Blog: The Wheat Sheaf
AWC Submission: Re: Consultation on proposed changes to tax planning using private corporations
The Honourable Bill Morneau
Minister of Finance
House of Commons
Ottawa, ON K1A 0A6
Via Email: Bill.Morneau@parl.gc.ca; email@example.com
September 20, 2017
Re: Consultation on proposed changes to tax planning using private corporations
Dear Minister Morneau,
The Alberta Wheat Commission (“AWC”), which represents the interests of 14,000 wheat farmers in the province of Alberta, is pleased to have the opportunity to provide comment on the Honorable Bill Morneau’s proposed changes to tax planning through the use of private corporations.
AWC acknowledges that a core component of this government’s mandate has been to decrease taxes for the middle class. Unfortunately, the changes being proposed target Canadian farmers, who are very much a part of Canada’s middle class. We believe that the proposed changes and how they impact the family farm are at odds with the government’s plans for growth in our sector, which include an increase in Canadian agri-food exports from $55 to $75 billion by 2025 (2017 Federal Budget).
While AWC cannot comment on how this legislation will impact other sectors, we do want the government to recognize that a resource-based industry like farming cannot be compared to an income profession. This submission will highlight the family farm’s necessary capital requirements and show how the proposed changes work against the government’s commitment to grow the farming sector through eroding the farmer’s ability to retain cash necessary for making the capital investments needed to grow their operations.
The capital resource base required to operate a farm is significant. Most farms have to invest one and a half times their gross revenues in equipment. With land, the investment requirement is approximately six times a farm’s gross revenue. Retaining liquid cash for future purchases is essential.
For example, if a farming operation earns $200,000 in gross revenues, based on the aforementioned capital requirements:
- $300,000 is required to be reinvested for equipment,
- $1,200,000 is required to be invested for land, and
- $375,000 is needed if a down payment of 25% is required to expand the operations in order to remain competitive.
Corporations are essential to modern agriculture. “Farm operators have been moving away from sole proprietorships and partnerships in favour of corporations, which for some, offer business and legal advantages particularly as the size and complexity of operations increases (Statistics Canada, 2016).” According to Statistics Canada, 22.5% of all Canadian farms were family corporations. The rate of farmers incorporating rose from 19.8% in 2011 to 25.1% in 2016. Quite often, farmers will utilize a corporation to make large capital purchases. Because of the lower tax rates, farmers in Alberta can retain $0.875 for every $1 of taxable income and repay their debt faster than if they were to earn the income as a proprietorship. In 2017, a non-incorporated farmer in Alberta will retain $0.52 for every $1 of taxable income earned, assuming they are taxed at the highest combined personal tax rate in Alberta. Sometimes, a farm corporation will purchase a low-risk investment, such as a GIC, with the funds it is saving to use as a future down payment on farmland or equipment. If the government was to change the rules relating to the taxation of corporations earning passive income, the corporation could pay significantly more in tax for every $1 of interest income earned from this GIC. This could be much more than the farmer would pay if he were to hold the investment personally and reduces cash flow for future farm investments.
The proposed changes on the taxation of passive income appear to be working against the government’s commitment to grow the agricultural industry. While it is more cost-effective for farmers to utilize a corporation as a means of purchasing the capital and repaying the associated debt, the government is looking to penalize farmers for saving up to grow their business. It is imperative that tax policies be adjusted to ensure Canadian agriculture is not placed at a competitive disadvantage in relation to other countries.
Additionally, the proposed changes involving the anti-avoidance provisions relating to surplus stripping are extremely broad. We believe these provisions inadvertently catch the transfer of assets, such as farmland, from a farmer to a corporation. The unintended consequence will likely deter farmers from incorporating, thereby once again restricting the cash flow they need to help grow the family farm and putting Finance’s draft legislation at odds with the government’s mandate of growing agriculture in Canada.
Furthermore, in an attempt to mitigate the increasing capital requirements, we see more farmers renting land from a retired neighbor, thereby allowing them to grow their operations while saving up to purchase the land in the future.
The proposed changes relating to the Tax on Split Income (“TOSI”) rules could make any future earnings from the rental income subject to tax at the highest personal tax rate.
Bringing in the next generation
The government recognizes the need for transferring the family farm down to the next generation and has provided special rules that allow for this. Regardless of these special rules, the average age of Canadian farmers is increasing. According to Statistics Canada, farmers aged 55 to 59 accounted for the largest share of farm operators in 2016 and only 8.4% of farms reported having a succession plan in place. Of this, 16.3% of the corporations had a succession plan versus only 4.9% of proprietorship operations.
As previously discussed, the business of farming requires a significant amount of cash flow to be reinvested in capital and to repay debt. Upon retirement, some of this capital needs to be converted into income to provide for farmers in their retirement. Quite often, farmers will utilize the inter-vivos rollover rules to transfer farmland to their children or their children’s companies, but will require these children to provide for their retirement by electing to transfer the farmland at an amount somewhere between what the land was originally purchased for and its fair market value. The farmer can claim his/her capital gains exemption against the farmland, allowing for a further conversion of capital into retirement income.
