FARM ACCOUNTING NZ BUSING RUSSELL. NEW Livestock Valuation Rules VOLUME 92 WINTER 2013

Transcription

1 VOLUME 92 WINTER 2013 NEW Livestock Valuation Rules The eventual passing (expected in July/August 2013) of the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Bill will confirm some changes that are being applied retrospectively. The key points to watch for are: Any intergenerational transfer on or after 28 March 2012, needs to be considered carefully. Herd Scheme elections are now irrevocable unless the election to exit the Herd Scheme was made before 18 August 2011, excepting where the farmer changes from a breeding to a fattening regime. Herd Scheme elections will now be made by type, whereas previously elections were made by class. (Type is Dairy Cattle, Sheep, etc., Class is Mixed Aged Cows, Mixed Aged Ewes etc., described in Schedule 17, column 1). Electing a type into the Herd Scheme will automatically include all classes listed in respect to that particular type. This is an improvement, as it saves partial elections as previously required. Herd Scheme elections MUST be made BEFORE FILING the first tax return in which the election is to be applied. (Section EC 11(1)) A new EC 20 provides that, where a farmer ceases to derive income from livestock, the farmer MUST adopt prior years Herd values if the livestock are sold on 31 October or before (before 1 November), or if the livestock are disposed of on or after 1 November, then they must use the current year Herd values. Previously, the farmer could choose which values to use, and could use prior years Herd values if they made an election to do so prior to 1 February. If a farmer purchases livestock from an Associated Person, and those livestock were previously valued by the Seller using the Herd Scheme, they must adopt the Herd Scheme and the Seller s base number Herd Scheme livestock for that type/class. This also applies where a farmer who owns livestock dies. There are limited exceptions. The base numbers on the Herd Scheme need to be adjusted by related party transfers in. This effectively restricts the number of livestock that can be valued using the alternative valuation options (AVO). AVO includes National Standard Cost, Self Assessed Cost, and Market Value/ Replacement Price. The proposed bill is expected to be passed as approved by the Finance Select Committee on 6 June 2013, but there are some amendments that need to be made and the combining of the National Average Market Value (Herd Scheme Values) for Friesian with Jersey Cows and Wapiti with Red Deer classifications. These were not included in the bill and are expected to happen in the 2014 or 2015 tax year. In this issue... NEW Livestock valuation rules 1 Herd Scheme Elections APPLYING THE NEW RULES 2 The Tax Consequences of Changing Herds 2 Fonterra Update 4 Freight 6 Flu Injections 7 FAQ: Fencing 7 The Back Paddock 8 Page 1

2 Herd Scheme Elections APPLYING THE NEW RULES Section EC 11(1) says a person must give notice by the date of filing their return of income for the income year in which the election is first to apply. So Herd Scheme elections need to be made BEFORE filing the tax return in which the Herd Scheme Values are first to be applied. Logistically, this means that accountants are going to need to change their internal processes and procedures so this is not missed. To be absolutely sure the election has been accepted by IRD, the tax return may need to be held until notification of acceptance of the election has been received by IRD. If the return is filed before the election is made, then the ability to use the Herd Scheme in that year is lost. The election must be to join the Herd Scheme for a type of livestock. It does not value any animals under the Herd Scheme. If elections were made under the old regime, you were required to elect by type and by class so effectively, a valid type election should exist for all livestock that were historically valued using the Herd Scheme. Animals are valued using the Herd Scheme by choosing the method when calculating their livestock values for taxation purposes, and including the results of those calculations in the farmer s return of income for the income year. Not all animals need to be included in the Herd Scheme, but once any animal of any class is included in the Herd Scheme, ALL male breeding animals MUST be included in the Herd Scheme (Section EC 8). Once the number to be included on the Herd Scheme has been established in the first year, this becomes the base number. At least this number must be valued using the Herd Scheme each year. More animals can be added to the Herd Scheme without any further election process. The base number is the number valued using the Herd Scheme in the previous year. Section EC 14(2) provides that a person who has chosen to value livestock of a particular type under the Herd Scheme may nevertheless value livestock of that type by another method, subject to restrictions described in Section EC 8. So a farmer could make an election, but NOT USE the Herd Scheme until some subsequent year/s. Livestock could continue to be valued using any Alternative Valuation Options of National Standard Cost, Self Assessed Cost and Market Value/Replacement Price. So, perhaps a good safety net may be to make an election for any type of livestock that a farmer owns which have not previously been valued under the Herd Scheme, so those elections have been accepted by IRD and the process completed before using the Scheme is needed/implemented. Tax Consequence of Changing Herds Farmers and sharemilkers who relocate to a new farm may sell their existing livestock and repurchase at the new location. Reasons for this include: High costs of transporting livestock, especially between the North and South Island. Potential production losses as the old herd acclimatise to the new location. The breed of the existing herd/flock may be unsuitable for the new location. The existing herd/flock may have been mated to calve/lamb at a time of year that is unsuitable for the new location. Some farm owners require the incoming sharemilkers to purchase the herd of cows that is already on the property. Selling one herd and buying a new herd can have serious tax consequences, even though the cash flow may remain relatively neutral. The situation is worse when the existing herd has been valued using National Standard Cost (NSC). We recently had a sheep and beef farming client who was looking at selling their Taranaki farm and purchasing a new farm in North Canterbury. Due to the high transportation costs and animal health concerns, the client was considering relocating only the best breeding ewes and cows. The rest would be sold in Taranaki, with replacement stock purchased from the Canterbury region. Page 2

