Hedging decisions risky
With an 80% likelihood the Reserve Bank will lower the official cash rate by 25 basis points next month, many rural borrowers are wondering if now is the time to look at fixing rates.
Tony Marshall, agri tax specialist at Crowe Horwath, points out that the IRD's 2016 Herd Scheme (HS) values have drawn to a point closest to the National Standard Cost (NSC) in some time.
"Valuation choice is important due to the tax treatment of livestock under each scheme," he says. "Once livestock are valued under HS, movements in value are non-taxable, whereas movements in value under the NSC method are always taxable, either as income or a deduction."
The HS value of a mixed aged dairy cow has fallen to $1356, and the NSC for a home bred cow now stands at around $900. At $456, the difference is the smallest for many years. By contrast, when the HS value for mixed aged cows peaked in 2012 at $2155 the corresponding NSC value was around $488 -- a difference of $1667.
In general, most farmers use HS, NSC, or a combination of the two methods to value their livestock for tax purposes.
However, switching the valuation method isn't a decision to take lightly, says Marshall, as it has further implications.
"Generally, changing from NSC to HS will incur a tax cost, as the difference between the values under each method would be taxable income. However, with the closing of the gap between the methods, there is now an opportunity to make the change with the smallest amount of taxable income arising."
As most dairy farmers are likely to incur a loss for the 2016 year, there is unlikely to be any cash cost associated with the change in method.
And whether or not it is appropriate to change methods depends on various factors which should be assessed on an individual basis. But there are some rules of thumb.
"Generally, if HS values are expected to increase, that signals a good time to enter this scheme. Once a farmer is in the HS, any increases in value each income year are tax free.
"Secondly, if the farmer is expecting to sell the herd in the near future, switching to HS could protect part of the purchase price from tax. Finally, if the farmer is undertaking succession planning in the future, election into the HS method could be beneficial."
Specialist advice should be taken before any decision is made as moving to the HS method is irrevocable.