The proposed rules that work to deny an individual the use of their capital gains exemption in relation to farmland previously subject to TOSI will cripple this conversion of capital into retirement income. If the rules are enacted as proposed, any farmer previously subject to TOSI will be required to pay tax at the highest personal tax rate should they need the next generation to provide for their retirement. This will directly impact their ability to convert their capital back into income to provide a retirement pension. If the family farm is subject to these proposed tax changes, not only will this transfer of capital to income be jeopardized, we are less likely to see farms successfully being passed on to the next generation.
Further to this, some of the economies of scale that farmers use to become as efficient and competitive as possible are achieved through spreading large capital costs in machinery over a larger land base. An efficient way of doing this is for a retired farmer to rent the land to a neighbor that is actively farming. This simultaneously provides for the farmer’s retirement and decreases the per acre costs of machinery for the neighbor. If the land was jointly owned between a farmer and his/her spouse and the spouse was previously subject to the TOSI rules relating to his/her ownership of the land, any future rental income earned could also be subject to TOSI. Furthermore, if the government does change how a corporation’s passive income is taxed, this may instead just encourage the sale of land. If so, this will make it harder for smaller farmers to expand and access land base to farm.
Disallowing farmers the ability to use their capital gains exemption on gains that accrued prior to their 18th birthday is also a measure that restricts farmers and their ability to build up the necessary cash flow to invest back into their farms. As noted above, the age of farmers across Canada is increasing, which means that farmers are taking longer to transfer the farm down to the next generation. For example, if a farmer holds off on transferring farmland until he is in his 70s and his son is in his 50s, it will be extremely cumbersome and expensive to provide a reliable real estate appraisal of the farmland 30 years ago when the son was 18. Likewise, the cost of valuing a family farm corporation 30 years ago will also be an expensive and burdensome task for the corporation to bear. The costs of compliance with these rules could be significant and once again show how the government’s proposed changes work against their desire to grow the industry.
AWC does recognize that Finance has provided farmers with the 2018 special election to trigger gains and that the rules relating to this election have accounted for the nuances involved with the actual process of triggering the gain (i.e. reducing the holding period to 12 months). We believe; however, that Finance has neglected to consider the impact of not being able to claim a capital gains reserve and the resulting impact of alternative minimum tax (“AMT”) and how this will impact farmers’ cash flow situations. As the farmer cannot claim a capital gains reserve in response to the gain triggered on the special election, AMT will apply and the farmer will be forced to come up with cash to pay this tax. This unfairly restricts farmers’ ability to retain the cash necessary to grow their farm. Furthermore, if a farmer does not have sufficient personal income to recover the AMT over the next 7 years, this potential tax becomes a true tax. The initial outflow of the cash required to pay AMT and the potential lack of recovery again show that the draft legislation works against objective to support the agricultural industry.
Contributing family members
Family farming operations are unique in that spouses and children play an active and pivotal role in the daily operations of the family business. Every day, fathers and mothers, husbands and wives, and children and grandchildren all work together to make sure the farm grows and produces a livelihood for their family and food for Canadian families and other countries around the world. It is for this reason that AWC believes that the extension of the tax on split income (or TOSI) rules should not be expanded to include family members of incorporated farming operations or family farm partnerships.
Because of the high capital requirements, farmers need to reinvest all their available cash into the farming operations. This often means that they will make sacrifices, such as putting aside money for their children’s post-secondary education. By allowing for the discretionary payment of dividends to children, farmers can provide for their post-secondary education without restricting the cash they need to help grow their operations. Often times, these children are not compensated in their youth, and are simply required to do chores around the farm to help it grow. Again, this practice helps preserve the cash needed to continue to grow the family’s farming operations.
Once again, the proposed changes relating to TOSI appears to be working against the government’s commitment to support agriculture. While it is more cost-effective for farmers to refrain from paying children annually and only pay their children when they need the income, such as to pay for post-secondary studies, the government is looking once again to penalize them for saving up to grow their business.
Farmers will often take off-farm jobs as a means of supplementing their total income. Statistics Canada reports that 44.4% of all farmers perform off-farm work as a means of supplementing their total income, with 1 out of 3 working an average of 30 hours a week or more off the farm. Often these off-farm workers are the spouses, who go to work to ensure that the mortgage on the family’s house is paid, or to ensure payments are made in a lean year so the loan on the newly purchased piece of farmland is not defaulted on. Regardless of the off-farm employment, these spouses will still equally contribute to the family farm, and still continue to be a part of the mind and management of the farm as well as the labour force.
Once again, the proposed changes relating to TOSI appears to be working against the government’s commitment to support agriculture. While it is necessary for family members to take off-farm employment to support the family, the proposed TOSI rules could use this as evidence to support the taxation of income earned from dividends or from a family farm partnership at the highest personal tax bracket. This practice will once again impede the family farm’s ability to retain cash to reinvest in the necessary capital needed to help grow the family farm.
Farming in Canada is a business that faces more volatility and unpredictability than many of Canada’s other sectors. As “price takers” in an international marketplace, farmers take on significant risk and often for very little return. Any policy changes that seek to erode farmers’ already thin margins and restricted cash flow will make farming in Canada unsustainable. The changes outlined in the July 18, 2017 draft legislation with respect to tax planning and private corporations inadvertently do just that. We therefore kindly request that Mr. Morneau reconsider his position in light of these unintended tax consequences, and help protect those who put food on Canada’s table.
Kevin Auch, Chairman
CC: The Right Honourable Justin Trudeau, Prime Minister of Canada
The Honourable Lawrence MacAulay, Minister of Agriculture and Agri-Food