It's fair to say that the past few years have thrown up some enormous challenges to anyone trying to run a primary production business in regional Australia.
These challenges go beyond financial and economic upheavals such as the GFC, the stronger dollar and constant volatility on global share markets. What I'm talking about are the dreaded "natural disasters" that periodically disrupt the businesses of primary producers, e.g. viruses, droughts, floods and bushfires.
It's not well known that our tax laws contain concessions that help victims of these disruptions to cope financially through these difficult periods. It makes the job of an Accountant that little bit more rewarding when we can pass on and apply these concessions, too.
This article will outline and discuss the concessions and a few tax tips that I consider most relevant for horse owners and breeders caught up in these circumstances. Even if you can't use them when preparing your 2011 tax return, I'm hoping you can tell a friend or two who needs some welcome good news after all that nature has thrown up to him or her recently.
1. Insurance Recoveries for loss of livestock can be spread over 5 years
If a taxation breeder receives an insurance recovery for a loss of ''live stock'' or for a loss of trees by fire, the tax act provides the breeder with an election to spread the assessment of that income over five years. However, the election is available only if the relevant live stock or trees are held as assets of a ''primary production business''.
N.B. This concession is not available to those who conduct a "stand-alone" racing activity, without any associated breeding.
Example
Peter has his breeding property in Toowoomba and lost his prized broodmare in the recent QLD floods.
The mare was insured for $200,000 and these proceeds were duly received in March 2011. Peter's cash-flow has been severely affected by the floods and he has little appetite for paying tax on this income until he can get some yearlings to the sales in the next few years.
To lessen the tax impact, Peter elects to spread his insurance recovery over 5 years, i.e. $200,000/5 yrs = $40,000 p.a. Accordingly, $40,000 was returned in FY 2011 and in each of the next four tax years.
2. Insurance received re destruction of a building is treated as capital proceeds
Many business related buildings were been destroyed as a result of the recent floods, bushfires etc.
The insurance recovered as a result of these occurrences are not returned as income in the year received, instead they are treated as the capital proceeds on the disposal of these assets.
Where an asset, or part of an asset is lost or destroyed, any proceeds received by a taxpayer under an insurance policy in respect of the loss or destruction are taken to be amounts of money received "as a result of or in respect of" the disposal of the asset or part of that asset. N.B. If an asset, or part of an asset was acquired before 20 September 1985, no part of the proceeds received in relation to that asset or part of that asset, would be subject to Capital Gains Tax (CGT).
Similarly, where a motor vehicle is lost or destroyed, any insurance recovery will be consideration in respect of the disposal of that motor vehicle, and so not subject to CGT.
Example
A breeding company acquires ownership of a newly constructed building on 1 July 1986.
The cost base of the building is $10 million and the building is treated as a separate asset for CGT purposes.
The building was subsequently destroyed by fire and the breeder lodged a claim under an insurance policy. At the time of acquisition, the taxpayer entered into an insurance agreement that would cover the taxpayer for the replacement cost of the building. The replacement cost at date of destruction is $18 million.
The insurance payout of $18 million is taken to be the consideration on disposal of the building and, thus, is not 100% assessable in the year received.
"Roll-over relief" under section the CGT act may be available where a replacement asset is acquired with the insurance proceeds, i.e. the CGT cost base of the replacement asset is reduced by the profit on disposal of the building. In the above scenario, the profit would be $8 million ($18 million insurance proceeds less $10 million cost base)
3. Insurance received for assets that are part of a "Small Business Depreciation Pool"
Many smaller breeders claim depreciation using the small business depreciation pool.
For the record, a Small Business Entity (SBE) is a tax business with generally less than $2m aggregated turnover p.a.
If in the event of insurance received for the destruction of assets, note:
- The pool balance is reduced by the extent of insurance received. Thus a profit or loss on the items destroyed need not be made when the insurance is received; and
- If the sum of the insurance received of assets disposed of during the income year exceeds the pool closing balance for the year, the excess is subject to taxation.
Example
Janet the breeder lost valuable sheds in the 2009 VIC bushfires.
The closing depreciation pool balance of her business at 30 June 2009, was $12,500. Insurance received for her sheds was $30,000. Accordingly, $17,500 ($30,000 less $12,500) is taxable income to the business in the FY 2009.
4. Assets subject to "Roll-Over Relief" due to destruction
As noted above in a CGT context, "Roll-over relief" occurs where profits on disposal of assets, e.g. where insurance proceeds exceed the written-down value of asset, can be deferred. In relation to a business asset, this is where the profit is offset against the cost of the replacement asset, instead of being declared as income immediately.
In short, yes, a breeder is able to obtain roll-over relief for an asset which was involuntarily destroyed by fire, flood etc. provided the following conditions are satisfied:
- The asset was not a pooled asset under the "Small Business Entity" (SBE) regime or as part of a low-value pool for non-SBE taxpayers; and
- The taxpayer acquires a replacement asset within the required times
Example
Big Breeder Pty Ltd, who does not qualify as a "Small Business Entity", had a float destroyed in the Victorian floods of 2011.
Insurance proceeds received in FY 2011 was $20,000, the written-down value of the float at time of destruction was $5,000, thus a profit on disposal of $15,000 was realised.
A replacement float was acquired for $30,000, within only 3 months of the event, well within the 12 month required time frame, which commences on 30 June 2011.
Instead of Big Breeder having to declare the $15,000 as a profit in FY 2011, what it does instead is to reduce the cost base of the new depreciable asset to $15,000 ($30,000 cost less $15,000 profit on the destroyed asset).
5. Assets that can be written-off immediately
In many instances, business plant and equipment is not insured and no proceeds are received.
