“Purify” Your Farm Corporation to Get the Farm Rollover

Restructuring may be necessary in order to transfer shares to a child using the farm “rollover”

Sean Rheubottom, B.A., LL.B., TEP

The farm rollover is one of the most important planning tools available to farmers considering a family succession or estate plan. Put simply, the farm rollover allows you to give farm assets to your child, during life or through your Will, without triggering any capital gains. This is very different from other kinds of property which are deemed to be sold by you for their fair market value if you transfer them to a child, resulting in a tax bill. Did you know that the farm rollover can apply to not just land and equipment, but also the shares of your family farm corporation? If the rollover works, the tax savings can be very significant. But there are certain requirements in the tax rules if the farm rollover is to apply. One main requirement is that 90% or more of the assets owned the corporation, by value, must be assets used in the family farm. It’s very common to see family farm corporations that own non-qualifying assets such as cash or investments, or other assets not used in the farming operation. Moving assets out of your corporation is often referred to as “purification”. If it’s done carefully, purification will not trigger any tax. Complex tax rules have to be considered.

John and Catherine incorporated J&C Farms Ltd. several years ago. One benefit has been a tax deferral on income that was higher than expected for a few years. The deferral is simply the difference between the low rate of tax paid by a corporation on its farming income up to certain limits (9% in Saskatchewan in 2021, up to a limit of $500,000 of active farming income), and the higher rate an individual would pay on the same type of income earned without a corporation (up to 47.5% in Saskatchewan in 2021).

When the after-tax income of the corporation is paid out to an individual shareholder as a taxable dividend, the combined tax of the corporation and the shareholder is very close to the amount of tax the individual would have paid had there been no corporation.  That creates an incentive to retain corporate income rather than pay dividends.

John and Catherine have had a couple of profitable years because of some good choices they made, and help from strong commodity prices. As a result they’ve accumulated a significant amount of cash in their corporation. The resulting tax deferral is a good thing, but the buildup of excess cash in the corporation may lead to tax problems that require “purification” to cure. “Purification” means moving excess or “passive” assets such as cash and investments out of a corporation.

Purify to qualify for the “rollover” of farm corporation shares to a child  

John and Catherine have a son, Brad, who also farms and will take over their operation within the next five to ten years. They are considering various ways to restructure J&C Farms Ltd. for succession purposes. Whatever succession strategy they choose, they understand that at some point they may need to directly pass shares of the corporation to Brad, either during life, or through their Wills.

John and Catherine knew that their land, which they own personally, could be passed to Brad using the farm rollover, which allows the land to pass to a child without triggering capital gains. The rollover works either during life or at death. John’s and Catherine’s farmland easily meets the “farm rollover” requirements.

But more recently they learned that the shares of J&C Farms Ltd. may also qualify for the rollover. However, certain “asset tests” must be met; otherwise capital gains tax will result when the shares are transferred to Brad. Basically, before the transfer, 90% or more of the assets of the corporation, by value, must be assets that were used principally in the family farming business. In view of the amount of excess cash in J&C Farms Ltd., the shares will not qualify for the farm rollover to Brad, unless some restructuring is done.

A tax problem and a solution

A problem with removing valuable assets from a corporation is that it causes tax. Taxable dividends can result to the shareholder who receives the assets, and the corporation itself can be hit with capital gains tax when the assets are transferred out. John and Catherine aren’t keen on receiving a large taxable dividend when they don’t require the funds for lifestyle expenses.

A solution is to purify J&C Farms Ltd. by transferring the passive assets to a separate corporation. This can be done on a tax-deferred basis, with proper implementation. The steps required to achieve this may be very complex or relatively straightforward, depending on the circumstances. Complex tax rules must be carefully considered, but it’s normally possible to get it done with minimal pain.

It’s important to do this kind of planning sooner rather than later. The planning can get more complicated and expensive if you’re doing it on the eve of a taxable event such as a sale.

J&C Farms Ltd. is now accompanied by a second corporation, “NestEgg Holdings Ltd.”, which received the excess cash without causing any unnecessary tax.

A structure that works now and in the future

J&C Farms Ltd. may well continue to produce excess cash in future years, interfering with the future rollover to Brad. The solution is to use NestEgg Holdings Ltd. to continue purifying J&C Farms Ltd. on an ongoing basis. NestEgg Holdings could subscribe for shares or debt from J&C Farms. Provided certain requirements are met, J&C Farms may pay tax-free dividends or loan repayments to NestEgg Holdings. NestEgg Holdings can therefore be used to keep J&C Farms free of excess cash - without spoiling the tax deferral John and Catherine have been enjoying by retaining farming income in the corporation.

Other reasons to purify 

There are several other reasons to consider “purifying” your corporation, but for farmers the farm rollover is one of the most pressing issues.

Be sure you’re working with an experienced farm tax advisor when considering these issues. Your various advisors, whether financial, accounting, or legal, should be working together as a team to be the most effective for you.

© Heritage Private Wealth Law

General information only; not intended as legal or tax advice. Readers are encouraged to obtain legal and tax advice before acting in their specific circumstances.