By Carissa Tolley*
Farmers may be experiencing a large fluctuation in their profits from one year to the next due to a number of factors i.e. payout, drought conditions, cost of supplements.
Tax planning is essential in these situations and there are strategies in which to smooth income between years to effectively manage tax.
While many farmers and their accountants have reviewed their options regarding the income equalisation deposit scheme to smooth profit over a number of tax years, there is also the option of applying the fertiliser deferral rules.
While the income equalisation deposit scheme involves estimating future profits the fertiliser deferral rules can be applied at the end of the tax year once your profit has been determined.
It also does not require a payment to the IRD and potential associated costs with lending, if required to fund the deposit, are removed.
The rules stem from the problem that arises because application of fertilisers can be expected to increase production and hence lead to an increase in income in later years. This can result in pushing the farmer into a higher tax rate bracket in future income tax years.
By deferring fertiliser costs over the associated income years it ensures a deduction against increased income in future years rather than a full deduction in year one.
EJ3 of the Income Tax Act 2007 allows for fertiliser costs to be spread over all or any of the four income years after the income year in which the expenditure was incurred in applying the fertiliser.
A business that engaged in any farming or agricultural business are eligible to defer fertiliser costs. Both land owners and lessees are included.
The costs that can be deferred over a number of years aren’t restricted to the cost of fertiliser, lime or urea but also can include associated costs for transporting the fertiliser to the farm or the actual application of the fertiliser to the farm.
To apply the fertiliser deferral rules notice must be given to the IRD in writing explaining your intention to elect to spread the costs and the total amount of costs over future years. The future income years in which you choose to claim the deduction and the amount you wish to claim back are at your discretion.
Notice needs to be forwarded to the IRD normally prior to the Income Tax return falling due. Any balance of the costs not deducted three years after the expenditure was incurred must be deducted in the final (fourth) income year.
The following is an example of how the fertiliser deferral option can produce an overall tax saving:
You are in a partnership and your 2015 taxable profit is $60,000. Included in this profit is fertiliser & associated costs totaling $50,000. You expect your 2016 profit to be over $120,000.
If you do nothing your total tax due for the 2015 and 2016 year will be $30,580 based on the current tax rates. If you defer the full $50,000 in 2015 and claim $50,000 in expenditure in 2016 the total tax due will be $29,330.
The tax saving from doing the fertiliser deferral is $1,250.
There may also be other tax savings by smoothing your income over fluctuating tax years such as working for families’ tax credits and student allowance benefits.