Help your farmer clients maintain their tax advantages, Part 1

You want to ensure your client benefits from available tax advantages. If your client is a farmer, those advantages come with stipulations about property and how it’s used.

Canadian farmers may report income on a cash basis, transfer qualified property to children on a rollover basis and access a lifetime capital gains exemption (LCGE) of $1 million. To access these provisions, the property must meet various criteria, including whether a qualified user is or was actively engaged in farming on a regular and continuous basis.

Consider the hypothetical case of Paul. Paul is married to Linda, and they have one child, Dana. Paul owns an estate winery in Ontario, and his operations include growing grapes in his vineyard, making wine on his property from those grapes and selling the wine in his tasting room. His retail operations are incorporated; the vineyard and winemaking are not.

Do you even farm?

In 1993, the Tax Court of Canada held that growing grapes and producing wine are commercially separate activities, with the former considered farming and the latter considered manufacturing and processing. This was subsequently confirmed in a 1999 CRA tax ruling.

Paul’s grape growing fits within the Income Tax Act’s (ITA’s) definition of farming. His winemaking falls outside the definition, unless he can convince the CRA (or a judge in tax court) that his winemaking is incidental to growing the grapes.

Whether an activity is incidental to farming is a question of fact. In the case of Tinhorn Creek VineyardsLtd. v The Queen (2005 TCC 693), Tinhorn had 160 acres of vineyards and a 1.5-acre winery, which began operations after the land was purchased. The business had an inventory of barrelled wine, a building and equipment.

Tinhorn successfully argued that capital assets used for grape growing had substantially higher value than the assets deployed for winemaking. Further, Tinhorn was an estate winery and used only grapes grown in its vineyards to make its wine, thus tying profits to the harvest’s success.

Tinhorn won its case and was able to report income on a cash basis (based on the year the amount was received, rather than when it was earned). The CRA had initially disallowed it from using this method.

Since Paul can similarly take the position that his winemaking is incidental to grape growing, he too may be able to extend the tax provisions related to farming to his winemaking — or any other activity so intertwined or subordinate to the farming operation that it could not be considered separate.

Another example of incidental farming activity could be selling produce or eggs at the farmer’s market as a subordinate activity to the main farming operations.

How a farmer can access the LCGE

The LCGE is available to individuals disposing of qualified farm or fishing property (QFFP) or qualified small business corporation (QSBC) shares. (While the new tax on split income (TOSI) rules extend to capital gains, TOSI won’t apply to LCGE-eligible gains even where the exemption isn’t claimed.)

If Paul’s estate winery qualifies as farm property, then he can access the enhanced $1-million LCGE on disposal of his vineyard. If the shares from Paul’s incorporated retail operation are qualified small business shares, he can access the lower LCGE of $866,912 for 2019. This amount is inflation-adjusted annually until it reaches the enhanced LCGE available on disposal of the farm. If both his small business shares and his farm qualify, his maximum exemption is limited to $1 million; he doesn’t get both limits.

Paul can claim the exemption whether he owns the property directly, as a partner of a partnership or as a beneficiary of a trust that owns the property. He must be resident in Canada throughout the year of claim.

Common reductions to Paul’s LCGE limit include the:

$100,000 capital gains exemption that was eliminated in 1994, if Paul filed the election to claim it;
cumulative net investment loss balance; and
allowable business investment loss claims.

Also, there are certain anti-avoidance rules that may reduce or eliminate Paul’s LCGE, such as the conversion of a capital gain that would otherwise qualify for the LCGE to a dividend upon disposition to family members. This can be particularly problematic if Paul were to dispose of property to his child’s holding company rather than directly to his child.

In the next article, we’ll examine the criteria used to determine whether Paul’s vineyard can access QFFP status.

Rebecca Hett, CPA, CGA, TEP, is vice-president, Tax, Retirement and Estate Planning at CI Investments.