My title for this article evokes the image in my mind of an ag lender scratching out a line in an equipment list as she goes through it with a farmer client. Lenders sometimes have a real challenge getting a clear understanding of the business structure of farms and the ownership of farm assets. The reason is in a statistic I recall reading someplace over the last few years that indicated 70 per cent of farming operations, regardless of business structure, involve more than one owner/operator. That might sound like a bit of a dumb statement at first — doesn’t the business structure reflect the number of people involved? A sole proprietorship business structure means there is one person, a partnership means there are two or more people and a corporation is a single entity like a person. Right? Well in my experience I have found that the reality is often not that simple and clear.
For example, in one farming operation we may have Mom and Dad who have been farming for years and a son who came home a couple of years ago to farm with them. The parents have most of their farm assets in joint names but when the son came home he bought a half section and is now joint owner of the new tractor with Dad. Mom had a quarter in her name that she inherited recently from her parents so it was used as extra security when the son bought his land and they put both Mom and son jointly on the title of all three quarters. Gets complicated pretty fast doesn’t it?
Usually in situations like I describe above, if you asked the family, they would say they farm in partnership. You would have to ask a few more questions about how income and expenses are accounted for and reported for tax purposes to be sure but very likely this is not a real partnership and no formal partnership agreement exists. The business arrangement is more likely what I would describe as an informal partnership or joint farming operation. I don’t think these are official or legal terms but they are pretty descriptive of the reality which is just three sole proprietorships operating collaboratively.
Often some parts of the business arrangement may be present that would support the idea it is a partnership — for example, crop insurance may be just on one contract but that is likely so the son can gain the advantages of Mom and Dad’s yield history and good experience discounts not for the purposes of establishing a true partnership.
Sometimes these situations can be further complicated by one or more privately held companies being involved as well. Incorporation can be a very useful form of business arrangement for a farm especially with multiple people involved. There can also be some good tax and succession planning advantages. If you are considering a corporation, however, careful planning and good legal and tax advice are important as it is relatively easy to form a company and roll assets into it but difficult and expensive to unwind or get them back out if you need to in the future.
CLEARING UP ARRANGEMENTS
In my view there are many good reasons to simplify, clarify and document the business arrangements and asset ownership on your farm if it involves multiple family members or non-family persons. One of them is for your lender as I mentioned above because confusion about who owns which assets or how revenue and expenses or net income will be split can affect both your ability to borrow and your cost of borrowing. For example, additional legal costs may be incurred to put cross guarantees in place between parties (individuals and/or corporations) in a joint farming operation if the lender is uncertain that sufficient income will flow back to the person they are lending the money to because the business structures and relationship between the parties is just too vague.
Another reason is to ensure proper accounting and a clear paper trail so that expenses are properly documented to the person or entity that actually earned and is entitled to receive the income. Minimizing tax is a good strategy for any business, unfortunately some of the ways we try to accomplish that can really complicate our farm businesses and our lives. Creating a simple joint operating agreement and using a registered farm name, even if the farm is not incorporated may help you with the issue of whose name should be on invoices for inputs, for example, and reduce the need to document transfers of expenses between individuals at the end of the year.
The last reason to put some focus on these issues that I will suggest here involves preparing for the unexpected. One of my favorite speakers is Dr. David Kohl, an agricultural economist from Virginia Tech who speaks frequently in Canada. If you have heard him you may recall he talks about the multiple “Ds” that you need to think about when planning. Most of them apply to this topic including: divorce, death, disagreement, disability, and disaster. So the question I think you need to ask yourself is “Given the current business structure and asset ownership mix of our farm, are we well positioned to handle the unexpected Ds that may come our way?” If you are not sure, it’s likely time to spend some time consulting with your business, tax and legal advisors, doing some scenario planning and perhaps making some changes to get things as “D” proof as you can.
Earl Smith lives near Sundre Alberta and does farm and business consulting in the areas of business management, finance and succession. He was previously with RBC Royal Bank where his last position was Manager, Agriculture and Agri-business, Prairies. Contact Earl at 403-586-2504 or [email protected]with questions or comments.