Miscellaneous Sources of Income

 
 
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 Surface Rentals and Farming Operations | Patronage Dividends | Sales of Farm Land Including the Crop | Sales of Rights to Harvest Crops | Farmers - Farm Produce Consumed | Exchange of Goods | Destruction of Livestock | Sale or Lease of Marketing Quotas | Mineral Rights | Grazing Leases | Timber Sales
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Surface Rentals and Farming Operations

People exploring or drilling for petroleum or natural gas often get a lease covering certain surface rights from the landowner. For example, the lease may cover several years of use of a small acreage of land, possibly set in from the owner’s boundaries.
The first year’s payment may be in a lump sum for such things as damage to land, land improvements, inconvenience, severance and the first year’s rent, without a specific amount being ascribed to any of these items. For the second and subsequent years, the lease may require a periodic payment or payments for rental, severance, or inconvenience.
In these circumstances, the portion of the lump sum paid in the first year equal to the periodic payments to be made in subsequent years is considered to be income within the meaning of subsection 9(1) of the Income Tax Act. The remainder of the lump sum payment is generally considered to be capital.
The capital portion of the first year’s payment as compensation for property affected, damaged or destroyed constitutes “proceeds of disposition” and may result in a capital gain or loss. The adjusted cost base for the portion of the property disposed of is the portion of the entire property’s adjusted cost base reasonably attributable to the part under lease. The adjusted cost base of the whole property is then decreased by that amount.
Where the part disposed of is relatively small in relation to the overall property, The Canada Revenue Agency accepts any reasonable portion of the adjusted cost base the taxpayer wishes to attribute to the proceeds.
Where a specific amount is stated in the lease (or in a supplementary letter) for each of the various items included in the first year’s payment, normally only those amounts for recurring items are considered income. An item may recur even though the amounts payable for it differ in the first and subsequent years.
The portion of the first year’s payment specified for damage to growing crops is considered to be income rather than capital. Income payments to a farmer actively engaged in farming the land, part of which is the subject of the lease, are income from the business of farming.

Tips and Traps
  • A reassessment originating in Saskatchewan included a seismic payment in income. The Canada Revenue Agency took the position that shot holes no longer occur, and the running of seismic lines across farmland does not cause damage other than packing the soil (which can be repaired using tillage equipment). Therefore, the payment was considered income.
  • In a private interpretation, the Canada Revenue Agency indicated that a portion of the land’s cost base must be allocated to the proceeds of disposition (i.e. it was not acceptable to use the capital gains exemption to fully offset the proceeds).
Sale of Gravel, Sand or Topsoil

The sale of sand, gravel, topsoil, similar substances and sod is considered to be farm income where:
  • amounts received depend on the use of or production from property contingent on the quantity of material taken at some rate or standard (such as a price per ton or per cubic yard); or
  • the sale constitutes business income.
For a sale to be treated as income, it is only necessary to establish that one of the above criteria apply, although in many cases both will apply. Instalments of the sale price of agricultural land are not generally treated as income. However, amounts received on the sale of earth substances extracted from farm land are not considered instalments of the sale price of agricultural land and, consequently, may be treated as income.

Tips and Traps
  • In deciding whether or not the profit resulting from the sale of earth substances is income, the courts have applied the following tests:
  • The taxpayer's intentions regarding the earth substances during the ownership period of the property.
  • The taxpayer's whole course of conduct indicates that in dealings with earth substances, he or she is disposing of them in a way capable of producing profits and has that object in view. The transactions are of the same kind, and they are carried on in the same way as those of ordinary trading in that substance.
  • Should the following factors exist, they provide additional evidence to indicate a taxpayer is in a business; however, by themselves, these factors are not enough to constitute a finding that a transaction is a business:
    a. the substances are advertised and are available for sale to the general public;
    b. an organization is established by the taxpayer for the sale of the substance;
    c. the taxpayer is involved in the removal of the substances;
    d. the number of sales is not limited to a single or isolated transaction; and
    e. the transaction is similar to other activities that the taxpayer has entered into before or since.
  • Situations may occur where a taxpayer sells the land that contains the substance rather than selling the earth substance itself. If the amount received reflects the value of the substance, proceeds from the transaction may be treated as an income receipt or a capital receipt depending on the circumstances of the case - see d. and e. above. Consider the example in which land that normally has a fair market value of $150 per acre is sold for $1,500 per acre because of the value of the earth substance.
  • However, if the sale terms require payments based on substance production over a period of time, the instalments are considered income regardless of whether or not the taxpayer is seen to be carrying on an adventure in the nature of trade as in a business
  • An aggressive approach to avoiding income treatment on the sale of gravel may be to sell the land instead of the gravel, claim the enhanced capital gains exemption on the land and lease back the land for farming.
Patronage Dividends

