Is your dream to operate a vineyard, an orchard or other agricultural pursuits? Cher Wood, CPA, CGA has a wealth of knowledge when it comes to operating a vineyard or conducting other agricultural activities in B.C. As a former vineyard owner Cher is knowledgeable in the day-to-day operations and challenges one can encounter when farming your own or contemplating a land leasing arrangement. When you marry that with her extensive accounting knowledge, having her in your corner is a true benefit to your success.
Cher loves to share her knowledge in order to set you up for success from the beginning. Here she has put together information landowners and lessees should be aware of when contemplating the leasing of farmland. If you have any questions Cher and RHN are here to help.
Basic Components of a Lease
Answering the five W’s of a leasing arrangement facilitates both parties in having a clear understanding of the terms of agreement and what each party’s respective rights are.
“Who” – are the parties involved in the lease arrangement and are comprised of a lessor and a lessee.
“What” – is an interest in land which gives a person all the usage and occupation rights of a landowner to a property (or a portion of the property) in exchange for rent paid to the landowner
“Where” – a formal description of the leased property.
“When” – outlines the specified period of time the agreement covers.
“How” – details the nature of the payment terms, provides security for both parties and can be registered with land titles.
TERMINOLOGY
The lessee pays rent to the lessor and the lessor collects payment from the lessee.
The landowner (lessor) retains the right to transfer ownership of the land and to even sell it. Conversely, the tenant (lessee) has exclusive possession of the land and the responsibility of maintaining it according to the terms of the lease. At the end of the lease, possession of the land reverts back to the landowner.
OTHER CONSIDERATIONS
Additional considerations that should be addressed in the lease agreement are:
- options for renewal (will the rental amount be reviewed and changed periodically?)
- termination (at what date does the lease end and what are the ramifications in the event that there is a non-fulfillment of the contract?)
- utilities and other costs relative to the property (who will be responsible for paying these costs?)
- insurance coverage,
- subletting (primary tenant is still liable for the obligations under the original lease including payment of rent unless released from this obligation by the landowner),
- maintaining farm classification and if not will the lessee pay the increase in property tax cost?
- dispute resolution avenues and criteria.
- repair and maintenance costs,
- registering the lease on land titles,
- where the lease expires but use continues (lessee continues to occupy the lands, lessor continues to accept rent—a new tenancy arrangement is created and deemed to be a yearly tenancy agreement subject to the provisions of the original lease insofar as those provisions apply to a year-to-year tenancy arrangement,
- personal improvements (chattels) brought or made on the land at the lessee’s expense are the property of the lessee; however, all improvements to the real property made on or to the lands at the lessee’s expense remain on the lands without compensation to the lessee at the termination of the lease,
- property access rights by the landowner and the lessee
(OTHER PLAYERS)
Section 73 of the Land Titles Act considers leases on part of a parcel of land for longer than three years or that have an option to extend beyond three years to be subdivisions. Accordingly, before a lease can be registered, the subdivision process must be followed and approval granted by the approving officer. The approving officer will depend on where the property is located. For example, rural subdivisions that are in Regional District electoral areas must seek approval from the Ministry of Transportation and Highways through the Regional District or Islands Trust. Further, if the property is in the Agricultural Land Reserve (ALR) permission for the subdivision is required from the Agricultural Land Commission.
Two types of subdivision are possible:
- Standard fee simple subdivision where the parcel of land is permanently subdivided into separate lots.
- Leasehold subdivision wherein the portion of the land with subdivision approval can’t be sold separately from the remainder of the parcel and the leasehold subdivision expires at the end of the lease. Approval from an approving officer is required however, the approving officer may not require the construction of roads or installation of utilities under a leasehold subdivision.
(Note** the longer the term of the lease, the more likely a subdivision and zoning requirement will need to be met and subdivision approval will be based, in part, on local zoning bylaws.)
A fundamental policy under BC’s Farm Practices Protection Act is that farmers have the right to farm in BC’s important farming areas (particularly those lands in the ALR) provided that normal farm practices are used and adherence to other legislations listed in the Act are followed. (Waste Management Act, Pesticide Control Act, Health Act).
Normal farm practice is defined in the Act to include an activity “that is conducted by a farm business in a manner consistent with proper and accepted customs and standards as established by similar farm businesses under similar circumstances.”
Under BC PST, you are a qualifying farmer if you are the owner or lessee of land that is classified as a farm under the Assessment Act of BC. Refer to the Province of BC PST Bulletin 101 for a detailed list for other activities that enable farmer qualification. As a qualified farmer there are PST exemptions available for the purchase or lease of farm equipment such as tractors, combines, and incubators. The PST exemption for this type of equipment and related services provided to exempt farm equipment is available only for qualified farmers and on the proviso that the equipment and goods are used solely for farming purposes.
In addition, there are PST exemptions for electricity, heat, natural gas or fuel purchased for farm use. However, PST will apply when these energy products are purchased for other uses such as energy used to package produce or to operate a retail stand.
In certain situations, farmers are eligible for certain tax reductions and exemptions under the Motor Fuel Tax Act on fuel used for authorized machinery and vehicles.
