 TAX
TIPS FOR HORSE BUSINESS DISRUPTIONS
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
Paul Carrazzo if you wish him to clarify or expand upon
any of the matters raised in this article. Contact details
for
Paul appear under. DISCLAIMER: Any
reader intending to apply the information in this article
to practical circumstances
should independently verify their interpretation and the
information’s applicability to their particular circumstances
with an accountant specialising in this area.
PAUL
CARRAZZO CPA
CARRAZZO CONSULTING CPAs
22 BLACKWOOD ST, NORTH MELBOURNE VIC 3051
TEL: (03) 9329 7044
FAX: (03) 9329 8355
MOB: (0417) 549 347
E-mail: paul.carrazzo@carrazzo.com.au
Web Site: www.carrazzo.com.au
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