AVOIDING THE GROSS REVENUE TEST

Originally published on June 4, 2009

 

Farming has always been and remains  a risky business.  In an effort to encourage and reward these risk-takers, the Income Tax Act (ITA)  provides a lifetime $750,000 exemption in respect of capital gains realized on the disposition of qualified farm property.

The ITA defines property eligible for this exemption as being "used in the course of carrying on the business of farming in Canada". One test included in this definition is particularly onerous and may yield a most unfavorable result, specifically if you've worked off the farm.

A real-life example

Saskatoon Joe grew up on his family's farm in rural Saskatchewan.   He has known farming his entire life and after establishing himself as a mechanic and welder by trade, began searching for a farm of his own.  In 1989 he bought 80 acres which included the family home and entered into a cash rental agreement for two adjacent quarter sections.  In 1990 he bought an additional quarter section and since then has seeded approximately 535 acres each year.

While Saskatoon Joe was a good farmer, his gross farm income never exceeded his off-farm employment income which peaked at $79,000 per year.  Last year, Joe's wife was diagnosed with cancer and Joe decided to opt for a simpler life at a slower speed.

When Joe and I met in my office, he had some good news.   There was some interest in the quarter section that he bought in 1990 for $50,000.  An out-of-province buyer had offered him $310,000.  Would this farmland qualify for the $750,000 exemption?

What is the Gross Revenue Test?

The gross revenue test applies to any property acquired after June 18, 1987 and for Joe to make this property eligible, in at least two years while the property was owned Saskatoon Joe's gross farm income must exceed his income from all other sources. 

 

 

 

 

Joe fails this test and with it his ability to offset his capital gain on part of his farm (one quarter section) with an equal capital gains deduction.  Put another way, Saskatoon Joe will have to pay approximately $55,000 of income taxes on the sale of one quarter section.  He is quick to point out that these unforeseen taxes are more than what he paid for the quarter section to begin with.

Avoiding the Gross Revenue Test

Fortunately for Saskatoon Joe, he is able to avoid the gross revenue test by structuring his farming operations as a farm partnership.  If throughout a period of at least 24 months, the property was used in a farming business by a "family farm partnership" and he was "actively engaged on a regular and continuous basis" in the farming business carried on by the "family farm partnership" then the gross revenue test will not apply. 

In Joe's mind, the farm was never his alone but always held in partnership with his wife.  But as I had mentioned in previous articles, this alone is insufficient to establish the existence of a partnership.   Judge Christie in Sedelnick Estate v. MNR,  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.

For Saskatoon Joe by restructuring his farming operations as a farm partnership, we are able to get him on-side with the capital gains exemption once his farm partnership has been in existence for 24 months.  To avoid the $55,000 of income taxes, Saskatoon Joe is prepared to wait it out.

Closing comments

By structuring his farming operations properly, Saskatoon Joe will reap an appropriate reward for his past years of risk.  Would the gross revenue test make your farm land ineligible for the capital gains exemption?  If you are uncertain then please speak to your accountant directly to ensure that you are doing all you can to safeguard your ultimate rewards.  You and your family deserve it!

 

 

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.