. Additionally, investment earnings within the plan are tax-sheltered until withdrawal, allowing for potentially significant growth over time.

Another advantage of IPPs is the ability to make catch-up contributions. If investment returns are lower than expected, the corporation can make additional tax-deductible contributions to ensure the plan meets its defined benefit obligations. This feature provides a level of security not available with RRSPs.

However, it’s important to note that setting up an IPP involves significant upfront costs and ongoing administrative requirements. Farm owners should carefully consider these factors and consult with financial advisors to determine if an IPP aligns with their retirement goals and overall farm succession plan.

Corporate-Owned Life Insurance

Another powerful tool for retirement and estate planning in incorporated farms is corporate-owned life insurance. This strategy can provide tax-exempt income protection for survivors and help fund the payment of taxes upon the farm owner’s death.

One of the key tax benefits of corporate-owned life insurance is the ability to fund premiums using after-tax corporate dollars. Since income earned in a corporation may benefit from lower small business or general corporate tax rates, it’s often less expensive to fund the policy using corporate funds compared to after-tax personal dollars.

When structured correctly, with the corporation as both the policyholder and beneficiary, there are generally no immediate tax consequences for the farm owner. Upon death, the insurance proceeds are received tax-free by the corporation, providing liquidity to address various needs such as buying out shares of deceased shareholders or covering potential tax liabilities.

Moreover, the death benefit, less the policy’s adjusted cost basis, can be added to the corporation’s Capital Dividend Account (CDA). This allows for tax-free distribution of these funds to shareholders, which can be particularly beneficial in estate planning and transferring wealth to the next generation.

However, farm owners should be aware that the cash surrender value of a life insurance policy is considered a passive asset. If the total non-active farming assets become too large, it may affect the farm’s eligibility for the Lifetime Capital Gains Exemption (LCGE) on the transfer of inventory or other farm assets.

In conclusion, both Individual Pension Plans and Corporate-Owned Life Insurance offer valuable tax benefits and retirement planning opportunities for incorporated farms. These strategies can enhance financial security, facilitate succession planning, and provide tax-efficient ways to transfer wealth. However, given the complexity of these tools, it’s crucial to work closely with tax and financial advisors to ensure they align with your farm’s specific circumstances and long-term goals.

Conclusion

The incorporation of farms in Canada offers a wealth of tax benefits that can significantly boost financial stability and growth potential. From lower corporate tax rates to enhanced retirement planning options, these advantages provide farmers with powerful tools to optimize their operations and secure their financial future. The flexibility in compensation structures and income splitting possibilities further contribute to the appeal of incorporation, allowing farm owners to tailor their financial strategies to their specific needs and goals.

To wrap up, the decision to incorporate a farm in Canada is a complex one that requires careful consideration of various factors. While the tax benefits are substantial, it’s crucial for farmers to work closely with financial advisors and tax professionals to navigate the intricacies of incorporation and ensure compliance with regulations. BOMCAS is Canada Farm Tax Accountant, offering expert guidance to help farmers make the most of these opportunities and secure their financial future.

FAQs

What tax advantages do Canadian farmers have?
Canadian farmers benefit from specific tax breaks that are not available to other types of businesses. These include deductions for expenses such as fertilizers, lime, veterinary fees, medicine, breeding fees, and fence repairs.

How profitable is farming in Canada?
In 2022, the realized net income for Canadian farmers decreased by 9.5% to CAD 17.35 billion. This decline came after significant gains in the previous two years, with a 50.8% increase in 2021 and a 79.1% increase in 2020. When cannabis is excluded, the realized net income for 2022 was down by 8.3% to CAD 17.63 billion.

What qualifies for the capital gains exemption on farm properties in Canada?
In Canada, the Lifetime Capital Gains Exemption (LCGE) allows individuals to avoid taxes on a portion of the capital gains earned from the sale of qualified farm property. To qualify for this exemption, the property in question must meet specific criteria established for farm properties.