WorksafeBC coverage is required if you lease or occupy lands or premises to be used as a workplace and always if you employ individuals or contractors either on a permanent on a temporary basis to perform duties. The lessee may also wish to consider applying for personal optional protection coverage.
BC Assessment
The assessed value of farmland is determined by regulation and differs from region to region based on a variety of factors such as cultivation, irrigation, land use, and soil capability. The assessed value has little do with market value.
Farm classification in BC is a voluntary program, but to obtain this classification owners must apply to the local assessor using the appropriate prescribed application form. Farm classification receives a preferred property tax rate (Class 9) which can significantly reduce the property tax burden by up to 50% of the residential rate.
Farm class applications and any applicable leases must be submitted to BC Assessment Authority by October 31st in order for the following tax year assessment to be adjusted.
Farm classification is granted on an annual basis. Only certain land uses qualify for farm classification wherein part of a parcel or parcels of land are:
- Necessary to the farm, and
- Predominantly used for a qualifying agricultural use (a detailed list can be found in the BC Assessment Farm Classification in British Columbia publication.)
Farm class regulation require producing farms meet minimum gross income tests which vary depending on the size of the farm operation:
- $2,500 gross income for a farm operation on 1.98 acres to 10 acres
- $2,500 plus 5% of the actual value of the area in excess of 10 acres
- $10,000 if the total area of the farm operation is less than 1.98 acres
Minimum income requirements must be met in at least one of two relevant reporting periods and a sale of a qualifying agricultural product must be made in every reporting period.
Land Leased – Farm Class Regulation
Farm class regulation sets out the information that must be contained in the lease if land is leased to a farmer and what must be provided to the assessor by October 31st in order for the land to be classified as a farm:
- Names and signatures of the lessee and lessor
- Land legal description
- Commencement date of the lease
- Signing date of the lease
- Duration of the lease
- Leased area
- Intended use of the leased land
- Consideration for the lease
Leased land that is outside of the ALR and less than 1.98 acres is not eligible for farm classification. However, several parcels or parts of parcels may be operated together as an integrated farm operation under one lease.
When land is leased to a farmer who farms other property, the lessee’s entire farm operation must meet the income requirement from the sale of qualifying agricultural products based on the acreage of ALL the land comprised in that farm operation.
When land is leased to a farmer who doesn’t farm other property, the production of qualifying agricultural products on the leased parcel(s) must meet the income requirement based on the acreage of leased land.
Land leased to a farmer must make a reasonable contribution to the farm operation. The lease or rental amount paid by the lessee is not considered qualifying income for the purposes of farm classification.
When an owner leases the property to a farmer under a crop-share arrangement, the land that is farmed will be eligible for farm classification but the land beneath a residence will not be eligible for farm classification unless the occupant is involved in the day-to-day activities of the farm.
Land Use Agreements
We’ll explore various types of land-use arrangements:
Crop Sharing
Crop Share – farming or rental? (plus 5% GST/rental)
Under a crop share arrangement the parties determine how the share of the crop revenues are to be divided—will it be the traditional 1/3 split or a cost contribution basis wherein the lessor shares in the payment of crop inputs (such as fertilizer and chemicals) on the same proportion as the crop revenues are shared?
Other considerations between the lessor and lessee will cover matters in which the lessor is granted influence under the terms of the agreement in decisions related to production, cropping, quality and condition of the land, the use of fertilizer and chemicals, crop insurance coverage, delivery and sale of the products and how government payments and subsidies are applied for and shared.
CRA sets out its position on crop sharing in IT Bulletin 433R wherein “sharecropping” is defined as “an arrangement where a taxpayer or landlord receives from a tenant a share of crop in lieu of rent.” The Bulletin further addresses where the sharecropper is an employee of the landowner and receives a share of the crop as payment for service. The landowner could still be viewed as being in the business of farming. It seems the key is whether the landowner maintains a level of involvement in the day-to-day operations and management of the farm including being responsible for the payment of expenses. Under any other derivation of the arrangement the payments received by a landowner is considered rental income and not income from farming.
The matter is further complicated when it comes to GST/HST in which the definition for sharecropping is “a system of agricultural production in which farmland is supplied by way of lease, license, or similar arrangement to a tenant who farms the land, in return for a portion of the crops grown on the property.” As such, if the use of the land is supplied in exchange for a share of the crop, then the supply of the land is considered “zero-rated” and GST/HST does not need to be charged by the landowner. However, if payment for the use of the land is not a share of the crop, but a fixed cash amount, then the supply of the land to the tenant is subject to GST/HST.
Cash Lease
Cash Lease – rental (plus 5% GST)
- Fixed payment to lessor that may be changed in the future.
- Provides a guaranteed/stable income.
- Great option for absentee landlords.
- Lessee receives all income from the crop production and pays expenses attributable to the operation.
- The lessee enjoys the flexibility and independence in managing all aspects of the crop production.
- Lends well to short-term arrangements.
Flexible Cash Lease
Flexible Cash Lease – rental (plus 5% GST)
- Lease arrangements where the payments vary year-to-year based on changes in commodity prices.
- The lessor shares in the risk associated with changing prices.
