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Tax Tools Available for a Farming Downturn

The nature of farming is extremely volatile and can result in huge profits one year followed by losses the following year due to the volatility of the commodities market. There are a few tools available to accountants to manage the taxable consequences of this volatility which can help smooth out tax liabilities from year to year.

Income equalisation

Income equalisation is a scheme operated by the IRD that allows farmers to spread out the income between years to level out peaks and troughs. For example, in a high profit year money can be deposited into the scheme, which is tax deductible, and withdrawn from the scheme in a loss year, which is taxable income.

Deposits can be used for up to 5 years after the deposit was made into the scheme.

The main problem with this option is that it requires cash to be paid, which farmers are often short of. The cash is also unable to be withdrawn for 12 months unless certain conditions are met.

A withdrawal is allowed after 6 months for planned development work or the purchase of livestock. This condition is hard to meet and subsequently rarely used.

A withdrawal is allowed before 6 months for purchase of livestock in a self-assessed adverse event; to avoid suffering serious hardship and at IRD discretion.

For example, a farmer impacted by Cyclone Gabrielle had to sell livestock from their flooded property which generates a profit. A deposit is made into income equalisation to reduce their profit and avoid paying tax. They then make a withdrawal a couple of months later to restock the farm, which offsets the purchase of stock and avoids/minimizes the loss incurred. This is an example of a self-assessed adverse event.

It is difficult to meet the serious hardship condition as the IRD have specified that a forecast reduction in income as a part of normal price fluctuation is not enough to meet serious hardship. Ie. a downturn in the milk payout is not sufficient, and this was the case during the low payout years of 2014-16. The taxpayer must also prove how the refund will be applied to avoid serious hardship.

Deferred fertiliser

Deferring fertiliser effectively moves the expense from the year it was incurred to a future year. A taxpayer in an otherwise loss position can defer the fertiliser expense to create a profit. The expense can be used as a deduction in any of the four subsequent years to reduce the profit in higher income earning years.

This is a good option for trusts and partnerships that end up in a loss position and can’t pay shareholder salaries like companies can to utilise lower individual tax rates.

An election needs to be made to the IRD to defer fertiliser.

Shareholder salaries from a loss company

A company that makes a loss is still able to pay shareholder salaries as long as the shareholder has worked on the farm. Although this creates a bigger loss in the company, it allows the ability to utilise lower individual tax rates (10.5% and 17.5% compared to 28% for a company) that would otherwise be lost for that financial year. The flip side to this is that tax is being paid for the shareholders when the overall position is a loss, and some farmers may not have the cash available to pay the tax.

Timing of income tax return filing

A final option is timing the filing of income tax returns based on the prior years tax liability. For example, if the prior year was a large profit and the current year is a small profit or loss, filing the tax returns early resets the provisional tax calculations and may mean no provisional tax is due, when it would have been if not filed early as it would have been based on the high profit year.

The alternative is filing tax returns late if the prior year was a small profit or loss and the current year is a high profit, provisional tax would have been based on the loss year and gives the farmer time to generate enough cash to pay the provisional tax.

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