Tax saving strategies for agricultural businesses
Accountants are always looking for ways to add value for our rural clients. That doesn’t often come in the form of operational advice, the purview of farm consultants. But tax saving advice is a topic we know inside out and one that is sure to grab farmers’ undivided attention.
Most farming business have bank debt and therefore any chance to defer or save tax increases farmers’ abilities to pay down debt, save interest or alternatively, reinvest tax savings in the business, creating future gains.
There are some long-held misconceptions about how to save tax. Below are some ideas that work and some that don’t. If the tax saving involves spending more money than made, then any decision has to be in conjunction with your cashflow forecast to ensure you don’t run short of cash at crucial times of the year.
What works and what doesn’t work?
1. Stockpiling consumables
Bring the purchase of consumables forward into the current year and claim a full deduction for items such as fencing materials, drenches, fertiliser, fuel, supplementary feed, water supply materials, chemicals, etc. as long as you are in possession of the consumable. Beware one major fishhook – you must not hold more than $58,000 worth of consumables, otherwise the entire deduction for consumables on hand is deferred to the following tax year, assuming at the end of that tax year you keep under the $58,000 limit. Another fishhook in relation to fertiliser - you are required to be in possession of the fertiliser at balance date. So, ordering it on the last day of the financial year but taking delivery the next year doesn’t meet rules for claiming a deduction.
2. Invest in farm development that is 100% deductible
The IRD allows a full deduction for the following items:
• Destruction of weeds, plants or animal pests detrimental to the land.
• Clearing, destruction and removal of scrub, stumps and undergrowth.
• Repairing flood or erosion damage.
• Planting and maintaining trees for the purpose of providing shelter.
• Construction of fences for agricultural purposes.
The key term here is “invest”. Remember, your tax benefit will only be (at the very most) 33% of the cost. The effect on your cashflow is therefore a 67% reduction. In other words, you are spending $1 to save 33 cents (at the most). Is that cash better utilised elsewhere or is it better not spent in the first place? Will the improvement generate more income in the future which will cover the cost incurred? How long is the payback period?
3. Utilising low income tax brackets
NZ’s tax rate structure for individuals is as follows:
|Taxable Income||Marginal Tax Rate|
|$0 - $14,000||10.5%|
|$14,001 - $48,000||17.5%|
|$48,001 - $70,000||30%|
On a “use it or lose it” basis, if you don’t utilise your low tax rate bracket one year, you cannot transfer it to the next year. It makes sense to smooth your income and ensure low tax rates are utilised each year. We can do this using fertiliser deferral rules, forestry income spreading rules, and income equalisation rules - and savings can be quite substantial too!
4. Paying the right amount of provisional tax
For those entities liable to pay overdraft interest or Use of Money Interest, a simple strategy is to just pay the right level of tax. If income has reduced, then we can complete a tax plan estimating your reduced taxation commitment. That could save overdraft interest. If income has increased, we can estimate a higher level of tax, saving you Use of Money Interest.
5. Utilising tax intermediaries
Instead of incurring the IRD’s Use of Money Interest, we can use companies such as Tax Management NZ Ltd and purchase tax shortfalls or finance tax payments at the required dates for a lower interest rate. If you’re a large taxpayer, this can be a suitable strategy to mitigate interest costs.
6. Deferring income realisation until the new tax year
As long as it doesn’t compromise your income or business, income realisation around balance date can be deferred in some circumstances. Taxable income is, in many circumstances, created when something is harvested or sold. If this was planned for close to balance date, ask yourself the question, can it be deferred into the next tax year without any adverse effects? Examples include; deferring fruit/crop harvest until the new year, deferring felling of forestry blocks and deferring stock sales.
7. Balance date structuring
The IRD is strict on non-standard balance dates, cracking down on this many years ago. However, the department published a list of accepted balance dates which it will generally approve upon application. If a change of balance date defers income to the following tax year, you’ve achieved a permanent deferral of one year’s tax. When considering a change of balance date we need to consider not only income but also when expenditure is usually incurred.
8. Employing your children
It is common for children to help out on the farm from a young age (opening gates, grubbing thistles, shifting stock, etc.) and we think paying a wage to your children is justified as long as it is reasonable given the work performed. All individuals (including children) are taxed at 10.5% up to an income level of $14,000. There is a real opportunity to utilise low tax rates by paying wages. We recommend:
• the wage is paid regularly (at least monthly); and
• an assessment of hours and a reasonable hourly rate are used to justify the payment, and
• an IR330 is completed and PAYE is deducted in the usual way.
If the farm’s marginal tax rate is 33% the tax saving could be as much as $3150 per child, but you also need to take into account other income your children might receive from interest, casual wages, trust distributions, or the like.
What doesn’t work
1. Purchasing assets
It would be nice to think you could buy a new tractor in the last month of the year and that could come off your tax, but the IRD isn’t quite that generous. You get a depreciation claim on fixed assets for the number of months it has been owned. A $60,000 tractor purchase in the last month will at best generate a depreciation claim of $650 and a tax saving at most of $215. Not so attractive!
2. Buying livestock
Livestock on hand at balance date is added back into income as “stock on hand”. This usually offsets the deduction for the purchase and therefore no tax benefit results. With livestock the general rule is you realise income when you sell - it’s the sale that creates the tax issue and that is within your control.
3. Booking up fertiliser purchases
As explained, fertiliser is counted as a consumable and you must be in possession of it at balance date. Payment can be deferred however as long as the invoice is dated on or before balance date.
4. Exceeding the $58,000 limit for consumables
Be mindful of this limit, especially when adding in the biggies such as the cost of bought fertiliser. Most farmers don’t store fertiliser so usually it needs to have been applied. Once applied to the land, it is no longer a consumable. It’s also important to note that feed produced on farm is excluded from the consumable value.
This is just an entrée of legitimate strategies our team use to add value to your business. To take advantage of these strategies, you need a proactive accountant who raises these issues with you. If you’re not receiving this level of service then feel free to call and discuss how best we can assist you save tax.
PKF Carr & Stanton