Canada: 9 Issues To Consider When Incorporating Your Farm Business

In a 2012 article, I summarized a few of the major planning items that need to be considered before and after incorporating a farm business. Over the last five years, some of these issues have changed and some have stayed the same. If you have consulted with your Collins Barrow adviser and decided incorporation is right for you, it is important to have an up-to-date understanding of these issues to ensure your corporation is set up correctly. This article offers a refresher on nine important aspects of incorporation, helping your business devise the most optimal tax strategy.

1. Corporate year-end

With a corporation, you can still choose a year-end that differs from calendar year-end. However, some potential changes in accounting policies are starting to emerge. In the coming years, it's possible that accounting standards (for example, those from CPA Canada) will change. For instance, unharvested crops might have to be valued at cost, regardless of whether they are close to maturity. If you choose September or October as your year-end, there's a possibility that you could end your year with unharvested crops still in the ground, causing wild fluctuations from one year to the next with regard to your income. In one year, your inventory would be valued at its harvested value – its full fair market value – whereas in another year, it would be harvested at cost.

Until now, there was no standard when it came to how inventories were valued for agriculture. Some use cost and some use fair market value. In the case of a near mature crop with an October year-end that is going to be harvested in the first week of November, the convention would be to value that as if it was already harvested. But due to potential CPA Canada changes, you may want to consider a year-end that's not in those months, as it may make more sense to minimize variation from one year to the next.

2. Incorporation date

You don't want to choose an incorporation date that puts you in a situation where you're rolling over your personal business to the corporation at a time when your personal business hasn't incurred any expenses for the upcoming crop year. In the year before you incorporate, you would have a lot of income but no expenses to offset it on your personal tax return, resulting in an expensive tax bill. Take cash crop farmers; since they plant their crops in the spring and harvest in the fall, the first half of their year is usually nothing but expenses, while the second half is nothing but income. When selecting your incorporation date, you've got to be cognizant of your operation's cash flows, ensuring income and expenses offset themselves properly before you incorporate. Otherwise, there could be an unpleasant personal tax surprise in a year of incorporation.

3. Company name

When incorporating, you still have the option of naming your company or using a numbered company. While incorporating a numbered company is slightly less expensive than a named company, I would still recommend you undergo the marginal extra cost to register an actual name for your business. When you are dealing with a numbered company, the name is harder to remember, which increases the potential for error.

In general, farms are less concerned about this than other businesses, but if you want to advertise the name of your operation, it's a lot easier with a name than a number. Any additional cost you would incur in giving your company a name should be too small to deter you from taking this step.

4. Directors and officers

The directors in a corporation could have some personal liability, especially when it comes to debts with the CRA. If the company owes HST and it goes bankrupt, the CRA can go after the directors personally for any unpaid debts. In order to keep liability to a minimum, we usually recommend that family farms name the minimum number of directors – one.

The rules for officers are somewhat different. Since they don't have the same kind of liability as directors, it is recommended that you appoint as many family members as possible to this role, as this gives you the ability to avoid premiums on wages paid to those family members. If you're an officer of a farming company, you may not have to pay your provincial workers' compensation board premiums on any wages, which can result in significant savings. As a result, you won't collect compensation if you get injured, so you should also take that into account. In most cases, farmers prefer to save on premiums and self-insure to protect against any mishaps that might occur on the farm.

5. Types of shares

The two main types of shares that corporations can issue are common shares and special shares. Common shares (also known as growth shares) usually start with zero value when a company is formed and increase in value as the company grows. You can issue different classes of common shares, which gives you flexibility in allocating dividends to optimize tax planning.

Unlike common shares, special shares are usually issued to represent the value of equity you are transferring from the partnership or proprietorship to the corporation. This value remains fixed unless shares are redeemed by shareholders. If you cash in special shares, there are tax consequences to you personally because you haven't paid tax on that value going into the company.

Special shares would be relevant in a situation where you have given your company to your son or daughter and want all the growth to go to them, but don't trust them to manage the company right away. Instead, you can give them all the shares in the company, but retain voting control through special shares. Since you have all the voting control, they can't make any major decisions on the company's behalf. Those voting control shares have no value, so all the value is still going to those children, but you stay in control of the company. They can't sell it behind your back or make any other major decisions without your consent.

