A couple we’ll call Bob and Linda, both in their early 60s, have run a successful farming operation in south-central Manitoba. They have 1,280 acres of which two quarters are pasture for 100 head of beef cows and the balance in wheat and barley. After 40 years of farming, they want to plan an exit that will allow two sons, James and Evan, ages 36 and 37, respectively, who farm with their parents, to keep the farm while keeping share division fair for their non-farming son, Matt, age 32, who works in town.
Bob and Linda approached Nathan Heppner, a chartered financial planner, and Erik Forbes, a registered financial planner, both with Forbes Wealth Management at Carberry, Man., to devise a land and property transfer to the three sons that would be fair and tax efficient.
The farm corporation has a fair market value of $5,000,000. Its adjusted cost base is $500,000. There are 100 common shares in the corporation jointly owned by Bob and Linda. An investment corporation owned by Bob and Linda, B&L Holdings Ltd., has $300,000. In addition to the active farming business, B&L Farms and the investment company, Bob and Linda have $250,000 of personal assets.
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B&L Farms is taxed at the small business corporate tax rate. Bob and Linda have been active in the operation of the farm. Each should therefore qualify for the $1 million lifetime capital gains exemption, Heppner explains.
The parents have conceived that the $5,000,000 farm is to be split between the farming sons, with $250,000 in holding company assets to go to the non-farming son. On a dollar basis, this plan is clearly unfair, for the non-farming son would appear to be shortchanged.
The income tax act allows parents to roll farm property to the next generation at any price between book value and market value. Bob and Linda can utilize the capital gains exemptions while taking back fixed value redeemable and retractable preferred shares equal to the book value plus the capital gains exemption. Bob and Linda could structure the reorganization and retain some or all voting rights on the preferred shares, however, they prefer to relinquish voting control to James and Evan.
In this plan, James and Evan would each receive newly issued common shares for a nominal value, say $100 each. James and Evan would each now have a nominal book value of $100 each and a market value of $1,250,000. All future growth of the farm would be attributed to them for tax purposes, Forbes suggests.
Preferred shares could be redeemed to fund Bob and Linda’s lifestyle through retirement. Any preferred shares remaining after their passing would be passed on to their heirs. They view these preferred shares as part of the farm and want any remaining preferred shares upon their final passing to go to the farming sons.
Although Bob and Linda can avoid paying any tax on the rollover of farm assets, there will be some alternative minimum tax (AMT) that is payable. AMT occurs when a taxpayer has claimed a preferential tax deduction like a capital gains deduction or capital gains exemption. AMT should be viewed as a prepayment of future tax. Once paid, a taxpayer can recover the amount paid against regular tax over the next seven taxation years. If no tax is generated over the next seven years to use against the AMT, the AMT will be lost.
The next issue is ensuring that Matt, the non-farming son, is treated fairly. The current plan is for Matt to receive the personal assets with a $250,000 market value ($125,000 book value) and proceeds from the holding company of $300,000 market value upon Bob and Linda’s passing.
However, these market values are pre-tax amounts. Both personal assets and assets in the holdco will be deemed disposed of on the date of death. Assuming that Bob and Linda are in the higher marginal tax rate, there will be tax payable of $31,875 ($125,000 divided by two multiplied by the 0.51 tax rate) and $38,250 ($150,000 divided by two multiplied by the 0.51 tax rate). Tax payable will be $70,125. His net will be $480,000 with these calculations, Heppner estimates.
Bob and Linda will have to come to a decision on what they deem a reasonable amount to provide Matt in addition to the $480,000. Let’s assume they decide an additional $1,000,000 is a fair amount.
This $1,000,000 could come from several sources. As the couple redeem their preferred shares, they could save any surplus cash into their personal assets. They could ensure any remaining preferred shares pass to Matt alone, but there is no guarantee of how many shares will be remaining. And, as previously mentioned, the couple’s current wish is for the preferred shares to pass to the farming brothers. Or they could use life insurance.
Life insurance plan
The life insurance could be held either personally or by the corporation. If held personally, premiums would be paid by Bob and Linda, and they would be able to designate whomever they wish as beneficiary. Premiums can be quite expensive as we progress through life and could put a strain on their cash flow. Life insurance death benefits are received tax free.
The life insurance could also be held in the corporation, which would make premium payments more tax efficient, however, the corporation is then listed as the beneficiary. In this instance, when Bob and Linda pass away, the death benefit from the life insurance would flow to the corporation. The funds would be available for the corporation, Forbes explains.
This life insurance plan would need to be backed by an agreement to distribute the preferred shares to be held by the parents when they die. It could say something along the lines of “upon our passing, any remaining preferred shares are redeemed by the corporation for the proceeds of the designated life insurance policy payable as a capital dividend.” This would ensure the corporation is required to pay out the proceeds to their estate. The proceeds would become a personal asset and would be distributed based on the will. Needless to say, any plan for distribution of farm assets should be vetted by both Bob and Linda’s solicitor and their accountant.
