Mycoplasma bovis tax issue
Special report on the Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Act 2021
Mycoplasma bovis tax issue
(Sections CZ 37, EH 1, EH 5, EH 13, EH 35, EH 36, EH 61, EZ 4B, EZ 80, EZ 81, YA 1 of the Income Tax Act 2007)
These amendments enable the taxable income arising from the culling of certain qualifying Mycoplasma bovis affected livestock to be spread over six income years.
Some farmers have significant unexpected taxable income through their herds being culled following a primary sector and government decision to eradicate Mycoplasma bovis in New Zealand.
Federated Farmers requested an amendment to ensure there would be no income tax implications from culling and replacing dairy and beef cattle impacted by Mycoplasma bovis. They cited the special treatment given to depreciation recovery income on buildings damaged by the Christchurch and the Hurunui-Kaikōura earthquakes as a precedent.
The issue arises for farmers who have used a cost-based method (that is, national standard cost (NSC) and the self-assessed cost scheme) to value their breeding stock on hand for tax purposes. This is because the difference between the total proceeds received from the cull and the cost of the stock is income. This creates a cash-flow issue for those farmers who purchase replacement livestock after the cull. The replacement stock is valued at its purchase price and cannot, for tax purposes, be immediately written down to the homebred cost to offset the income.
To avoid this outcome, the legislative changes enable the proceeds from the cull to be transferred from the year of the cull and to be spread evenly over the following six income years. This ability to spread is optional.
The income can only be spread if:
- The business has been subject to Biosecurity Security New Zealand requiring a cull of Mycoplasma bovis affected stock.
- The business is a dairy or a beef breeding operation, with the breeding stock that is culled being valued under NSC or the cost price method. The expectation is that the breeding stock that is culled comprises mainly mixed-aged cows, in combination with any other class of breeding stock.
- The stock is substantially replaced through purchasing equivalent breeding stock by the end of the income year following the cull year.
- The replacement stock continues to be valued using, as relevant, NSC or the cost price method. This is to ensure that farmers cannot enter the herd scheme on more advantageous terms than those not affected by Mycoplasma bovis.
Given that a livestock owner might use a couple of valuation methods in combination, not all of the breeding stock might be valued at cost. However, only the income derived from the culling of the breeding stock valued under NSC or the cost price method can be spread. For this purpose, breeding stock includes immature female stock intended for future breeding in the business.
Owners of the affected livestock, including sharemilkers, are covered, that is, the ability to spread income from the cull is not be limited to just the owners of farmland with livestock.
The qualifying proceeds from the cull would comprise payments from the slaughterhouse, top-up compensation from the government for the difference between the normal market value for the stock and the payments from the slaughterhouse, and in some cases, further compensation to cover the additional cost of purchasing equivalent replacement stock.
The income arising from the culling of stock valued under another valuation method, or stock culled from a fattening stock business valued under NSC, do not qualify for this spreading provision. The Income Equalisation Scheme is available in those circumstances to mitigate the income implications of the cull.
Livestock owners who have previously made deposits into the Income Equalisation Scheme or the now repealed Adverse Events Income Equalisation Scheme to mitigate the impact of the additional income, can retrospectively switch to the income spread. In such cases, the tax effects of the deposit will be reversed.
The amendments apply for the 2017–18 and later income years.
The Act amends the Income Tax Act 2007.
Relevant current legislation
The livestock valuation rules are contained in subpart EC of the Income Tax Act 2007, including the requirements that apply when using multiple valuation options and the restrictions on switching between valuation options. These rules ensure that the cost of stock on hand is valued appropriately and that the cost of purchases is not deducted ahead of their being sold.
Precondition for the spread (section EZ 4B(1))
New section EZ 4B(1) sets out the following preconditions:
- A person needs to have, as part of their business, mixed-age cows on hand at the start of the cull year that they use for breeding and those cows need to be valued under either NSC or the cost price method at the end of the income year before the cull year. The cull year would need to be before the 2028–29 income year. (The focus on mixed-age cows is to ensure that the spread is provided to those who have sizeable additional income as a result of the cull given that female breeding stock make up a high proportion of a standard herd. The 2028–29 income year cut-off is in the expectation that Mycoplasma bovis should be less significant by that stage).