- Similar to the cash lease the lessee receives all income from crop production and pays expenses attributable to the operation.
- The lessee enjoys the flexibility and independence associated with managing all aspects of crop production. Longer-term leases are often negotiated under this arrangement.
Other drawbacks to leasing
Drawbacks to land leasing arrangements?
- Non-payment by the lessee
- Damages to the property by the lessee
- Loss of farm classification for property tax purposes
- Loss of income tax savings (ie. capital gains exemption as land lease is not considered farming under the Income Tax Act [ITA])
- Loss of intergenerational rollover rules as the property must be used “principally” in farming over the ownership period
- Lease to a child generally qualifies as farming, however there is a potential risk that a subsequent sale of the land by the child could be treated as an income rather than a capital gain
- Agristability/AgriInvest participation is limited to crop-share and joint venture arrangements wherein for AgriStability a crop share arrangement qualifies as a joint venture if the landlord’s share of allowable expenses reported to CRA is approximately the same as their share of the allowable related income. For AgriInvest a crop share arrangement qualifies as a joint venture if the landlord’s share of the eligible purchases reported to CRA is approximately the same as their share of the allowable related income.
- Determining the rent to charge can be challenging and the lessor and lessee cost approach will differ greatly
Contract Farming Arrangement
Contract Farming Arrangement – farming
- Provides an alternative to leasing for those landowners that wish to remain classified as farmers under the ITA.
- The landowner retains full control of the farm business but doesn’t necessarily have to be actively involved in the day-to-day operations.
- The landowner assumes all the risks and rewards associated with the business and is responsible for decision-making.
- All revenue and expenses are received and incurred by the landowner who then pays a basic lump-sum fee to the custom operator on a specified date.
- Sometimes a bonus may be negotiated such that the operator shares in the benefit from crop volume/price or on a profit percentage basis.
Joint Venture Arrangement
Joint Venture Arrangement – farming
- Enables individuals to join resources but retain ownership to create larger operations.
- It provides the opportunity to create a business structure that combines all operations of each member for the purpose of enhancing diversification and increasing the scale of operations without purchasing more land.
- The structure can be tax efficient and relatively simple to administer.
- A joint venture provides a flexible option for groups who wish to work together towards a common purpose without merging their entire operations.
- It provides some stability to the members as each member is committed to the arrangement for the long-term.
- Has a specific term of existence – defined by time or by desired outcome.
- Profits of the joint venture are allocated based on the individual member’s percentage of contribution.
- The members retain ownership of the assets contributed to the joint operations.
- No formal registration is required and the tax reporting is combined with the member’s regular reporting.
Other taxes
Other taxes to consider on a lease arrangement
- PST (land and building is exempt) – but equipment leases are subject to PST (unless listed as qualifying agricultural equipment)
- Property transfer tax – a registration of a lease is a taxable transaction for property purchase tax purposes but there is an exemption for leases having a term of 30 years or less.
Capital Gains Exemption “Qualified Farm Property”
Are custom farming contracts the answer to the farm classification issue from property assessment and income tax perspectives? There is no question that these arrangements will require more work from the landowner not only from an administrative perspective but on an operational level. Further, it is important from an income tax perspective that the landowner be actively engaged on “a regular and continuous basis in the business of farming” to substantiate the argument that the property is qualified farm property.
One needs to consider the future tax implications should the ability to claim the capital gains exemption be challenged by the CRA.
If you are contemplating a transfer of the property to another generation, there could be negative tax results should your child later sell the property and discover that it is not considered qualified farm property eligible for the capital gains exemption.
For properties acquired after 1987, there is a two-year gross revenue test; property must have been used principally in a farming business and the specified person must have been “actively engaged on a regular and continuous basis in the farming business throughout a period of at least two years OR the property must have been used by a family farm corporation or a family farm partnership for a period of at least 24 months and the specified person must have actively engaged on a regular and continuous basis in the farming business in which the property was used.”
License or Lease?
Let’s explore aspects related to a licensing agreement
- A license gives someone permission to do something on or with someone else’s property.
- A license is NOT an interest in land and therefore does not attach itself to the land—therefore on sale the license is terminated (unless otherwise provided for in the contract of purchase and sale.)
- It is not enforceable against successors or future purchasers of the land.
- It can’t be registered with the BC Land Titles.
- A landowner can enter into multiple license agreements for one parcel of land or one license on part of a parcel of land.
- No restrictions to the landowner entering into multiple license agreements with the ALR (nor is permission by the ALR commission required.)
- A contractual license lasts for a defined period of time and can be deemed to be abandoned should the licensee cease to make use of it for a length of time.
- The license should stipulate whether a sublicense can be entered into.
- A license is not collateral for a mortgage.
Note revenue from a licensing agreement would not qualify as farming income unless it was relatively inconsequential to other bona-fide farming income reported for the same parcel or part of a parcel. It would be subject to GST/HST if the landowner is registered as a small supplier.
This post has been prepared for general information purposes. It is not advice. The information presented may not fit your unique situation, please consult one of our trusted business advisors at RHN CPA for further clarification and interpretation of your particular circumstances.