ARCHIVED - Farming or Fishing - Use of Cash Method
What the "Archived Content" notice means for interpretation bulletins
DATE: June 4, 1993
SUBJECT: INCOME TAX ACT
Farming or Fishing - Use of Cash Method
REFERENCE: Section 28 (also section 119 and subsections 22(1), 69(1), 76(4), 85(1), 248(7) and the definitions of "farming" and "fishing" in 248(1))
This bulletin replaces and cancels Interpretation Bulletin IT-433 dated June 25, 1979. Current revisions are indicated by vertical lines.
This bulletin deals with various matters relating to the cash method of computing income which may be used by a taxpayer in the business of farming or fishing. Basically, the cash method income or loss is calculated as the difference between the cash revenue received in the year and the cash revenue expenditures paid in the year with appropriate adjustments for non-cash items such as capital cost allowance and the recapture of capital cost allowance. The topics discussed in the bulletin are:
- how to make the election to use the cash method,
- the meaning of received,
- when a cheque is included in income of a taxpayer using the cash method,
- the carrying on of separate businesses,
- the meaning of a farming or fishing business,
- the inventory adjustments pertaining to taxpayers in the farming business who use the cash method,
- the transfer of inventory and accounts receivable to a corporation, and
- the use of the cash method in a partnership.
Discussion and Interpretation
1. In computing the income of a taxpayer from a farming or fishing business, the income may be computed in accordance with the "cash method" if the taxpayer so elects. Section 28 of the Income Tax Act provides the authority and rules for using this method.
2. A taxpayer may make an election to determine income from a farming or fishing business under section 28 simply by filing a tax return reporting the farming or fishing business income using the cash method. Once a taxpayer has filed a return using this method, subsection 28(3) requires that income from the business for each subsequent taxation year be computed in accordance with this method unless the taxpayer receives the concurrence of the Minister to adopt some other method upon such terms and conditions as the Minister may specify. A request to change from the cash method to some other method should be made to the Director-Taxation of the taxpayer's District Office.
Meaning of Received
3. When computing income using the cash method paragraph 28(1)(a) requires that amounts be included in income when received or when deemed by the Act to be received. The meaning of the term received is not necessarily limited to those situations where the income was actually received in cash. Received has a broader meaning, and an amount may be said to have been received by the taxpayer at the time when, for example,
(a) it was received by a person authorized to receive it on behalf of the taxpayer
(b) it was offset against an amount owing by the taxpayer
(c) it was paid or transferred to a third party pursuant to the direction of or with the concurrence of the taxpayer (this may be implicit)
(d) a security or other right or a certificate of indebtedness or other evidence of indebtedness was received in payment or part payment of a pre-existing debt of an income nature. For further explanation see the current versions of IT-77, Securities in Satisfaction of an Income Debt and IT-184, Deferred Cash Purchase Tickets Issued for Grain
(e) a commodity is accepted in lieu of cash.
4. A payment made to a taxpayer by first class mail or its equivalent is deemed by virtue of subsection 248(7) to be received by the taxpayer on the date of its mailing. An item entrusted to a courier service for prompt delivery is considered equivalent to first class mail.
Receipt of a Cheque
5. The value of a cheque that is received by a taxpayer who uses the cash method to compute income is considered to be income at the time the cheque is received from a person who was indebted to the taxpayer provided the following conditions are applicable:
(a) the debt is payable at the time the taxpayer receives the cheque,
(b) the debt is of such a nature that it would be income of the taxpayer if it were paid in cash,
(c) the cheque does not have any conditions attached to it such as, for example, postdating or an arrangement that the cheque is not to be used for a specific time, and
(d) the cheque is honoured on presentation for payment.
Where a debt is not payable at the time a taxpayer receives a cheque, the value of the cheque is considered to be income at the earlier of:
(e) the time the cheque is cashed or otherwise negotiated, and
(f) the time the debt becomes payable.
6. Normally, a post-dated cheque will be accepted as security for a debt without extinguishing the original debt. Where such a debt is an income debt then payable, the value of the post-dated cheque will be brought into income at the earlier of the date that the cheque is payable and the date the cheque is negotiated. In the event that the debt is not payable at the time the post-dated cheque is payable, the value of the cheque will be brought into income at the earlier of the date that the debt becomes payable and the date that the cheque is negotiated. On the other hand, where a postdated cheque is accepted in absolute payment of debt, the value of the postdated cheque is normally considered to be income at the time it is received subject to a subsequent adjustment if it is not honoured on subsequent presentation for payment. In this situation, the taxpayer accepts the post-dated cheque as full payment of the debt and as such accepts it at the risk of it being dishonoured with the only recourse being an action against the maker of the cheque for failure to honour the cheque.
