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Succession planning for small-scale forest owners

Tony Marshall, New Zealand Tree Grower May 2017.

In any business, the choice of business structure is an important decision which requires careful planning. This is particularly true with respect to the ownership of forestry as there are very long timeframes associated with the growth of trees through to maturity and the income tax treatment of the sale of standing timber.

As with any structural choice, there is often a trade-off between short-term and long-term benefits Many of these decisions are due to the tax outcome that the forest owner wants to achieve. It is often accompanied by a short-term focus of the opportunity to offset expenditure incurred against income from other business activities. The problem with the short-term approach is that it invariably results in a structure which is not appropriate for the transfer of the forestry asset to the next generation.

In this article we consider the structures available for the ownership of forestry assets and those which are best suited to succession, together with the income tax consequences that need to be managed as part of that succession process.

Income tax consequences

It is very important to understand the income tax consequences associated with ownership of forestry as this can have a significant bearing on what is an appropriate structure to undertake the forestry activity. This leads us to the ease at which succession can be undertaken with respect to the forestry assets.

The Income Tax Act provides for a range of deductions for someone who carries on a forestry business in New Zealand. A deduction is allowed for expenditure incurred in relation to the ownership of the forest, interest on money borrowed, planting and maintaining the trees on the land, applying fertiliser, disease and pest control, maintenance of forestry equipment, and most other expenditure you can think of which would be incurred in relation to the ownership of the forest. The main consideration is that a forestry business is being conducted. The requirements that must be met for a forestry business to exist have been canvassed in previous issues of Tree Grower. For the purposes of this article we assume that a forestry business exists.

This is a departure from the usual position with respect to revenue account property which includes forestry where a deduction for expenditure would be deferred until the forestry asset was disposed of, either as a sale of standing timber or as harvested timber. It is the availability of these immediate deductions which often drives a forestry owner to adopt a structure which allows them to offset those deductions against the other income, and often their own personal income, resulting in an income tax refund.

This resulted in the ownership of forestry being undertaken by sole traders, partnerships, loss attributing qualifying companies and more recently, ‘look through’ companies. To a much lesser extent, the use of limited partnerships also allows for the immediate use of forestry deductions to offset against other income derived by the owner.

The advent of the Emissions Trading Scheme has potentially changed the way that people go about structuring forestry investment. Registration in the scheme can give rise to cashflow advantages for a forestry owner who attempts to arbitrage the emissions units they receive against their future obligations when they harvest. This potentially takes away some of the desire to use tax refunds that the forestry expenditure generates to help fund the overall forestry project.

Taxable income

On the income side of the ledger, the disposition of any timber, harvested or standing, or the disposition or granting of any right to take timber, gives rise to taxable income in the relevant income year. Therefore, the transfer of the forest as part of a succession plan will, in most cases, give rise to income and a potential income tax obligation for the vendor. The purchase price of the forest will be allowed as a deduction for the buyer but only in the income year in which the forest is harvested or otherwise disposed of.

It is also important to remember that there are provisions which deem the sale of standing timber and the granting of a right to take timber to occur at market value, irrespective of the price actually paid. This is particularly important in the case of inheritance where the recipient is likely to have paid little or no consideration for the forestry assets received but the vendor will be deemed to have been paid market value for the assets.

Rollover relief

Particular provisions also apply to situations where a forest is transferred on the death of a person to a close relative. In those circumstances, the transfer is treated in the same way as the settlement of relationship property, which in effect means that the close relative recipient is deemed to have always owned the forest, thereby deferring any income tax consequence associated with that transfer. A close relative is defined as meaning a surviving spouse, civil union partner, a de facto partner of the deceased person, or a person who is within the second degree of relationship to the deceased person. That would include children and grandchildren of the deceased as well as siblings, parents and grandparents of the deceased.

This is referred to as rollover relief, in that the usual tax consequences are rolled over to the eventual sale of the forest. Similar consequences arise when forest assets are transferred under a relationship property settlement. The main consideration is whether the forestry assets are passing to a close relative. If the assets were passing to a trust for the benefit of a close relative, the rollover relief would not apply and there could be an income tax consequence for the deceased estate. For this reason, it is always important to carefully review the terms of a will when it is being drawn up if forestry assets are involved.

These two scenarios are the only time where the physical transfer of the forest is exempt from income tax obligations.

Forestry rights

One way in which the tax obligations can be mitigated on the transfer of the forest is for the transferor to retain a forestry right over the forest. From an income tax perspective, the forestry owner is able to take a forestry right in favour of themselves and then sell the underlying land and forest, subject to that forestry right to another party. Whilst this mitigates the income tax consequences from the sale, it does mean that any income derived from the eventual harvest of the forest will remain income of the transferor which in itself may not be particularly effective from a succession planning perspective.

