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Chapter 2 - The two common valuation methods

2.1 Conceptually, the Income Tax Act treats specified livestock owned by a farming business in a similar fashion to trading stock, notwithstanding the characteristics of the herd scheme. The two most common methods of valuing specified livestock are the herd scheme and the national standard cost (NSC) scheme.

The herd scheme

2.2 The herd scheme effectively treats qualifying livestock as a capital asset, notwithstanding its similarity to trading stock. Changes in herd values (specifically “national average market values” or “NAMVs”) from year to year are tax-free, but changes in numbers are on tax revenue account.

2.3 The herd scheme’s capital asset treatment is effected by revaluing each year’s opening stock to the closing values for that year (the opening value of trading stock is in all other cases the last year’s closing values). This revaluation amount is a capital (and therefore non-taxable) gain or loss.

2.4 This revaluation is what makes the herd scheme unique. No other trading stock is subject to such an adjustment. The ability to cease making this adjustment is key to the issues discussed in this paper.

2.5 Example 1 is a simplified example that presumes a dairy farmer has 300 MA (mixed age) Friesian cows and replacement livestock on hand all valued in the herd scheme. The period selected is the years from 2006–07 to 2008–09 as in this period a very large price spike occurred in the value of dairy cows. Unless otherwise specified, the examples in this paper use these numbers and presumptions, although a number of examples are simplified further by referring to MA Friesian cows only.

2.6 Example 1 illustrates the significant tax-free “gain” from the 2006–07 income year to the 2007–08 income year of $344,940. Equally, it illustrates the significant non-deductible “loss” from the 2007–08 income year to the 2008–09 income year of $329,340.

2.7 An opening stock revaluation is generally compulsory in respect of opening livestock that was valued in the herd scheme as closing stock in the previous year. However, there are exceptions discussed in the next chapters.

2.8 What is not illustrated in Example 1 is that changes in the number of herd scheme livestock on hand are on tax revenue account. Thus, for example, if cow numbers being valued in the herd scheme increased during the year, the total closing tax value of the livestock would increase over the opening value and taxable income would result. The alternative valuation option (AVO), which is discussed later, can offer some tax relief in this circumstance.

  No. on Hand NAMV $ Value $ Tax-free $
Example 1: Simplified herd scheme example
2006–07 income year
Closing stock
MA Cows 300 1,245 373,500    
R 2 Heifers 60 1,075 64,500    
R 1 Heifers 60 594 35,640    
        473,640  
2007–08 income year
Revalued opening stock
MA Cows 300 2,150 645,000    
R 2 Heifers 60 1,856 111,360    
R 1 Heifers 60 1,037 62,220    
        818,580  
Closing stock
MA Cows 300 2,150 645,000    
R 2 Heifers 60 1,856 111,360    
R 1 Heifers 60 1,037 62,220    
        818,580  
Change in tax value       Nil  
Tax free gain/(non-deductible loss)         344,940
2008–09 income year
Revalued opening stock
MA Cows 300 1,312 393,600    
R 2 Heifers 60 1,083 64,980    
R 1 Heifers 60 511 30,660    
        489,240  
Closing stock
MA Cows 300 1,312 393,600    
R 2 Heifers 60 1,083 64,980    
R 1 Heifers 60 511 30,660    
        489,240  
Change in tax value       Nil  
Tax free gain/(non-deductible loss)         (329,340)

 

  No. on Hand NSC $ Value $
Example 2: Simplified NSC example
2006–07 income year
Closing stock – say
MA Cows 300 755.10 226,530  
R 2 Heifers 60 771.30 46,278  
R 1 Heifers 60 652.00 39,120  
        311,928
2007–08 income year
Opening stock
MA Cows 300 755.10 226,530  
R 2 Heifers 60 771.30 46,278  
R 1 Heifers 60 652.00 39,120  
        311,928
Closing stock
MA Cows 300 758.34 227,502  
R 2 Heifers 60 756.80 45,408  
R 1 Heifers 60 608.60 36,516  
        309,426
Change in tax value – income/(loss)       (2,502)
2008–09 income year
Opening stock
MA Cows 300 758.34 227,502  
R 2 Heifers 60 756.80 45,408  
R 1 Heifers 60 608.60 36,516  
        309,426
Closing stock
MA Cows 300 758.68 227,604  
R 2 Heifers 60 751.20 45,072  
R 1 Heifers 60 787.60 47,256  
        319,932
Change in tax value – income/(loss)       10,506

This example presumes that for ease of calculation the cost of each of the 2006–07 MA cows is $755.10.

National standard cost

2.9 In contrast to the herd scheme, the NSC scheme is a valuation regime similar to one manufacturers would use to value trading stock, except that as a simplification measure it uses national averages to calculate the on-farm costs of breeding, rearing and growing livestock (BRG). Thus, not only are changes in number on tax revenue account, but also changes in value as well.

2.10 Example 2 is a simplified example that presumes a dairy farmer has 300 Friesian cows and replacement homebred livestock on hand all valued using the NSC scheme. The period selected is again the years from 2006–07 to 2008–09 as in this period a very large market price spike occurred. Because NSC reflects on-farm costs rather than the market value of livestock, this spike is not reflected in the NSC values of homebred livestock.

2.11 The examples in this paper presume that the NSC stock flow method used is first-in, first-out (FIFO) rather than weighted average.

Contrast between the methods

2.12 Using the above examples, the differences in year-end values between the herd scheme and NSC are substantial:

Year Herd values $ NSC cost $ Difference $
2007 473,640 311,928 161,712
2008 818,580 309,426 509,154
2009 489,240 319,931 169,309

2.13 Among other things, this shows clearly the effect of the market value spike in 2008 and the resulting volatility in herd values or NAMVs that occurred in this period. Although this volatility was extreme by historical standards, the graph at the start of Chapter 3 shows that there was another price spike for MA Friesian cows in the last decade. The above table also shows the relative stability of the NSC scheme when replacement livestock is homebred.

The alternative valuation option (AVO)

2.14 This alternative was introduced at the same time as the NSC scheme in the 1992–93 tax year. It allows farmers who are using the herd scheme and whose livestock numbers are expanding to value some or all of those extra numbers at cost. This allows farmers to avoid paying tax on some or all of the write-up from cost to NAMVs on those extra numbers. In a home breeding situation this could be particularly significant. Although the AVO is part of the solution suggested by officials, no changes to it are suggested.

2.15 Example 3 deals with the base herd of 300 MA cows that feature in the above examples and that are valued in the herd scheme. Over time this is increased by home breeding to 340. For simplicity, replacements are ignored.

Year Herd numbers opening Total numbers closing Minimum closing herd numbers Maximum numbers in AVO
Example 3: AVO example
2007 300 300 300 0
2008 300 325 300 25
2009 300 320 300 20
2010 300 340 300 40

2.16 Presumably the AVO cows will be valued in the NSC scheme. Thus there is no extra tax cost of increasing these numbers, whereas if the extra 40 were valued in the herd scheme extra tax would have been payable.

2.17 The maximum AVO numbers presume that the minimum of 300 MA cows were valued in the herd scheme at the end of each of the years. Alternatively, if in 2009 the 320 MA cows had been valued in the herd scheme then only the increase of 20 could be valued using the AVO in 2010.