Chapter 1 - Overview
1.1 As signalled in Budget 2011, this review of the rules governing livestock valuation elections is driven by a need to ensure greater fairness in the tax system. Suggestions presented here seek to strike a balance between fairness for all taxpayers and fairness for farmers.
1.2 This officials’ issues paper looks at problems that have arisen with certain livestock valuation elections rules where the flexibility of the rules is being inappropriately used. This practice was not intended and resulted, for example, in an estimated fiscal cost to the Government of over $100 million of lost tax revenue as a result of the 2007–08 year peak in dairy cow values.
1.3 Put simply, it appears that it is too easy for farmers to exit the herd scheme and there is a significant cyclical fiscal cost associated with this.
1.4 No other livestock valuation matters are considered in this paper.
1.5 Of necessity this paper is technical and is therefore targeted at farm accountants and their farmer clients. Further, while this paper focuses on Friesian dairy cows as an example because of the recent volatility in the market values of dairy cows, it is equally relevant to all specified livestock (sheep, cattle (dairy and beef), deer, goats and pigs).
1.6 This paper discusses the two main livestock valuation methods in Chapter 2, and Chapter 3 presents high-level analysis of the problems. The problems and suggested reforms to the election to exit the herd scheme are discussed in detail in Chapter 4. Chapter 5 considers the problems and suggested reforms when there is a cessation of farming.
Background and problem
1.7 There are two main livestock valuation methods – the herd scheme and national standard cost. The herd scheme views the farm livestock as a machine held on capital account. It uses annually announced national average market values, and makes annual changes in value tax-free by way of adjusting, on capital account, the value of opening livestock to that of closing livestock for each year.
1.8 National standard cost is a more typical inventory regime where changes in values are on tax account, but it uses national average costs rather than farm-specific costs. Farmers can elect to move between these valuation methods.
1.9 The problem is that some farmers are making elections with the apparent objective of taking tax-free herd-scheme gains when livestock values are increasing and tax deductible write-downs as values decrease. The livestock valuation rules and their associated elections were not intended to allow farmers to shelter their ordinary farming taxable income in this fashion.
1.10 The two elections associated with the herd scheme that are causing problems are:
- the election by a continuing farmer to exit from the herd scheme to use another livestock valuation method; and
- the election when a farming enterprise that uses the herd scheme sells its specified livestock and ceases farming. A similar election is available when a farmer dies.
1.11 The concern is an equity issue in the tax system as no other business taxpayers can value a major asset such as trading stock in one year as if it were a machine on capital account, and in another year value it as trading stock under a cost-based regime.
1.12 Officials’ suggestions to address the identified problems are:
- That, once a farmer has elected to use the herd scheme, the election is irrevocable (as was originally proposed by the consultative document in 1986).
- That, when a farmer has ceased farming and disposed of their livestock to a non-associated person before, say, 31 July of a year, it is compulsory for the vendor to use the herd values issued during that calendar year in the tax return that covers the period of sale (i.e. no opening herd scheme adjustment). Otherwise it is compulsory for the vendor to use the next calendar year’s herd values for opening stock (i.e. do the opening herd scheme adjustment).
- For all sales to associated persons, the associated person is bound by any herd scheme election and base herd scheme numbers of the vendor. The vendor must use the year-end herd values in the period covering the sale (i.e. do an opening herd scheme adjustment).
- Where a farmer has died, the same associated persons rule applies.
1.13 Feedback is welcomed on these or alternative suggestions, as long as the tax base is appropriately protected. The main alternative suggestion canvassed in this paper is to extend the notice period for the election to leave the herd scheme. Buttressing of the suggestions by consideration of the treatment of associated persons’ transactions will be necessary regardless of which option is chosen.
1.14 Given that these are, at this stage, only officials’ suggestions and are subject to consultation, no consideration has been given to potential application dates.
1.15 A change to prevent future herd-scheme write-downs is a base maintenance measure by nature. The existing baselines do not include livestock valuation fluctuation forecasts. Hence, for budgetary purposes, no fiscal savings arise from these suggestions to prevent farmers swapping between the schemes.
1.16 This does not imply that it is not fiscally important to do this work, since in the absence of the policy change, the Government would instead be facing a negative variance against forecast when such an event occurs again.
1.17 Officials invite submissions on the suggested reforms. Submissions should be addressed to:
Herd scheme elections
C/- Deputy Commissioner, Policy
Policy Advice Division
Inland Revenue Department
PO Box 2198
or email [email protected] with “Herd scheme elections” in the subject line. Electronic submissions are encouraged as this increases the efficiency of the analysis process.
1.18 The closing date for submissions is 30 September 2011.
1.19 Submissions should include a brief summary of major points and recommendations. They should also indicate whether it would be acceptable for officials to contact those making the submission to discuss the points raised, if required.
1.20 Submissions may be the subject of a request under the Official Information Act 1982, which may result in their release. The withholding of particular submissions on the grounds of privacy, or for any other reason, will be determined in accordance with that Act. Those making a submission who consider there is any part of it that should properly be withheld under the Act should clearly indicate this.