In central Manitoba, two brothers we’ll call Sam and Fred, each in his 30s, inherited a successful third-generation farm split fifty-fifty. Their parents took a $10-million slice of farm capital in preferred shares. All growth of farm value subsequent to the estate freeze goes to the brothers in equal amounts to their common shares.
Nathan Heppner, a certified financial planner, and Erik Forbes, a registered financial planner, reviewed the brothers’ farming interests for Forbes Wealth Management Ltd. based in Carberry, Man., which advised Sam and Fred.
If the farm prospers and achieves growth at 7.2 per cent per year, as it has done in recent years, then in 25 years each brother will have a $28.5-million interest. At four per cent growth, their interest will be $13,329 million each.
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Problems arise if one brother dies or becomes unable or unwilling to manage his part of the farm. Each brother will have his own heirs with distinct interests. And, over time, the brothers’ interests may diverge. The challenge is to anticipate changes of status (married or not), mates and potential divorces, children and even the vagaries of life, such as premature death or disabling injury.
A buy-sell agreement can give priority to the surviving brother. However, if the surviving brother or his heirs do not want to continue farming, then the survivor will have to purchase shares from his brother’s heirs.
It will take money to shift interests under these conditions. The survivor could use cash in the corporation, borrow needed funds, or use life insurance. The planning problem is to anticipate value in what could be several decades in the future. Each brother could have several children. As a backstop, the corporation could set up a compulsory first refusal contract for each brother or have a first in line default payback for any and all farm assets held or make the corporation a creditor first in line for loan repayments. Thus, an attempt by a disgruntled spouse of either brother would require waiting in line behind the prior creditor for payment.
Assuming the corporation is valued at $60 million, each brother has equity of $25 million with $10 million in preferred shares to the parents. When both brothers have died, the full amount of future equity has to be paid out to their heirs. Assuming they have contributed equally, a fifty-fifty asset division would be fair and reasonable. To anticipate unequal contributions, a plan can be devised to apportion farm value on the basis of work done or other contributions made measured in work, capital investment, loans to the corporation or other means. Prediction of cases can lead to easy prescription of who gets what and when.
The following examines each of three cases:
1. If there is sufficient cash in the corporation, it could be used to redeem the shares of the deceased brother. If there is not enough cash, then the corporation would have to sell some assets to raise the needed cash.
2. The corporation or the surviving brother could borrow the funds needed. Raising cash from land or equipment sales would be cumbrous, however, and could entail hefty transactions costs.
3. Life insurance would provide cash on the death of either brother with the farming corporation as beneficiary of the policy. The death benefit would be a credit to the farm’s capital dividend account in an amount equal to the death benefit less the adjusted cost base of the policy.
In this arrangement, the capital dividend account would allow the corporation to pay out a tax-free dividend. Then the capital dividend account would eventually flow to the heirs of the deceased brother as payment for shares. It’s worth noting if funds are invested in a corporate investment account, taxes still need to be paid. But with a life insurance policy, the funds would flow to beneficiaries without tax. Life insurance is always a pay first, draw benefits later contract. Under Canadian law, benefits are regarded as the property of the beneficiary. Therefore, claims for injury or insolvency do not reach the beneficiary.
Sam and Fred need to take advice from their lawyers, accountants and farm advisors to get their individual interests aligned in a compatible fashion. There are inevitably upfront fees, most of which are deductible from taxes.
If the farm prospers and throws off cash surplus to its costs, the brothers will have the choice and challenge of diversifying into things they may not know as well as farming or sticking to the farm and adding to its capital. They can cover debts, death of one brother, future family interests and even pesky creditors. However, to the extent that risk grows with time hedged only by present capital or future benefits provided by insurance, they have to carry risk over generations. Keeping each other and their mates informed about their farm’s fortunes is the best way to manage risk and family, Heppner concludes.
