Why do primary producers get all the tax breaks? What are income equalisation deposits?
Why do primary producers get all the tax breaks?
Income equalisation deposits - What are they and who can make them?
How does a primary producer make a deposit?
How much money can be deposited?
Is interest received on the deposit?
How does the primary producer get his money back?
Withdrawing the money and paying the tax
What the future holds - Farm Management Deposit Scheme
The Income Tax Assessment Act has several measures aimed at promoting horizontal and vertical equity. You can find out about these equity concepts and why the have special relevance to primary producers in the topic on
Why do the primary producers get to fiddle with the tax rate?What are they and who can make them?
We have discussed the adverse effect progressive rates have on the amount of tax paid by persons with fluctuating incomes in the topic on primary producers.
The introduction of the progressive rate scale to ensure that people who earn higher incomes pay a larger proportion of that income in tax, has unintended effects of persons whose income can fluctuate wildly, such as primary producers. This is demonstrated by the following example.
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Wage earner |
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Farmer |
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Year 1 |
Income= 20,700 |
Tax= $3,060 |
Income=nil |
Tax= nil |
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Year 2 |
Income= 20,700 |
Tax= $3,060 |
Income=nil |
Tax= nil |
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Year 3 |
Income= 20,700 |
Tax= $3,060 |
Income= $60,210 |
Tax=$18,900.70 |
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Total income = $60,210 |
Total tax = $9,180 |
Total income = $60,210 |
Total tax = $18,900.70 |
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This inequitable situation arises because of the tax rate structure so it is addressed by the income averaging provisions
Another method of smoothing out income flows allowed to primary producers is the income equalisation deposit scheme.
Under this scheme the taxpayer can 'deposit' money with the government in good years, and receive a tax deduction for such deposits, then withdraw these sums in bad years when the funds are needed. Such withdrawals are included in assessable income in the year of withdrawal.
The Loan (Income Equalization Deposits) Act 1976 outlines the conditions under which income can be deposited and withdrawn.
Sec 159GA to 159GDA of the Income Tax Assessment Act give authority for the tax aspects of the scheme.
How does a farmer make a deposit?
The money is lodged with the Department of Primary Industries and Energy (together with the prescribed form and a $20 fee)
How much money can be deposited?
The maximum Income Equalisation Deposit a person can make is $300,000.
The minimum amount which can be deposited at any time is $1000.
Is interest paid on the deposit?
Interest is received on part of the funds deposited.
How much interest?
The rate of interest is equal to the short term Commonwealth Bond rate.
It is included in the assessable income of the taxpayer.
So the taxpayer gets the short term Commonwealth Bond rate on all the funds deposited with the Government under the scheme?
Well, not quite 'all the funds'
Interest is payable on the 'INVESTMENT COMPONENT' of the deposit
.Generally that is 61% of the amount deposited....
but, on 1/10/92, a special category of Income Equalisation Deposit funds was created, called Farm Management Bonds.
80% of these funds attract interest - compared to the 61% for other funds
So why not make the total deposit a Farm Management Bond?
Under sec 15 of the IED Act, at taxpayer can elect to have any part of a new or existing deposit treated as a Farm Management Bond if....
taxable non-primary production income is less than $50,000 in the year the election is made
total amount of Farm Management Bonds does not exceed $80,000.
deposit satisfies conditions laid down in sec 159GC of the Income Tax Assessment Act for tax deductibility.
Answer this question….
A primary producer has deposited the $80,000 as a Farm Management Bond.
The short term Commonwealth Bond rate is 10%.
What amount of interest will be received?
80% of the $80,000 will earn interest.
80% of $80,000 is $64,000. 10% of $64,000 is 6400
Now assume the taxpayer has the maximum amount of $300,000 on deposit.
We know that he will get $6,400 interest on the first $80,000.
$300,000 less $80,000 gives us $220,000, which is subject to the 61% limit.
61% of $220,000 is $134,200.
Answer this question….
If the interest rate is 10%, what interest will he earn on this part of the deposit?
10% of 61% of 300,000 less 80,000 is the same as 134200 * 10% = 13420
How does the primary producer get his money back?
Let's assume times have got harder, and now the primary producer needs the money. Because times are hard, his income will be lower, so the tax rate on the money returned to him will be lower.
A withholding tax of 20% is payable (just like tax instalment deductions from salary) when the withdrawal is made (sec 159GDA). The taxpayer is allowed to nominate how much of the withdrawal should be subject to these deductions.(sec 18, 20A, 20B of the IED Act)
A penalty of 20% per annum of the tax that should have been withheld is payable if the assessable amount is understated on withdrawal. (sec 20D)
A lower rate can also be requested.
It is easier to withdraw an Income Equalisation Deposit than a Farm Management Bond.
An Income Equalisation Deposit is repayable at any time, 12 months after it has been deposited.
