CHANGING A BUSINESS FROM PROPRIETORSHIP TO PARTNERSHIP

Originally published on April 3, 2008

 

While generalizations in tax planning can get you into trouble, I am prepared to make one: “Every non-incorporated farm on the Prairies should be structured as a farm partnership!”  A farm partnership with your spouse or farming child offers up some real tax and estate planning advantages.   First, unlike that of a sole owner or proprietor, with a farm partnership you are able to avoid the full income inclusion of your commodity or livestock inventories at succession or death.  Second, from a tax planning perspective, amongst tax practitioners a farm partnership is often referred to as an excellent “intermediate” step to incorporation.  While the incorporation of the farm might not be on the immediate horizon for some Prairie farmers, the option to incorporate before you sell should be.  For the incorporation to be tax-efficient, the partnership should be in place for at least 24 months.  Third, a farm partnership provides a means of splitting income with your spouse or children, without the complexity of a corporation.

What constitutes a farm partnership?

The term “partnership” is not defined in the Income Tax Act.  The Canada Revenue Agency (CRA) states in its Interpretation Bulletin that “a partnership is the relation that subsists between persons carrying on business in common with a view to profit”.  This implies that a partnership is a separate person, and we make this assumption when we report the activities of the partnership, such as its measurement of profit and its acquisition of property.

In the Tax Court of Canada case of Sedelnick Estate v. MNR,  John Sedelnick, now deceased, carried on a farming business in Saskatchewan.   All of the farm property was owned jointly with his wife and all proceeds of the farming business were placed in joint bank accounts.  Eva Sedelnick assisted in the preparation of the land for cultivation, in harvesting and feeding the animals.  She also performed the usual duties of a farmer’s wife and took an active interest in the acquisition of farming assets.  The Estate filed an income tax return on the assumption that there was an active farming partnership, whereas the CRA included all of the farming income on the Estate’s return.  The Estate appealed.

The appeal was dismissed.  The Court found that there was insufficient evidence to establish the existence of a partnership.   Judge Christie referred to the special status that exists between a husband and wife, and that without a document proving otherwise, Eva Sedelnick was simply behaving in a manner consistent with her marital status.  While she was commended for being a good wife, she was unable to prove that she was a farm partner.

Get in writing and register for GST

From Eva Sedelnick’s perspective, a written farm partnership agreement would have saved her professional fees, income taxes and grief. A signed farm partnership agreement is as important as your Last Will & Testament.  It is an essential component of a non-incorporated farmer’s estate plan.

 

 

While a lawyer should draft your farm partnership agreement, just like your Will, your accountant should be involved in the process.  I have seen farm partnership agreements which don’t properly address the death of a partner.   If your farm partnership can be continued after death, you have just dealt your executor and beneficiaries with a more favorable and winning hand.  They may choose to incorporate the partnership, prior to a whole-farm auction and in the process achieve some real tax savings, by applying a lower marginal rate of tax to the farm’s sale of inventories or recaptured income.  Recaptured income occurs when the depreciable equipment proceeds (removed at the lower of cost or market) exceeds the equipment’s depreciated tax value.

You must also register your farm partnership for GST.  This is done by simply calling your local district taxation office.

Transfer it right or not at all

If you are changing your structure from that of a proprietor to a partnership then please avoid the “instant” farm partnership.  This is a recipe for disaster! Since a partnership is a person for tax purposes, any transfers of farm properties, without the proper elections will be considered by the CRA to have taken place at its fair market value at the time of transfer.  To see the significance of a faulty transfer, let’s assume Farmer Joe, after hearing at coffee-row the advantages of a farm partnership, decides to transfer $300,000 worth of grain and livestock to an “instant partnership” which includes himself and his wife.  Can you imagine Farmer Joe’s heart murmur when he opens his mail to find a CRA tax reassessment in the amount of $117,000?

There are rules in the Income Tax Act that permit the deferral of income or capital gains on the disposition of a proprietor’s assets to a partnership, provided that appropriate tax elections are filed, specifically prescribed form T2059.  The underlying premise of these rules is to permit a tax-deferred disposition provided that the proceeds (as established by the agreed amount and the amount and type of consideration) do not exceed the cost amount of the property transferred.

To ensure that GST does not apply on the transfer of the proprietor assets to the partnership, a GST 44 election should also be filed.

Closing comments

In our practice, we continue to get excited, when we explain the benefits of a family farm partnership to the sole owner.  It’s sound, it’s sleek and it’s sexy.  Check it out!

 

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.