Can you simplify transition by splitting the farm into two corporations?
The following is a fictional case study created by MNP.
Darlene and Ian started transition planning when they turned 50. At the time their two children, Glen and Amy, were in university and had no idea if they would come back to the farm. Ten years later, both children committed to return to the farm full time. They had both been very active in the farm as youngsters but had been encouraged to take some time away after graduation to explore work and have other experiences before making a decision about farming.
Now in their late 20s, both Glen and Amy have been ramping up their involvement in the family business for the past five years. They were doing well, and with oversight from their parents had settled into a division of tasks and responsibilities. But Dad and Mom still ran the show and the kids wanted more ownership and autonomy.
Logical division of duties
Like many sibling relationships, Glen and Amy had each other’s backs but they did get into some heated arguments. It was not always optimal for them to be working shoulder to shoulder. It was better if they had separate tasks and if they needed help, they could ask for it. The relationship between Amy and her Dad was different than how Glen and Ian interacted. Amy was quick to defer to Dad’s opinion whereas Glen often challenged Dad and wanted to go his own way.
Amy’s personality was to get up and get at it. She liked the daily challenges, solving problems and getting things done. She was also very good with employees and keeping the team on track. Glen was more analytical and tended to spend more time on budgets, marketing and planning. They had complimentary skills, but they definitely came at things from different perspectives.
Darlene and Ian were very pleased that both children were showing the work ethic, management skills and commitment to the farm, but they did worry about the long-term realities of the two kids working together. With Glen planning to marry his long-time girlfriend in the coming year, there would be new dynamics and relationships at play.
Seeking professional advice
They shared these concerns with their transition specialist and got to work updating the transition plan. Darlene and Ian planned to fully step away from the farm in five years, at age 65. They had previously incorporated the farm and put all land into the company. Any new land was also owned by the company.
The transition specialist suggested they retain control over the short term and split the company into two via a process called a “related-party butterfly.” In simple terms, this involves divesting assets to people who are related. The result is that the assets from Darlene and Ian’s company are put into two companies that will ultimately be owned by Glen and Amy. This strategy is not a common path for farm transition, but a number of factors make it a viable option in this case. Also, both Amy and Glen are on the same timeline in returning and committing to the farm business.
Butterfly splits can be complicated, but if pulling out assets individually to separate companies is not feasible and the corporation has to be divided between family members, then a butterfly split is one way to do it.
The beauty of this plan is the simplicity and flexibility.
This related-party butterfly process requires forward planning. Darlene and Ian must retain control of both companies for a period of two to three years before they can gift their common shares and control to Glen and Amy.
At some point, Mom and Dad can freeze their common shares in each company and bring Glen and Amy in as owners – each with their own separate company. Freezing the common shares creates preferred shares that Darlene and Ian can sell to Amy and Glen to fund their retirement. The balance of shares over and above their retirement needs will be gifted to the kids via their estate.
The beauty of this plan is the simplicity and flexibility it affords the next generation. Amy and Glen can continue to farm together indefinitely through a joint venture arrangement, but if they choose to split at some point in the future, the two-company structure makes it relatively straightforward.
When multiple siblings have shares in the same company it can be problematic because the Canada Revenue Agency (CRA) does not consider siblings as related for the purposes of such split-up transactions. An “unrelated party” butterfly carries more risk and is expensive as it often involves getting CRA to provide advance tax rulings on the split-up transaction to ensure everything is on-side from an income tax perspective. The alternative is to pay the tax which, in this case, would be excessive.
At first, Glen and Amy were uncomfortable with the plan. They insisted they would be able to work together and continue to expand on what Darlene and Ian had worked so hard to build. But they listened to some of the cautionary stories from their transition specialist about some tough family business breakups. This helped them both start seeing it as a way to reduce the pressure on their relationship and manage any unforeseen events that might change how either of them view their commitment to the farm enterprise.
Looking even further down the road, the two-company structure makes transition planning for Glen and Amy much simpler and easier as well.
Working with an experienced specialist was key to this transition plan. A related-party butterfly split is not something Darlene and Ian would have considered. A good relationship with their transition team allowed them to engage in a more complex process that matched their unique circumstances.
From an AgriSuccess article.
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