Estate Planning with Farming, Fishing or Combined Farming and Fishing Businesses

Last updated: February 2022

Introduction

This tax topic will discuss the special tax issues relating to farming and fishing businesses.  The long-standing farm tax rules were extended to fishing operations in 2006.  In 2014 these special rules were extended to combined farming and fishing operations.  The tax rules for fishing or combined fishing and farming generally parallel those for farms.  To the extent that the discussion below may focus on farms, the comments could equally apply to fishing or both farming and fishing.

Special Tax Rules

Farming and fishing businesses can potentially enjoy two unique and significant tax incentives:

1. Qualifying farming or fishing assets are transferrable from parents to children on a tax-deferred “rollover” basis thereby avoiding the taxable event normally occurring when such transfers are made, and
2. The “lifetime capital gains exemption” (LCGE) can apply to certain personally held farming and fishing properties.  For other non-farming or non-fishing businesses, the LCGE is only applicable to shares of qualifying corporations and not personally held business assets.

Farm and Fishing Estate Planning

Due to these special rules, estate planning for farming and fishing or combined businesses tends to focus on ensuring the conditions for the intergenerational rollover are met in order to defer the tax on the transfer to heirs.  Where other businesses generally use life insurance to finance the tax liability arising on transfers to heirs, this need may not exist in farming and fishing businesses that can successfully meet the rollover conditions.

However, many farming and fishing operations represent the bulk of the parents’ assets.  Issues often arise as the parents start planning, how to divide their estate where they have both farming children and children who are not actively involved on the farm.  Like all businesses, mixing active and non-active children as business owners can be problematic as there may be conflict naturally arising from their different objectives.

Life insurance can provide a tax-efficient method of equalizing an estate among heirs by enabling parents to transfer the ownership of the business to the active farming children during their lifetime (or at their death) and providing an estate consisting of life insurance proceeds to the non-active children on their parents’ death.

Where a farming, fishing or combined business is held in a qualifying corporation, parents can rollover qualifying shares to a child, including the non-active children on a tax-deferred basis.  If the farming corporation is the beneficiary of a life insurance policy on the parents’ death, the life insurance proceeds can be used to redeem the shares owned by the non-farming child(ren).  This redemption results in a deemed dividend for income tax purposes that can be paid as a tax-free capital dividend to the child(ren) to the extent that the life insurance death benefit has been added to the corporation’s capital dividend account.  This “roll and redeem”- type strategy can allow the non-active children to receive their share of the parents’ estate in the form of cash without incurring a tax liability.

Farming and Fishing Intergenerational “Rollover” Rules

The rollover rules apply to transfers of certain farm and fishing properties from parents to children.  There are separate sets of rules for transfers during lifetime and on death.  Subsection 73(3) of the Income Tax Act (the “Act”) deals with personally owned qualified farm or fishing property transferred during lifetime, while subsection 70(9) outlines rules relating to such transfers at death.  Similar provisions apply to qualifying company shares and partnership interests (subsection 73(4) while living and 70(9.2) at death).

The following conditions must be met in order for the tax-deferred transfer to apply:

• The property must be land in Canada or depreciable property in Canada of a prescribed class. (Note that since 2017 depreciable property includes goodwill and other intangibles such as quota.)
• The property was, before the transfer, used principally (discussed below) in the business of farming or fishing (also discussed below) and
• the taxpayer, parent, spouse or common-law partner, or any child was actively engaged on a regular and continuous basis in that business;
• the child of the taxpayer was resident in Canada immediately before the transfer. 

Several concepts mentioned above are reviewed below. 

Personally Owned Farm or Fishing Property

During life, for tax-deferred transfers by a parent to a child, personally owned property must be land in Canadaor depreciable property in Canada of a prescribed class, (goodwill, farming or fishing quota and fishing licenses are included in Class 14.1), of a farming or fishing business carried on in Canada

The rules are similar for transfers upon the death of a parent to a child.

When a parent is incorporating personally held farm or fishing assets, consider triggering any LCGE available on these personally owned farm and fishing assets.  For one thing, this increases the amount of debt the parent can take from the company, allowing for future tax-efficient extraction of corporate dollars by paying down this debt.  Another advantage of triggering LCGE is the opportunity to increase the tax cost base of the assets transferred to the company.

Family Farm and Fishing Corporations and Partnerships

If the farm or fishing business is carried on by a corporation or partnership, the asset the parent must transfer to the child are the shares of the corporation or the interest in the partnership.

