Which business structure is right for your farm when it comes to succession?

Farming today requires extensive operational knowledge. To thrive in today’s market, farmers need to embrace ever-changing agronomy practices, new cropping options, and emerging agriculture technologies. If they do, they’re typically rewarded with increased profitability — which gives rise to the need for yet another new skillset; one that involves selecting the right business structure to maximize both operational and taxation efficiencies.

The tax structure evolution

The default farm structure was traditionally a proprietorship which, in many ways, reflected the limited profitability in the agricultural sector during the 1990s and early 2000s. Year-end tax planning typically consisted of a combination of pre-buying inputs, grain cheque deferrals and optional inventory adjustments to manage the amount of income that would be reflected on the proprietor’s personal tax return each year (at tax rates ranging from 25.5 percent to 47.5 percent in Saskatchewan).

In many circumstances, the proprietorship would eventually restructure into a partnership with the introduction of the proprietor’s spouse, adult child, or even a sibling interested in combining farming operations. The year-end tax planning for a partnership owned by individuals wouldn’t be all that different from the previous proprietorship — meaning, the net profit generated during the year would be allocated to the partners at the end of the year.

But once a farm sees several consecutive highly profitable years as a sole proprietorship or partnership, managing the farm’s taxable income can become much more difficult. While the year-end planning options mentioned above do provide a tax deferral, the deferrals are temporary and will eventually be included in the individuals’ taxable incomes and be subject to personal income tax at marginal tax rates up to 47.5 percent in Saskatchewan. At this stage, many farms decide that a corporate tax structure would best serve their operational and taxation needs going forward.

The taxation advantages of a corporation are relatively straightforward. In Saskatchewan, the first $500,000 of net taxable income inside a corporation will be taxed at 9.5 percent, between $500,000 and $600,000 will be taxed at 15.5 percent, and any net taxable income over $600,000 will be taxed at 27 percent. After the corporate taxes are paid, the remainder is left to be reinvested into the farm or used to pay down debt inside the farming company. Any funds withdrawn from the farming company would still be subject to personal tax at the individual’s personal tax rates. It’s this deferral of personal tax that offers significant financial advantages to farms looking to expand.

Passing the torch

Not only do the three basic structures differ in their annual taxation burden, but they also stand to impact intergenerational transfer. There are significant differences in how the farm assets (excluding farmland) are taxed upon the passing of the individual proprietor / partner / shareholder.

For a proprietor, for instance, all equipment and buildings can be transferred to a spouse or the next generation on a tax-deferred basis, provided specific criteria are met as defined in Canada’s Income Tax Act. It’s important to note that grain inventory, receivables and deferred grain cheques can’t be transferred on a tax-deferred basis and, as such, will be taxable on one of the proprietor’s final tax returns or on that of the beneficiaries listed in the proprietor’s will. This means that the aggregate of these amounts will often be taxed in one taxation year, which will likely incur personal taxes at 47.5 percent in Saskatchewan.

If the farm was structured as a partnership, the death of a partner would not necessarily trigger personal income tax. This is because partners can transfer their partnership interest to a spouse or child on a tax-deferred basis, provided certain criteria are met. The advantages of this tax deferral can be very significant as it can allow the successor to retain cash and ensure it’s still available to the farm in the coming years.

The rules for shares held in a family farming corporation are similar to those of a partnership. They, too, can be transferred on a tax-deferred basis to a spouse or child with proper planning ahead of time. As such, both the partnership and corporate structures provide the ability to achieve a significant tax deferral upon death when properly planned.

The partnership and corporate structures also provide significant advantages when it comes to intergenerational transfers during the lifetime of the partners and shareholders. The same transfers available upon passing of the partners and shareholders are also available during their lifetime. Additionally, there are opportunities available for individuals to access their $1 million lifetime capital gains exemption through the transfer of partnership interest, shares, and farmland with proper planning. This planning should also tie in with an overall succession and estate plan that can be implemented when the timing is right.

Getting started

For most farms, the goal is to maximize the overall profitability of the farm in a tax efficient manner. The three traditional tax structures — sole proprietorship, partnership, and corporation — all have different nuances that need to be evaluated in the context of your individual farm. By doing so, you can determine how each structure will impact your overall taxation, succession and estate planning objectives going forward and select the appropriate one to meet those objectives.

This article reflects calendar 2022 tax rates as of March 31, 2022.