New small business deduction rules may impact many farm corporations

April 5, 2017

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As many of you will know, if you carry on your farm operation in a corporation, a significant tax benefit is the federal small business deduction (SBD) on the first $500,000 of active business income.  Most, but not all, provinces have a SBD at the same income limit. When the federal and provincial SBDs are combined, the tax rate is significantly lower when compared to the general rate. 

If the farm corporation is associated with another corporation then the two corporations would share the SBD limit.  Association is a complicated tax concept. For example, this would occur where two corporations were owned by the same person or group of persons. 

The rules have been changed and expanded for taxation years beginning on or after March 22, 2016, so these rules are coming into play for all taxation years ending March 21, 2017 or later (assuming a 12-month tax year). These rules were meant to deal with situations where taxpayers were trying to multiply the number of small business deductions available, but they have also caused issues which we believe are unintended. 

What do these new rules mean for you?  They are complicated, but in general will apply if the following conditions are met: 

  1. Does your company provide services or property to another private corporation that is not associated with your company? This can be directly or indirectly.  The likely answer is yes. 
  2. Does your company or any of its shareholders or anyone non-arm’s length (generally related) to your company or its shareholders, own a direct or indirect interest in the private corporation that is receiving the services or property from your corporation?  Consider a company that is owned by another family member, say your brother or sister. If your company sells its product to their company then this condition would be met.  We will call these other companies “connected companies”.
  3. Does your company earn more 10% of its active business income from providing property and services to connected companies?  

If the answer is yes to all of the above, then these new rules apply.

The income subject to these new rules is called “specified corporate income” or SCI for short.  Your company will not be able to claim the small business deduction on SCI.  However the connected company in question may be able to assign some of its SBD limit to your company. This would obviously result in the connected company having its SBD limit reduced by the amount assigned to your company.  The bottom line is there will be a reduced SBD limit available under the new rules and more income will be subject to a higher rate of tax.

There is a significant concern that these rules can apply to farm corporations that are members of a co-operative.  Many farm corporations will sell more than 10% of their commodities to a co-operative and will be a member or shareholder of that co-operative. In this case, the three tests described above would be met since you own an interest in the co-operative.  Technically, the rules could apply to the income earned from the sales to the co-operative and would not be eligible for the small business deduction unless the co-operative assigned some of its SBD limit to the corporate member.  

For more information on how these new rules will affect you, contact your BDO Advisor

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