As a result of this income tax obligation, it is very important to choose an appropriate structure when acquiring or planting a forest so that problems involving succession can be appropriately dealt with at that time.

Trying to implement a succession plan at a later date could result in an income tax consequence without a corresponding cash receipt to pay the resulting tax liability.

Structural choice

As alluded to above, there are many different structures commonly used for the ownership of forestry assets. All of these allow for deductions arising from the ownership of forestry assets to be offset against other income obtained by the forestry investor, but not all structures provide an easy path to succession planning. Some of the choices may also come with fish-hooks that could result in unexpected tax consequences.

The problem that forestry assets present when considering an appropriate structure is the long time it takes a forest to grow. The 28-year average harvest time frame for a pine forest, and 45 to 65-year harvest timeframe for Douglas-fir, mean that forestry ownership can be expected to be an inter-generational activity.

Therefore, any ownership structure needs to be able to outlive the growth cycle of the forestry asset and to help the transfer of the forestry assets to a new owner without triggering an income tax consequence. As a result, ownership of a forest as a sole trader or in partnership, while providing tax advantages does not usually result in tax efficient succession. On occasion, tax efficient rollover relief will arise for a sole trader or partnership by way of rollover relief. However, it simply passes the succession problem on to the next generation.


Companies are another popular choice for the ownership of forestry assets. A company comes with the advantage of being a structure which has an unlimited life, but also can provide the tax benefits associated with offsetting deductions with the use of the ‘look through’ company regime, and before that, the ‘loss attributing qualifying company’ regime. In simple terms, both of these tax regimes provide for the pass through of deductions to the company shareholders on an annual basis to offset against other income that the shareholder obtained from other sources. Both of these tax regimes were designed for companies with five or fewer shareholders which makes them well suited for small forestry holdings. The ‘loss attributing qualifying company’ tax regime stopped at the end of the 2011 income year and was replaced by the ‘look through’ company.

The ‘look through’ company tax regime is more complex, but it provides many of the same results that would have arisen under the ‘loss attributing qualifying company’. However, it also has some additional catches which you should be wary of. It was possible for a ‘loss attributing qualifying company’ to transition and become a ‘look through’ company without any income tax consequences. The main difference between the two tax regimes in a practical sense is that both income and deductions are passed through to the shareholders of a ‘look through’ company, whereas only the loss arising in a ‘loss attributing qualifying company’ were attributed to the shareholders. If the company was deriving a loss, in many cases the result was the same under both tax regimes.

One very important point to note with a ‘look through’ company is the different result from a ‘loss attributing qualifying company’ in relation to exiting the tax regime and the transfer of shares. In both cases there is a deemed sale of the underlying assets of the company which could give rise to an income tax consequence.

Limited liability

For larger forestry syndicates a partnership of ‘loss attributing qualifying companies’ was popular, with many of them continuing after the transition to the ‘look through’ company. The only real practical downside is the limit on the number of shareholders, which as mentioned above is a maximum of five. However, in a succession where many of the shareholders could be close relatives, the shareholder count concessions for close relatives being counted as one shareholder allows for a larger group of related shareholders.

Company ownership also has the advantage of providing limited liability for the shareholders, rather than joint and several liability in a partnership. The major difficulty with both of these tax regimes is that neither are well suited for trusts to be shareholders. This is problematic as trusts are a very useful in helping with estate and asset planning.

Using a trust

The reason that trusts are problematic in relation to ‘look through’ companies is the shareholder count test and how the number of shareholders is determined under that test. In most family scenarios this should not cause a problem. However, it pays to be aware that there are potential problems with the use of a trust as a shareholder of a ‘look through’ company due to the way that the number of shareholders is determined as it looks through to the beneficiaries of the trust who have received the distribution. There are changes currently before Parliament which includes some substantial amendments to the ‘look through’ company tax regime, including a change to the limitation on deductions and some extensive changes to the shareholder count test in relation to trusts.

While a ‘look through’ company is advantageous in that it allows deductions to be passed through to shareholders in proportion to their shareholding, any income must also be passed through in those same proportions. Therefore, at harvest or sale of the forest, all of that income will be attributed to the shareholders which may not be particularly effective in relation to any estate planning which has been carried out for those shareholders. Unlike a ‘loss attributing qualifying company’, where a trust shareholder of a ‘look through’ company receives income, it is not required to pass that income to its beneficiaries to remain a ‘look through’ company.


