HOW TO FARM WITH A PRODUCTION JOINT VENTURE

Originally published on December 16, 2004

 

A number of farmers want to work less without giving up their land and their active farming status.  Others want to expand but not by borrowing excessively to buy land.

The typical solution for these two groups has been a cash rent or a crop share arrangement, but there are downsides.

The landowner exchanges his source of income to rental from farming, which means he is no longer eligible for a farm-status license plate, the new Canadian Agricultural Income Stabilization program and the long list of farm expenses that were available to him on his personal or corporate tax return.

For the expanding farmer, limited cash resources may eliminate cash rent as an option.  Also, renters often complain that crop share arrangements, even when input costs are shared, give too much to the landlord in the year of bumper crops.

There is now a new solution on the horizon; the production joint venture.

While not defined in the income tax act, generally it refers to a business structure closely resembling a partnership but lacking one or more of its essential elements.  In a joint venture, the individual partners keep individual ownership of their assets and contribute only the the use of their assets.

In exchange for the use of their assets, the partners receive a predetermined percentage share of the gross revenue and expenses of a single project or limited number of products.

The joint venture does not borrow money or file an income tax return.  The partners report the income on their tax filings.

Because the joint venture does not own assets, the capital cost allowance is claimed by the partner who owns the equipment.  Their is mutual control and management of the venture.

In the accompanying table I have illustrated an example of a production joint venture that I came across recently at a 2004 agriculture tax update course.  Tax lawyer Greg Gartner of Felesky Flynn in Edmonton put forward the concept of a landowner agreeing to receive one-third of the joint venture revenue but also negotiating a cap for bumper crops.

Through their negotiations, the landowner also agrees to pay all of the crop insurance premiums along with a fixed crop input per acre payment.

In our example, the landowner agrees to pay $10 per acre for the crop inputs such as chemicals, fertilizer and seed.

By securing crop insurance and providing the $10 per acre crop input payment, our landowner has secured a "production value floor" or minimum gross profit or $24.22 per acre, or one-third of the insurance payment minus his negotiated costs.

Through the negotiations, the landowner agrees to cap his joint venture agreement to be payable to the operator partner.  This is referred to as a "production value ceiling" and in our example of the good crop, it caps the landowner partner's gross revenue at $57.25 per acre.

 

 

Our operator partner realizes larger proportionate gross revenue of $122.75 per acre and a higher ending gross profit of $62.75 per acre.

In the event of a "home run" crop, the operator partner sees his ending gross profit raised to $102.75 per acre while the landowner partner's gross profit remains at $44 per acre.

According to the CAIS program handbook, income and expenses are considered allowable "where the arrangement constitutes a joint venture."  Alternatively, "landlord income earned through a crop share must be reported as rental income for income tax purposes, and is therefore considered non-allowable under the program."

Written agreement

For this reason, anyone interested in substantiating their claim of a joint venture should draft a joint venture farming agreement.

I have only seen one such agreement, which Gartner drafted.  It quantified the production-value ceiling as an addendum to the agreement and set out cropping plans for the year in advance.

Anyone contemplating a production joint venture should endure their drafted agreement captures the essence of a joint venture.

I expect to see more land this way in the future.  It allows the landowner to insure for a guaranteed minimum revenue per acre and assures the operator that when his good management combines with good weather to produce a home run crop, the property owner's revenue share is capped.

 

 

Allyn Tastad, certified general accountant, is a partner in the accounting firm of Hounjet Tastad Harpham in Saskatoon at 306-653-5100, e-mail at allyn@hth-accountants.ca or website www.hth-accountants.ca. He is also involved in the family farm near Loreburn, Saskatchewan.  The opinions expressed in this column are for information only.