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S38
Issued
15 May 2015

Application of financial arrangements rules to loans by NZ Dairy Farming Trusts to New Zealand resident farmers

Determination S38 (15 May 2015) relates to the financial arrangements rules as applied to loans from NZ dairy farming trusts to NZ resident famers.

This determination may be cited as Special Determination S38: "Application of financial arrangements rules to loans by NZ Dairy Farming Trusts to New Zealand resident farmers."

1. Explanation (which does not form part of the determination)

  1. This determination relates to Loans between an NZ Dairy Farming Trust (the Fund) and New Zealand resident Farmers.
  2. The Fund will lend money to Farmers under the Loan Agreement.
  3. Loans from the Fund to Farmers will rank as junior debt of the Farmers.  In general, a trading bank will provide senior debt, working capital, transactional banking facilities (and other banking facilities) to Farmers.  For each Loan, the Fund, the trading bank and the Farmer will enter into an inter-creditor security agreement.  
  4. Under the Loan Agreement, a Farmer will pay:
    • an Establishment Fee;
    • Milk-Priced Interest;
    • Land-Priced Interest; and
    • Early Repayment Interest (if the loan is repaid before the agreed maturity date).
  5. Milk-Priced Interest will be payable monthly and will be charged at a single rate of interest for each 12-month milk season ending 31 May.   The Milk-Priced Interest rate for each milk season will be linked to Fonterra's prevailing Farmgate Milk Price for milk supplied for that season.  Fonterra forecasts the Farmgate Milk Price at the start of a milk season for the season and provides quarterly updates to the forecast.  If the forecast increases, Milk-Priced Interest payments for the season to date will increase and Farmers will make a catch-up payment as part of the next monthly Milk-Priced Interest payment.  When Fonterra finalises the Farmgate Milk Price for the season ended 31 May (generally in September), the Fund will calculate a final interest reconciliation and Farmers will make an adjustment payment.
  6. Land-Priced Interest is payable on maturity of the Loans, with the rate linked to the increase in a land price index (for the area in which the Farmer's Farm is located). 
  7. This determination applies to calculate and allocate the Fund's income and Farmers' expenditure under the Loans for each income year over the term of the Loan Agreement (other than the income year in which the base price adjustment is calculated). 

2. Reference

This Determination is made under ss 90AC(1)(bb) and 90AC(1)(d) of the Tax Administration Act 1994.

3. Scope

  1. This determination applies to the tax treatment of the Loan Agreement by the Fund and Farmers.
  2. Farmers applying this determination pursuant to s EW 15E of the Act must meet the requirements of s EW 15E(1)(c). 
  3. In accordance with s EW 20 of the Act, this determination cannot be applied by Farmers who are able, and choose, to use the straight-line method to calculate and allocate income and expenditure under financial arrangements.
  4. The Funds will use IFRS to prepare financial statements and to report for financial arrangements.

4. Principle

  1. The Loan Agreement is a financial arrangement under s EW3(3) of the Act that is not part of a wider financial arrangement.
  2. This determination specifies that the Milk-Priced Interest payable or accrued by a Farmer in an income year together with a portion of the Establishment Fee and a portion of the estimated Land-Priced Interest calculated by reference to the movement between:
    1. the average level of the Index at the end of each quarter in the income year; and
    2. the average level of the Index at the end of each quarter in the preceding income year;

    is income for the Fund in the income year and is expenditure for the Farmer in the income year.
  3. In the income year the Loan Agreement matures (or when the rights and obligations of the Fund or Farmers cease as specified in s EW 29 of the Act), the Fund and Farmers must calculate income and expenditure under the base price adjustment in s EW 31 of the Act.

5. Interpretation

In this determination, the following expressions have the following meanings:

the Act means the Income Tax Act 2007.

Establishment Fee means the fee payable by the Farmer to the Fund when the funds under the Loan Agreement are drawn down.

Farm means a Farmer's farm land.

Farmer means the borrower under a Loan Agreement.

Fund means the trustee(s) of an NZ Dairy Farming Trust that enters into a Loan Agreement with a Farmer.

IFRS means International Financial Reporting Standards as defined in s YA 1.

Index means:

  1. the REINZ Dairy Land Price Index, or
  2. the PropertylQ Index, or
  3. a similar land price Index,

applying to the area in which a Farmer's Farm is located.

Loan means the funds advanced by the Fund to a Farmer under a Loan Agreement. 

