Chapter 19 Primary Producers National Core Accounting Publications

Chapter 19 Primary Producers © National Core Accounting Publications 1

What is primary production? s. 995 -1(1) states that a primary production business is carried on where a taxpayer is engaged in: the cultivation or propagation of plants, fungi or their produce or parts the maintenance of animals or poultry for the purpose of selling them or their bodily produce, including natural increase fishing forest operations manufacturing dairy produce from raw materials that the taxpayer has produced © National Core Accounting Publications 2

Primary production income For tax purposes income from primary production includes the following receipts: proceeds from the sale of produce proceeds from the sale of livestock stud fees, prize monies insurance recoveries for loss of profits agistment fees value of primary produce taken by the owner for domestic use © National Core Accounting Publications 3

Averaging of income Often a primary producer’s income may vary greatly from year to year due to seasonal, climatic factors or commodity prices Averaging provisions ensure that taxpayers who are engaged in the business of primary production, do not pay greater tax over a number of years than those taxpayers on comparable but non-fluctuating incomes © National Core Accounting Publications 4

Averaging of income Eligibility for averaging An eligible primary producer may be: § an individual § a partner § a trustee provided that the main or sole purpose is carrying on the business of primary production for a period of at least 2 years © National Core Accounting Publications 5

Averaging of income Averaging involves the granting to the taxpayer of a tax offset or imposition of extra income tax in the calculation of tax payable • Tax offset - occurs when taxable income exceeds average income - calculated as the difference between tax on taxable income at ordinary tax rates and tax on taxable income at the average tax rate © National Core Accounting Publications 6

Averaging of income Extra income tax - occurs when taxable income is less than average income - also calculated as the difference between tax on taxable income at ordinary tax rates and tax on taxable income at the average tax rate © National Core Accounting Publications 7

Averaging of income Calculation of average income Average income is calculated by dividing the sum of basic taxable incomes of the years from and including the first eligible year for averaging purposes by the number of years (but to a maximum of 5 years) © National Core Accounting Publications 8

Averaging of income Calculation of average income § Averaging will not apply where the taxpayer's basic taxable income in the first year of primary production is greater than basic taxable income in the second year § A year in which a loss occurs is counted as a NIL amount in the calculation of average income The loss can be carried forward for deduction in a following year(s) © National Core Accounting Publications 9

Illustration: Averaging of income • A. Farmer commenced primary production on 1 July 2007. Her basic taxable incomes were as follows: Year ended 30 June 2009 $ 16, 000 2011 12, 000 14, 000 2012 2013 7, 000 9, 000 Assume that all taxable income was derived from primary production activities. Required: Calculate average income for each year of income. © National Core Accounting Publications 10

Illustration: Averaging of income Solution: Average income is calculated as follows: 2009: 2010: 2011: 2012: 2013: averaging provisions not applicable since basic taxable income of Year 1 > Year 2 12, 000 + 14, 000 2 = $13, 000 12, 000 + 14, 000 + 7, 000 3 = $11, 000 12, 000 + 14, 000 + 7, 000 + 9, 000 4 = $10, 500 Average income is the average of basic taxable incomes over a maximum of five years (i. e. the current year plus the preceding four years) - s. 392 -40. © National Core Accounting Publications 11

Averaging component Where a primary producer derives both primary production income (PPY) and non-primary production income (non-PPY), then the averaging scheme applies only to the taxpayer's averaging component © National Core Accounting Publications 12

Averaging component The Averaging Component is calculated as follows: § Averaging component consists of all the taxable income where the taxpayer's non-PPY is less than $5, 000 § If non-PPY is between $5, 000 and $10, 000, then the averaging component consists of all PPY plus an allowance of $5, 000 reduced by $1 for every $1 by which the non-PPY exceeds $5, 000 § If non-PPY is greater than $10, 000, then only the PPY comprises the averaging component © National Core Accounting Publications 13

Illustration: Calculation of Averaging Component a) Taxpayer A has $42, 500 basic taxable income, comprising $40, 000 taxable PPY and $2, 500 taxable non-PPY. b) Taxpayer B has $46, 000 basic taxable income, comprising $40, 000 taxable PPY and $6, 000 taxable non-PPY. c) Taxpayer C has $55, 000 basic taxable income, comprising $40, 000 taxable PPY and $15, 000 taxable non-PPY. Required: For each of above examples calculate the averaging component. © National Core Accounting Publications 14