The shares of the corporation or the partnership interest must qualify for the rollover at the time of the transfer and subsection 70(10) sets out the requirements.  “All or substantially all” (meaning at least 90% according to Canada Revenue Agency (“CRA”) guidelines) of the fair market value of all corporate or partnership assets must be:

• Property used principally in the course of carrying on a farming, fishing or combined business in which the individual, partner, child or parent was actively engaged on a regular and continuous basis by:
• The corporation or any other family farm, fishing or combined corporation of the individual, partner, child or parent;
• A corporation controlled by the corporation;
• The individual, partner, child or partner; or
• A family farm, fishing or combined partnership of the individual, partner, child or parent; or
• Shares or debt of another family farm or fishing corporation of the taxpayer, partner, child or parent.

The shares or partnership interest must meet the above definition at the time of death or at the time of the inter-vivos transfer and the transferred property must have been used by the corporation or partnership in the course of carrying on a farming, fishing or combined business. 

The CRA has commented in the technical interpretation letter, 9617525 dated June 24, 1996, that cash or other cash-type assets which have been received when property is sold, do NOT qualify as “property that has been used by…”. This may require reviewing the percentage of usage of a particular property as well as the amount of time the property was held for the business of farming/fishing.

Life insurance held by a farming, fishing or combined corporation or partnership is not considered to be property used principally in the course of carrying on a farming, fishing or combined business.  See the discussion “Life Insurance as a Non-business asset” below.

Definition of Farming Business

Although not specifically defined in the Act, the word “farming” has a broad definition in subsection 248(1).  Farming can include, among others, tillage of the soil, livestock raising or exhibiting, maintaining of horses for racing, raising of poultry, fur farming, dairy farming, fruit growing, the keeping of bees and fish breeding or raising.  For more information, please refer to page 9 and 10 of CRA’s Guide T4002, Self-Employed Business, Professional, Commission, Farming, and Fishing Income, and Income Tax Folio S4-F11-C1, Meaning of Farming and Farming Business.
In determining whether or not a farming operation is a business, the following are some of the criteria established by the CRA in paragraph 1.21 of Income Tax Folio S4-F11-C1, which must be considered.

The CRA would consider the extent of activity in relation to that of businesses of a comparable nature and size in the same locality. The main test is the size of the property used for farming. If it is much too small to give any hope of profit, the presumption is that the property is being held for personal use or enjoyment of the taxpayer. On the other hand, where the land is large enough to be profitable, it may still be non-business, but in much more limited circumstances.

Another consideration would be the extent to which the taxpayer actively engaged on a regular and continuous basis in the business of farming i.e. time spent on the farming operation in comparison to that spent in employment or other income earning capacity. If the taxpayer spends most of his time during the crop season attending to the farm, there is a strong presumption that he is carrying on a farming business. This is particularly so where the taxpayer has farming background or experience.

The development of the farming operation and commitments for future expansion according to the taxpayer’s available resources are considered. This test is based on the capital investment of the taxpayer in the operation over a number of years and on the acquisition of buildings, machinery, equipment and inventory by the taxpayer.

Used principally in the business of farming and fishing

The phrase “used principally in the business” is seen in the definitions of “qualified farm and fishing property”, “shares of a family farm or fishing corporation” and an “interest in a family farm or fishing partnership”.  The CRA has commented on this phrase indicating that it is a question of fact whether an asset is “used principally”, but they generally look to a two-part test: the percentage of the property used in the business as well as the percentage of the time it was used.

Normally a property is used principally in a farming, fishing or combined business if its primary use (more than 50% of its use) is in respect of the farming/fishing business operation as opposed to a concurrent operation that might be ancillary to the farming, fishing or combined business (such as storage or trucking of farm products for others or contract harvesting).

In addition, it is necessary to consider the time of the property’s ownership to determine if it is “used principally”.  Again, the CRA looks to the total ownership time, and if the property has been used in the farming business for more than 50% of the time, it is considered “used principally”.

This test becomes important in situations such as where a family has ceased to farm certain land and has started to rent it.  Provided the total rental time does not exceed 50% of the total ownership time, the land should continue to meet the “used principally” definition.

Definition of “child”

The definition of “child” for these rules is broader than but also includes the normal definition (subsection 252(1)) which is:

• Any person of whom the individual is the legal parent
• A person who is wholly dependent on the individual for support and of whom the individual has, or immediately before the person attained the age of 19 years had, in law or fact, custody and control
• A child of the individual’s spouse or common-law partner (subsequently referred to as the “partner”) and,
• A partner of a child of the individual.

This definition is extended in subsection 70(10) of the Act for purposes of the farm and fishing rollover rules to include a grandchild, a great grandchild, and any person who at any time before the age of 19 years was wholly dependent on an individual for support and of whom the individual had, at that time, in law or in fact, custody and control of the person.

Transfer Price - Transfers During Lifetime

A transfer to a child can occur by sale or gift under subsection 73(3) or 73(4) of the Act. The transfer price determines the proceeds of disposition to the parent and the cost of acquisition to the child.  The transfer price must fall within the following limits:

Transfers by Sale

If the parent transfers a particular piece of farm/fishing property for consideration within the limits above, that amount is deemed to be the parent’s proceeds of disposition and the cost of acquisition of that property to the child.

