Is Tax Really a Burden for your Farming Business?
Rural accountants across the country will have their hands full over the next six months dealing with their dairy farming clients' high levels of income for the season just completed. There will be some dairy farmers particularly in the Waikato thatsuffered from the drought; however with the record payout level most will still show excellent surpluses. What this generally means for dairy farming businesses is a hefty tax bill.
As accountants, one of the main reasons we are employed is to help our clients minimise their taxation obligations. Generally we do this through structuring our client's affairs carefully and claiming the maximum amount of deductions available.
At the end of the day if your business is making good levels of profit then you will also be paying tax. Unless you have substantial tax losses or have a high amount of off farm income, the only way your business will grow is by making good profits, paying the right amount of tax, reinvesting the after-tax profits and keeping your personal expenses to a reasonable level. From our experience this is one of the keys to a successful farm business.
Tax Planning Options
Farmers are in a unique position where they do have a number of options available to them to assist with manipulating their taxable incomes. This is important because farming incomes do tend to fluctuate from year to year as a result of fluctuating export returns, cycles in the exchange rate and changeable climatic conditions. The main methods we use to increase or decrease taxable incomes are:
• By ensuring that farmers are trading in the correct business structure.
• By carefully considering livestock valuation options each year in the financial accounts.
• By appropriately using the income equalisation scheme.
• By deferring fertiliser expenditure which can be claimed in higher income years.
• By strategically spending on repairs, maintenance and development in higher income years and deferring this spending in the tougher years.
Income Equalisation Scheme
For dairy farming businesses there are two main factors that influence profitability and these are the climatic conditions and the payout. While it is impossible to guess what kind of season we will have, one thing we do know is that the current forecast payout is down compared to the season that has just been completed. Where a farmer is expecting a drop in income the income equalisation scheme can be very effective as it gives farming businesses the ability to defer income to a future tax year. Farming taxpayers are able to deposit funds with the Inland Revenue Department which pay interest at a rate of 3% on all deposits that they hold for at least twelve months. The amount deposited comes directly off the income for the year and gets added to income when the amount is withdrawn.
Farming businesses that have a tax agent and have an extension to file their tax returns until 31 March 2015 have until this time to pay funds over to the Inland Revenue Department. Generally the Inland Revenue Department allow a withdrawal of funds after six months and even earlier if drought provisions or financial hardship applies. Generally we advise dairy farming clients to wait until 1 June (if they have a traditional 31 May balance date) to withdraw the funds as this defers the income for two years, despite the money only being with the Inland Revenue Department for three months.
The income equalisation scheme is available to all types of farmers and we have used this scheme for sheep and bee farmers as well as dairy farmers. It is most effective where tax will be paid at a lower rate on withdrawal such as when a farm has been sold or other changes of circumstances. It can also be used to avoid Inland Revenue interest or penalty charges where provisional tax was estimated or underpaid.
In order for your accountant to plan your tax effectively they must know your current and future plans to get an idea of where your income will be going forward. It is important to have good communication and to understand why your accountant has done certain things. Five or six years ago many dairy farmers benefitted from a (legal) livestock tax loophole, however the IRD have changed the rules so minimising tax is now harder than ever. Having the right attitude to paying tax is imperative – it means you are making money. It is the business that pays little to no tax that has the real problem.
Cheyne Waldron is a partner at Bailey Ingham Ltd, Chartered Accountants in Otorohanga