Illustration: Calculation of Averaging Component Solution: The Averaging Component is: (a) $ 42, 500 (b) 44, 000 i. e. 40, 000 + 5, 000 – (6, 000 – 5, 000) or 40, 000 + (10, 000 – 6, 000) (c) 40, 000 © National Core Accounting Publications 15

Calculating tax payable under averaging The steps involved are: 1) Calculate taxable income 2) Calculate comparison rate of tax a) calculate average income b) calculate comparison rate of tax as follows: tax on average income x 100 average income 1 3) Calculate the averaging component 4) Compare tax on taxable income at ordinary rates with tax on taxable income at comparison rate to determine the Gross Averaging amount. 5) Calculate the Averaging Adjustment The Averaging adjustment is: Gross Averaging x Averaging component amount Taxable income 6) Calculate tax payable © National Core Accounting Publications 16

Illustration: Tax Offset (where taxable income > average income) • Hey Seed had basic taxable income of $80, 000 and average income of $50, 000. All income was derived from primary production activities. He has adequate private health insurance. Required: Calculate tax payable for the current income year. © National Core Accounting Publications 17

Illustration: Tax Offset (where taxable income > average income) Solution: step 1) Basic taxable income is $80, 000 step 2) a) Average income is $50, 000 b) Comparison rate of tax is: Tax on Average income x 100 Average income 1 = 7, 797 x 100 = 15. 59% 50, 000 1 © National Core Accounting Publications 18

Illustration: Tax Offset (where taxable income > average income) step 3) Averaging component is $80, 000 step 4) Tax on $80, 000 @ ordinary tax rates is $17, 547. 00 Tax on $80, 000 @ comparison rate of 15. 59% is $12, 472. 00 Therefore, $17, 547. 00 less $12, 472. 00 = $5, 075. 00 Gross Averaging amount © National Core Accounting Publications 19

Illustration: Tax Offset (where taxable income > average income) step 5) Averaging Adjustment is: Gross Averaging amount x = 5, 075 x Averaging component Basic taxable income = $5, 075. 00 80, 000 NB: Step 5 is unnecessary when the averaging component equals basic taxable income. step 6)Tax Payable is: Tax on $80, 000 $ 17, 547. 00 less Tax Offset 5, 075. 00 12, 472. 00 Medicare Levy 1, 200. 00 13, 672. 00 © National Core Accounting Publications 20

Special deductions A number of special tax concessions are available as an encouragement to primary production for various capital costs incurred These include: § Telephone lines § Water facilities § Landcare operations © National Core Accounting Publications 21

Special deductions Telephone lines s. 40 -645 allows a deduction in ten equal annual instalments for capital costs incurred in extending a telephone line to a primary producer © National Core Accounting Publications 22

Special deductions Water facilities s. 40 -515 allows a deduction in three equal annual instalments for capital costs incurred on water facilities (i. e. in conserving and conveying water) e. g. dams, tank stands, bores, wells, irrigation channels, pipes, pumps, water towers, windmills and extensions or improvements to any of these items © National Core Accounting Publications 23

Special deductions Landcare operations s. 40 -630 allows an outright (100%) deduction for capital costs incurred on landcare operations e. g. soil conservation measures, the eradication and extermination of animal or vegetable pests, and the destruction of weeds and plants detrimental to land © National Core Accounting Publications 24

Farm Management Deposits scheme (FMD) The FMD scheme is designed to provide a means whereby primary producers (except companies) can reduce the tax effects caused by fluctuating incomes Features of the FMD scheme include: § deposits into the FMD scheme are deductible in the year of deposit provided that the primary producer did not derive more than $65, 000 in non-primary production income (excluding capital gains) § the minimum deposit and withdrawal is $1, 000 § the total of all deposits cannot exceed $400, 000 § interest is payable on deposits and is assessable § withdrawals from an FMD are assessable in the year of withdrawal © National Core Accounting Publications 25

Horticultural Plants A horticultural plant is defined as: “a live plant or fungus that is cultivated or propagated for any of its products or parts” © National Core Accounting Publications 26

Horticultural Plants A depreciation deduction is available for capital costs incurred in: § § § Acquiring the plants or seeds Planting Preparation for planting Grafting trees Maintaining until planting © National Core Accounting Publications 27

