| | If the decision is made to sell the incorporated business, two general approaches can be taken. The first is for the corporation to sell the assets of the business. The other approach is to sell the shares of the corporation.
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If the shares are "qualified small business corporation shares" or "qualified farm property", the individual may be able to claim up to the lifetime capital gains exemption of the gain on the sale of the shares. No capital gain exemption is available to the corporation if it sells the assets. So from the vendor’s viewpoint, it is often preferable to sell shares.
The buyer of the business, however, will often prefer to purchase assets. One reason for this preference is that this approach will normally allow the buyer to claim higher capital cost allowance on the cost of the depreciable assets. If a sale of assets occurs, the corporation will have to pay tax on income, recaptured depreciation and capital gains. Tax planning should be done to minimize this tax.
Tips and Traps
Retiring Allowance
In the sale of an incorporated farm business, it may be better to pay a retiring allowance to employees, such as the farmer and his wife, who have received employment income from the corporation in the past.
Reasonable retiring allowances are a deduction to the company and can be transferred to the employee's RRSP. These allowances are limited to $2,000 per year of employment before 1996, plus $1,500 for any years of employment before 1989 for which employer's pension contributions have not vested. For very large retiring allowance transfers, alternative minimum tax should be considered.
Double Tax on Sale of Assets
If the company is contemplating a sale of assets, consideration must also be given to personal tax to the extent that shareholders will withdraw funds from the company after the business sale. If dividends are to be paid, the dividend tax credit should be considered, and the possibility of recovering a portion of the tax paid on capital gains by the company should also be considered (refundable dividend tax on hand). Under this strategy, it may make sense to take out $30,000 of dividends annually (if the recipient has little or no other income – personal tax would be likely nil.)
Capital Dividend Account
If a capital gain is incurred by a company, consideration should be given to paying out a tax-free capital dividend to the extent that one is available. This situation will often occur when assets are sold by the company. Whenever a company has the ability to pay a capital dividend (because of capital gains or additions from collecting on life insurance for example), the dividend should be paid since a subsequent capital loss or other reduction in the balance of the capital dividend account could remove the ability to pay the tax-free dividend
Taxation
A company is not eligible for the exemption from tax on capital gains for principal residence, nor is it eligible for the capital gains exemption. In addition, any benefits received by shareholders or employees are taxable unless a reasonable amount is paid for these benefits (see section on Taxable Benefits).
Corporate losses cannot be transferred to an individual to offset income from other sources as can losses from a proprietorship or partnership. Assets that are transferred tax free into a corporation cannot be subsequently withdrawn without triggering what might be a substantial tax liability.
Key Issues in Working with Companies
Land in or out?
In some situations, incorporation may make sense based on the income level of the farm operation, but there may be a reason not to put the actual farm land into the company. The farmer might simply prefer to keep the land. Or a farmer wishes to hold the land longer in the hopes of an increase in value that he or she might be able to use the capital gains exemption on (since a corporation does not have access to the exemption).
In these situations, all other farm assets including inventory and equipment may be transferred to the company (normally buildings are held personally with the land). The company can then enter into a lease agreement with the individual to lease the land for farming activities to be carried on by the company.
In this type of situation, consideration must be given to any debt that may be outstanding on the land and buildings. Since those assets are being kept personally, the debt would also be held personally in almost all situations. In that case, care must be given that the company lease payments are enough to service the debt. Note that the lease payments cannot exceed a reasonable amount, or they will not be deductible to the company. In the case where reasonable lease payments would not be sufficient to make the personal debt payments, it may be necessary for wages or other forms of remuneration to be considered.
Note that lease income will be taxable to the individual farmer, and only the interest portion of the debt payments will be deductible against the lease income. Therefore, the individual farmer may be taxed on the portion of the lease payments used to make principal payments.
Also note that in this type of situation, it will be necessary to review the amount of debt (e.g. on equipment or operating loans) to ensure the corporation can assume those debts without tax consequences. It is often desirable to elect to transfer the inventory to the company under Section 85 at an elected amount of $1. For equipment, usually one would elect to transfer at a number equal to the undepreciated cost. If the debt to be assumed by the company exceeds these numbers, the debt cannot be assumed without increasing the elected amount and, therefore, resulting in current taxes.
It is necessary to consider whether GST should be charged on any lease payments made by the company to the individual.
Cash Basis Accounts Receivable
Most farmers are on a cash basis for income tax purposes. Many also have substantial accounts receivable at any given time for interim and final payments on crops previously delivered. Unfortunately, these accounts receivable do not qualify for tax-free rollover to a corporation. Therefore, when planning for the individual income once a company has been set up, allowance must be made for this income that will have to be reported personally. The income may come in over a year or two after incorporation.
Another option when considering incorporation is to collect on any accounts receivable possible (e.g. collect on previously deferred cheques) and then use the funds to purchase farm inventory prior to incorporation. In this manner, the individual farmer would have more personal income (collecting the cheques) initially, but this would be offset by the expense for the purchase of farm inventory. The inventory would be a qualifying asset for purposes of transfer to a corporation under Section 85.
Employment Insurance Considerations
In many cases, it is desirable to avoid employment insurance premiums on salaries paid to the farmer or spouse from their company. One method to avoid the requirement to pay the premiums on wages and salary paid from a company is to ensure the employee controls more than 40 per cent of the voting shares of the company paying the wage.
Therefore, two parties could be exempt from employment insurance premiums by ensuring each had more than 40 per cent of the votes. This outcome might be achieved by issuing voting shares that have no equity participation to the person who needs additional votes to reach the 40 per cent threshold. |
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