3 Example Assume: Existing flock of 1,500 MA ewes is valued at NSC of $47/head (ignore all other livestock) The flock is sold for $110/head net of sale costs and GST A new mob of 1,500 MA ewes is purchased for $110/head plus GST Sales Revenue 1,500 x $110 $165,000 Purchase Expense 1,500 x $110 $165,000 Net Cash flow Net Income $NIL $NIL Opening Stock (NSC) 1,500 x $47 $70,500 Closing Stock (NSC) 1,500 x $110 $165,000 Taxable Increase in Stock $94,500 What Can Be Done? Some minor relief can be obtained by opting to value the new flock using the Herd Scheme. For 2013, the Herd Scheme Value for a MA Ewe is $ This would give a closing stock value of $153,000, reducing the taxable increase in stock on hand to $82,500 (a reduction of $12,000 compared to NSC). Obviously, this ability to use the Herd Scheme to get a lower closing tax value only works when the purchase price of the new livestock is greater than the Herd Values. Be careful not to include any livestock in the Herd Scheme when it seems likely that the Values will decrease in the following year, as there may be a non tax deductible write down. Consider the timing of the sale and purchase in relation to the client s balance date. If the client has a 30 June balance date, it may be possible to arrange the purchase to be before 30 June, and the sale to be in July. This would delay the cash flow impact of the tax for an extra year, but it would have no impact on the total tax cost. Further Points Similar but smaller scale problems can occur when a farmer improves the herd by culling underperforming livestock and purchasing in large numbers of replacements. Be careful if the stock are purchased from an associated entity/person the new livestock valuation rules to be retrospectively applied back to August 2011 with the eventual passing (expected in July/August 2013) of the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Bill will mean the Herd Values are the only option available to the transferee (purchaser) if the transferor used the Herd Scheme. There can be cash flow benefits/problems in relation to GST when the sales and purchases fall into different GST periods. Sharemilkers Growing Their Herd A similar tax issue occurs when dairy farmers/ sharemilkers increase the size of their herd. As the stock numbers increase, so does the herd s closing tax value. The increase in value is taxable, yet there is no extra cash generated to pay the tax. Dairy farmers/sharemilkers have the ability to grow the size of their herd (and their equity) by simply rearing more calves. The value of the herd increases as more calves join the herd and as the existing animals mature. Some lower order sharemilkers rear calves for extra income/equity. It is a tempting proposition to rear a small number of heifer calves that can be later sold as Rising 2 heifers/ MA cows for say $2,000/head. A large part of the $2,000 will become taxable on sale. Tax will have been incurred when the animal was on hand as a rising 1 year old, and then again as a rising 2 year old. This can bring about an unexpected tax liability over the life of each animal to maturity. When clients tell us of their plans to start raising calves, we highlight the tax consequences and planning required. If the cash flow is tight, we may recommend they sell the occasional heifer so that cash is available to pay the tax. Page 3