Horticultural Plants The annual write-off rate is determined by the effective life of the horticultural plant Effective Life (years) 3 to fewer than 5 5 to fewer than 62/3 to fewer than 10 10 to fewer than 13 13 to fewer than 30 30 or more © National Core Accounting Publications Annual write-off rate % 40 27 20 17 13 7 28

Illustration: Horticultural plants • On 1 February 2013 Stella Cerasus, a resident primary producer, incurred the following capital expenditure for cherry trees: § Costs of acquiring and planting trees $ 15, 000 § Grafting expenses 4, 500 § Land preparation expenses – soil enhancement 7, 000 Required: Calculate the deduction for horticultural plants for the current income year. Solution: The horticultural plant deduction is: 26, 500 x 150/ 365 x 13% = $1, 416 © National Core Accounting Publications 29

Trading Stock Trading stock of primary producers includes: § Livestock § Harvested crops of grain or fruit § Wool once shorn from the sheep © National Core Accounting Publications 30

Livestock valuation Under s. 70 -45, the closing value of livestock is calculated, at the taxpayer’s option, using of any one of the following valuation options: § Cost (average cost) § Market Selling Value § Replacement Price © National Core Accounting Publications 31

Natural increase valuation When cost price is used for valuing livestock, then in calculating the average cost to be used for valuing closing stock, a cost must be assigned to any natural increase during the year When any natural increase of a taxpayer's livestock is first brought to account, any value may be selected provided it is not less than the minimum prescribed value given by ITR 97 reg 70 -55. 01 © National Core Accounting Publications 32

Natural increase valuation The minimum prescribed values for the year ended 30 June 2013 are: Livestock Sheep Cattle Horses Pigs Deer Goats Poultry Emus Cost per head $4 $20 $12 $20 $4 $0. 35 $8 © National Core Accounting Publications 33

Killed for rations The value of livestock killed for rations will depend on whether it was: i. on hand at the beginning of the year - value using the same method as was used to value the opening stock ii. purchased during the year - value using its purchase price iii. from natural increase - value using the elected value for natural increase If unable to identify the source of livestock killed for rations, then use the average cost of stock to calculate the value © National Core Accounting Publications 34

Illustration: Gross Profit from livestock trading A. Grarian provides the following details: Sheep No. Opening Stock Purchases 800 Natural Increase Deaths 10 Sales 1, 000 18, 000 Killed for Rations Closing Stock 375 $ 500 6, 000 12, 000 110 25 ? Assume: Market Selling Value of closing stock is $17 per head. Livestock killed for rations was entirely from stock on hand at 1 July. Required: Calculate Gross Profit from Sheep trading for the current income year using: (a) Market Selling Value, and, (b)Cost Price. © National Core Accounting Publications 35

Illustration: Gross Profit from livestock trading Solution: Market Selling Value method ( Killed for Rations is: 25 x 6, 000/500 Closing Stock value is: 375 x $17 = $300 = $6, 375 © National Core Accounting Publications 36

Illustration: Gross Profit from livestock trading (b) Solution: Cost Price method © National Core Accounting Publications 37

Double Wool clips Under s. 385 -135, if receipts from two wool clips are included in assessable income in a single year due to an advanced shearing because of drought, fire or flood, then the wool grower may elect to defer the net income received for the second wool clip to the following year © National Core Accounting Publications 38

Illustration: Double wool clip deferment • The taxpayer, a wool grower, sold two wool clips during the year of income. The first clip was shorn and sold in August 2012 for $20, 000. The second clip was shorn and sold in February 2013 because of drought and realised $11, 500. Deductible expenses for August 2012 and February 2013 were as follows: August February Shearing $ 3, 000 $ 3, 400 Selling 2, 500 2, 800 Required: Calculate the taxpayer’s taxable income for 2012/13, assuming he made an election under s. 385 -135. © National Core Accounting Publications 39

Illustration: Double wool clip deferment Solution: $ Assessable Income Proceeds from sale of wool - August - February less Deductions Shearing expenses - August - February Selling expenses - August - February less s. 385 -135 deferment Sale of Wool - February Less Shearing expenses Selling expenses Taxable Income 11, 500 3, 400 2, 800 $ $ 11, 500 20, 000 31, 500 3, 000 3, 400 2, 500 2, 800 6, 200 © National Core Accounting Publications 11, 700 19, 800 5, 300 14, 500 40

Insurance recoveries for loss of livestock Insurance recoveries received by a primary producer for loss of livestock due to a natural disaster such as flood, fire, drought, or any other disaster may be spread in equal instalments over a five year period The effect is to reduce the taxpayer's assessable income in the year of receipt by 4/5 of the amount of the insurance recovery receipt © National Core Accounting Publications 41