Because the taxpayer can choose the value at which the property passes to the child (ie., where the child gives actual consideration), the parent can choose to transfer the asset at a value that allows the parent to utilize other tax planning strategies.  For example, the parent could choose to realize recapture on the transfer of depreciable property.  If the parent has losses otherwise available in the year, the parent may choose to offset the income from the recapture with the losses otherwise available.

If the consideration is higher than the greater of the limits above, then the greater of those limits is deemed to be the parent’s proceeds of disposition and the child’s cost of acquisition.  Where the transfer is made during lifetime and the individual wishes to transfer at a higher amount than the rules automatically provide, it is necessary to enter into a legal sales agreement with the child that establishes this higher transfer price.

If the consideration is less than the lesser of the limits above, then the lesser of those limits is deemed to be the parent’s proceeds of disposition and the child’s cost of acquisition.  Note where a transfer from a parent while living to a child takes place at less than fair market value, and the child subsequently sells the property within three years of the receipt, the parent can be deemed to have received fair market value on the original transfer to the child (subsection 69(11)). 

Land may be transferred at a price that gives rise to a capital gain. If the parent has LCGE available, the parent may choose to recognize a capital gain in order to utilize any available LCGE.  Where the land was gifted to a child (ie., no consideration was received from the child) and the FMV of the land was less than the parent's ACB, a capital loss could be triggered on the transfer.

Transfers by Gift

For parent-to-child transfers via gifts, the transfer price is automatically the lesser of the above amounts.  A taxpayer cannot “gift” a qualifying farm/fishing property to a child and achieve a deemed disposition at fair market value (if it is greater than cost) by making an election in the income tax return of the transferor parent. Fair market value proceeds must be determined in accordance with a normal business transaction such as, an agreement for sale.

Generally, there will be no tax on a gift of farming assets but gifting non-farm assets may be taxable.  Gifts to minor children can result in property income from the asset being attributed back to the parent.

Transfer Price - Transfers at Death

For bequests made at death, the transfer price is determined similarly; the transfer price is automatically the lesser of the above amounts.  However, depending on the type of property, the estate’s legal representative can elect under subsection 70(9.01) or 70(9.21) of the Act, in the parent’s terminal return, for the transfer to take place at any amount between the above amounts.  The “elected” amount becomes proceeds of disposition to the parent for purposes of determining capital gains and recaptured capital cost allowance.   A higher transfer price may be desired, for example, to make use of any unutilized losses or LCGE available to the parent which at the same time increases the child’ s tax cost base of the transferred asset.

In summary at death:

Situations Where Farm and Fishing Assets Do Not Rollover

There is no rollover provision for the transfer during lifetime of cash-basis farm inventory from a parent to a child.  Any such transfers are deemed to occur at fair market value. The parent may consider selling inventory to a child over a period of time to spread the income out over a number of years.

On death, cash-basis inventory is considered a “right or thing”.  It can be either included in a separate terminal tax return for the deceased (subsection 70(2)) or transferred to a beneficiary on a tax-deferred basis (subsection 70(3)).

If these assets are owned by a farm or fishing corporation, they would be considered assets used in the farming or fishing business.  Consequently, consider transferring these assets to a farm or fishing corporation whose shares would qualify for a rollover.

The Lifetime Capital Gains Exemption

The LCGE increased from $750,000 to $800,000 effective January 1, 2014 and is indexed to inflation in subsequent years.  For 2022, the LCGE is $913,630.  For qualified farm, fishing or combined property, the LCGE is increased to $1 million for dispositions after April 20, 2015.  Going forward, for dispositions of qualified farm/fishing property the exemption will be the greater of $1 million and the indexed LCGE.

Capital gains and gains from the disposition of Class 14.1 assets (i.e. goodwill, quota and fishing licences) realized by an individual on farm or fishing assets can be offset with the LCGE.  The rules to determine qualifying farm or fishing property for the LCGE are similar to the rollover rules, but there are some extra conditions for the LCGE application. 

Gains eligible for the LCGE include gains on:

• Land, buildings, fishing vessels or Class 14.1 assets used in a farming or fishing business by:
• the individual, partner, child or parent
• a family farm or fishing corporation or partnership of the individual
• Shares of a family farm or fishing corporation of the individual or partner, and
• Interests in a family farm or fishing partnership of the individual or partner.

Capital gains realized on other depreciable property such as machinery and equipment do not qualify for the exemption.

