Seven ways incorporating your farm can improve your operation

Successful farms depend on having smart, strategic people, no matter what structure. However, being incorporated has forced farms to create accrual financial statements and operate under certain rules of engagement, which has jumpstarted more professional behaviour, such as having farm meetings.

“There is a requirement to file a balance sheet as part of the corporate income tax return so reporting gets more sophisticated,” says Lisa Kemp, CPA, and partner at BDO in Lindsay, Ont.

Corporate accrual financial statements clearly measure how well the business is doing on an accrual basis, rather than simply using cash-based income and expense or profit and loss statements.

The power of generating these accrual reports comes when they’re used to make decisions for the future. When these accrual reports are used to make decisions rather than as a report card for compliance with the bank and the government, it can really be an advantage, says Jim Snyder, national director of agriculture for BDO.

For any structure, key ratios can be generated and show how they have an impact on business performance, but sometimes being incorporated tends to formalize the process and make it part of the routine. “All of these management tools are available to unincorporated businesses but, personally, I have found the corporate model easier to manage. Yes… easier not more complex,” says Snyder.

In Snyder’s experience, the decision to incorporate has little bearing on whether the business operates in a professional manner. Instead, he finds it usually hinges on whether the restructure is undertaken as a reaction to some situation, such as tax, creditor proofing or liability, or whether the business is being structured to meet longer-term goals.

“Well-managed businesses are usually the result of the passion and vision of the leadership team, combined with the hard work that goes into every successful business,” Snyder says. “And yes, most all of them end up being structured as corporations. So if that is the outcome, why not structure the business for success from the outset?”

“Sometimes it’s not very hard to get into the highest tax bracket,” says Vandervalk. Especially with the last decade’s volatile markets, some years easily put farmers into a big tax-liable position.

Incorporating a farm may allow a farmer to take advantage of some unique income splitting opportunities. Like sole proprietorships and partnerships, the farms can pay reasonable salaries to lower-income family members for the services they provide, thus taking advantage of their lower marginal tax rates. However, incorporated farms can add lower income-earning adult family members as shareholders, and also pay them dividends. (Note, though, that dividends from private corporations paid to minor children will be taxed at the top marginal tax rates, i.e. the “kiddie tax.”)

One of the major criticisms of farm corporations starts when farmers put land into a corporation and then find that getting it out creates a tax problem. Once assets are rolled into a corporation tax-free, they cannot come out tax-free back to a shareholder.

This can mean some farmers have missed out on the huge estate and succession planning benefit of personally held farmed land being rolled over to the next generation of farmers tax-free. But, says Good, “It’s possible to transfer corporate shares just like land.”

However, some farms are focused on expansion, not estate planning. Vandervalk says being incorporated has enabled them to expand with lower-tax dollars being drawn out of the corporation’s working capital. He says this has been essential for competing for land in southern Alberta’s very aggressive market, pushed by expanding Hutterite colonies, feedlot alley and the growing number of irrigated farms. “I see no chance for my children to farm here,” he says.

Today Stephen and his brother Brian operate over 17 sections of rented and owned, dry and irrigated land, growing canola, mustard, malt barley, durum, spring wheat, and export timothy hay. The family also operates a manufacturing business in Fort Macleod, called FalCan Industries.

Recently the Vandervalks went through a large expansion of their irrigation that required the purchase of some land for access. Not only was this financed with lower-taxed income in the corporation but the decision to expand spurred succession. “Dad’s 72, so when we looked at this investment, he said it’s time,” says Stephen, “… although he left operationally many years ago, when he was in his 50s.”

For the Vandervalks, having the corporate structure helped in succession, because converting the share ownership to the three siblings became seamless.

Shares can be set at current value for the older generation and growth shares to the newer generation. Transferring shares can be done incrementally and with little or less value than trying to buy or transfer all the farm assets at once.

Sometimes for farms like the Vandervalks’ that have higher value and multiple siblings, a corporation permits the succession of whole, intact farm businesses with all the opportunity costs of scale.

A corporate structure allows for more transfer options and configurations than the next generation simply buying the farm outright from their parents. “How many generations have to buy the home quarter?” asks Vandervalk.

Besides, the shares of corporate family farms do qualify for capital gains exemption of up to $1 million and the family farm rollover. There’s also the potential to add other family members as shareholders to allow your family to multiply the capital gain exemption on the future growth of the corporation. The downside to this flexibility is that you have to think about all the potential implications; in a few generations it can get very complicated with too many shareholders.

Succession also led the Vandervalks to write a new shareholders’ agreement. The process of doing this required them to set up some rules under which the shareholders will operate. Now, if one of them wants out or death or divorce becomes an issue, they already have a template.

An often undervalued but important side benefit to setting up a corporation is that roles and responsibilities are defined. Who’s the CEO? Who’s the secretary? “It establishes a clear understanding of the roles and responsibilities of employees, shareholders and family members, recognizing that sometimes those roles overlap,” says Snyder.

Many of the farms that Gordon Colledge, from Lethbridge, Alta., works with are incorporated, but there either isn’t a Unanimous Shareholders’ Agreement (USA), or if there is one, the shareholders didn’t know where the agreement is kept or never had a voice in its creation. He says when something happens and it comes under pressure, they find their USA is only a cut-and-paste product that is ill-suited to the family in business.

Colledge works mainly with the “soft skills,” so he usually gets involved with rural families when there’s a wreck or when something didn’t work. In his many years helping farm families he has noticed a difference between how generations approach incorporation. “Senior, Dad, or the majority shareholder, is focused on the tax savings, while the younger shareholders are looking at the exit clause,” he says.

Farm incorporation forces shareholders to learn to adopt business meetings with agendas and recorded minutes. “In a well-run corporation, communication on and off the farm moves to a higher level,” Colledge says.

Furthermore, conflict resolution clauses have meaning, he says. Sometimes a mediator like himself even becomes a key member of the team, along with an agronomist, accountant, lawyer, nutritionist and the vet.

“I love incorporation when it professionalizes the way the business is run and forces shareholders to demonstrate their professionalism as directors of a multi-million dollar corporation,” he says.

The process of incorporating also tends to require proof of up-to-date wills. It also spurs improved education and emphasizes the importance of relationship management, partnership insurance and an indemnification clause (marriage or co-habitation).

However, it doesn’t guarantee communication. “I’ve heard the phrase, ‘I didn’t know,’ too many times,” Colledge says.

“If I was king for a day, I would not allow lawyers or accountants to issue a single share or give the green light to a company without each shareholder and his/her spouse knowing what’s in the U.S., understanding a shareholder’s responsibilities, and the meaning of voting/non-voting shares,” says Colledge.

It’s also really important to have a discussion upfront about what is a corporate expense and what’s not, including company vehicles versus personal use and when to use a company credit card. Vandervalk farms with his brother Brian, and they both own personal vehicles outside the corporation.

Although most loans require personal guarantees, a corporation still creates another layer of liability insulation against farms. This becomes significant for farms with multiple enterprises such as a daughter diversifying into custom work like spraying or trucking.

“If one of our trucks drives out the lane and smokes somebody, it should help protect us from being sued personally,” says Vandervalk.

Unlike a sole proprietorship, a corporation operates perpetually, even when something happens to one of the owners. A sudden loss of the owner of a sole proprietorship can result in a myriad of problems such as frozen bank accounts, no cheque signing authority or huge tax bills due to inventory deferrals. Says Snyder, “Corporations do not die.”