If the taxpayer dies, is made bankrupt or ceases to be a primary producer the money is repayable immediately.
If the taxpayer is experiencing serious financial difficulties, it can be withdrawn before the 12 months have elapsed.
Section 159GC(2) deprives the taxpayer of a deduction for the deposit if the withdrawal is made under any of the above circumstances.
Farm Management Bonds are a little harder to redeem
Farm Management Bonds
loose their status (80% of funds attracting interest) and revert to plain of Income Equalisation Deposits (61% of funds attracting interest) if they are withdrawn for reasons, other than serious financial difficulty.What is serious financial difficulty?
-Section 15A(2) to (4) of IED Act spells it all out.
significant fall in commodity prices (generally average price in current year at least 25% lower than average for previous 3 years)
drought, disease, fire, flood or similar natural events affecting the primary production business.
As already mentioned, the Farm Management Bonds can be redeemed
without any grounds (serious or otherwise) after 12 months,
or even before 12 months on serious grounds other than those listed above
BUT, they are deemed never to have been Farm Management Bonds.
The deduction received - sec 159 GC.
A deduction equal to the funds deposited is allowed in the year in which the deposit is made.
So a primary producer can squirrel away up to $300,000, and pay no tax on that income until he withdraws it?
Pretty well right.
There are a couple of conditions.The deduction CAN NOT EXCEED the taxable primary production income of the taxpayer for that year.
What's this TAXABLE PRIMARY PRODUCTION INCOME?
Section 159 GA(1) defines it as ...
the assessable income derived by the taxpayer...
from carrying on a business of primary production in Australia
less any deductions relating EXCLUSIVELY to that business.
(and an appropriate proportion of other deductions, such as general overheads)
The Income Tax Assessment Act defines the term apportionable deductions for such items as gifts - no allowance is made for these
What is the other condition?
See sec 159GC(2) says
No deduction is allowed if the deposit is withdrawn in less than 12 months due to
serious financial difficulty,
ceasing to be an eligible primary producer,
dying
becoming bankrupt
What's this 'eligible primary producer' business?
Section 159 GC(1) defines an eligible primary producer as..
a natural person
who carries on a business of primary production
in Australia.
or a partner in a partnership which carries on such a business.
A beneficiary presently entitled to a share of the income or a trust, the trustee of which is carrying on such a business also qualifies.
Answer this question….
1. natural person
2. partner in a farm business
3. farming company
4. beneficiary receiving income of a trust carrying on a farming business.
Which one would not receive a deduction in respect of an income equalisation deposit?
A company will not receive a deduction for an income equalisation deposit
Withdrawing the money and paying the tax
Section 159GD includes in assessable the amount withdrawn, in the year in which the request is made.
Answer this question….
A taxpayer applies for a withdrawal on 29/6/93 and receives the money a month later - 29/7/93. In which tax year should the income be returned?
Income is deemed to be derived in year in which withdrawal is requested
The assessable amount is limited to the UNRECOUPED DEDUCTION. which is that part of the deduction which has not previously been brought to account
Section 159GD(2) deems a withdrawal to be made in the year in which a taxpayer
becomes bankrupt, or
dies
Section 159GD(1A) deems a withdrawal to be made in the year in which a taxpayer ceases to be an eligible primary producer.
What the future holds - Farm Management Deposit Scheme
The following details have been reproduced from the Department of Primary Industry and Environment web page (http://www.dpie.gov.au/dpie/pr/media_releases/aaa.html#fmd)
The Government will replace the existing Income Equalisation Deposit Scheme (IEDs) and Farm Management Bonds (FMBs) with a new, fully commercialised scheme known as the Farm Management Deposit Scheme. After the legislation for the new scheme is passed current deposits in IEDs and FMBs will be fully transferable to FMDs over a number of months to a accredited financial institution of the depositor's choice.
The new scheme will authorise financial institutions to hold FMDs, and will be more attractive to farmers as a risk management tool.
Legislation to implement the Farm Management Deposit Scheme will be introduced into Parliament shortly.
Its key features will be:
a limit on holdings in the scheme of $300,000 per taxpayer;
the investment component set at 100 per cent on the first $150,000 of holdings in the scheme, and 80 per cent on the balance thereafter;
eligibility be restricted to primary producers with a taxable non-primary production income of less than $50,000;
deposits fully tax deductible in the year of deposit and taxable in the year of withdrawal;
a 20 per cent withholding tax on each withdrawal;
variable rate of withholding tax in times of financial hardship and no penalty tax if the assessment is subsequently found to be incorrect. Financial hardship will be assessed against the criteria which currently apply to withdrawals made under the FMB scheme;
other than withholding tax, no withdrawal conditions apply to the scheme;
interest taxable in the financial year it is earned; and
financial institutions will pay an interest rate determined in the market place;
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