Carrying on of Separate Businesses
7. When a taxpayer is carrying on a farming or fishing operation together with some other business operation (e.g., the processing of fish or farm products - see the current version of IT-145, Canadian Manufacturing and Processing Profits - Reduced Rate of Corporate Tax), it is a question of fact dependent upon the circumstances of the case as to whether or not the farming or fishing operation can be considered a separate business for which the taxpayer can elect to report the income using the cash method. Normally, a taxpayer will be considered to operate two separate businesses if the businesses are not so interlaced, interdependent and interconnected that it is virtually impossible to separate one operation from the other. If it is established that two separate businesses are being carried on, the taxpayer may elect to report the farming or fishing business income using the cash method provided a separate set of books and records for the farming or fishing business is maintained.
Meaning of a Farming Business
8. Farming is defined in section 248 to include the various activities of a person who is engaged in the business of earning income from
(a) the tillage of soil,
(b) the raising or exhibiting of livestock,
(c) the maintenance of horses for racing or exhibiting,
(d) the raising of poultry,
(e) the keeping of bees,
(f) fur farming,
(g) dairy farming, and
(h) fruit growing.
The definition is not exclusive and it has been decided by the courts that farming also includes
(i) tree farming (Her Majesty the Queen v. Douglas C. Matthews 74 DTC 6193 - (1974) CTC 230 (FCTD)),
(j) the operation of a wild game reserve (Al Oeming Investments Ltd. v. Minister of National Revenue 72 DTC 1057 - (1972) CTC 2008 (TRB)), and
(k) a mechanical hatching operation where eggs are acquired, hatched in incubators and the chicks sold within a few days of hatching (June A. Pollon and Clifford M. Pollon v. Her Majesty the Queen 84 DTC 6139 - (1984) CTC 131 (FCTD)).
In certain factual circumstances it is considered that farming includes
(l) raising fish,
(m) market gardening, and
(n) the operation of nurseries and greenhouses.
The cultivation of crops in water and hydroponics are also considered farming activities. However, "farming" does not include trapping or an office or employment under a person engaged in the business of farming.
9. The following comments concern whether or not a source of income can be considered to be part of a farming business:
The crop share received by a landlord in a sharecropping arrangement is considered to be rental income and not income from farming. However, such income is, by reason of subsection 119(7), considered to be income from the business of farming for purposes of the five year block averaging provided by section 119 (note that subsection 119(4) eliminated the block averaging provisions for any five-year block that commences after 1987). In addition, a deferral of income resulting from that portion of rent that relates to grain delivered against cash purchase tickets will be permitted pursuant to subsection 76(4) (see the current version of IT-184).
The above reference to "sharecropping arrangement" means an arrangement where a taxpayer or landlord receives from a tenant a share of crop in lieu of rent. There may be other types of sharecrop arrangements, for example, where the sharecropper is actually an employee of the taxpayer and receives a share of the crop as remuneration for services rendered. Under these other types of arrangements the landlord could be in the business of farming depending upon the facts of a specific case.
(b) Woodlot Operators
Although, strictly speaking, an established woodlot operation is a logging business, where it is combined with a farming business the combined operation will be viewed as a farming business if the taxpayer elects to report such business income under the cash method. (See the current version of IT-373, Farm Woodlots and Tree Farms).
(c) Christmas Tree Growers
The planting, care and harvesting of Christmas trees, by persons who plant evergreens to sell and by those who buy land so planted to obtain and harvest the trees, is considered a farming business regardless of whether or not the taxpayer is carrying on any other farming operation. (See the current version of IT-373).
(d) Surface Rentals
Amounts that are received by a taxpayer actively engaged in the business of farming from the leasing of surface rights to persons exploring or drilling for petroleum or natural gas are income from the business of farming to the extent that they are considered to be income. (See the current version of IT-200, Surface Rentals and Farming Operations).
(e) Marketing Quotas
Payments received by farmers for granting other farmers permission to use their marketing quotas (e. g., tobacco, egg, milk) are considered to be income from a farming business.
(f) Sale of Sand, Gravel and Topsoil
The sale of sand, gravel and topsoil or a similar commodity removed from the farm lands of a taxpayer actively engaged in the business of farming is normally considered to be income from the business of farming.
