Dairy Farmer saves tax using Income Equalisation
The average Dairy Farmer should be able to save $20,000 in tax over two years by utilising the Income Equalisation Deposit Scheme as a result of the Fonterra Farmgate Milk Price falling from $8.40 for the 2013/14 Season to a forecast of $5.30 for the 2014/15 Season.
For those not familiar with the scheme the idea is to spread a farmers’ taxable income over two or more tax years so as not to expose that farmer to a particularly high average tax rate in one year due to seasonal factors or exceptional pay outs. The farmer physically deposits money into the scheme which is administered by the Inland Revenue Department and requests that money back in 6 to 12 months or longer depending on the circumstances of that farmer. In the deposit year the amount of the deposit is deducted from the farmer’s taxable income and in the refund year it is added to the farmer’s taxable income. To make the tax concession even more attractive the deposit or refund does not actually need to be made within the tax year concerned but can made up to as late as the 31st of March following the tax year end. So dairy farmers with a 31 May balance date have up till 31 March 2015 to make a deposit that will reduce their 2014 taxable income which is the tax year we are concerned about.
Back to the $20,000 tax saving over two years….
Firstly the assumptions. For most dairy farmers gross taxable income from dairy milk each year is a combination of last seasons’ final payments and this seasons current payments. So whilst the 2013/14 Fonterra Farmgate Milk Price excluding dividend was $8.40 and the forecast for the current season is currently $5.30, for tax purposes the average using a combination of last season payments and current season payments for a May balance date farmer will be $7.59 and $5.55 respectively.
Now for the costs. I have used a total of $5.80 per milk solid made up of $4.80 Farm Operating Costs, $0.30 depreciation and $0.70 interest. The interest cost is based on $12.00 of debt per milk solid at 6% which is lower than the Bay of Plenty average of around $17.00 per milk solid. Using these cost assumptions the farmer will have taxable income of $1.79 per milk solid in the 2014 tax year and incur a taxable loss of $0.25 per milk solid for the 2015 tax year.
If I assume production of 110,000 milk solids and the figures above, taxable income will be $196,900 for the 2014 year and the 2015 year will be a taxable loss of $27,500. The overall tax bill for the two years for a couple earning only dairy income $46,568.
Now as I mentioned above, the idea of the Income Equalisation Deposit regime is to spread your income so that the marginal tax rate between the two years is the same. That way you are not being penalised for a particularly high marginal tax rate in the 2014 year. The best we can hope for is to achieve exactly the same taxable income for both the 2014 and 2015 tax years which in this example requires making an Income Equalisation Deposit of $98,100 leaving taxable income of $84,700 in both years. The overall tax bill for the two years for a couple earning only dairy income will be $25,728. That’s a saving of $20,858 in tax over two years by using the Income Equalisation Deposit regime*. Or to make it sound even more attractive a return of over 25% on your 12 month income equalisation deposit.
So if you want to make tax savings using the Income Equalisation Deposit scheme give me a call so that we can run your numbers. The earlier you make your deposit the earlier we can get the deposit money back – as mentioned above the deposit must be left with the Inland Revenue Department for at least 6 months and usually 12 months depending on your circumstances.
*The tax benefit on the $27,500 of losses the farming couple could carry forward to the 2016 year if they did not make the income equalisation deposit has been ignored in this example – it is three years or more away and too hard to quantify with any accuracy but could be around $5,000 still leaving tax savings in excess of $15,000.
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