Taxation Options in the Agricultural Sector
New Zealand farmers face an ever changing and challenging economic scene. While agricultural productivity gains throughout the past fifteen years have been leading many other sectors of the NZ economy, increased costs and outside factors such as fluctuating export returns, a high exchange rate and effects of the Covid 19 pandemic continue to present a challenge. Inflation, higher costs and increased personal spending have put pressure on cash flow and farmers’ ‘real’ incomes. Going forward we face global warming and ETS issues as well as increasing government and local body issues.
New Zealand farming taxpayers do have a number of options available to them in to assist with ‘manipulating’ their taxable incomes. This is important because farming incomes do tend to fluctuate from year to year for various reasons including those outlined above. Methods used to increase or decrease taxable incomes are:
- Having the correct business structure - such as the use of companies, trusts, partnerships, look through companies, limited partnerships or sole trader.
- 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 (and other expenditure) in higher income years and deferring this spending in the tougher years.
A key feature of the legislation in relation to the valuation of livestock is the range of choice that is given to taxpayers. For specified livestock - that is sheep, beef cattle, dairy cattle, deer, goats and pigs, there are four options:
- Herd scheme (National Average Market Values)
- National standard cost
- Market value or replacement price
- Self-Assessed cost
There are some entirely separate rules for high priced livestock. A further element of choice in the valuation of specified livestock is that individual taxpayers may use several of the four choices listed above at any one time. For different types and ages of livestock there are advantages in using the different options for the same taxpayer.
Average market values are collected nationwide at the end of April each year. The figures are weighted, collated, averaged and reviewed, which results in the Commissioner of the Inland Revenue Department publishing the herd scheme values usually around the end of May each year. From a taxation point of view, any increase in livestock values is tax free. Any decrease in value is not tax deductible. Over time we would usually expect inflation to drive values up, so the herd scheme definitely has its merits when livestock values are increasing.
The problem with the herd scheme is that it delivers a negative benefit if livestock values fall. In addition the herd scheme usually incurs a tax cost at the time that additional animals are added to the herd livestock scheme. For example, the national standard cost that might be attributed to some additional Two Tooth Ewes that have been bred, reared and grown on the property would be about $59. The herd scheme value of the same class of animal for 2014 is $131. One of the keys to the herd scheme is getting on the scheme when values are low and your income is low. If you believe that medium to long term values will rise you should use herd values. If not, national standard cost or market value may be a more appropriate option.
National Standard Cost
This method is also widely used by farming taxpayers. Each year the IRD give us “standard cost” figures for breeding, rearing and growing each of the livestock types through to rising one year olds and further “standard costs” figures for rearing and growing those animals through to maturity. Depending on the farming policy it is possible to have widely different national standard costs from one farm to the other. For sheep and beef cattle, national standard costs are generally well below the value of livestock on the herd scheme.
The market value of livestock can be used as an alternative to the cost price. Market price is the value that the livestock would be worth on the open market at balance date. We would use market value where we want to increase taxable income to meet a specific tax situation e.g. to fully utilise the low tax bracket (up to $48,000 of income) this year and get some of this offset against next year’s profit if incomes were expected to increase.
Self Assessed Cost
Self assessed cost is not widely used. In our practice we do not have any clients that use this method.
Movement from one method to the other:
Moving livestock from the National Standard Cost or Market Value schemes to the Herd Scheme can be done at any time and would generally be done when herd scheme values are low. However the ability for farmers to change from the herd scheme to National Standard Cost has been retrospectively removed with effect from the 2012/2013 income year. No longer will it be possible for farmers to use the livestock valuation methods to obtain the tax advantages sometimes used in the past. Careful decision making must be done when taxpayers use the herd scheme.
Tax Planning Opportunities:
Most taxpayers actively seek ways to value their trading stock at the lowest possible levels. Farming taxpayers have different valuation options. It is then over to each farming taxpayer to weigh up the pros and cons and make a choice as to which method is to be used. We need to be able to “read the markets” to work out when livestock values are likely to trend upwards and, more particularly, when they are likely to decline significantly. It is not a case of following what has happened. Rather we need to look forward sufficiently far enough to get the best outcomes.
Income Equalisation Scheme
The Income Equalisation Scheme is a method whereby farming taxpayers are able to deposit funds with the Inland Revenue Department in a “high income tax year”. A deduction from gross income is permitted for sums deposited under the scheme, thereby, reducing taxable income. Upon withdrawal the sums are included in the taxpayer’s gross income. The taxpayer is able to withdraw funds after one year and should do so preferably when incomes are lower. The Inland Revenue Department pays interest at a rate of 3% on deposits. The funds must be deposited with the scheme for a minimum of twelve months to receive the interest.
A withdrawal of funds is able to be made after six months for the following purposes:
- For immediate development or repair work unforeseen at the time of making the deposit.