All patronage dividends with the exception of those for personal goods or services are taxable in the hands of the farmer when received. Where the payment has been made in the form of a share or certificate of indebtedness, the patronage dividend is deemed to be received by the customer.
For example, farm co-operatives often declare dividends, but the farmer receives only partial cash consideration. For income tax purposes, however, a farmer is required to pay tax on the cash received plus that portion of the dividend retained by the co-operative and converted to equity.

Tips and Traps
  • These patronage dividends should be included on the statement of farming income and expense.
  • They are not eligible for the dividend tax credit.
  • The co-operative will often withhold tax from the dividend. When reporting the income on the farm statement of income and expense, be sure to report the dividend's gross amount.
  • The tax withholding can be claimed on the farmer's income tax return as an amount paid by instalment.
Dividends received for personal items are not to be recorded for tax purposes as income; however, the tax withheld can still be treated as an instalment.

Sales of Farm Land Including the Crop

Where an agreement for the sale of farm land with a standing crop specifies the amount payable for the crop, the amount specified is considered income to the vendor and an allowable deduction to the purchaser. Where the agreement does not specify an amount payable for the crop, no portion of the sale price may be attributed to the crop as far as either the vendor or the purchaser is concerned.

Sales of Rights to Harvest Crops

A taxpayer in the business of farming may choose to retain title to the farm and merely sell the right to harvest the crop from it. In this situation, the consideration paid for that right is considered income to the vendor and an allowable deduction to the purchaser for tax purposes.

Farmers - Farm Produce Consumed

The cost value of all materials or produce that were stock in trade and could have been sold as such consumed by a taxpayer in the business of farming should be deducted from the otherwise allowable farm expenses. The same conditions apply for produce from the farmer’s home garden. Expenses incurred in producing for personal consumption rather than for sale should be excluded from the farm operating expenses. This is often accomplished by an add-back to income for personal consumption.

Exchange of Goods

Where a taxpayer in the business of farming receives goods or services in exchange for farm products, the fair market value of the farm products given by the taxpayer in exchange must be included in his or her income. The value of the goods or services received in exchange by the taxpayer may possibly be expensed or capitalized, depending on what is received. For example, if a taxpayer exchanges wheat for repairs made to a tractor, the value of the wheat would be added and the value of the repairs would be deductible in computing farm income.

Destruction of Livestock

Situations may occur where livestock need to be destroyed, such as under the Animal Contagious Disease Act. An amount received or receivable (depending on the method regularly followed in computing income) by a taxpayer in the business of farming as compensation under statutory authority for the forced destruction of livestock is considered income.
Section 80.3 permits the deferral of reporting of this amount to the year following that in which it was received or receivable. This deferral is not available in the taxation year during which a taxpayer dies or ceases to be resident in Canada or in any subsequent year.

Sale or Lease of Marketing Quotas

An amount received or receivable (depending upon the method regularly followed in computing income) by a taxpayer for granting a farmer permission to use the taxpayer’s marketing quota (e.g. milk) is considered income. This amount will be treated as income from farming if the taxpayer is engaged in a farming business. The sale of the actual quota by a farmer would be considered to be the disposition of an eligible capital property.