- In the cull year, some or all of the person’s cattle need to be destroyed, because of Mycoplasma bovis, using the powers in either sections 121 or 122 of the Biosecurity Act 1993 that enable Biosecurity New Zealand to examine organisms and give directions. (Normally the whole herd is destroyed but in some isolated cases only a portion needs to be destroyed).
- A significant portion of the culled stock need to be replaced by the end of the income year following the cull year. The expectation is that the culled livestock are replaced with purchased stock. Specifically, the requirement is that the number of mixed-age cows valued under the national standard cost scheme or the cost price method that the person has on hand (or expects to have on hand) at the end of the income year following the cull year is at least seventy five percent of the number of mixed-age cows valued under the national standard cost scheme or the cost price method that the person had on hand at the start of the cull year.
The spread (sections EZ 4B(2), (3) and (5) to (13))
There are two parts to the spread. Section EZ 4B(2) enables the income calculated under section EZ 4B(5) to be spread evenly over the six income years following the cull year. Section EZ 4B(3) spreads the deduction that the livestock owner would otherwise be able to claim under section EC 2 for the equivalent number of stock. Their combined effect is that the net income arising from the culling of the relevant livestock is spread.
For the income spread component, the formula in section EZ 4B(5) is:
Σ(number × (sale proceeds + compensation) ÷ culled stock)
This formula works on a livestock class basis, where:
- Σ is the summation of the amounts calculated using the formula for each of the following classes of each of the beef cattle and dairy cattle types of livestock:
(a) rising 1 year heifers
(b) rising 2 year heifers
(c) mixed-age cows; and
(d) breeding bulls.
- Number, for a class of livestock, is the number that is the lesser of:
(a) the number calculated using the formula in section EZ4B(12):
valuation method breeding stock + culled stock − opening stock
(b) the number of livestock of that class that:
(i) were breeding stock or stock that the person expected to be capable of, and intended be used for, breeding upon reaching maturity, and
(ii) the person valued under NSC or the cost price method in the income year before the cull year.
- Sale proceeds, for a class of livestock, is the amount of income the person derives from the disposal of the livestock of that class that are part of the destroyed cattle.
- Compensation, for a class of livestock, is the amount of compensation which the person is entitled to under section 162A of the Biosecurity Act 1993 and that the person receives by the end of the income year following the cull year for:
(a) the difference between the stock’s market value and the sale proceeds; and
(b) the cost of the replacement cattle of the same class being greater than the total amount received in relation to the stock it replaces.
- Culled stock, for a class of livestock, is the number of livestock of that class that are part of the destroyed cattle.
- Valuation method breeding stock is the number of livestock of that class that:
(i) were breeding stock or stock that the person expected to be capable of, and intended be used for, breeding upon reaching maturity; and
(ii) the person valued under NSC or the cost price method in the income year before the cull year.
- Opening stock is the number of livestock of that class that the person had on hand at the start of the cull year.
The formula takes into account the possibility that a livestock owner might be using more than one valuation method to value the stock and might reduce the number on NSC or the cost price method between the start of the cull year and the cull date. When all the stock are on NSC or the cost price method, stock numbers are constant and all stock is culled, then the formula simplifies to just the sales proceeds plus compensation.
If there is an increase in livestock numbers for a class over the cull year, those additional stock are excluded from the spread through section EZ 4B(8)(b) which caps “number” at the number of livestock of that class on hand at the beginning of the cull year and valued in the previous year under either NSC or the cost price method.
Person ceasing business (section EZ 4B(4))
Should a person cease carrying on the business in which they use the relevant livestock, section EZ 4B(4) requires any unallocated amount of spread income and deduction to be allocated to the cessation year.
In the case of a sole trader, the person would effectively cease business once probate has been granted, but with a company, the death of a shareholder would not automatically trigger an allocation of the remaining spread. In the case of a look through company or a partnership, the owner or partner who has died would effectively cease their proportion of the business which would trigger an allocation of their proportion of the remaining spread.