4 Fonterra Update The past few months have seen Fonterra introduce a number of changes that will impact on dairy farmers. The major change has been the introduction of Trading Amongst Farmers (TAF), which is aimed at reducing Fonterra s share redemption risk. Other significant changes include volatility in the share price, a rolling three year average based share standard and RWT on some dividends. Fonterra Shareholders Market and the Fonterra Shareholders Fund There are now two markets for trading in Fonterra Investments and both are operated by the New Zealand Stock Exchange (NZX). The two markets were established to remove share redemption risk, provide new capital, and to retain farmer control of Fonterra. The Fonterra Shareholders Market involves Fonterra, farmer shareholders and the Market Maker (known as the Registered Volume provider (RVP)). The Market Maker s role is to continuously offer buy and sell shares. The Fonterra Shareholder s Fund is a unit trust established to allow non farming investors to invest in Fonterra. These units (not shares) are bought and sold on the NZX and ASX, and may be bought and sold like any other listed security. Non shareholding investors are unable to trade on the Fonterra shareholders market, and cannot exchange units for shares (unless they are able/choose to supply milk to Fonterra). Although the markets are separate, they are designed to work together. Shareholders, Fonterra and the RVP can buy and sell shares in both markets, meaning shares can be exchanged for units and vice versa. The differences between the units and the Fonterra shares are that while both are subject to capital gains/ losses and right to receive distributions, only the shares carry voting rights and the right to supply milk. By limiting voting rights to farming shareholders only, control of Fonterra remains with farmers. Trading Amongst Farmers (TAF) Farmer Shareholders now buy and sell Shares among themselves, rather than directly with Fonterra. There are three methods by which farmers can trade their shares. The first involves farmers managing the process themselves via the Fencepost website or for the less technologically savvy, phoning Fonterra on Trades involving shares are free, while buying or selling units incurs a 0.15% fee. Farmers can use their own broker to trade on their behalf, but the Computershare supplied CSN number for the farm must be used. The brokers used must be approved to participate on the Fonterra Shareholders Market. The final method involves farmers contacting Fonterra to arrange them an independent broker to act on their behalf. Share Price After remaining static at $4.52 for the last three years, the Fonterra shares will need to be revaluated at balance date. Due to the close relationship between Fonterra shares and Fonterra units, it is anticipated that the Fonterra share value should closely reflect the unit price. This is because, under the TAF framework, farmers can either buy additional shares from other farmers or purchase units which can then be converted to shares. We anticipate that in most cases, farmers will purchase the lowest price option, causing the prices to be similar. We have been using the findata.co.nz website to source the share price (security code FCG) at our March, May and June balance dates, and using these to value the shares. Any revaluation/devaluation of the Fonterra shares will be on the capital account. Fonterra Share Price (findata.co.nz) 31 March 2013 $ May 2013 $ June 2013 $7.290 Changes to Dividends There is now a difference between the tax treatments of Wet shares compared to Dry shares. Dividends on Dry shares are subject to RWT at 33%, which is deducted at source by Fonterra. Wet shares are not subject to RWT. Page 4

5 The new dividend statements, which are issued by Computershare (no longer part of the monthly dairy statement), clearly break down the dividend based on the Wet/Dry share numbers. The Wet shares will continue to be part of the business income and are therefore subject to ACC, while dividends on Dry shares are consistent with investment income, and not subject to ACC. The April and October 2013 dividends have been based on shareholding as at 12 April 2013, rather than the previous 31 May date. Any change in bank accounts will require both Fonterra and Computershare being notified. Bonus Shares Fonterra has announced a bonus share issue of one extra unit/share for every 40 held as at 12 April The issue date for the shares/units was 24 April Supply Offers During April and May, Fonterra offered farmers a supply offer that allowed them to sell economic rights to Wet shares to the Fonterra Shareholders Fund. In return for the economic rights, farmers received cash and vouchers. These vouchers carry voting rights and allow the farmer to meet the required share standard. The price received for the economic rights will be $7.92. We believe that the proceeds from the sale of the Fonterra shares will be tax free, unless the shares had originally been acquired for resale, in the business of trading, or to make gains from a profit making scheme. New Share Standard Fonterra farmers are no longer required to have production fully share backed at the end of each season. The new share standard is now based on a three year rolling average. However, farmers may receive a lower price per kg of solids for non share backed production (i.e. production in excess of shares and vouchers held). Farmers now have six months from the end of the season (31 May) to ensure that they comply with the share standard. This would mean farmers have until 1 December to comply. Share Contract Options There are a number of new contract options available to allow new Fonterra suppliers to build their shareholding over time. Details on these contracts can be found on the Fonterra website. Contracts available include: Transition Period: allows three seasons to share up, with dividend entitlement on shares held. Supply Contract 2013: where 1,000 shares are purchased up front and the remaining shares purchased in thirds in seasons 4, 5 and 6. No shares are required to be bought in seasons 1, 2 and 3. Fixed Investment Contract: where 10% of shares are purchased in year 1, with a fixed cash investment in shares from season 4 until shared up. Flexi Milk Price Contract 2013: where 50% of shares in first season, then only required to buy shares when Milk Price is above $6.40/kg ms. Sharemilkers Under TAF, sharemilkers are able to trade in Fonterra units independent of the supply number and are able to own Fonterra shares in limited situations. Where the sharemilker holds shares: the shares must be held under the supply number, with the farm owner s agreement, and they must own a percentage of the farm s minimum shareholdings, and sharemilkers will be required to share up/down to reflect changes in minimum shareholding. For a farm owner, having a sharemilker who own shares contains an element of risk. As the sharemilker must own a percentage of the farm s minimum shareholding, the land owner will be required to find additional shares if the sharemilker leaves. Guaranteed Milk Price Fonterra is now offering a guaranteed milk price as a pilot programme for the 2013/14 season. This allows farmers to lock in between 10 75% of their milk supply at $7.00 km/ms. Page 5