All income and expenditure of a ‘look through’ company is passed to its shareholders in the income year when it arises. Therefore, when the company eventually pays a dividend, from a company law perspective, the dividend will be exempt income of the shareholders so that the income of the ‘look through’ company is not double taxed. So while a ‘look through’ company structure may present a number of advantages in relation to a forestry activity, the detailed rules of the tax regime need to be carefully considered to ensure that there are no unintended tax consequences.

The choice of a company has significant advantages with respect to succession planning in that shares in the company can be transferred without an income tax obligation with respect to the underlying assets owned by the company. It is important to remember, however, that this would only apply in the case of standard company. It also applied under the old ‘loss attributing qualifying company’ regime.

For a ‘look through’ company, where a person disposes of their shares in the company, they are deemed to dispose of their share of the underlying assets of the company also. In addition, if the ‘loss attributing qualifying company’ leaves that tax regime, it is also deemed to have disposed of all of its assets at market value upon leaving.

This is potentially a significant concern. Many ‘loss attributing qualifying companies’ which were involved in forestry partnerships, or had direct forestry investment, transitioned into the ‘look through’ company regime but without a real appreciation of the consequences of doing so if they later want to change the shareholding in that company or leave the ‘look through’ company regime, intentionally or unintentionally by failing to satisfy the requirements of the tax regime. This highlights the point made at the beginning of this article in that your choice of structure must be a decision which is very carefully made with both an eye to the future and to your current tax position.

Company advantages

There are definite advantages of using a company and electing it to be a ‘look through’ company. However, you need to be aware of the consequences of doing that should you change your mind later. It is worth noting that there is an exclusion in relation to a change in shareholding in a ‘look through’ company, but only to the extent that the share of the market value of the asset is less than $50,000 more than the cost base of the asset. For a forestry entity which planted a new forest, the cost base for the forest carried in the financial statements will be nil as a deduction has been taken for all of that expenditure.

None of these problems are suffered by a standard company. However, you do lose the ability for the losses to be attributed to the shareholders, the losses could still be offset against other income, either directly in that company or by use of the company group loss offset rules with another company with 66 per cent common shareholding.

Ownership of forestry assets directly by a trust may also be an appropriate structure because a trust does have a life which can extend beyond that of an actual person. At present, the maximum life of a trust is 80 years, with the rule against perpetuities ensuring that the trust assets have to pass out to beneficiaries after that time. However, there is significant reform of trusts currently before Parliament, including a proposal to extend the maximum timeframe for a trust to 125 years, and to abolish the rule against perpetuities. The rule against perpetuities was designed to stop people avoiding the application of estate and death duties, something which has not existed in New Zealand for over 25 years.

A trust does, however, lack flexibility with respect to ownership. The trustees hold the assets for the benefit of the beneficiaries and inherently there is inflexibility to the extent that unrelated parties may attempt to use a trust for the ownership of assets.

Is there a perfect structure?

This is really is the million dollar question when it comes to the ownership of forestry assets following the repeal of the ‘loss attributing qualifying company’ regime. When that was in existence, the best of both worlds could be obtained. Tax deductions could be attributed through to shareholders in the income year that they were incurred. When it came time for the forest to be harvested, the company could leave the ‘loss attributing qualifying company’ regime, transfer shares from individuals to a family trust and protect the gains rising from the sale or harvest of the forest without inadvertently triggering an income tax obligation before the sale or harvest of the forest.

‘Look through’ companies, and limited partnerships, have the same downsides as a change in ownership gives rise to a deemed sale of the owners share of the underlying assets. In a family reorganisation this can be problematic as there may be no cashflow to fund the resulting tax obligation arising on the transfer.

No magic answer

Depending on the other business activities of forestry investors, the use of a standard company may be appropriate and give the investor significant flexibility in relation to the shareholder of that company. A shareholding change in a standard company will not trigger an income tax obligation in relation to the underlying assets, assuming that the shares in the company are being held on capital account. To the extent that expenditure is being incurred on the forestry asset, those costs can be offset against other income derived by the company or through the group loss offset provisions with the income of another company which has 66 per cent common shareholding.

Of course this type of structure does come with additional compliance costs which may be unpalatable, in particular a wage and salary earner who has decided to invest in a small scale forestry block. Unfortunately there is no magic answer to the question of what is the best structure, other than that the use of a company is likely to give investors the best results.

The article provides general information only and which is current at the time of writing. Any advice in it has been prepared without taking into account your personal circumstances. As always, you should seek professional advice before acting on any material.

Tony Marshall is a Partner-Tax Advisory at Crowe Horwath Dunedin. Tony specialises in providing tax advice to agricultural businesses throughout New Zealand.


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