For LCGE purposes, any personally owned property must be owned throughout the immediately preceding 24 month period by the individual, partner, child or parent and in at least two years while the property was owned by one of these individuals, the gross revenue from the farming or fishing operation exceeded the net income from all other sources. (subsection 110.6(1.3))

For LCGE purposes, the definitions of family farm or fishing corporations and partnerships are set out in subsection 110.6(1).  At the time of sale, at least 90% of the fair market value of the property owned by the corporation or partnership must be:

• Property used principally in the course of carrying on a farming or fishing business in which the individual, partner, child or parent was actively engaged on a regular and continuous basis by:
• The corporation or any other family farm or fishing corporation of the individual, partner, child or parent
• A corporation controlled by the corporation
• The individual, partner, child or partner
• A family farm or fishing partnership of the individual, partner, child or parent
• Shares or debt of another family farm or fishing corporation of the individual, partner, child or parent, and
• Interest or debt of a family farm or fishing partnership.

To qualify for the LCGE, at least 50% of the fair market value of the corporation or partnership property must be assets listed immediately above throughout the 24 months immediately preceding the sale.

Where a parent transfers property to a child on a rollover basis, whether during life or at death, and the child subsequently sells the property realizing a capital gain, the child may use the capital gains exemption to the extent permitted.  However, if the child’s sale takes place within three years from the parent’s transfer, the parent may be deemed to have received fair market value proceeds at the time of the original transfer (subsection 69(11)).

Transitional Rules for Long Held Farm Properties

Favorable transitional rules apply to personally owned farm (but not fishing) property acquired before June 18, 1987 (paragraph 110.6(1.3)(c)), and the property need only be: (1) used principally in farming in the year the property was disposed, or (2) used principally in farming during any five years of ownership (and not necessarily in the year disposed).  These transitional rules are not available on fishing property because the fishing rules came into effect after 1987.  For these transitional rules to apply, the property must be “last acquired” by the individual prior to June 18, 1987.  This “last acquired” test may not be met if the property was the subject of a 1994 income tax election to utilize the then available $100,000 general capital gains exemption which was phased out after 1994.

Life Insurance as a non-business asset

The CRA does not consider life insurance as an asset used in a business.  Therefore, its valuation becomes important when determining the qualification for a rollover of shares or partnership interests or for the LCGE in respect of a farming/fishing corporation share or partnership interest.

Should non-active assets build up in farming/fishing corporations while parents are living, they can generally reorganize their corporate holdings into two corporations if desired; one corporation owning the active farm or fishing business and another corporation owning the non-active assets.  This structure helps the parents access their LCGE and the rollover rules on their business corporation.  A caution regarding the transfer of life insurance policies: life insurance policies are not eligible for a tax deferred rollover (section 85 of the ITA) between corporations that most other assets can enjoy, and a transfer may give rise to a taxable policy gain.  This was the case in a 2017 CRA ruling (#2017-0714411R3), a farm corporation’s (Farmco) assets, including life insurance, were being split between a mother and her two children.  After the reorganization Child 1 would retain Farmco, and Child 2 and mom would hold the shares of the transferee corporation (TCo).  The transfer of the life insurance policies on mom and Child 2 from Farmco to TCo could not occur on a tax-free basis.  For a more detailed discussion on the tax implications of transferring a policy, please see the Tax Topic entitled, “Transfer of an Insurance Policy Involving Corporations and a Shareholder or Employee”.

One strategy may be to transfer life insurance to a non-active corporation before the policy has an accrued taxable gain.  Where farm or fishing corporations have policies with sizable gains, consideration can be given to transferring the farm or fishing assets to a separate active corporation and leaving the policy in the original corporation which becomes the non-active corporation.  This reorganization structure may achieve the desired split between active and non-active corporations while avoiding the need to transfer the life insurance policy.

For the purposes of the deemed disposition at an individual’s death, the fair market value of any life insurance policy on the individual is deemed to be its cash surrender value immediately prior to death (subsection 70(5.3)).  This provision is applicable to all businesses, not just farm and fishing businesses.

After death, if the life insurance proceeds are used to redeem, acquire or cancel the shares owned by the insured within 24 months after death, the policy and its proceeds will continue to be valued at its cash surrender value immediately before death (subsection 110.6(15)).  This makes it easier to meet the 90% and 50% business asset tests, since a policy’s cash surrender value is usually significantly lower than its death benefit. 

Conclusion

The special rules available to the family farm and fishing business give these types of businesses some unique planning opportunities when compared to regular businesses.  Planning techniques are primarily based on the ability (or inability) to utilize these special tax provisions in the farm or fishing business situation being considered.

Life insurance may not be needed to provide for a tax liability where the farm or fishing rollover and/or CGE provisions can be structured to eliminate the tax that would otherwise arise.  However, life insurance can provide tax-effective solutions for other purposes such as key person coverage, funding a buy-sell agreement, and in particular, for estate equalization purposes using the “roll-and-redeem” type strategy.