Farms are typically small businesses entitled to the small business tax rate each year.
But farm finance experts say even relatively small farms can lose access to small business tax rates through several means.
Why it matters: Under current rules, even small farms can lose access to small business tax rate in some circumstances.
As described in Ontario’s Ministry of Finance resources, corporations carrying on business through a permanent establishment are subject to both federal and Ontario corporate income taxes.
The general corporate income tax rate for all taxable income allocated to Ontario is 11.5 per cent. This amount varies between provinces, and is added to a 15 per cent federal tax.
The default corporate income tax rate in Ontario currently stands at 26.5 per cent.
As in other provinces, though, overall combined tax rates are reduced, in varying degrees, by “small business deductions” for the first $500,000 of active business income.
As described by Shawn Deyell, a Guelph-based chartered professional accountant with RLB, active business income generally refers to revenue less expenses, and whatever tax write-offs are available. The lowest rate in Ontario currently stands at 12.5 per cent (nine per cent federal, plus 3.5 per cent provincial).
“Simply put, $500,000 is the maximum amount where you have access to the lower rate,” says Deyell. “The (federal) small business rate has been in play since 1982.”
Once taxable farm earnings reach $10 million, access to the deductions keeping the corporate tax rate down start to diminish. At $15 million of taxable capital, or more, a business is no longer eligible for the 12.5 per cent rate. Now, the full 26 per cent applies.
Passive income problems
If half a million seems like a lot, that’s because it is. Deyell says his experience indicates most farms in Ontario generally do not reach post-$500,000 tax rates.
The problem instead lies with “passive income” and how it affects the limit at which higher corporate tax rates apply.
Passive income can include revenue from land rented to a third party. If a person or farm couple has investment income of more than $50,000, for example, the small business tax limit is reduced to $150,000. After that, the full corporate tax rate applies.
“Those amounts can add up pretty quickly and can impact the business itself and its access to lower rates,” Deyell says.
However, these tax rules come from the federal level, and each province must choose whether to implement the full tax rate.
Deyell says many provinces have done so, but Ontario has not. Instead, Ontario farmers surpassing the passive income threshold are only subject to a business tax rate of 18.5 per cent.
“If you’re at 12.5 and get ground down, its 18.5,” says Deyell. “Whereas if Ontario adopted the same rules, the 26.5 per cent rate would apply.”
Issues for larger, multi-faceted farms
Even without passive income, the full corporate tax rate can be a major problem for large farms and those with many people, or many families, all contributing to the same company.
Matt Bolley and Ryan Kehrig, tax experts with MNP in Brandon and Saskatoon respectively, say current tax rates and deduction stipulations are becoming more of an issue for the large farms of Western Canada. This is due to a number of overarching factors:
- The average size of farms.
- Significant increases in land values, as well as equipment and building costs.
- Higher productivity from better technology, farming practices, and other factors.
- Higher per-bushel values.
All of the above, they say, results in much larger balance sheet figures. This pushes many businesses, even relatively small farms, past the $10 million small business tax rate limit, even for relatively smaller farmers.
Acquisition more taxing then inheritance
Bolley says the cost of acquiring assets like land biases the current rules against newer or growing farmers. This is because total liabilities and equities must be considered in tax calculations.
Compare a farmer taking over his or her parents’ farming company with all historical figures on the balance sheet, with one starting from scratch. In the first instance, a quarter of farmland might be recorded at its historic cost of $100,000, even though the land is worth $700,000. The second farmer has to use $700,000 in his calculation.
“It’s the same farm, but the calculations used for the legislation place the second farmer at a huge disadvantage to the first,” says Kehrig. “It could be argued that the second farmer needs the small business limit more than the first, as this farm likely has much larger third-party debt that needs to be repaid, whereas the first farmer simply needs to pay out his parents over the years.”
“The second farmer would have to pay his debt after having paid (the highest tax rate) on his income, but the first pays the (lowest) rate only.”
To level the playing field, both Bolley and Kehrig believe correcting current discrepancies with a one-time upward adjustment of the small business tax threshold might be required. Annual inflation adjustments could then be implemented to account for future change.