3 March 2011 Internal T.I. 2010-0381261I7 - Farming - From switchgrass to pellets

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether certain activities constitute "farming" for the purposes of the Income Tax Act.

Position: See response.

Reasons: See response.

                                                      March 3, 2011

      London Tax Services Office                      HEADQUARTERS
      Specialist - Agriculture, Aquaculture           André M. Gallant
         and Fisheries                                (613) 957-8961
      Technical Applications and Valuations Division
      Audit Professional Services Directorate
      Attention : Mr. William MacGregor
                                                      2010-038126

Farming - From Switchgrass to Pellets

This is in response to your email of September 23, 2010, with which you forwarded an email inquiry you received from XXXXXXXXXX , regarding whether a farmer's revenue derived from the sale of switchgrass pellets would be considered income from a farming business for purposes of the Income Tax Act (the "Act"). This also confirms various telephone conversations (Gallant/MacGregor; and Gallant/XXXXXXXXXX ) regarding this matter.

More specifically, the request involves the following hypothetical scenarios:

A farmer grows switchgrass and then brings it to an arm's length pelletizing facility to have the switchgrass transformed into pellets. The farmer then gets the pellets back from the arm's length company and sells the pellets to arm's length third parties to either be used as fertilizer or to be burned in a wood stove to heat homes or other buildings.

A detailed description of switchgrass production and its different uses can be found on the website of the Resource Efficient Agricultural Production (REAP) organization at www.reap-canada.com. The website suggests that the information therein was co-produced or sponsored by Ontario Ministry of Agriculture, Food & Rural Affairs, the Natural Resources Canada, Canadian Farm Business Management Council and the Collège d'Alfred/University of Guelf.

We understand that switchgrass (Panicum virgatum L.) is a perennial warm-season grass growing in most of the Eastern half of North America. It can grow up to 2.7 meters high with leaves 30 to 90 centimeters long. Switchgrass has been used for different purposes. It can be used for biofuel pellets and briquettes, biogas, cellulosic ethanol, livestock bedding, soil conservation, erosion control, forage, grazing, game cover, biodegradable plastics, paper and "straw bale" housing.

Your question concerns whether the income from the sale of pellets by the farmer in the above scenario can be considered income from farming activities for the purposes of the Act.

OUR COMMENTS

Whether or not a taxpayer's business operations are considered to be "farming" for the purposes of the Act is a question of fact. The word "farming" is given a wide definition by subsection 248(1) of the Act. It includes tillage of the soil, the raising or exhibiting of livestock, the maintenance of horses for racing, the raising of poultry, the keeping of bees, fur farming, dairy farming and fruit growing. As indicated in IT-433R, Farming or Fishing -Use of Cash Method, this definition is not exclusive and would also include tree farming, the operation of a wild game reserve, a mechanical egg hatching operation, and the cultivation of crops in water and hydroponics. In certain factual circumstances, farming also includes raising fish, market gardening, and the operation of nurseries and greenhouses.

The Canadian Oxford dictionary ("Oxford") defines a "farm" as an area of land, and the buildings on it, used for growing crops, rearing animals etc. A "farmer" is defined in Oxford to be a person who farms land or rears certain animals. In the case of De Cloet Ltd. v. Minister of National Revenue (89 DTC 207), the Court noted that "[a]gricultural farming involves the whole aspect of commercial production of any crop or plant which has economic value". In De Cloet, the taxpayer's sequential activities of growing tobacco and of curing tobacco leaves in bulk kilns were considered to be farming.

However, farming generally does not include the processing of harvested agricultural products unless the processing activities are incidental to the main farming activity of growing the products (see e.g. Interpretation Bulletin IT-145R (Consolidated), Canadian Manufacturing and Processing Profits - Reduced Rate of Corporate Tax, at paragraph 7) and are necessary to turn the harvested agricultural products into saleable products. The expression "incidental" implies a subordinate relationship or "having a minor role in relation to". Although whether or not processing is incidental is a question of fact, a factor to be considered would include the quantum of value added by the processing activity to the end product sold to customers. Where the processing is incidental to the main farming activity, the fact that the processing of the farmer's harvested agricultural products is accomplished by a third-party instead of directly by the farmer does not, in and of itself, result in the end products of the processing activity not producing farming income when the end products are sold by the farmer.

In a situation where the processing of harvested products is not incidental to the taxpayer's main farming activities of growing such products or the taxpayer processes both products (e.g. switchgrass) grown directly by the taxpayer and the same type of products purchased by the taxpayer from other persons, it is a question of fact whether the taxpayer is involved in one business or more than one business. For more information, please refer to Interpretation Bulletin IT- 206R, Separate Businesses. If the taxpayer is involved in one business, it is a question of fact whether the business is farming or non-farming. Factors to be considered include invested capital, labour, and the value contributed by the various functions to the value of the end product sold to customers.

Subject to the foregoing comments, where a taxpayer has one business and grows switchgrass as a farming activity, the mere processing (which we assume to be incidental to the main farming activity) of the harvested switchgrass into pellets for sale to customers would be not unlike the drying process of harvested tobacco leaves in the situation under review in the De Cloet case and, as the drying process in that case, would be considered farming.

We trust that these comments will be of assistance.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CRA's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Céline Charbonneau at (613) 957-2137. A copy will be sent to you for delivery to the client.

Yours truly,

S. Parnanzone
Manager
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch