You’re ready to start growing your farm, but you aren’t sure how to structure the business to ensure it’s financially feasible and productive. You know for certain that you want your farm operations to be profitable and successful. But what is the best way to make that happen? It’s time consider one of three options for a farm structure:
- Proprietorship - the business is operated by a single individual
- Partnership - two or more people operate the business
- Corporation - the business is operated by a distinct legal entity
Before selecting which is best for you, ask yourself these questions:
- How many employees will your farm require?
- How much income would you like to generate or anticipate from your farm?
- How much capital is required to purchase the farm and run the day-to-day operations?
- Do you have a partner or partners who are interested, with the capital and knowledge to run or invest in the farm with you? If so, how would the investment and profit be split?
- How risky is your business plan? Will the risk of debt be significant enough for you to want to safeguard your personal assets?
- What sort of taxation options are attractive to you?
- How comfortable are you with accounting, bookkeeping and administrative tasks? Or would you rather have this aspect of the handled by someone else?
Once you’ve answered these key questions, it’s important to recognize the unique advantages and disadvantages of each type of farm structure. In this article we will outline these in detail.
1. Farm Sole Proprietorship
According to the Statistics Canada 2016 Census of Agriculture, just over half (51.7 percent) of all Canadian farms were sole proprietorships in 2016. This type of farm structure is the simplest to implement. Essentially, all a sole proprietor needs to operate a farm is a farm business registration number and an HST number. Here are the key advantages and disadvantages of this farm structure.
- Less expensive to set up and maintain then a corporation.
- Losses for tax purposes from the farm business maybe deducted against other sources of personal income.
- There is a $1,000,000 capital gains exemption on the disposal of eligible farm property (i.e. land and quota).
- Proprietorships are the only structure that allows individual pieces of farm property (such as one piece of land) to be transferred to the next generation at less than fair market value.
- In the event of legal action against the farmer, all personal assets (not just the business assets) can be exposed to the creditors of the business, i.e. liens.
- Farm proprietorships will be subject to higher tax rates as taxable income increases.
- Farming as a sole proprietor may not be suitable where partners or other siblings are involved in the farm business.
2. Farm Partnership
Operating a farm as a sole proprietor is enticing for the simplicity and advantages, however, it’s also a lot of work to manage a successful farm by oneself. It can also be costly. For this reason, a farm partnership is another attractive farm structure and accounted for 22.9 percent of farms as of the 2016 Census of Agriculture. In general, a farm partnership shares many of the same advantages and disadvantages of a proprietorship, with a few differences noted below:
- A well structured farm partnership agreement can clearly define the rights and obligations of the partners, providing for an orderly dispute resolution mechanism and a means to divide farm assets in the event the farm partners no longer wish to work together.
- The income generated from the farm business is split amongst each partner in accordance with the partnership agreement and claimed in each partner’s individual tax return.
- The cost to start a partnership is slightly more than a proprietorship. Legal agreements are typically required to register the partnership's name and prepare a partnership agreement. Depending on size, the partnership may also be required to file a partnership information return with the CRA.
- Each partner is jointly liable for the actions of the other partners. So, if only one partner is negligent in any respect to the business or finances, then all other partners maybe exposed to the related loss or legal action.
3. Farm Corporation
A corporation goes beyond a traditional business structure. A corporation is a separate entity, distinct from the individual shareholders. Since 2016, the rate of incorporation among farm operations increased from 19.8 percent in 2011 to 25.1 percent in 2016. Of all farms in Canada, approximately 25% were corporations. As your farm grows, it is important to consider discussing the benefits of starting a corporation with a lawyer and your accountant. The advantages and disadvantages are quite different from a farm sole proprietorship and farm partnership.
- The corporation provides protection for personal assets from creditors.
- Corporations are taxed at a lower rate than individuals.
- The amount of wages and dividends paid to the shareholders can be limited, making it easier for the farmer to qualify for the government’s social benefits, such as Old Age Security and CPP.
- Family farm corporations may be transferred to the next generation or the shares sold and the shareholders can take advantage of similar capital gains exemptions available to sole proprietors.
- In Ontario, secondary wills can be set up for the shares of private corporations. By doing so, the assets of the corporation would not be subject to probate tax upon the death of the shareholder, which can be up to 1.5% of the value of the business.
- There are more complexities and expenses to consider when it comes to accounting, bookkeeping, administrative and legal costs.
- Unlike a proprietorship and partnership, a corporation's losses can only be used to offset business or property income within the corporation.
Consult with a Lerners Agricultural Lawyer
Structuring a farm business, particularly for a partnership and corporation, will require legal documentation. The Lerners LLP Agricultural Law Group can help clients with all aspects of agricultural law, including the necessary legal agreements to structure the farm business in the most effective way for the farmer’s needs.
For more information, please contact us at: 519-672-4510.