The 2013 federal budget made some changes to the Income Tax Act that will impact farmers. They are Restricted Farm Losses (RFL), Lifetime Capital Gains Exemption (LCGE) and Dividend Tax Credit (DTC).
The RFL rules apply to farmers who have other sources of income besides farming. Prior to this budget the maximum RFL that could be claimed was $8,750 against other sources of income. This was calculated on the first $2,500 of farm losses plus one-half of the next $12,500 of farm losses. The remaining farm losses could be carried forward up to 20 years to be claimed against farming income.
The RFL rules were introduced in 1951 and were interpreted by the Supreme Court of Canada in 1971 regarding Moldowan vs the Queen. The Court ruled that the RFL rules would not apply to farms whose chief source of income was farming. Chief source of income is interpreted as gross income and not net income. In a case where off-farm income was $125,000 and gross farm income was $200,000 then the Muldowan ruling would apply and the farmer could deduct all farm losses against both the farm and off-farm incomes. But if the gross farm income was $100,000 in the above case and farm expenses were $120,000 resulting in a net farm loss of $20,000 then the RFL rules apply and the individual could deduct only $8,750 from the $125,000 off-farm income.
However, in 2012 the Supreme Court of Canada in the case of Craig vs the Queen overruled the Moldowan ruling holding that in this case the taxpayer met the chief source of income test even though the taxpayer's other source of income was greater than that of farming. The court held that there was significant farm income to meet the test. Therefore, the court ruled that where there was significant farm income that all farm losses could be deducted against other income.
The 2013 budget restored the RFL rules back to the Moldowan test. The budget amended the act to clarify that the total of all sources of other income must be subordinate to farming income otherwise the RFL rules would apply. However, the budget increased the RFL allowances to $17,500 (the first $2,500 and half of the next $30,000 of farm losses).
The 2013 budget increased the LCGE from $750,000 to $800,000 and indexed it to inflation. This means the LCGE will increase every year according to the level of inflation. If inflation were two per cent then next year the LCGE would be $816,000. This means if a farmer sold qualifying farm property the difference between the sale price and adjusted cost base would be a capital gain. The adjusted cost base is the V-day value for land or the purchase price of the property adjusted for sale and buying costs. For example, a farmer sold a quarter of land for $300,000 in 2013 and the price paid for the land less the Crow Benefit payout was $50,000. Then the capital gain would be $250,000 to which the farmer could use the LCGE against and pay no tax assuming there are no old age security claw-backs and no Alternative Minimum Tax implications.
The budget changed the rules regarding the DTC. This refers to income earned by a farming corporation paid out to shareholders as a dividend. This results in double taxation. The farming corporation pays tax on the income the dividend was based upon and the taxpayer pays taxes on the dividend based on their personal marginal tax rate. The DTC was brought in to alleviate the problem of double taxation.
The way the DTC works is that it calculates a proxy for the pre-tax corporate dividend and then provides a tax credit against that income. This means the taxpayer first is required to "gross-up" the taxable dividends and then applies the DTC against that gross-up income. The concept is to treat the taxpayer as if that income was received directly from them and not through a corporation.
There were two DTC rates and gross-up factors. One for the general corporate tax rate referred to as eligible dividends and the other is for corporations not taxed at the general tax rate referred to as non-eligible dividends. Saskatchewan farming corporations are normally not taxed at the general tax rate because they receive the small business tax rate of 13 per cent compared to the general tax rate of 27 per cent.
Previous to this budget it was felt that individual taxpayers were overcompensated for the DTC gross-up factor for non-eligible dividends. This budget tries to address this issue such that the individual tax payer is not better off by receiving dividend income in this case from a farming corporation or receiving that income directly. This budget therefore adjusts the gross-up factor from 25 per cent to 18 per cent and the DTC from 2/3 of gross-up amount to 13/18. The following table shows the change assuming a $100 dividend.
For more information on this, or other farm business related topics, contact Morley Ayars at 306-446-7479 or the Agriculture Knowledge Centre at 1-866-457-2377.
