Farm businesses have special status under certain provisions of the Canadian Income Tax Act (ITA).
Along with fishing operations, farmers can use the cash method of accounting (or cash accounting) for reporting income for income tax purposes.
If you have a valid farming business under the ITA, you are eligible to use cash accounting for tax reporting.
Cash accounting is 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 don't include inventory when you calculate your income (excluding optional and mandatory inventory adjustments) or accounts receivable and payable.
Easier Than Accrual Accounting
The alternative accrual method of accounting is considered more complex.
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.
Must Qualify as a Farm Business to use Cash Accounting
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 and can use the cash method of accounting.
The Income Tax Act 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
- Keeping of bees
According to the ITA, farming does not include an office or employment under a person engaged in the business of farming. In other words an employee or farm hand working on a farm.
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 that can use the cash method of accounting.
Judicial interpretations of the word "farming" fall into 3 categories:
- Single-faceted businesses
- Multi-faceted businesses
- Contracts for services to farming businesses
Single-faceted businesses that the courts have decided are farming include:
- Tree farming
- Raising fish
- Market gardening
- Wild game reserves
- Nurseries and greenhouses
- 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.
CRA will usually consider certain non-farming activities to be part of the farming operation when:
- Taxpayer does have a bona fide farming operation
- Activities are related to the other farming activities
- Activities are undertaken on a small scale
- 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.
In some cases, processing activities that occur on the farm are considered part of the farming business. In isolation these activities would be classed as processing and farm accounting methods would not be allowed.
Switching Accounting Methods May Require CRA Consent
If you're thinking of switching from cash accounting to accrual accounting, you'll need to formally request a reporting change from CRA. However, CRA consent is not required to switch from the accrual method of accounting to cash accounting.
For more information on FBC and the farm tax services we offer, call us today at 1-800-265-1002 or submit an online form and an FBC farm tax specialist will contact you at your earliest convenience.