6 The programme is restricted to 15 million kg/ms and aims to include a broad representation of shareholders. This is being run as a test to monitor the benefits and risks, and may be considered as an option to all shareholders in the future. A guaranteed milk price may assist in providing greater certainty towards cashflow, loan servicing, and tax payments. The application period closes on 21 June 2013, with confirmation of acceptance expected in late June. Exiting Fonterra When exiting Fonterra, shareholders have up to three years to sell their shares. A minimum of 1/3 of shares must be sold each season. This staggered approach allows the shareholder to manage their exit, and provides more flexibility in when they sell shares. Shares must be sold via the Fonterra shareholders market or in an off market transaction. The shares cannot be exchanged for units, although the share proceeds can subsequently be used to purchase units. Summary of Fonterra Markets Fonterra Shareholders Market Fonterra Shareholders Fund Investment Co-operative Shares Units Participants Supplier Shareholders Fonterra Fund Investors Capital gain/loss Distributions Right to Vote X Right to receive Milk Price X Freight Freight and cartage are an enigma when it comes to including them in the financial statements and we can understand why farmers are confused. The Income Tax Act 2007 provisions require the accumulation of costs to be allocated to the costs that the freight pertains to. Cartage of Livestock Purchases The freight and cartage costs on the purchase of livestock should be included as part of the livestock purchase price. As part of the National Standard Cost calculation, we are required to include the inwards freight expense as part of the purchase cost of the livestock. (Section EC 24 (2c) of the Income Tax Act (ITA) 2007.) Fertiliser Cartage All fertiliser expenses (including cartage) can be spread over one or more of the following four income years (Section EJ 3 ITA 2007) so Fertiliser cartage and spreading costs should be included as part of the fertiliser expense. Cartage of Newly Acquired Fixed Assets All costs of having an asset commissioned need to be added to the purchase cost of the asset and capitalised (DA 2(1) ITA 2007 Capital Limitation). Cartage of Personal Goods Freight costs for the cartage of personal goods are to be coded to drawings (Section DA 2(2) ITA 2007 Private limitation). Other Freight Costs Freight costs for getting livestock or wool to sale should not be offset against the sale proceeds, but instead be treated as a farm working expense. This allows the financial statements to show the true sale proceeds, and reflect the freight as a cost. Where farmers graze stock off farm, the freight costs of moving animals between properties should be coded to freight. Freight on farm supplies, such as stock food or fencing supplies, should be coded to the relevant expense, as this is an additional cost of acquiring the supplies. However, where the freight is for a number of items and the correct allocation of the freight costs is unclear, we would recommend simply treating this as a freight cost. Page 6

