Keep in mind that succession and estate planning are not events, they are processes.
With the high increase in farm values today, you may have begun to wonder how a transfer to your next generation will ever be possible. Today, the capital gain exemption available on shares of family farm corporations, or on farm properties and quota (if not incorporated), is $750,000 per individual. With the price of quota and land, many family farms are worth well in excess of $3 million.
Even if farmers have the opportunity to give part of their farm value to their children or grandchildren without income tax consequences under the Income Tax Act of Canada, they still need to maintain sufficient investment income to ensure a healthy retirement. This is also necessary if a farmer wants to provide for their other children who are not actively involved in the operation.
Many family farms currently operate through a corporation to benefit from lower tax rates. We will consider this as we look at the quick overview of one possibility available to farm owners to transfer shares in the corporation to the next generation.
The farm owners of a family farm, valued at $4 million, have three goals: To transfer the farm to their son and daughter-in-law who are actively engaged on the farm; to receive $2.5 million as retirement income; and to give the balance of $1.5 million to their son, as a gift.
To realize their goals, the farm owners would create another corporation commonly called a “holding corporation.” If the farm has excess cash (that is, above what’s needed for day-today operations), it must be first withdrawn in order to ensure the shares qualify for the capital gain exemption. This is referred to as “purifying the corporation.” The excess cash can be used to repay any outstanding loans the farm owners may have. Next, they would transfer shares of the farm corporation to the holding corporation for $1 million. The shares would then be redeemed by the farm corporation in exchange for a $1 million promissory note payable to the farm owners’ holding corporation. The promissory note would be payable, in part, by any excess cash and by monthly payments over a specified period (15-20 years), and would bear a set interest rate.
The farm owners would then sell their shares of the family farm corporation of $750,000 each to their son and daughter-in-law. Part of the amount would be payable on the closing date, while the balance would be payable over 15-20 years with or without interest. The balance of the shares, valued at $1.5 million ($4 million minus $1 million transferred to the holding company, minus $1.5 million of shares sold directly), would then be gifted to the son. This gift should be excluded under the Family Law Act, and the legal documents should indicate so, in order to protect the gift to the son in the event of a separation.
To protect the investment left in the corporation (promissory notes), the holding corporation (farm owners) should take a general security agreement on the farm properties and include other protective clauses in the agreement of sale. For example, what happens if the farm is sold within a specified period of time? The farm owners, if possible, should have a life insurance policy for last to die to cover any income taxes payable on death. They should also review their wills to ensure that they contain continuity payment clauses to the estate, and should review their power of attorney documents.
In planning for yourself and the future of your farm, the decisions you need to make may seem overwhelming, however, it is important to keep in mind that succession and estate planning are not events, they are processes. As such, it is best to address these issues over time with the help of your tax advisor.
Chantal Gagné is a certified general accountant with BDO Dunwoody based at Embrun, Ont.