[Updated: Dec. 12, 2016] – Merle Good has a new piece of estate planning advice for Canadian producers: “Create a damn shareholder’s loan.”
“This isn’t a new idea, but it isn’t done as frequently as it should be,” said the farm business management expert. “This strategy allows us to do a lot of neat things that we never could do before as families with intergenerational transfers.”
Good explained this strategy at an Alberta Canola ‘Powering Your Profits’ event here last month, using an example from an operation in Manitoba he worked with. In that instance, the older generation had $5 million in land, livestock, and machinery and shared that business — let’s call it Farm Inc. — with their son. But the parents were winding down and wanted to create a tax-free retirement pension.
So they created a new company.
“We’re going to take $3 million of preferred shares and transfer it to a new company,” said Good. “We haven’t moved any assets — all I’ve done is move $3 million of preferred shares to this new company that Mom and Dad own.
“The son still gets to work on the same land base, the same cows, the same machinery. We’re not stripping assets out.”
Farm Inc. is now worth $2 million, and the son has 100 per cent operating control over it. The new company — let’s call that one NewCo — is worth $3 million, and the parents share operating control and ownership of it.
“As a parent, do I feel more comfortable bringing my son or my daughter in to a smaller business or to a bigger business?” said Good.
“If I have everything I own in one company, I’m not going to give him much control over that company very quickly. Everything I own is in that business. As parents, we want to transfer the equity down, but we also want to control it.”
Giving the son control over a smaller piece of the business is good for the parents, but it’s also good for the son.
“If I move $3 million over to NewCo, is he excited about working Farm Inc.? Yes, because he may have a bigger say in a smaller piece than a smaller say in a bigger piece,” said Good.
Shareholder loans are also good for a tax-free retirement pension, but that’s where things get tricky. The parents sold NewCo $2 million in personal land, creating a $2-million shareholder’s loan.
“Most of the time, I would say you have to sell your land to the company you and your son own together (Farm Inc.) to get your shareholder’s loan, but that makes the farming corporation even bigger,” said Good.
“If you want to create a shareholder’s loan, don’t necessarily consider selling land to a company that you already own with a son or daughter. Think about doing this strategy instead.
“You’re selling personally owned land to your own personally owned company, not to the jointly owned company. With that, we’ve created a $2-million shareholder’s loan.”
A shareholder’s loan is created when your company owes you money because you’ve contributed an asset to the corporation, explained Good.
Usually, if a farmer sells $2 million in personal land to his own company, the company would have a $2-million capital purchase and the farmer would have $2 million capital gain. But the income tax act allows farmers to transfer that land in exchange for cash owed – which then creates a shareholder’s loan.
“Because land qualifies for a deduction exemption, I can sell the land to my company, and it owes me $2 million,” said Good. “And because I qualify for the capital gains exemption, it wipes out my personal tax no different than if I sold the land to my neighbour. Now the company owes me $2 million, and because I’ve used my capital gains deduction, it’s tax free.”
To create an intercorporate loan, a slightly different methodology is used. The parents are able to take equity as shares and convert it to an intercorporate loan, so “they’re a creditor, not a shareholder.” The son still has access to $5 million in assets, but he owes his parents $3 million as a tax-free intercorporate loan.
“If you own shares, you have no security. So we’re converting equity into an intercorporate loan, which I can secure against the assets, plus sell personal land to NewCo,” said Good.
“I want to sell my land to myself, but my new company has no cash. It’s not farming, so how do I get the money? I get the money by moving my $3 million in equity out of the jointly owned corporation and creating an intercorporate loan, which is a tax-free loan.
“Dad’s taking $3 million in equity and saying, ‘Hey, instead of me being a shareholder, I’ll become a creditor.’ The only way to do that is by creating a new corporation. That’s an intercorporate loan.”
Good summarized the strategy this way: “I moved $3 million across to NewCo and I sold $2 million in personal land to it. Farm Inc. owes NewCo $3 million, which gets the $3 million tax free, and I created a $2-million shareholder’s loan by utilizing my $2-million capital gains exemption because I sold my own land to my own company,” he said, adding the $2 million acts as a sort of tax-free pension.
“That is neat.”
Shareholder’s loans also create an “off-farm asset for intergenerational wealth transfers,” said Good.
“I can leave a shareholder’s loan to a child who’s not farming,” he said, adding he is “violently” opposed to leaving farm shares to an off-farm child.
“It doesn’t work. If you have kids who are not involved in the active part of the business, I will not ever recommend that parents leave shares to them,” he said.
In their will, the parents would likely leave their shares to their son and the shareholder’s loan to their off-farm children — in this case, their daughters.
“We can agree on terms, that Farm Inc. pays NewCo so many dollars a year that the son can live with,” he said. “What’s nice about that is we have a repayment term — maybe it’s $50,000 a year that the farm can afford.
“The shares go to the son. The girls aren’t part of the business, but they get their money on the shareholder’s loan tax free, say $50,000 a year over 20 years.”
If you’re considering going down this route, you’ll likely want to consult with a tax adviser, said Good, because as far as he knows, this isn’t done very frequently.
“No one — in all the years I’ve worked with accountants and lawyers — has ever thought of creating intercorporate loans between companies you own yourself.”