| | Transfer to a Child During a Farmer’s Lifetime | Transfer on Death | Transfer of a Company | Cattle Lease | Transfer to Child
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Transfer to a Child During a Farmer’s Lifetime
Inventory does not qualify for any “rollover” provision; therefore, a transfer will deem a sale to have occurred at fair market value. The taxpayer will be deemed to have received fair market value for the inventory transfer while the recipient will be allowed an offsetting expense.
Tips and Traps
- To complete the transfer on a reduced tax basis, the inventory could be sold to a child for a debt due over a period of time with or without interest. This approach would effectively provide a "reserve mechanism." The child would pay the sale proceeds over time to the parent, resulting in taxable income (assuming the cash basis of income reporting) as received by the parent and a corresponding deduction for the child.
- This strategy would allow immediate transfer of the inventory while spreading the income out over more than one year. Care should be taken in structuring this sale. A transfer of inventory (e.g. cattle) that may only be held for two or three years by the child but for which the payments will be made to the parent over a long period might cause concern with the Canada Revenue Agency.
- It may be possible for the parent to subsequently gift part of the cash back to the child if that is the parent's desire. (A gift of cash to a child who has reached the age of majority would not normally constitute forgiveness of the debt or be subject to attribution. Forgiveness of the loan could cause the loan to be considered to have been paid. See section on Forgiveness of Debt.)
- Transfer inventory as a payment in kind for labour on the farm - if farm inventory is transferred to a child as payment for farm labour, the parent should technically report a sale of the inventory and also a salary expense (which could result in a requirement for payroll deductions and reporting). The child, technically, would report the salary income and then also show a purchase of farm inventory. Any subsequent sale of inventory by the child would be taxed in the child's hands.
Transfer on Death
Inventory can be transferred on a tax-deferred basis by a will under a special provision related to “rights or things.” Under this provision, inventory can be left to any named beneficiary, and the beneficiary will pay tax on the inventory when it is sold. This method effectively achieves a rollover of inventory on the death of the taxpayer. (Note: other options exist for rights or things including the possibility of reporting them on a separate tax return of the deceased.) There are no restrictions on transfers of rights or things to beneficiaries
Tips and Traps
- A strategy to consider is to combine a note payable with the special rights or things provision. The taxpayer could sell the inventory to a child and through a will, forgive the balance owing on the note. There are no adverse tax consequences with this strategy, and the child will now inherit the cattle with
- the note being extinguished. (Note: there would be no deduction on the part of the child for the inventory.)
- This type of plan might be best used where the parent has a serious health problem (and the impact of the general anti-avoidance rule must always be considered).
Transfer to a Company
Where a farmer wishes to incorporate a farm business, business assets such as inventory may be transferred to a corporation without incurring an immediate tax cost. Inventory may be transferred by an individual to a corporation at any amount between cost and fair market value if the appropriate income tax election is filed under Section 85 of the Income Tax Act and assuming that all necessary conditions are met.
Tips and Traps
- An election form must be filed with the Canada Revenue Agency to record the transaction for tax purposes.
- Electing at any amount above cost will result in income to the transferor.
- To avoid tax, it is often necessary to elect on inventory at an amount of $1 for the purposes of the transfer to the company. This means that only $1 of debt can be transferred into the company on the rollover. Attempts to have the company assume more debt on the inventory transfer would result in an automatic increase in the elected amount and resulting tax. It may, therefore, be necessary to also transfer other farm assets that have cost base to allow debt to be assumed by the company without negative tax consequences.
- Accounts receivable such as deferred grain sales (e.g. deferred grain tickets) cannot be transferred into a company. The income from the receivable could be offset by an inventory purchase that could be transferred to the company on a subsequent Section 85 transfer. One unique strategy is to exchange a deferred grain ticket for a storage ticket (which results in income and an offsetting expense). The storage ticket is inventory which can be rolled into the company.
Example of personal vs. corporate tax rates on sale of inventory
| Assumed Inventory on Hand | $150,000 |
| Personal Tax on Inventory | $56,000 |
| (assuming Alberta resident with $30,000 of other farm income and no other income) |
| Corporate Tax | $21,000 |
| (assuming business income eligible for the small business deduction in Alberta) |
| Potential Tax Deferral | $35,000 |
Cattle Lease
Leasing has become very popular for many types of property. Cattle leases are also available to farmers. Common types of cattle leases are:
- Cash lease - cash rent per cow per annum. Operator accepts all production and market risk.
- Fixed number of calves lease. Owner receives a predetermined number of calves as rent (not based on numbers born, weaned or sold).