- For immediate purchase of livestock.
- To avoid hardship.
- For any other purpose which the IRD determines a refund shall be made.
Funds can be withdrawn earlier than six months where the Commissioner of Inland Revenue Department is satisfied the refund is required for any of the following:
- For immediate purchase of livestock to replace livestock sold or disposed through a self-assessed adverse event.
- To avoid hardship.
- Drought provisions.
- For any reason which the IRD determines a refund shall be made.
To put funds in the Income Equalisation Scheme requires cash. There is a disadvantage of using the scheme if the cost of borrowing is 5% while you only earn 3% on the funds with the IRD. Therefore, there must be compelling reasons to use this scheme if cashflow or borrowing is an issue. In our office we use the Income Equalisation Scheme in two main cases. These are to avoid the top tax bracket (previously 39%) and to avoid “Use of Money” interest charges with the Inland Revenue Department. We also use the scheme when clients are going to have a change in circumstances such as buying another farm, retiring or planning to carry out development.
One of the keys is to get money into and out of the scheme as quickly as possible to:
- Get the best tax advantage
- Reduce the cashflow loss.
Deposits to the Income Equalisation Scheme can be used for the previous income year and can be paid to the Inland Revenue Department at the time of filing a tax return. Therefore, it can be advantageous to hold off filing your tax return for the year until funds are available.
Other Taxation Planning Options
Under the Income Tax Act there is flexibility for farmers in the way they report their fertiliser expenditure. As fertiliser provides future benefits for farmers they are given the discretion to “defer” the claiming of fertiliser until future income years. Fertiliser must be claimed within four years of it being deferred. It is possible however to defer current years fertiliser to extend the period again.
Where incomes are low fertiliser can be deferred to ensure taxable incomes are set at appropriate levels. In future tax years this fertiliser can then be claimed which will offset taxable income. In this way farming taxpayers are able to “smooth” their incomes to appropriate levels.
The Government introduced changes a few years ago to remove the tax-free exemption for children which was $45 per week. Children who work on the farm however can be paid a wage (but need to have PAYE deducted). The PAYE rate of 11.89% can be used up to an income of $14,000 per year.
Taxpayers have the option of estimating their provisional tax payments downwards if incomes are expected to fall. Care must be taken as the IRD will impose Use of Money Interest Charges where the estimate is not within 80% of the correct amount.
Farmers are able to claim back the off road component of the Excise Duty and fuel levies from Land Transport New Zealand. In the past many taxpayers have never bothered to make these claims. With higher fuel costs it may be time to take advantage of the claims available.
Family Assistance thresholds have increased significantly. Good tax planning to take advantage of the available entitlements is essential in the tight years. Other considerations include student allowances and community services card entitlements.
The following types of expenditure are fully deductible:
- The destruction of weeds or plants detrimental to the land.
- The destruction of animal pests detrimental to the land.
- The clearing, destruction and removal of scrub, stumps and undergrowth.
- The repair of flood or erosion damage.
- The planting and maintaining of trees for the purpose of preventing or combating erosion.
- The planting and maintaining of trees for the purpose of providing shelter.
- The construction on the land of fences for agricultural purposes, including the purchase of wire or wire-netting for the purpose of making new or existing fences rabbit-proof.
- The re-grassing and fertilising of pasture where the expenditure is not incurred in the course of a “significant capital activity” (effective 1 April 2005).
Tax Rates (As at January 2021)
- 0 – 14,000 10.5%
- 14,001 – 48,000 17.5%
- 48,001 – 70,000 30%
- 70,001 + 33%
- Flat tax rate 33%
- Flat tax rate 28%
- DWT (Dividend Withholding Tax) 5%
- Farmers are in a unique position in that they have several ways to manipulate taxable incomes.
- It is important to look at the long term when addressing tax. It is not a good situation for tax planning to have a husband and wife with taxable incomes of $15,000 each in the first year and $80,000 each in the second year.
- Taxpayers need to look ahead and make good decisions now based on what they believe will happen in the future.
- Having the correct business structure is imperative.
- Trusts and companies give taxpayers more tax flexibility as well as protection of assets and assist with succession planning.
- Communication is vital. Good communication with farm advisors, bankers, solicitors and accountants assists, not only in the running of the farm operation, but also can lead to significant financial gains.
- Look outside the square – as well as actual tax payable, consideration should always been given to factors like family assistance entitlements, student allowance and community service card entitlements.
- Have the right attitude to paying tax – it is better to make money and pay tax than not make any money and pay no tax.
- While New Zealanders are quite highly taxed with income, GST, road users, excise tax etc, we are fortunate to have no capital gains tax. Many farmers have seen their properties increase in value over a number of years (with the last four or five years being an exception) with no tax consequences – so it isn’t all bad.