7 Flu Injections We have recently seen a number of farming clients paying for employees to receive flu injections. We can see the logic in spending a few dollars now to help prevent staff spending time off work sick. These are normally provided onsite by a nurse, or in some cases staff are given vouchers entitling them to a flu injection, or are reimbursed for paying for it themselves. The provision of flu injections to staff is a deductible expense to the taxpayer and should be coded to general expenses. It does not give rise to an FBT liability, even when the benefit is provided off the employer s business premises. The flu injection relates to health and safety, which has an FBT exemption. Section CX 24 of the Income Tax Act 2007 provides that a benefit provided by an employer to an employee is not a fringe benefit if it is related to the employee s health or safety and is aimed at hazard management in the workplace. FAQ: Fencing Question: A farm s sale and purchase agreement include fencing as one of the separately identified assets/ development expenditure, with a dollar value allocated to it. Is the fencing deductible under section D0 1 of the Income Tax Act 2007, capitalised and amortised, or capitalised as part of the purchase of the land? Answer: The fencing is non deductible and should be capitalised as part of the cost of the land. There is no amortisation or depreciation that can be claimed on this. Section DO 1(1)(f) of the Income Tax Act 2007 allows a taxpayer a deduction for fencing when it is for the construction on the land of fences for farming or agricultural purposes, including buying wire or wire netting for the purpose of making new or existing fences rabbit-proof. The key words here are construction. If the taxpayer has not incurred the expenditure in constructing the fences, then there is no deduction. The previous land owner will have received the deduction when they incurred the fencing costs. Fencing for farmers is not a fixed asset that appears in the depreciation tables. Its attachment to the land appears to be more in the nature of land development. However, fencing is not included in the list of Farming Improvements in Schedule 20, Part A of the Income Tax Act The purchaser is unable to assume the vendor s unexpired portion of fencing development expenditure and continue to amortise. Published By Busing Russell + Co Ltd Phone: Chartered Accountants Fax: PO Box Devon Street East NEW PLYMOUTH info@farmaccountingnz.co.nz Copyright This publication is now your property. You can use the information in it in any manner you choose, except electronic reproduction on any open website, public website or third party website. Editor s Note We welcome brief questions and comments or suggestions from subscribers and readers. If you have a problem, we might have an answer and everyone might like to know about it. Disclaimer Information contained in is of a general nature and does not purport, nor is intended, to be advice on any particular matter. No person should rely on the contents of this publication without first obtaining advice from a qualified professional. The author, editor, consultants and publisher expressly disclaim all and any liability and responsibility to any person, whether a purchaser or reader of this publication or not, in respect of anything done or omitted to be done by any such person in reliance upon the whole or any part of this publication. Page 7

8 THE BACK PADDOCK Financial Literacy among Farmers On 29 and 30 May 2013, OneFarm hosted The Financial Literacy Forum at Massey University in Palmerston North, which focused on the Financial Literacy of farmers and those involved in farming businesses. Speakers and participants came from the USA, Australia and New Zealand-wide, a mixture of academics, bankers, farmers, accountants, farm advisors, DairyNZ, AgITO, MPI (Ministry for Primary Industries) and agricultural industry service providers. OneFarm ( is dedicated to increasing farm business management capability and is a joint venture by Lincoln and Massey Universities, with the support of Dairy NZ and MPI. The basis of the discussion was that Financial Literacy of farmers was generally viewed as poor, in relation to the size and scope of business they are operating. Frazer Weir (CA, BDO Christchurch) summarised the current level of Financial Literacy as Poor, but improving due to: Improved education and awareness, Global Financial Crisis has made people become more focused, Technology is allowing more accurate and timely information, Finance Industry stepping back from being Advisors/Advocates, More use of effective Advisory Boards, and Better understanding of Governance and Management functions, roles and responsibilities. Frazer went on to say Technology does not always assist with improving financial literacy. Computers allow people to produce the reports; however, often they do not actually understand the information, as they do not understand the process. That s where anyone involved in assisting farmers financially should be assisting. Part of our advisory role is, and should be, education. And we do that. So why is there a perception that farmers have a poor financial literacy? Since attending the forum, I have been more conscious of what I do, say and think while talking with farmer clients and what they say and do in response to our discussions. It is my view that they stick to their knitting by focusing on the farming and production, trust the accountant to bat on their side by highlighting financial issues that need attention, understand where prices are at, how much tax they need to pay, and try to keep the bank manager happy and rate their financial success by the money in the bank (or decreasing the overdraft), and their level of debt versus their asset values (net equity). Ross Verry from the ANZ bank said One of the problems is that we tend to think we are looking at a farmer, not a business. Management has been defined as the operational role and centre on the skills of an individual. The function of governance often doesn t exist in any recognisable form until a crisis emerges perhaps product price falls or the need for succession. As a result, as bankers, we can see management is often quite similar to that of personal banking clients: Limited governance, risk management, long-term planning, Few business plans, business management cycle not operating, Poor business information. Intuitive, informal decision processes, not responsive to outside input, Capital growth rather than profit focus, Not using professional advisors for key areas such as planning, risk management. Even quite large businesses have operated quite informally and there is a wide span of profit performance. So in my view, it is our (all financial advisors to farmers) role to make sure we help them understand profitability, progression and productivity growth, be aware of the financial risks and opportunities of their business, help them with information they need for informed choices and to do whatever we can to take effective actions to improve their financial well-being (Dr Pushpa Wood, Massey University). Let s be more proactive. Page 8