1. Transition Planning – Never too Early & July 18 Proposed Tax Changes
Presented by Vern H. Peters, CPA, CA – Tax Partner
(2018/02/13)

2. Topics Transition Planning Land Companies Asset freeze
July 18 Income Tax Proposals
What’s scrapped?
December 13 – Income Splitting
To come (March 2018?) – Passive Assets

3. Land Companies

4. Land Companies
Agriculture producers have been and continue to be inclined not to have land owned inside of a company.
Not sure why that is.
From an income tax perspective, it makes the most sense to own farmland in a company.

5. Land Companies
If purchasing farmland at today’s prices, a company provides more after tax dollars for the land purchase or principal payments on the mortgage
For a Canadian-controlled private corporation, the first $500,000 of active business income will be taxed at 11%.
Personal income tax rates vary from 25.5% to 47.5%

6. Land Companies
Could currently have land with significant equity owned outside of a company
Transfer the land to the company, utilize the capital gains deduction (CGD) and create a large shareholder’s loan
Pay no tax on the transfer
Able to pay tax at 11% in the company and repay the shareholder’s loan without further income tax consequences

7. Land Companies
It is becoming more common for a company to purchase the shares of another company that contains only farmland
The individual vendor can claim the CGD on the sale of the shares

8. Land Companies Should land be owned by the operating company?
Likely not
A land company will assist with estate planning, exiting farming and situations where one no longer wants to actively farm, but would like to retain ownership of the land

9. Land Companies
For estate planning, one may not be able to provide sufficient other assets to non-farming children. Some of the value in the land may need to be provided to non-farming children.
Likely best that non-farming children are not shareholders in the operating company.
Having a separate land company allows them to participate in the land ownership.

10. Land Companies Estate planning (cont’d)
If there are concerns that non-farming children would prevent the farmland being used as security for expanding the operation, you could establish two land companies – one for the farming child and one for the non-farming children.

11. Land Companies
Separate land companies will provide income tax benefits where there is a total exit from farming or a partial exit with sale of operating assets, but retention of land.

12. Land Companies
On total exit, if land was contained in the operating company, other operating assets would need to be liquidated and the after tax cash removed prior to selling the shares of the operating company.
For example, let’s say that there was $1 million left after the sale of operating assets. Immediate income taxes could be as high as $398,000.

13. Land Companies Total exit (cont’d)
If had a separate land company, would still liquidate operating assets in the operating company, but would not need to remove the after tax cash prior to selling the shares of the land company.
Could withdraw cash from the operating company over a period of years reducing the tax rate on the dividends from 40% to 23%

14. Land Companies Total exit (cont’d)
Not possible to create a separate land company without creating income tax consequences immediately prior to the share sale.
Better to have a separate land company where the creation of that company is not linked to a subsequent sale.

15. Land Companies
On partial exit, where land was contained in the operating company, the company shares would no longer qualify for the capital gains deduction or tax free intergenerational rollover.
More than 10% of the fair market value of the assets will consist of inactive assets, i.e., cash and investments received on liquidation of the operating assets.

16. Land Companies
With a separate land company, the shares of that company can continue to qualify for the CGD and tax free intergenerational rollover.
One could reorganize and create a separate land company after partial exit where the land was contained in the operating company.

17. Land Companies
Let’s look at an example of creating a land company where land is currently owned personally
This example is for retiring parents. Goal in retirement to have non-taxable cash flows.
However, the structure could be used well before retirement to create non-taxable cash flows.

18. Land Companies Dad Mom 50% 50% Farmer Farms Ltd.
FMV of Farmer Farms Ltd. is $2.2 million
Dad & Mom own some farmland personally worth $2.2 million and cost of $200,000

19. Land Companies Dad Mom Son 50% 50% 100% DM Farms Ltd.
Farmer Farms Ltd.
Loan owing to DM $2.2 million (secured)
Tax paid shareholders’ loan owing to Dad and Mom for $2.2 million from DM Farms Ltd.
DM owns farmland with a FMV and cost of $2.2 million

20. Asset Freeze

21. Asset Freeze Two children may want to farm
Do not recommend having two brothers in the same company
Each may want control of their own company
May not be able to get along
Expensive to split a company with two brothers – could be at least $37,000 for accounting fees

22. Asset Freeze Set up two new companies – one for each son
Parents’ company transfers inventory and equipment to each company on an income tax deferred basis
Receive preferred shares
Redeem the preferred shares in exchange for promissory notes

