Tax law experts fear a nasty surprise awaits many farmers as the end of harvest nears and they begin to grapple with changes the federal government is proposing to the income tax act.
Federal Finance Minister Bill Morneau announced tax reforms July 18 in a move the Liberals say is aimed at limiting the use of private corporations to reduce personal income taxes.
But as Oct. 2 and the end of the 75-day public consultation period looms, farm advisers grow increasingly worried their clients have yet to figure out just how significantly these new rules will affect them.
This impacts nothing less than farmers’ ability to pass a farm to the next generation, said Mona Brown, an attorney and tax law expert with Brown and Associates Law Office in Carman.
“They’re really harming that possibility of keeping the family farm in existence because there won’t be a way to do it without paying huge tax,” she said.
“And the reality is these rules are now going to be so complicated that people will be forced to hire professionals who will be forced to charge a bunch of dollars just to try to sort out the rules for each and every situation. I cannot think of one farm client who will not be affected by these rules.”
Brown has prepared a document that details how restricting capital gains deductions earned by minors and restricting the use of family trusts will affect farmers and small-business owners.
This is targeting critical tax planning strategies used by many farmers and small-business people and doing so retroactively, she states in that document.
Income splitting, paying dividends to family members, and use of lifetime capital gains deductions, will all be subject to new restrictions.
For example, children under the age of 18 who receive a capital gain will not be able to use their deduction on any property, and capital gains allocated from a family trust will no longer be eligible for a deduction.
All capital gains earned by an individual who is related to the farmer will be subject to a “reasonableness test.” Canada Revenue Agency (CRA) will be looking at whether the amount is “reasonable” given the work done for the business by the person claiming the exemption, and any income over what CRA deems reasonable will be taxed at the highest marginal rate.
As well, the government is tightening rules that recognize the labour of farmers’ children under the age of 25 who work on the farm. If they’re not working there on “a regular, continuous or substantial basis,” they will not be considered to be working there at all, and therefore not eligible to receive dividends, Brown also says in her summary document.
The practice of having children and spouses subscribe for common shares in the farm corporation to split income is also being targeted.
“If the government decides that the contribution of labour and capital by the child is insufficient, the proceeds of a sale can be taxed and be considered ‘split income’ and the capital gain will be taxed at the highest rate and not eligible for the capital gains exemption,” she writes in her summary. “If the sale is to a related party, it won’t even be treated as a capital gain, but as a dividend, with even worse tax treatment. This can be a major problem where two brothers are farming together and one brother is buying out the other’s family.”
As of January 1, 2018 family trusts can no longer be used to allocate capital gains to beneficiaries to use their capital gains exemptions either.
Tax law experts also have significant concerns with the provision of a one-time ‘special election,’ allowing individuals to use capital gains deductions under the current tax rules until Dec. 31, 2018. For starters, doing so will mean paying a tax called the alternative minimum tax (AMT) — and it will be steep. It’s an option that basically favours the wealthy, Brown said.
“There’s a number of reasons why people won’t be able to use that exemption,” she said. “The main one is they won’t be able to pay the alternative minimum tax. It could be $50,000. If you’re a wealthy person you may be able to afford that. But if you’re a farmer who doesn’t have that kind of disposable income, it’s just going to be beyond you.”
What this essentially boils down to is higher taxes looming, and far greater complications for succession and estate planning, making selling the farm to family members more costly than selling to someone outside the family from a tax point of view.
There seems no regard at all given as to how this will affect the family farm corporation, Brown said.
“I don’t think it was the intention to muck about with farmers, but they seem to have no concept of what they’ve done.”
“They should have exempted farmers from all of this. These rules were made in Ottawa and Toronto by employees who were trying to attack certain very specific transactions predominantly done by professionals who had management companies and management partnerships. But what they’ve done is used a sledge hammer to try to solve a problem that only needed a thumbnail clipper. They’ve tarnished everyone with the same brush and changed the rules for everyone.”
At the end of last week pressure continued to mount from a new 42-member Coalition for Small Business Tax Fairness to abandon the scheme.
Farm organizations across the country, which are part of the coalition, have also decried the timing of the consultations, saying it doesn’t give farmers enough time to tackle the complexities nor allow for meaningful consultation.
The Canadian Federation of Agriculture (CFA) is urging farmers and their organizations to contact their MPs immediately.
Along with other farm groups it wants these tax reform proposals taken off the table and reconsidered until more fulsome consultation has taken place.
“These tax proposals represent transformative changes that would bring about major uncertainty for farms that are incorporated, especially for multi-generational family farms,” said CFA president Ron Bonnett in a news release August 31.
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