Tax Saving Strategies for the Rural Business
By Campbell Brenton-Rule
Farming incomes are subject to so many variables it can be difficult to forecast where you are headed but with a few years under your belt, you start to get a picture of how things look in a good year versus a bad year. This helps us develop a business model which can be used for all sorts of future planning opportunities such as succession and purchasing additional land.
Most rural business owners have a gut feel on how the year might pan out and that’s what we use to start our budgeting process. As the year progresses, there will be a point at which time you’ve got a pretty good handle on how the year will finish up. For sheep breeders it will be when the majority of their lambs are finished or sold. For cropping farmers it will be once the harvest is complete (assuming a market is secured for sale). Every business is different and part of our role is to identify when that time might occur and plan to complete your tax forecast at this time.
If your balance date suits your income cycle, the tax update usually occurs between your second and third provisional tax due date. That gives us a chance to amend the last payment to make sure you don’t pay too much or too little tax.
It also gives us a chance to look at tax saving strategies that you can implement before the year ends. It’s often too late to do it at the annual accounting meeting as the horse has bolted.
So why do we do tax planning?
Contrary to popular belief it’s not just to save tax! There’s more to it than that.
- Our main goal is obviously to reduce or defer tax to save you money
- Smoothing tax payments to take out the peaks and troughs to help cashflow planning
- Saving you IRD Use of Money Interest and penalties
- To assist with entitlements for income tested entitlements such as Working for Families and Student Allowances
- To give you a yardstick of how your business is performing
- To give the bank an update on current performance
What works and what doesn’t work?
- Stockpiling Consumables
You can bring forward into the current year the purchase of consumables 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. There is a major fishhook though – you must not hold more than $58,000 worth of consumables in total, otherwise the entire deduction for consumables on hand is reversed, even though you’ve paid for the goods. It will be deferred to the following tax year assuming at the end of that tax year, you keep under the $58,000 limit. The other fishhook we come across is 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 and not taking delivery until later on, doesn’t meet the rules for claiming a deduction.
- Invest in Farm Development that is 100% deductible
The IRD allow a full deduction for the following items:
• The destruction of weeds, plants or 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 providing shelter.
• The construction on the land 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?
- Utilising low income tax brackets
NZ’s tax rate structure for individuals is bracketed as follows:
Taxable Income Marginal Tax Rate 0 – $14,000 10.5% $14,001 – $48,000 17.5% $48,001 – $70,000 30% $70,001 + 33%
There is a “use it or lose it” rule, which means if you don’t utilise your low tax rate bracket one year, you cannot transfer it to the next year. So our goal is to smooth your income and ensure low tax rates are utilised each year. We can do this by utilising the fertiliser deferral rules, the forestry income spreading rules, and the income equalisation rules. The savings can be quite substantial too!
- 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 you overdraft interest. If income has increased, we can estimate a higher level of tax, saving you Use of Money Interest (currently 8.27%).
- Utilising tax intermediaries
Sometimes you just can’t predict your income until later in the year and yet the IRD expect you to have paid the right amount of tax in the first two instalments. Instead of incurring the IRD’s Use of Money Interest at 8.27%, we can use companies such as Tax Management NZ Ltd and purchase the tax shortfall 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.
- Deferring income realisation until the new tax year
As long as it doesn’t compromise your income or your 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, so it goes without saying if this was planned to happen 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 the felling of forestry blocks and deferring stock sales.
- Balance date structuring
The IRD are strict on non-standard balance dates and cracked down on this many years ago. They have however published a list of accepted balance dates which they will generally approve upon application. If a change of balance date defers income to a 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.
- 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. So 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 $3,150 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
- 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 aren’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!
- 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. So it’s the sale that creates the tax issue and that is within your control.
- 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.
- Exceeding the $58,000 limit for consumables
Be mindful of this limit especially when adding in the biggies such as the cost of fertiliser purchased. 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 the sorts of legitimate strategies the team at Farming Growth use to add value to your business. In order to take advantage of these strategies, you need a proactive farm accountant that raises these issues with you. If you’re not receiving this level of service then phone us on 06 876-8124 or email Campbell at email@example.com or Joanna at firstname.lastname@example.org and we’ll be happy to discuss how we can add value to your rural business.