By Connor Lynch
WINCHESTER — Tax advantages that have taken some of the pressure off farms and smoothed out succession planning could get the axe as of Jan. 1, 2018.
That means farmers, particularly those who run incorporated farms, need to talk to their accountants right away, said Winchester-based Collins Barrow partner and agri-business specialist Kathy Byvelds, whose parents are dairy farmers.
The federal government announced July 18 that it would be changing the tax rules “to ensure that the richest Canadians pay their fair share of taxes,” targeting tax strategies “that can result in high-income individuals gaining tax advantages that are not available to other Canadians.”
Critics of the proposals have contended that small business owners in particular lack many advantages that employees have. Passive investments help get them through lean times, and small business owners can’t count on many things that employees can, like pensions, regular working hours, and benefits.
Four strategies have been targeted.
Income sprinkling: The practice of distributing dividends to members of the family farm because other members of the farm are taxed at a lower rate (to be axed).
Passive investments: Investments in things like stocks, funded from after-tax active business earnings (to be taxed more heavily).
Capital gains lifetime exemption: The lifetime exemption on capital gains used in a family trust or on an asset held by a minor (to be axed).
Surplus-stripping: A tool that allows farmers to pass on the farm to their children at a much lower tax rate (to be axed).
Income sprinkling is subject to the so-called kiddie-tax rules that prevent a child under the age of 18 from earning dividends. But now any member of the family will be subject to extra scrutiny from the federal government if he or she collects a dividend. Family members between 18 and 25 who are collecting dividends from shares in a private corporation will need to pass a stringent reasonability test to prove they earned the dividends they collect.
For farmers who use dividends to fund their children’s education, it’s going to hurt, said Byvelds. What form the reasonability test will take isn’t clear. But the common practice of a child away at school helping out by coming home on weekends or during the summer to help on the farm likely won’t cut it, she said.
Regular work on a consistent basis is the new standard for a family member to receive a dividend, a stricter standard than for wages, said Byvelds. A spouse listed as a shareholder who doesn’t help out on a constant basis would be in a similarly questionable situation.
“What the legislation is saying is they must be active and continually engaged (on the farm).” If they can’t prove that they work full-time then any money they receive would be taxed at the top rate, Byvelds said.
It’s been common practice to take some profit after expenses and re-invest in stocks or government bonds, forms of income to cut down the tax bill. Not anymore.
There’s no way around it, Byvelds said. Expect your tax bill to go up, though without any draft legislation on the table, it’s impossible to say by how much.
In addition, a non-taxable portion of a capital gain in a passive investment could be paid out tax-free. Now the non-taxable portion will be considered part of income.
When it comes to capital gains, any asset owned by a minor is no longer eligible for a capital gains exemption. Byvelds said she would never recommend a minor own an asset in the farm, and “I’ve never seen (a case) where a minor has his name on a parcel of land.” But if a farmer did have that arrangement in place, cash it in before January, she advised.
Also the farm family trust will no longer be eligible for the lifetime capital gains exemption.
A common strategy, surplus stripping is a succession planning strategy by converting part of a farm transfer into a tax-free capital gain. Land is transferred into a private corporation, the farmer claims a capital gain and uses his exemption to offset it, and benefits from the much lower tax rate on capital gains. Under the new rules, that capital gain will be treated as a taxable dividend and does not qualify for the $1-million lifetime exemption either.
The change would only affect a farmer trying to transfer the farm to a relative. Arms-length transactions won’t be affected, said Byvelds, which would ultimately make it cheaper to sell the farm to a stranger than to a farmer’s own child, she said.
“It is completely unacceptable that legislative changes would make it easier and lower the tax bill for a farmer to sell his farm business share to a stranger, rather than his own child or grandchild,” said Ontario Federation of Agriculture director Mark Wales.
Working around the changes is going to be impossible, Byvelds said. “They’ve (federal government) gone all out (closing loopholes).”
Though the proposed changes are open for public consultation for 75 days, closing on Oct. 2, Byvelds wasn’t optimistic that weighing in would change anything. “The Ontario Medical Association has been lobbying hard against this, and I truly believe that this is a Liberal platform and I think they’ll go through with it,” she said.
Leeds County cash crop and beef farmer Eleanor Renaud told Farmers Forum that even though she isn’t incorporated, the new rules are going to be a headache for farmers. “Thank God I am not incorporated, but there are a lot of farmers out there that are. This is throwing 40 years of tax planning out the window.”
Renaud said that farmers might be able to continue with income splitting, as long as they start documenting when, how, and how much their children or spouse contribute to the farm. “We don’t think about things like leaving a paper trail of your kids working for you.” But it might mean the difference between being able to use income sprinkling with your child, or not.
It’ll be a problem in particular for succession planning, something Renaud herself hasn’t gotten around to yet, she said. For other farmers in a similar situation, careful consideration and a professional opinion will be necessary to spare the next generation the worst impacts, she said. A farmer who left land assets to his child in a trust may well end up giving his child a whopping tax bill in the future, given how much land values have increased in Eastern Ontario. “It’d be like buying the farm all over again,” Renaud said.