Insurance recoveries for loss timber Insurance recoveries received by a primary producer for loss of trees by fire may also be spread in equal instalments over a five year period © National Core Accounting Publications 42

Illustration: Insurance recovery for loss of livestock deferment • Reel Mc. Coy derived the following primary production income: • Net income from trading - $50, 000. • Insurance recovery for loss of livestock - $20, 000. Assume she makes the s. 385 -130 election. Required: Calculate taxable income for the current year of income. Solution: Assessable Income Net income from trading $ 50, 000 Insurance recovery for loss of livestock 20, 000 70, 000 less s. 385 -130 election 20, 000 x 4/5 16, 000 Taxable income 54, 000 © National Core Accounting Publications 43

Profit from death or forced disposal If livestock is disposed of as a result of: § the compulsory acquisition of land, § a cattle tick eradication program by the State, or § the loss or destruction of pastures or fodder due to fire, flood or drought, § the receipt of a statutory notification regarding the contamination of property, then any profit on disposal forms part of a taxpayers' assessable income However, there are two alternative forms of concessional tax treatment available by election to the taxpayer © National Core Accounting Publications 44

Profit from death or forced disposal Spreading the tax profit An election can be made by that taxpayer to spread the assessment of the profit over five years – s. 385 -105 All profit is included as assessable income in the current year, but 4/5 is deferred to the succeeding four years For the election to apply, the taxpayer must satisfy the ATO that the profit has or will be applied to the purchase of breeding or replacement stock © National Core Accounting Publications 45

Profit from death or forced disposal Deferring the tax profit s. 385 -110 provides an alternative to the election made under s. 385 -105 The taxpayer may elect to have any profit offset against the cost of replacement stock purchased during the year of disposal or any of the next five years following the year of forced disposal Any profit not brought to account at the end of five years is included in the assessable income of the fifth year © National Core Accounting Publications 46

Illustration: s. 385 -105 deferment • Kevin Steer, a cattle grazier and wheat farmer, had to dispose of 3, 000 cattle because bushfires destroyed a large section of his pastures. He received $81, 000 from this forced sale. Also, he received $22, 250 from the sale of a wheat crop. The cattle sold were from the following sources: § 500 from opening stock § 2, 100 from purchases § 400 from natural increase © National Core Accounting Publications 47

Illustration: s. 385 -105 deferment Therefore, Average Cost is: 60, 000 + 150, 000 + (500 x $20) 3, 000 + 6, 000 + 500 = $23. 16 per head Therefore, value of closing stock is $23. 16 x 3, 300 = $76, 421. Required: Calculate Kevin Steer’s taxable income for the current income year. © National Core Accounting Publications 48

Illustration: s. 385 -105 deferment Solution: Assessable Income Gross Profit – cattle Proceeds from sale of wheat $ $ 34, 596 22, 250 56, 846 less s. 385 -105 deferment Sales of cattle 81, 000 less Cost of Sales Cost of 500 on hand 1 July @ $20 per head 10, 000 Cost of 2, 100 from purchases @ $25 per head 52, 500 Cost of 400 from natural increase nil 62, 500 PROFIT 18, 500 Spread 4/5 of $18, 500 14, 800 Taxable Income 42, 046 In each of the following four years the assessable income of J. Steer will be increased by $3, 700 (i. e. 18, 500/5). © National Core Accounting Publications 49

Illustration: s. 385 -110 deferment Using the information in the previous example calculate Kevin Steer’s taxable income on the basis that the profit on forced disposal of livestock is treated as per s. 385 -110. © National Core Accounting Publications 50

Illustration: Solution: Assessable Income Gross Profit – cattle Proceeds from sale of wheat s. 385 -110 deferment $ $ $ 34, 596 22, 250 56, 846 less s. 385 -105 deferment Sales of cattle 81, 000 less Cost of Sales Cost of 500 on hand 1 July @ $20 per head 10, 000 Cost of 2, 100 from purchases @ $25 per head 52, 500 Cost of 400 from natural increase nil 62, 500 PROFIT 18, 500 Defer entire profit of $18, 500 Taxable Income 38, 346 In each of the following five years the profit of $18, 500 on the forced disposal will be used to reduce the cost of replacement livestock. © National Core Accounting Publications 51