Where this occurs, the tax "written-down" value of the asset can be immediately written-off, this being an immediate deduction in the tax year this occurs.
However, it should be noted that only a "non-SBE" can take advantage of this concession as they are not be eligible to use "pooling" for their business assets.
Example
Big Breeder Pty Ltd chooses not to insure any of its "on-farm" motor bikes.
All of these bikes were "written-off" as unrecoverable after the VIC floods.
The tax written-down value of its bikes at the date of destruction was $25,000. As no insurance was received, an immediate $25,000 deduction can be claimed for these assets in that tax year.
6. "Loss of income" insurance is assessable to the breeder
Where insurance payments are received to replace lost income, the proceeds are assessable to the breeder (e.g. business interruption insurance which generally provides cash flow until business profits reach what they were before the fire. flood etc.).
7. Dealing with the destruction of trading stock
a) Can a horse be written-off if no proceeds received?
A breeder is entitled to claim a deduction for the cost of trading stock destroyed.
The deduction is obtained via the movement in the opening and closing stock provision.
b) Tax profits from "forced" disposal of stock
Under the tax act, where a primary production business is forced to dispose of or destroy livestock, the breeder may be entitled to concessional treatment in relation to any resulting tax profit, as follows:
- spread the tax profits over 5 income year; or
- defer the tax profit and offset it against the cost of replacement stock over the subsequent 5 income years.
This relief relates to the forced sale of livestock, and differs to the relief re spreading insurance recoveries over 5 years, which relates to the death of livestock.
However, this election will not be available where the business is sold following the natural disaster.
Example - spreading the tax profit
Breedco's yearlings have to be destroyed because of the recent Hendra virus.
The insurance proceeds of the forced disposal are $250,000 and the tax profit is $150,000. Breedco elects to spread the tax profit over five years. Breedco's assessable income in the disposal year includes an amount of $130,000 in respect of the disposal. This amount is arrived at by reducing the proceeds of $250,000 by the tax profit of $150,000 and adding an amount of $30,000 (i.e. 20% of the tax profit of $150,000). For each of the four income years following the disposal year, Breedco must include an amount of $30,000 in its assessable income.
c) Closing stock value method can be altered
The golden rule of stock accounting is that opening stock should always equal closing stock and nothing has changed in this regard.
However, this does not stop a breeder from changing the year end accounting stock valuation method.
For instance, if market selling value has been used in the past, this can be altered to use either the special "write-off" or "cost" closing stock valuation methods. This strategy would help immensely in reducing taxable income in a particular tax year, something that would be most welcome if you've been a victim of a natural disaster.
Example
Stockco was severely affected by a new outbreak of EI virus that swept through the Hunter Valley, leading to many of its prized yearlings being withdrawn from the 2012 Easter sales. However, good money was made on foals sold at the earlier Magic Millions QLD sales. Tax profit for the year is $350,000.
Without the cash-flow from the Easter sales, Stockco requires options to reduce its tax profit for FY 2012. Martin the accountant finds that many of the mares have been valued @ market value as at 30 June 2011. By valuing these mares @ cost as at 30 June 2012, the closing stock value of the mares is reduced by $150,000 and tax profit is also reduced by this amount to $200,000 ($350,000 less $150,000).
8. Issues re withdrawing funds from a Farm Management Deposit (FMD)
The FMD provisions are contained in the tax act and broadly enable an eligible taxpayer to defer the income tax on taxable primary production (breeding) income from the income year in which a FMD deposit is made (i.e. a deduction is available for such a deposit) until the FMD deposit is repaid (i.e. this amount is included in taxable income in the year of withdrawal).
However, a FMD deposit (or part thereof) loses its status as a FMD where it is withdrawn within 12 months of the deposit date. In these circumstances, a partial withdrawal of an FMD means that only the residual deposit amount qualifies as an FMD, provided the remaining amount is $1,000 or more and provided that it stays in the account for at least 12 months.
The implication for a FMD withdrawn within 12 months is the no deduction is available for the deposit (and taxpayers will need to request an amended assessment where this rule effects a deduction claimed in the prior income year).
TAX TIP - Farm Management Deposits withdrawn in exceptional circumstances
However, as an exception to this, a deposit retains it status as an FMD even if it is withdrawn within 12 months where the taxpayer is in an area the Minister Of Agriculture, Fisheries and Forestry has declared an "exceptional circumstances"' area. In this regard, FMD deposit holders have until three months after the year of income of the withdrawal to obtain an "exceptional circumstances"' certificate from the relevant state authority.
Example
Vanessa is a Victorian breeder who has a long history as a successful breeder and in the FY 2008 made $450,000 profit from her activities.
To reduce her breeding profit for FY 2008, before year end she deposits $200,000 under the FMD scheme, this reducing her taxable income to $250,000 ($450,000 less $200,000).
Only a few months later, the bushfires destroy her property and she now has urgent need for part of that $200,000 FMD cash to help her in the rebuilding process.
Accordingly, she withdraws $100,000 of her FMD in March 2009.
Under the general FMD rules, she must go back to the ATO and reduce her 2008 FMD deduction by $100,000, increasing her 2008 taxable income to $350,000.
However, as the Minister of Agriculture, Fisheries and Forestry has declared her breeding property to be in an "exceptional circumstances"' area, and she has obtained her certificate within 3 months of the end of the tax year, she is still eligible to claim that $100,000 withdrawal is a deduction in 2008. This $100,000 withdrawal is declared as income in FY 2009, the year of withdrawal.
You are welcome to contact me if you wish me to clarify or expand upon any of the matters raised in this article.
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