Notification (sections EZ 4B(14) to (16))
Those taking up the spreading option need to notify Inland Revenue in writing. This can be done electronically.
Section EZ 4B(14) requires an election to be made by the date of filing the taxpayer’s return of income for the 2020–21 income year, if the cull year is the 2020–21 income year or earlier, and by the date of filing their return for the cull year in any other case.
The additional compliance costs from this notification requirement would be small given the anticipated small number of farmers affected by Mycoplasma bovis. The amount of income and tax involved is significant for each affected taxpayer so knowing who has taken up this option will also be helpful from a compliance perspective.
The election is irrevocable, but under section EZ 4B(16) is treated as not being made if, at the end of the income year following the cull year, the number of mixed-age cows on hand that were valued under one of the cost schemes is less than seventy five percent of the equivalent pre-cull levels. This is to ensure that there has been material replacement of the culled stock.
Enabling switching from the Main Income Equalisation Account or Adverse Events Income Equalisation Account to the income spread
(Sections CZ 37, EH 1, EH 5, EH 13, EH 35, EH 36, EH 61, EZ 4B, EZ 80, EZ 81)
As culls began in 2017, some Mycoplasma bovis-affected farmers will by now have made deposits into the Main Income Equalisation Scheme (MIES) or the now repealed Adverse Event Income Equalisation Scheme (AEIES), to mitigate the tax consequences created by the cull. The legislation gives Mycoplasma-bovis affected farmers that made such deposits the option of retrospectively switching to the proposed six-year income spread provided the tax effects of the relevant deposits are reversed and the election is made by the date of filing their return of income for the 2020–21 income year. The spread is likely to be better at mitigating the income effects as in many cases the deposits will have needed to be withdrawn after a year to fund the purchase of replacement stock.
Under normal circumstances, a deposit into the MIES or AEIES results in a deduction for the livestock owner, for the amount of the deposit, and a withdrawal of a MIES or AEIES deposit results in equivalent income. However, deposits in any one year cannot exceed net income. If deposits in a year exceed this maximum, the excess needs to be refunded.
This concept is built upon in the new legislation to achieve the necessary reversals of the tax effects of deposits made in relation to the income that is now to be spread. It also means that the tax effects of deposits in relation to other income are not reversed.
Reversal of deduction for the deposit
Specifically, a retrospective amendment to section EH 35 (meaning of main maximum deposit) ensures that the spread is included in the calculation of the maximum deposit and, therefore, automatically leads to a reversal of the earlier deductions for the deposit, to the extent the maximum deposit is then exceeded. A comparable change has been made to section EH 61 to include the spread in the meaning of adverse event maximum deposit.
Reversal of income from withdrawal of deposit
Any such excess deposit is refundable. This is separate from any earlier excess deposit that arose under the standard provisions (respectively, sections EH 8 and EH 42) that require Inland Revenue to refund amounts that exceed the maximum deposit. Sections EZ 80 and EZ 81 treat this refund as excluded income (and therefore as not taxable) to negate any income that would have arisen when the deposit was withdrawn – see section EZ 80 (6)(b) and EZ 81(6)(b) in conjunction with section CZ 37(2).
Sections EZ 80(8) and EZ 81(8) stipulate that section EZ 80 and EZ 81 respectively override sections EH 8 and EH 42. This override is necessary to distinguish when Inland Revenue needs to repay any additional excess deposits arising from the spread, from any other excess deposit situation. Sections EH 8 and EH 42 envisage the automatic refund of an excess deposit soon after the end of the accounting year. They were therefore considered to be impracticable for an election to spread the income which is made retrospectively and may involve amounts that have already been refunded under other provisions.
To the extent that the excess deposit has not already been withdrawn, sections EZ 80(2) and EZ 81(2) require Inland Revenue to pay it out as soon as practicable after the election to use the spread is made. Practicably, the revised income tax returns outlining the spread amount will be necessary for Inland Revenue to calculate any remaining deposit amounts that need to be repaid.
