Business side: Structure matters

(R.H.) WHAT BUSINESS STRUCTURE OPTIONS ARE AVAILABLE TO FARMERS?

(C.F.) There are three main types of businesses structures — sole proprietorship, partnership, and corporation.

Sole proprietorships can be thought of as an extension of oneself and may be the most simple of the options. For tax purposes, business profits are included as personal income, in addition to off-farm income or other earnings.

Partnerships are often informal in nature, such as a husband and wife partnership. Two person partnerships are most common, with 50 per cent/50 per cent ownership or 60 per cent/40 per cent ownership. Partners, however, do not have to be related and farmers can certainly establish partnerships with more than two people. For tax purposes, income earned by a partnership is also an extension of the partners’ other income.

Corporations are separate legal entities and can continue to exist indefinitely. This structure is the most complex but is very common among family owned farming operations for a variety of reasons such as income earned and the related tax implications.

WHAT FACTORS SHOULD BE CONSIDERED IN CHOOSING A STRUCTURE?
The main factor involved in this type of planning is income. How much income will the business generate? The answer to this question can guide the structure. Purely from a tax perspective, Ontario businesses consistently earning less than $80,000 are not likely to benefit from incorporation unless that income can be shared with multiple individuals through a partnership. Those reaching the $70,000 to $80,000 revenue range could see a positive impact.

Sole proprietorships may be the place where some farmers choose to start. If the business is expecting losses for the first few years, this structure could be a strategy to reduce tax since the annual loss will be added to other personal income and then taxed.

If a farm does not earn enough money to make incorporation worthwhile, partnerships are a way to split income and enjoy tax benefits as well. Partnerships can be flexible in nature and are often a stepping stone to incorporation. I always recommend that a partnership agreement is put in place to add some formality to the business structure.

It is important to begin with the end in mind. Thinking about what the long term goals of the business are — including income generating activities as well as who is going to be involved — can help in choosing which structure is the best fit. Partnerships, for example, can be very flexible when they are active but can often become complex situations when the business is winding down or is moving towards incorporation and one partner wants to exit.

WHY ARE MANY FARM BUSINESSES CHOOSING TO INCORPORATE?
Given the recent strong commodity prices, I have seen more growers incorporate in the last couple of years than over the previous decade. These decisions are primarily driven by income earned.

In Ontario, corporations pay tax at a rate of 15.5 per cent. Depending on overall income, individual rates for sole proprietorships and partnerships could be in excess of 40 per cent — a significant difference that translates into an opportunity for substantial savings. A corporation can have up to $500,000 in income taxed at the lowest bracket. In Ontario, individuals reach the 43 per cent tax bracket when they have just under $90,000 of taxable income. Depending on overall income earned, this can be a key reason to change structures.

Business owners looking to incorporate have choices in terms of what assets are rolled into the corporation. In some cases, it makes sense for equipment to be inside the corporation and land to remain outside while for others it may be recommended that the land is included. Owners also are faced with decisions about who should be involved in the corporation and how the director piece should be structured.

There are costs to incorporate and maintain this structure, but it is also important to note that the Income Tax Act has very favourable rules for farm operations. Transferring assets into a corporation can be done with minimal tax implications so if the operation is being transferred to children, this can be the best way to do it.

HOW DO EXISTING BUSINESSES KNOW WHEN IT’S TIME TO TRANSITION?
It is important for farmers to speak with their accountant about business structure. Identifying tax implications and discussing long term strategies should be the first steps. Discussions should then involve a lawyer and financial lender who will play roles in making any changes happen.

It is difficult to comment on every factor to be considered because each situation is different. Choosing a structure or transitioning to a new one is certainly not something farmers can start today and finish tomorrow. Despite whether incorporating is encouraged or discouraged at the local coffee shop, growers need to remember their business is unique and should speak with their advisors directly.

WHY ARE MANY FARM BUSINESSES CHOOSING TO INCORPORATE?
Given the recent strong commodity prices, I have seen more growers incorporate in the last couple of years than over the previous decade. These decisions are primarily driven by income earned.

In Ontario, corporations pay tax at a rate of 15.5 per cent. Depending on overall income, individual rates for sole proprietorships and partnerships could be in excess of 40 per cent — a significant difference that translates into an opportunity for substantial savings. A corporation can have up to $500,000 in income taxed at the lowest bracket. In Ontario, individuals reach the 43 per cent tax bracket when they have just under $90,000 of taxable income. Depending on overall income earned, this can be a key reason to change structures.

Corporations also offer a margin of liability protection because they are a separate entity. I advise clients that incorporation is like a “suit of armour” as it provides another layer of protection from personal assets in a legal situation where there is an environmental problem or employee injury, for example.

But the decision to incorporate requires thought. Beyond tax projections, there are many decisions to be made that need thorough planning. Business owners looking to incorporate have choices in terms of what assets are rolled into the corporation. In some cases, it makes sense for equipment to be inside the corporation and land to remain outside while for others it may be recommended that the land is included. Owners also are faced with decisions about who should be involved in the corporation and how the director piece should be structured.

For start-up farmers or sole proprietors, incorporation may be a way to formalize the business. Financial practices for corporations can improve management skills and assist in planning. Revenue and expenses having to go through a business bank account, for example, can significantly help to separate farm business activities from family living expenses.

For someone already established, incorporation may be driven by succession planning. Sometimes this structure makes transition planning easier and sometimes it does not. Incorporating can be a good way to get the next generation involved by transferring a portion of the shares at a favourable tax rate while the older generation can remain involved and have structured retirement funding. If there are no children wishing to take over the farm operation, however, a corporation may be less appealing as there are tax costs to extract cash and farming assets out of it.

There are costs to incorporate and maintain this structure, but it is also important to note that the Income Tax Act has very favourable rules for farm operations. Transferring assets into a corporation can be done with minimal tax implications so if the operation is being transferred to children, this can be the best way to do it. •