23. Asset Freeze Dad Mom Parent Co Son 1 Son 2 Son 1 Co Son 2 Co
Promissory note
Promissory note
Son 1 Co
Son 2 Co
Both new companies contain inventory and equipment

24. Asset Freeze What have we accomplished?
Have reduced the cost to split into two companies during the parents’ lifetime
The only assets in Parent Co. are the notes receivable. It will be easier and cheaper to split this company between the two sons on the last of the parents to die

25. July 18 Proposed Income Tax Changes

26. July 18 Tax Changes
On July 18, 2017 the Department of Finance issued a discussion paper and some draft legislation that addressed three areas relating to private corporations:
Income splitting
Passive investments
Conversion of income into capital gains

27. July 18 Tax Changes Scrapped from the original proposals
Initially included with the income splitting proposals were limitations for multiplication of the CGD with family members.
Conversion of income into capital gains
This area also included a very broad piece of draft legislation that many were concerned could apply to transactions such as transferring land or a farm partnership interest to a company

28. July 18 Tax Changes Scrapped proposals (cont’d)
The broad piece of legislation could have converted what would have been a non-taxable amount from a company to a taxable dividend

29. Income Splitting
Modified draft legislation reintroduced on December 13, 2017
Previously had rules to tax dividend income and certain partnership income received by a minor child from a related private company or partnership
Tax on split income (TOSI) – taxed at the highest marginal income tax rates
Top rate for ineligible dividends in Saskatchewan is 40%

30. Income Splitting Draft legislation focuses on expansion of TOSI
Most professional corporations and service companies will not be able to dividend sprinkle with inactive family members
More restrictive rules for family members aged 18 to 25
Effective for dividends paid after 2017

31. Excluded Shares
Dividends paid on excluded shares are not subject to TOSI
This is the best way to remove concerns with respect to TOSI where a spouse or children over the age of 25 do not have significant involvement in the following areas:
Work performed
Property contributed
Risks assumed

32. Excluded Shares Excluded Shares
Are not shares of a professional or service corporation
Also cannot be a company that obtains greater than 10% of its income from a professional or service corporation
Shares owned by an individual over the age of 25 where the share ownership constitutes at least 10% of votes and value

33. Excluded Shares (cont’d)
Currently have some uncertainty with respect to holding companies and investment companies
Is the 10% of income rule applicable to all holding companies?
Excluded share definition refers to business income. Is investment income of an investment company included in this?

34. Excluded Business
Dividends received by a family member from an excluded business will not be subject to TOSI
An excluded business is one in which the family member has either worked an average of at least 20 hours per week in the previous year or in any 5 previous years
Seasonally adjusted. Not sure what that means for a grain farm.

35. Income Splitting
For those aged 25 and older who are not able to access the excluded shares or business rules
Will need to determine if dividends are reasonable with respect to work performed, property contributed and risks assumed
Tracked during entire period of share ownership

36. Income Splitting
For those aged 18 to 25 who are not able to access the excluded business rules
Can receive a reasonable return on property contributed.

37. Income Splitting Other rules
Can split income with a spouse when the principal active shareholder is 65 or older
Dividend income from shares received as the result of death or marriage breakdown can be excluded
Deemed capital gains on death are excluded

38. Passive Assets There has been no draft legislation
Expected to be introduced with the federal budget in March
Expected to be effective January 1, 2018
Existing rules
Investment income initially subject to income tax at 50 2/3%
Reduced to 20% when dividends paid to individuals

39. Passive Assets Proposed rules
Investment subject to income tax at a rate of 50 2/3% with no refundable portion
By the time investment income has flowed through to the individual, the overall tax rate is 70%
Passive assets that existed on December 31, 2017 are subject to the old rules

40. Passive Assets Proposed rules (cont’d)
First $50,000 of income from new passive assets is subject to the old rules
Non-taxable portion of capital gains from passive assets under the new rules not added to the capital dividend account

41. Passive Assets Proposed rules (cont’d)
Dividend income from publicly traded stocks will not be added to the general rate income pool (GRIP).  Dividends paid from GRIP are eligible dividends that are subject to a lower rate of income tax at the individual level
Can still continue to defer income tax on the initial after tax dollars that created the passive asset

42. Passive Assets Cash rent received on farmland is a passive income
In the future, where farmland would have been converted from active to passive use, one will need to determine if possible to retain active status

43. Additional Change
On a brighter note, the income tax rates for active business income are reducing
In 2017 the rate was 12.5%
Reducing to 12% for 2018
Reducing to 11% for 2019