Mineral Rights

Farmers and others who own gas and oil mineral rights could have serious income tax liabilities when the ownership of these rights changes through transfer by way of sale, gift or bequest. For income tax purposes, Canadian resource properties are added to a Canadian oil and gas property expense account that functions similar to a capital cost allowance schedule for depreciable assets.The rollover provisions of the Income Tax Act may apply to resource properties. These provisions will apply where the resource property is transferred to a spouse or spousal trust. The transfer may take place at any elected amount up to fair market value of the property.
Transfers of resource property to children or any other person must take place at fair market value. The full amount of the deemed proceeds resulting from the transfer must be brought into the income of the transferor in the year the transfer takes place. A mineral right does not qualify for the family farm rollover provision.Resource properties can be rolled into a partnership or corporation on a tax-deferred basis. The owner of the mineral right will receive a partnership interest or corporate shares that reflect the value of the mineral right transferred. Any increase in the value of the mineral rights can be divided among the other partnership members or shareholders.
On the death of the original holder of the partnership or corporation’s mineral rights, the estate will be receiving shares or a partnership interest and not the actual mineral right. Any tax liability on the shares or partnership interest will likely be a capital one. The revenues received by a company from “leasing” mineral rights would usually be considered income from property taxed at the highest corporate tax rate rather than active business income eligible for the small business tax rate.

Tips and Traps
  • Consider using a bare trustee corporation to transfer the mineral rights. In this manner, a party interested in leasing the rights may only have to deal with one contact (the bare trustee) rather than contacting several individuals with respect to a particular mineral right title. However, the corporation does not have beneficial ownership and for tax income reporting purposes, the individual would still be considered the owner.
  • Consider transferring mineral rights to a corporation. By transferring the rights to a company, it may be possible to freeze the value of the rights at current amounts (to cap the tax exposure). In this way, the deceased will have a deemed disposition of a share instead of mineral rights that should result in a capital gain of which 50 per cent is non-taxable rather than fully taxable deemed disposal of mineral rights.
Grazing Leases

Grazing leases often have significant value and, as a result, two questions often result:

Can the purchase of a grazing lease be depreciated?
Technically, it would appear a purchase of a grazing lease would normally qualify as a Class 13 asset (see comments in Paragraph 22 of Interpretation Bulletin 464).

Is the sale of a grazing lease eligible for the enhanced capital gains exemption?
The answer to this question is not totally clear. In one private interpretation, The Canada Revenue Agency took the view that a grazing lease does not qualify. The department supported this position on the following basis. While Section 248 of the Income Tax Act indicates that an interest in real property includes a leasehold interest in real property, the definition in Subsection 110.6 (1) regarding the capital gain exemption refers only to real property (and not an interest in real property). However in another interpretation, The Canada Revenue Agency did feel the gain on a sale of a grazing lease was eligible for the exemption.

Timber Sales

A farmer may receive proceeds from the sale of timber located on existing farm land or as a part of clearing land to be used for farming purposes. The tax treatment of these proceeds depends on the given situation.
The Canada Revenue Agency has indicated that the determination of the treatment of timber proceeds as income or capital (potentially eligible for the capital gains exemption) depends on a number of factors including:
    A. The status of the underlying land (i.e. used in farming, held for investment, purchased with the intent of selling the standing timber);
    B. Whether the trees were removed by the taxpayer-owner of the wood lot or by some other person;
    C. Whether the payment received for the timber is a fixed price for a fixed quantity of timber to be taken within a fixed time or an amount related to the use of or production from the wood lot on a continuing basis; and
    D. Whether the taxpayer-owner is involved in farming activities.
    The Canada Revenue Agency has indicated, in general terms, that where a taxpayer acquires land with the specific intent of selling timber, the taxpayer is considered to be in the business of logging. Therefore, amounts received by the taxpayer for sales of timber are business income.
If, on the other hand, the selling of timber was not the motivating factor for the purchase of the land, amounts received by the taxpayer would likely be considered capital receipts. If a farmer uses timber proceeds to reduce the cost base of the underlying farm land so that no cost remains, the question is whether any additional proceeds from timber sales would be eligible for the $750,000 capital gains exemption. The Canada Revenue Agency has indicated that to qualify for the exemption, timber sales must be viewed as a disposition of real property used in carrying on a farming business in Canada. The Canada Revenue Agency views the timber as an asset not distinct from the land on which it stands and has indicated the enhanced capital gains exemption could only be claimed in respect of a disposition of the land. This position appears to indicate that the underlying land would need to be sold with the timber to have any opportunity to claim the enhanced exemption - assuming the land would otherwise qualify for the enhanced exemption.
 
 
 
 
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For more information about the content of this document, contact Joel Bokenfohr.
This document is maintained by Nicole Halvorson.
This information published to the web on July 28, 2014.