Meaning of Fishing Business
10. Fishing is defined in subsection 248(1) to include the various activities of a person who is engaged in the business of earning income from fishing or catching shell fish, crustaceans and marine animals. However, fishing does not include an office or employment under a person engaged in the business of fishing.
11. For fiscal periods commencing after 1988, the optional and mandatory inventory adjustments under subsections 28(1)(b) and (c) respectively apply to a farmer (other than the fiscal period in which the farmer has died) using the cash method in computing income from a farming business. Paragraph 28(1)(f) requires that the amount included in income under paragraph 28(1)(b) or (c) reduces income in the immediately subsequent fiscal period. See the current version of IT- 526, Farming - Cash Method Inventory Adjustments, for a discussion on these adjustments. For fiscal periods commencing prior to 1989, only the optional inventory adjustment under paragraph 28(1)(b) was available to a farmer using the cash method and only with respect to certain livestock inventory.
12. A taxpayer using the cash method to compute income from a farming or fishing business may elect to roll over inventory owned in connection with the farming or fishing business to a corporation under subsection 85(1). Where such a taxpayer carries on a farming business and disposes of inventory owned in connection with that business to the corporation, paragraph 85(1)(c.2) will apply for dispositions occurring after July 13, 1990. Paragraph 85(1)(c.2) restricts the selection of the deemed proceeds of disposition of the taxpayer and the cost to the corporation in respect of purchased inventory of the taxpayer to an amount that is the aggregate of
(a) the proportion of the amount that would have been included under paragraph 28(1)(c) in computing the taxpayer's income, if the taxpayer's taxation year had ended at the time of the disposition, that the value of the purchased inventory disposed of is of the value of all purchased inventory owned by the taxpayer at that time, and
(b) such additional amount as the taxpayer and corporation may designate, not exceeding the excess of the fair market value of the purchased inventory disposed of over the amount described in (a) above.
The amount selected may also be restricted by paragraph 85(1)(b).
13. Subparagraph 85(1)(c.2)(ii) ensures that the taxpayer will be required to include the deemed proceeds of disposition in income under subparagraph 28(1)(a)(i). On the other hand, subparagraph 85(1)(c.2)(iii) ensures that the corporation will be entitled to deduct the deemed cost of the inventory under subparagraph 28(1)(e)(i) where the corporation computes its income using the cash method and will be required to consider such inventory as purchased inventory for the purpose of the mandatory inventory adjustment (see 11 above).
Change in Income Reported
14. If a taxpayer has included an amount in income under paragraph 28(1)(b), a written request to change this amount will only be acceded to if the time has not expired for filing a notice of objection for that year. Where the Department reassesses a particular year, a request to adjust the amount included in income under paragraph 28(1)(b) for that year will be acceded to provided it is made in writing before the reassessment is issued or within the time for filing a notice of objection for the particular year.
Rollover of Accounts Receivable
15. A section 85 rollover is not available to a taxpayer using the cash method in respect of accounts receivable since they are an income amount to the taxpayer when received. Subsection 22(1) does not apply to a taxpayer who is using the cash method of reporting income. If the taxpayer disposes of accounts receivable to a corporation in a non-arm's length transaction for shares, the cost of the receivables to the corporation would be determined as the fair market value of the shares except to the extent that paragraph 69(1)(a) applies. In the hands of the corporation the receivables would be regarded as capital property and the usual implications concerning subsequent receipts and bad debt write offs follow (see the current version of IT-188, Sale of Accounts Receivable).
Using the Cash Method in a Partnership
16. The election to start computing income in accordance with the cash method does not apply for the purposes of computing the income of a taxpayer for a taxation year from a farming or fishing business carried on jointly with one or more other persons (e.g. a partnership), unless each of the other persons has elected to have the income from the business computed in accordance with the cash method. Consequently, if a partner (including a person not resident in Canada) in a farming or fishing partnership is not taxable in the year of election, the partner must still file an income tax return in order that the other partners may elect to compute their income from the farming or fishing business in accordance with the cash method.
17. The inventory adjustments referred to in 11 above form part of the income of the partnership which are allocable to the partners in accordance with the terms of the partnership agreement.
If you have any comments regarding the matters discussed in this bulletin, please send them to:
Director, Technical Publications Division
Legislative and Intergovernmental Affairs Branch
Revenue Canada, Taxation
875 Heron Road
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