FBC – Canada's Small Business Tax Specialist

The business of farming is broadly defined. If you can convince the Canada Revenue Agency that your business and all its ventures fall within this definition, you are among the select citizens of Canada who can use cash accounting to report business income for income tax purposes.

Farming businesses have special status under certain provisions of the Canadian Income Tax Act (ITA). One notable constant has been that only they, along with fishing operations, can use the cash method of accounting for reporting income for income tax purposes. However, not all farm-type activities necessarily qualify as farming for purposes of the Act. There is legislation – as well as judicial interpretations of that legislation – that ultimately will determine if a business qualifies as farming.

The ITA states that, "Farming includes tillage of the soil, livestock raising or exhibiting, maintaining of horses for racing, raising of poultry, fur farming, dairy farming, fruit growing and the keeping of bees, but does not include an office or employment under a person engaged in the business of farming." However, since the definition says farming "includes" the list of activities given, various judicial interpretations over the years have resulted in additions to the list of qualified farming businesses.

Judicial interpretations of the word "farming" fall into 3 categories: single-faceted businesses, multi-faceted businesses, and contracts for services to farming businesses.

Single-faceted businesses that the courts have decided are farming include tree farming, raising fish, market gardening, and the operation of wild game reserves, nurseries and greenhouses, and chicken hatcheries.

Multi-faceted businesses are commercial operations that are centered around a typical farming operation but have other integrated enterprises carried on to add value to the primary production. CRA generally looks at the amount of interconnection or interdependence among the various enterprises to determine whether they are all part of the same farming business.

In addition, CRA will usually consider certain non-farming activities to be part of the farming operation when the taxpayer does have a bona fide farming operation, when the activities are related to the other farming activities, when the activities are undertaken on a small scale, and when income generated by these activities is incidental to the taxpayer's other farm revenue. If the activities in question go beyond these guidelines, CRA would deem them to be a separate business.

There also is "farm gate" doctrine that allows, in some cases at least, processing activities that occur on the farm to be considered part of the farming business. In isolation these activities would be classed as processing, and farm accounting methods would not be allowed.

These "farm gate" interpretations sometimes end up in court. A recent appeal heard before the Tax Court of Canada involved a case where CRA had denied Tinhorn Creek Vineyards in B.C. use of the cash method of accounting for the 2000 and 2001 taxation years. CRA said Tinhorn Creek was not in the farming business. Instead, CRA said the company was operating a winery with an attached vineyard and therefore was in the business of processing and selling wine. The government agency did not dispute that Tinhorn was operating just one business. Rather, it judged that one business to be winemaking – not farming.

The general manager of Tinhorn Creek Vineyards told the court that during 2000 and 2001 the company owned 175 acres of land, of which 160 acres were planted as vineyards. During both years, all of the grapes grown on the 160 acres were used in the winery. The winery, which is a building and equipment where the wine is produced, used only about 1.5 acres. The market value of the capital assets used for growing grapes was substantially more than the market value of the assets involved in the winemaking operation. Tinhorn Creek is an estate winery, which means it must grow all of its own grapes to produce its wine.

The manager also explained that most of Tinhorn's operation focused on the vineyard, with extensive pruning, irrigation, fertilization, pest control and harvesting activities, with much more time and staff dedicated to growing the grapes.

In his judgment in favor of Tinhorn Creek, the judge said there was clear evidence of the extensive farming practices in the vineyards in comparison to the less involved steps in the winery. He concluded that the vineyard operation played a predominant role in the overall business. If the vineyard should have bad weather or pests, the grapes and ultimately the amount and type of wine that could be produced would be directly affected – and so would the business profits. In summary, the judge said he viewed the winemaking so interlaced with the vineyard operation that both are just facets of one continuous farming operation that begins with the growing of the grapes, through the harvesting of the crop, and followed by the commercialization of the grapes through the production of wine.

The agricultural industry has many multi-phase production operations called "loops." In the pork industry, for example, loops involve the planned production of pigs from sow to weanling to market hog using dedicated farm facilities designed for each phase. The owner of the farm doesn't own the pigs, but is paid a fixed contracted amount for providing the facility and care of the animals. So who is the farmer in this case? Because the feed company or cooperative that owns the livestock, benefits from the profit and bears the risk of loss, it is considered to be carrying on a farming activity.

What about the independent contractor who looks after the pigs at some stage in the loop? Since the ITA definition of farming includes "livestock raising" and does not say a person must have ownership interest, the definition of farming can usually be extended to include the contractor. In fact, depending on the circumstances, the definition of farming could be extended to the following independent service contractors: feedlot operators, cattle drovers, herdsmen, custom work operators and agricultural consultants.

So, if you have a valid farming business under the ITA, you are eligible to use the cash method of accounting for tax reporting. It's a simple system in which you report income in the fiscal period in which you receive it and deduct expenses in the fiscal period you pay them. You do not include inventory when you calculate your income (excluding optional and mandatory inventory adjustments) or accounts receivable and payable.

The alternative accrual method is considered more complex in that you must report income in the fiscal period in which you earn it – regardless of when you receive it – and you deduct expenses in the fiscal period you incur them – whether or not you pay them in that period. The value of all of your inventories, such as livestock, crops, and purchased inputs like feed and fertilizer, must be included in your calculation of income.

The pros and cons of the cash and accrual methods are another story. If you are thinking of switching from the cash method to the accrual method, you will need to formally request a reporting change from CRA. However, CRA consent is not required to switch from the accrual method to the cash method. But talk to your tax advisor or accountant before doing so to make sure you are making the right decision. We will have more on this next month.