6. Assets and liability at the incorporation date

To properly document the transfer of assets from a partnership or proprietorship to a corporation, your advisor will need a complete list of assets and liabilities (including cash, accounts receivable, prepaid expenses, inventory, farm equipment, investments, accounts payable and loans) as of the date of incorporation, as well as their current fair market value. A reasonable estimate is acceptable to the CRA (you don't necessarily have to get a professional appraisal for everything), but it can challenge the values used when assets are rolled into the company. In order to protect against those challenges, there is a type of share you can issue on the transfer of assets into the company. If the CRA challenges the values you use, you can replace them with a different value share.

In essence, you are compiling a list of all your assets and debts. You'd have to get in contact with your lenders for an up-to-date listing of the balances on your loans and mortgages as of the date of incorporation. In addition, you may have to obtain a list of all your accounts payable, so the net worth of your business can be accurately determined. In the paperwork you send the CRA when you incorporate your farm business, you will also need the original cost base of everything, which is not just today's fair market value, but what you paid for your assets originally.

7. Transferring land and marketing quotas to the company

With quota and land, there is a capital gains exemption available on the sale of some farming assets. For example, if I were to purchase a piece of land for $1 million and sell it for $2 million, that would be a $1 million gain. This transaction would be tax-free because there is a $1-million capital gains exemption on farmland, and the same kind of exemption applies to quotas. When you're incorporating a farm business, you can elect to claim a gain on the transfer of assets into the company to use up any capital gain exemption you have. Instead of receiving that money in cash, you obtain credit in the company as a shareholder loan or a tax-free shareholder loan for that capital gains exemption that's used for the transfer of that asset into the company. So consider planning to use those capital gains exemptions on the transfer of property into the company.

In terms of both quota and land, you should watch out for the alternative minimum tax, which applies when you're using a tax preference like a capital gains exemption where your gross income is quite high, but your net income is low. When the CRA thinks you haven't paid enough tax because of the tax-free capital gains exemption, you may be forced to pay the minimum tax. This is not the same as regular income tax because it is refundable over the next seven years against taxes you would otherwise be paying. If you owe tax in the future, you can use advance alternative minimum tax against that tax. You should always plan for this to happen and make sure you have enough personal taxes to use up that minimum over the next few years.

The other thing you need to consider is that part of the quota you have is actually depreciated for tax purposes, so you get a tax write-off for it every year. When you sell the quota back to the company and you lodge a capital gains exemption, all that depreciation you claimed in the past as a write-off for your quota against your income goes back into your income on your personal tax return. In other words, you need to plan for potential recaptured capital cost allowance for quota. It's the quota depreciation you claimed in the past that's going into your income, and there are a variety of things you can do. For example, you can make a big RSP contribution the year you have that substantial amount of income coming in from the quota. That will offset the taxable income on that quota, and the RSP can be subsequently withdrawn when you have less personal income.

8. Government filings

Shortly after your lawyer files articles of incorporation, the CRA will mail you a letter with your new business number. Upon receipt of this letter, you must call the CRA to set up new corporate HST and payroll accounts, which will be used for your regular filings moving forward. You also have to file some paperwork with the CRA, within a certain period of time. The deadline is the earlier of your personal or corporate tax filing. Complete this in a timely fashion, as you will be subject to a penalty if it's late.

9. Customers and suppliers

After incorporation, you should contact all of your customers and suppliers to ensure payments and invoices are made out in the name of your new company, rather than your old proprietorship or partnership. As soon as you register your company, you will get an articles of incorporation from your lawyer. You should take that to your bank right away and set up a corporate bank account. From that day forward, you will use your corporation for all business transactions.

As previously mentioned, once you receive your business number, call the CRA to set up your HST account. This should be backdated to the day you incorporated. This is important, as all your HST credits and charges are under the business number of that incorporation, rather than your old partnership. When you contact your customers and suppliers, be sure to tell them the new name of your business and your new HST business number.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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