What values livestock when paying the taxman?

Press, 17 January 1986, Page 10

What values livestock when paying the taxman?

Farmers and their advisers are going to have little time in which to comment formally on the details of the proposals for the valuation of livestock for taxation purposes. A Christchurch farm accountant, Mr TIM HERRICK, of Lawrence Anderson Buddle, gives his early interpretation to help those affected to develop their thoughts and plan their submissions.

The changes to the valuation of livestock for taxation purposes were announced by the Minister of Finance, Mr Douglas, on December 12.

Since then, a committee has been formed to look into the implementation and administration of the changes, but not the policy decisions themselves. The Government will publish a consultative document setting out the details of the changes by February 28.

Public submissions on the schemes will close on March 31, and the Brash committee will consider the submissions and report to the Government by April 30. The announced proposals intend to abolish the fixed standard values which have traditionally been used for taxation purposes for livestock on hand at balance date. Almost without exception these standard values have been considerably below market value. Even the revised approved standard values introduced from December 1, 1985 are well below market values in most cases. This meant that when stock was purchased, there would be a writedown from the purchase price to standard value.

Stock would be carried in the taxation accounts at below market values with a contingent liability for taxation on income arising from the difference between standard and market values. This liability would only materialise when the stock was sold. Considerable financial assistance was available from the taxation deferral for anyone starting up fanning or increasing their stock numbers. In recent years the legislation was altered to spread this benefit over a three-year period. The new system proposes to adopt standard values which are more closely related to market values. This will eliminate the taxation assistance previously available to buyers of livestock. The mechanics of setting these market related standard values will no doubt be one of the more difficult areas for consideration by the committee. Announcements to date indicate that they would be set annually, related to a three-year rolling average of market values based on auction prices at representative saleyards. The committee will be asked to examine whether regional standard values should apply to allow for the considerable regional variation in livestock prices. They will also have to give a great deal of thought to the variation in livestock values caused by differences in breed, location, regional climatic differences, and not least of all, individual farm management skills. The committee will require a little of the wisdom of Solomon when resolving this issue.

The proposals differentiate between trading stock and capital breeding stock. The trading stock scheme will apply to livestock dealers and also to immature breeding and fattening stock. This trading stock will be brought into the accounts at balance date at 70% of the annual standard market The adjust-

ment to 70% intends to recognise that stocks are normally recorded on a cost rather than a market value basis in non-farming businesses. The three-year rolling average used to set the market values intends to assist in smoothing out fluctuations in market prices. However, if stock is bought on a falling market where the cost is lower than the standard values set, closing stock will be brought in at higher than cost, with taxable income arising. On the other hand, when the market is rising, there will be a taxation deduction for the- difference between current cost and the value based on the three-year average. Mature breeding animals will be dealt with under the herd basis scheme. This means that they will be treated as capital rather than as trading stocks. Normally, for instance, ewes two years and older and rams will be dealt with on the herd basis. The cost of the initial herd, or flock, and all net additions to it, will not be deductible.

Where breeding stock is replaced in the normal course of events, sale proceeds will be taxable and the cost of replacement animals deductible. This will result in a net deduction of the difference between cost of the replacements and the sale proceeds of the culls. If the sale and replacement do not take place in the same year, the sale proceeds would not be taxable and the cost of the replacements would not be deductible. The sales would be treated as a reduction in capital stock, the proceeds of which would not be taxable. The subsequent replacements would be treated as an increase in the capital stock with no deduction being allowed for the cost.

The setting of basic herd or flock numbers presents another difficulty for the committee to resolve. Livestock numbers vary from year to year for a number of reasons.

Climatic and market conditions can both have an effect on a farmer’s decision on the number of stock that he carries. These variations could be in what will be considered trading stock. However, there are variations in capital stock from time to time, such as changing from sheep to cattle, or reducing livestock to increase cropping. Careful thought will have to be given to the cash effect of taxable income arising from an increase in stock numbers for which no cash is generated to pay the tax. Any increase in the number of immature breeding stock on hand at balance date will be brought in at 70 % of the market related standard values. This will be taxable income.

Mature capital breeding stock valued on the herd basis are brought in at

i of the market related standi ard value. This appears to > mean that there will be ■ taxable income amounting . to 70% of market value in I. the first year and the furR ther 30% (bringing to a total of 100%) in the second year when they are taken into the capital stock. i A farmer increasing and ’ improving his capital stock j through his own breeding i programme will have to be : aware of the effect of this. I This would particularly apply to higher priced stock such as deer and goats, even if the price of these does come back. The position of farming estates with life tenants will ’have to be considered. There may be no capital cash to pay the taxation on the revaluation of capital stock. Farmers need to4be particularly aware of the transitional measures that are proposed. Livestock will be written up to the new market related standard values at the end of the 1987 financial year. For sheep, cattle and pigs, 50 per cent of the increase in value will be treated as non-taxable. For goats and deer, the amount to be treated as non-taxable will be up to 75 per cent of the revised standard values that were announced to come into effect on December 1, 1985. In the case of a red deer hind, the revised standard value was $BOO, and $6OO of the write up to the new market

related standard value would be non-taxable. In all cases, the taxable proportion of the write-up is spread over the 1985/86, 1986/87, 1987/88 and ten subsequent years.

Farmers who cease farming before the end of the 1987 income year can adjust their trading stock to 70 per cent of the sale price and capital breeding stock to 100 per cent of the sale price.

The non-taxable part of that write-up will be the same as will apply to farmers adjusting their livestock values for stock retained at the end of the 1987 year. This has considerably eased the taxation cost of a farmer considering giving up farming. These provisions should also be borne in mind by anyone considering transferring livestock to a member of the family as a normal transition from father to son or under the Matrimonial Property Act. The timing of such transfers during the transitional period could have a considerable bearing on the taxation effect. On the face of it, it seems that the non-tax-able concession on write up could be obtained twice if the transfer takes place in the 1986 income year. The vendor gets the benefit on the sale of the livestock. The purchaser gets the initial write, down to old style standard values.

He then gets the concession on the write up to the

new values in the 1987 year. It does appear that the transitional measures could be beneficial to some farmers. The existing standard values scheme applies for the 1985/86 year. Any stock purchased in that year can be written down in the normal way, providing a deduction for taxation purposes. That write down from market value to standard values will be reversed in the 1987 year. A substantial portion of the reversal will not be taxed, and the taxed proportion is spread over 13 years. The following example il-

lustrates the point: If 50 cattle were bought for $5OO each and written down to a standard value of $l5O each in the 1986 year, there would be a deduction of $17,500. If those cattle were treated as capital breeding stock, in the 1987 year they would be written back to market values, and $8,750 of that write back would be treated as non-taxable. The balance would be spread for taxation purposes over 13 years, giving a taxable income in each year of $673. This advantage could be watered down by the need to spread the write down from purchase price to standard value over three years, or in the case of the part time farmer, the $lO,OOO loss offset limit still applies for the 1985/86 year. The actual benefits would vary depending on the purchase price of the stock and the standard values used. It is clearly the intention of the Government to remove taxation considerations from the business decisions of farmers. This may be no bad thing in the long run, but everyone needs to be clearly aware of the effect of the mechanics of the proposals before they are enshrined in law.