Refunds are to first come from the deposits made for the accounting year in which the excess arose. In many cases an excess amount will likely have already been refunded through a standard withdrawal request, to pay for replacement livestock. Therefore, if there are insufficient remaining deposit amounts to fully refund the excess deposit, sections EZ 80(5) and EZ 81(5) provide ordering rules (starting with the earliest refunded deposits) to determine which, and how much, of the deposits for that accounting year that have been already refunded under other provisions (sections EH 13 and EH 15 but not EH 8), are instead treated as being refunded under sections EZ 80 and EZ 81. This means that those refunds change from being income to being excluded income.
Treatment of interest
Any interest paid or payable on the deposits, under sections EH 6 (interest on deposits in main income equalisation account) and EH 40 (interest on deposits in adverse event equalisation account), will still stand and be income. Interest on any excess deposits is calculated to the date the election is made (see sections EZ 80(7) and EZ 81(7) which respectively modify sections EH 6 and EH 40 to achieve this).
A livestock owner deposits $200,000 into their MIES account in their 2018–19 accounting year. As the maximum deposit that they could make at that stage was $120,000, $80,000 was refunded under section EH 8 (and is excluded income).
With the passage of the new legislation, the person decides to take up the income spread option for the 2018–19 accounting year. This reduces their maximum deposit amount to $0, in which case Inland Revenue now needs to refund a further $120,000 (which is also treated as excluded income, and no deduction can be claimed for that deposit amount). $100,000 of deposits for 2018–19 have already been withdrawn (ignoring the $80,000 refunded under section EH 8). Those withdrawals are now treated as refunds under new section EZ 80. The remaining $20,000 not already withdrawn is also refunded under section EZ 80.
Interest on the $20,000 is still payable as those funds have been in the scheme for more than one year. The $100,000 withdrawn earlier did not meet this standard timing test to qualify for any interest.
A livestock owner deposits $150,000 into their MIES account in their 2018–19 accounting year, the maximum deposit that they could make. This comprises $100,000 for the additional net income arising from the cull of their herd in that year, plus $50,000 in relation to other income.
With the passage of the new legislation, the person decides to take up the income spread option for the 2018–19 accounting year. This reduces their maximum deposit amount to $50,000. As none of the $150,000 deposited for that year has been withdrawn, under section EZ 80 Inland Revenue now needs to refund $100,000 (which is treated as excluded income, and no deduction can be claimed that deposit amount).
Under section EH 6, interest is payable on the full $150,000. Interest is payable on the $100,000 up to the date of the election. Interest is payable on the remaining $50,000 up until the deposit is refunded, either because it has been withdrawn or the maximum deposit period has expired (whichever is earlier). The maximum deposit period ends five years after the end of the accounting year for which the deposit was made.
Consequential changes have been made to sections EH 1, EH 5, EH 13, EH 36, YA 1 and the former EZ 80 (now EZ 82) to update them for the new provisions.
Already filed income tax returns
Since the spread applies from the 2017–18 income year, taxpayers who take up the spread for a past year, can now request that the Commissioner of Inland Revenue amend their relevant past assessments, under section 113 of the Tax Administration Act 1994.
Previously, up to the enactment of the legislation, Inland Revenue had been allowing instalment arrangements to be entered into in relation to the tax due for the 2018–19 income year, to match the proposed spread.
|Opening numbers for cull year||Cull numbers||Income spread|
|Total for class||Valued in cost||Held in herd scheme A − B||Held for breeding||Breeding in NSC D − C||Number culled||Valued in NSC E + F − A||Spread based on smaller of E or G||Cull proceeds per class||Compo per class||Gross cull income I + J||Cull income per head K ÷ F||Income to spread H × L|
|R1 heifers cows||0|
|R2 heifers (AVO in use)||20||5||15||20||5||19||4||4||$15,200||$7,600||$22,800||$1,200||$4,800|
|Total income spread||$154,800|
Presumed that when the alternative valuation option (AVO) is in use, the herd scheme animals are the breeding or replacement animals.
Spread based on smaller of E or G
Last year NSC per class
Spread H × M
|Total deduction spread||$77,380|