Income tax - When is it smart to be a farmer?
Howard Moore, New Zealand Tree Grower August 2018.
There are 3,351 pages in the Income Tax Act 2007 and it keeps on getting longer. Because it treats farmers differently from foresters it pays to know why, where and what that means for you as a farm forester. Happily, it is not too hard to pick out the highlights so if you are growing trees for timber, here is a summary.
I do not claim it is all relevant or sufficient or true, but I hope it is useful. The idea is to give you enough information to ask the right questions of some professional you are paying for an answer. It is sometimes surprising − and distressing – to find you know more than they do. The Act is available online and if you are keen, for download, go to the website www.legislation.govt.nz.
The first thing to understand is the language used. It is important to know how Inland Revenue thinks about you as a land owner, and why you need to define yourself for tax purposes. For Inland Revenue, a ‘forester’ always grows timber while a ‘farmer’ grows trees. ‘Timber’ is live, harvestable wood while ‘trees’ although equally big and green, are non-harvestable.
With this as a guide you should make sense of the points below, which are given in a sort of alphabetical order. References to parts of the Act are shown in square brackets.
If you are growing either timber or trees and earn New Zealand Units from forests grown after 1989 under the Emissions Trading Scheme, they are not taxable on issue or surrender, but create taxable income on sale [CB 36]. If you were issued New Zealand Units for pre-1990 forests, they are effectively capital and not taxable on issue, surrender or sale, [CB 36 and CX 51B].
If you buy and hold stocks of New Zealand Units for trading then you must value them each year [ED 1]. You must also deduct the value at the start of the year from the value at the end of the year and pay tax on the difference [DB 49] as if it were cash income.
Nothing to do with carbon credits
Fencing is fully deductible if you are a farmer [DO 1] but depreciable at 10 per cent of the diminishing value if you are a forester [Schedule 20 and DP 3]. You would think the fence around a forest to keep animals out would get the same wear and tear as a fence around a paddock, but Inland Revenue thinks not.
Harvesting and marketing are part of administration costs and fully deductible for foresters [DP 1]. The costs are also fully deductible for farmers, but like foresters, you must declare any income you earn from that harvesting and marketing as part of your normal taxable activity. Timber harvested and used in the forest or on the farm does not generate taxable income.
Inventory is part of administration costs and fully deductible for foresters [DP 1]. Land clearing is also fully deductible if you are a farmer [DP 1] but depreciable at five per cent diminishing value if you are a forester [Schedule 20]. Of course, land cleared for farming might later be subject to a forestry right because farmers must remain flexible about land use change.
Land preparation is a capital cost for farmers or foresters, depreciable at five per cent diminishing value [Schedule 20].
Management, fertiliser, weed and pest control costs are fully deductible if you are a farmer managing trees for erosion control, shelter or water quality [DO 2]. They are also deductible up to $7,500 a year if you are managing for timber [DO 3]. For a forester all management is fully deductible [DP 1].
Planting and planting stock is fully deductible if you are a farmer planting for erosion control, shelter or water quality [DO 2]. It is also deductible up to $7,500 a year if you are a farmer planting for timber − roughly equivalent to planting around eight hectares a year [DO 3]. For a forester, all planting is fully deductible [DP 1]. Several regional councils offer subsidies for erosion control planting, which do not affect deductibility.
Plant and machinery purchase is a capital cost depreciable according to the nature of the equipment. To find current depreciation rates and methods go to the Inland Revenue website.
Repairs and maintenance are fully deductible for farmers and foresters [DG 7 and DP 1].
Spreading income for farmers and foresters can be carried out from the sale of timber forward for up to five years, using an interest bearing income equalisation account held at Inland Revenue [EH 1 to EH 36]. Interest is paid at three per cent a year with daily rests [EH 6]. You only pay tax on the amount of income withdrawn from the account in any year. A forester may also spread income backwards for three years [EI 1].
It looks as if a forester can use both methods at once, allowing a spread of up to eight years.
Tracks, roads, culverts and bridges for farmers are capital costs depreciable at five per cent diminishing value [Schedule 20]. For foresters they are fully deductible costs if the assets are used for less than 12 months [DP 1]. However, if they are designed for a longer life they are capital expenditure, depreciable at 20 per cent diminishing value if they are partially or not metalled, and five per cent if they are sealed or metalled [Schedule 20]. Foresters have the advantage with roads.
Selling standing timber is taxable [CB 24]. In a sale of land with standing timber, the part of the sale income which is attributable to the timber is taxable [CB 25]. The buyer of the standing timber cannot claim the purchase as an expense against other income but must carry it forward until the timber is harvested or resold [DP 11 and EA 2]. This anomaly is because Inland Revenue has chosen to make standing timber a ‘revenue account property’ like land for subdivision. It is not a big deal if the harvest is imminent but can be a problem if the harvest is decades away. Since 2010, the industry has been arguing to remove this anomaly because it affects the marketability of small forests.
For selling standing trees, the Tax Administration Act outranks the Income Tax Act and presumes all trees are timber unless proven otherwise. Trees for shelter, erosion control or carbon are treated as timber, and taxable on their sale as standing trees [CB 25]. Farmers who sell land with such trees should have them valued for tax or obtain a certificate [Tax Administration Act Section 44 C] proving they are incidental, horticultural or ornamental. ‘A certificate as to whether trees are planted mainly for the purposes of timber provides conclusive evidence if it is given by a properly authorised officer of the relevant regional council; or a properly authorised officer of the Ministry for Primary Industries; or any other person suitably qualified’ This is enlarged on below.
Of course, the Income Tax Act has a lot more, but the rest is generally less relevant. If you are interested in navigating it, use the references above as a guide. You will also find it has a search function which highlights all occurrences of your search term, making it easier to find your way. The big hurdle is in following up cross-references to other sections in the Act and when you get there, understanding what they mean.
The really big hurdle is checking to see if what you have is actually all there is, because somewhere, another section or another Act, such as the Tax Administration Act, using different language might affect what you are trying to do. I suggest that is when you call in the experts.
The points above seem to have two interesting implications. First, it seems to me that because of the identified tax differences, a land owner might improve his position by being a farmer on one part of his land and a forester on the other. This could be achieved by the farmer entering into a forestry right with himself as a new tax entity to run that part of the land where it was smart to grow timber, while keeping the rest of the farm to grow trees.
Second, it is clear that anyone growing trees on steep land for carbon and erosion control should be aware of tax if they are thinking of selling. The tax risk could be minimised with a certificate from the regional council confirming that harvesting is out of the question, or a certificate from a ‘suitably qualified person’ arguing that the harvest costs would outweigh the returns. Of course, costs change and the buyer will have their own objectives, but that is not the seller’s responsibility.
Howard Moore is a member of the NZFFA and NZIF living in Wellington. He knows little about tax and less about forestry but holds opinions on both.
He willingly shares his prejudices and writes the odd irrelevant verse including what is believed to be the world’s first limerick addressing the syntactic challenge of mycorrhizal fungus. The editor was not impressed.