- Percentage share lease. Each party receives a predetermined percentage of revenue from the sale of calves.
- Flexible share lease. Allocates revenue based on contributions to costs. For example, perhaps the first $300 of revenue per cow is allocated to the lessee to cover direct costs. Perhaps the next $100 is allocated equally to recognize the capital costs (of the cows for the lessor and of the facilities for lessee) and the balance of revenues is allocated based on a negotiated basis (e.g. 80 per cent to the lessor and 20 per cent to the lessee).
- The best lease for the situation depends on the amount of risk the lessor and the lessee are each willing to bear.
Advantages of Cattle Leasing
- Reduce herd to more manageable levels without immediate sale.
- Another alternative as part of an estate plan in transferring farm assets.
- Maintain ownership of animals without day-to-day responsibilities.
- Allows child to reap some of the rewards of a cattle operation without laying out significant cash to purchase animals.
- Effective way for an operator with excess capacity to ensure use of facilities.
Disadvantages of Cattle Leasing
- Possible lower returns for owner due to poor management by lessee.
- May limit liquidation options.
Tips and Traps
Issues to consider when drawing up a cattle lease:
- description of cattle, brand and arrival date
- location of cattle (e.g. where to be kept and rights of inspection)
- breeding policy (which party provides the bull, authority for selecting the bull, timing)
- veterinary policy (who pays for vet bills, any practices to be followed to ensure herd
- health)
- culling and replacement policy
- death, loss and strays (who bears cost)
- division of income
- termination of lease (timing and rights for early termination)
Transfer to Child
Farming parents often wish to gift their inventory to their children. While farming inventory may be given away, one must consider the tax consequences. The farm rollover provisions allow for the transfer of land, buildings, equipment and quota on a tax deferred basis to children, but this provision does not apply to inventory.
The general rules of the Income Tax Act deem that when a farmer gives away inventory, he/she is considered to have sold the inventory for its fair market value, and tax will likely result. There is some question of whether the recipient child would be entitled to a deduction on the cash basis. Therefore, it may be better to structure the transfer as a sale with the outstanding debt to the parent forgiven under the terms of the parent’s will.
Tips and Traps- Alternatives to be considered:
Agreement for Sale - Producer Note
- An Agreement for Sale is put into place between a parent and child for a sale over a
- period of time. If both the parent and child are filing on the cash basis, the parent would report income when received and the child would get a deduction when paid.
- The term of agreement should not exceed the expected lifetime of the assets sold (e.g. maximum seven to ten years for a cow herd).
- There is the concern that the Canada Revenue Agency might view this arrangement as a complete sale by the parent in year one with fully taxed proceeds. This assumption is on the basis that the child is receiving 100 per cent of the economic benefit of the cow herd, even though only a portion of the purchase price is paid in year one. Refer to the next section to avoid this concern.
Lease Agreement - Option to Purchase
- A lease could be entered into that also gives the child the option to purchase, at any time, a certain percentage of the parent's remaining cattle herd. The purchase price can be set at the inception of the lease or negotiated on a yearly basis. In this situation, the parent would be entitled to an annual cow lease payment or calf crop share, based on bred cows remaining.
- If entering into this type of lease arrangement, the cash outlay by the child must be considered since the parent will be receiving a lease payment or calf crop share plus full cow receipts and purchase payment from the child.
Transfer to a Partnership or Corporation
Consider rollover election and transfer to a partnership or corporation in which the child is involved.
If a corporation is used, the parent might take back preferred shares and have the child subscribe for all the common shares to effect a freeze.
The question might be raised, can a farmer transfer say $250,000 worth of cattle to a newly-formed corporation and then immediately sell the corporation to the child and incur a capital gain that would be sheltered by the enhanced capital gains exemption? Unfortunately, this situation has some risk.
Normally, Section 54.2 of the Income Tax Act provides that for the share to be deemed to be capital property, the property transferred to the corporation must be all or substantially all of the assets used in active business prior to incorporation. Therefore, this condition would require a transfer of more than 90 per cent of all the farming assets (not just inventory). A similar result would likely occur for a partnership.
Feeder Association Purchases
Farmers may use a feeder association to purchase their cattle inventory. Where the feeder association is used, a farmer will generally not be required to make a full cash payment for the cattle. The association will issue a note that the farmer will extinguish when the cattle are sold.
Generally, the cattle are branded with the feeder association brand for security purposes. Although the farmer does not have a cash outlay for the full amount of the cattle purchased, a deduction can be taken for the full amount of the cattle purchased in the current year. (Mandatory inventory adjustment rules still apply.) |
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