Loan Agreement means a debt instrument issued by the Fund to a Farmer:

  1. for use in purchasing or developing the Farmer's Farm;
  2. for a fixed term;
  3. on an interest only basis;
  4. under which interest is payable by the Farmer to the Fund on loan principal, comprising:

    monthly payments made during the term of the Loan Agreement pegged to Fonterra's forecasted Farmgate Milk Price, as adjusted for Fonterra's final Farmgate Milk Price for the year (Milk-Priced Interest); and

    a balloon payment at the time the Loan is repaid at a rate equal to the percentage difference between:

    the average level of the Index at the end of each of the last four quarters before the Loan is repaid; and

    the average level of the Index at the end of the last four quarters before the loan was drawn down (Land-Priced Interest); and

    any interest due as a result of early repayment of the Loan principal (Early Repayment Interest);
  5. under which the Loan principal is payable to the Fund at the maturity of the Loan Agreement.

NZ Dairy Farming Trust means a trust that is a New Zealand tax resident and is managed by AgInvest Holdings Limited or an associate, which lends money to Farmers under the Loan Agreement.

6. Method

  1. The Fund's income for a Loan Agreement for an income year equals:
    1. the Establishment Fee divided by the term of the Loan Agreement (in years);
    2. the Milk-Priced Interest payable by the Farmer to the Fund for that income year;
    3. a portion of the estimated Land-Priced Interest payment due on maturity of the Loan equal to:
      1. in the income year the Loan is drawn down:
        • Average level of the Index at the end of each quarter
          in the income year – average level of the Index at the
          end of the last four quarters before Loan drawn down  x Loan principal
          Average level of the Index at the end of the last four
          quarters before Loan drawn down
      2. in following income years (except for the year in which the base price adjustment must be calculated):
        • Average level of the Index at the end of each quarter
          in the income year – average level of the index at the
          end of each quarter in the preceding income year     x Loan principal
          Average level of the Index at the end of the last four
          quarters before Loan drawn down

      provided that no account will be taken of any movement in the average level of the Index below the average level of the Index at the end of the last four quarters before the Loan was drawn down.
  2. The Farmer's expenditure for a Loan Agreement for an income year equals:
    1. the Establishment Fee divided by the term of the Loan Agreement (in years);
    2. the Milk-Priced Interest payable by the Farmer to the Fund for that income year.  If the Farmer files its tax return before the Milk-Priced Interest is finally calculated for a period that falls within the income year, the Farmer should use the Milk-Priced Interest most recently calculated before the Farmer files its return;
    3. a portion of the estimated Land-Priced Interest payment due on maturity of the Loan equal to:
      1. in the income year the Loan is drawn down:
        • Average level of the Index at the end of each quarter
          in the income year – average level of the Index at the
          end of the last four quarters before Loan drawn down         x Loan principal
          Average level of the Index at the end of the last four
          quarters before Loan drawn down
      2. in following income years (except for the year in which the base price adjustment must be calculated):
        • Average level of the Index at the end of each quarter
          in the income year – average level of the index at the
          end of each quarter in the preceding income year     x Loan principal
          Average level of the Index at the end of the last four
          quarters before Loan drawn down;

      provided that no account will be taken of any movement in the average level of the Index below the average level of the Index at the end of the last four quarters before the Loan was drawn down.

7. Example

  1. This example illustrates the application of the method (set out in this determination) for determining the income and expenditure under the Loan Agreement for an income year.
  2. The example is based on a Loan Agreement as follows:
    Start date 1 August 2014
    End date 31 July 2024
    Loan principal $1,000,000
    Establishment Fee $5,000
    Milk-Priced Interest Farmgate Milk Price Interest rate
    Milk Price<$5.26 2.5%
    5.25<Milk Price<$7.01 6% minus .02% for each cent below $7.00
    7.00<Milk Price<$9.01 6% plus .02% for each cent above $7.00
    $9.00<Milk Price 10%
    Land-Priced Interest

    Principal Amount x the percentage difference between:

    • the average level of the Index at the end of each of the last four quarters before the Loan is repaid; and
    • the average level of the Index at the end of the last four quarters before the Loan was drawn down

    2015 income year
  3. This example assumes that in the 2015 income year:
    • The Farmgate Milk Price for the 2015 season is $7.50, so that the Milk-Priced Interest rate for the period to 31 March is 7.00% (6.00%+(.02% x50)).
    • The average level of the Index at the end of each of the last four quarters before the Loan was drawn down was 103, and the average level of the Index at the end of each quarter in the 2015 income year is 106.
  4. Income to the Fund under this determination for the Loan for the 2015 income year will be:
    Total Milk-Priced Interest payable to Fund for 2015 income year $1M x 7.00% x 8/12 = $46,666.67
    Portion of estimated Land-Priced Interest allocated to income year $1M x((106-103)/103) = $29,126
    Portion of Establishment Fee allocated to income year $500
    Total income under Loan Agreement for income year $76,292.67

    2016 income year
  5. This example assumes that in the 2016 income year:
    • The Farmgate Milk Price for the 2016 season is $5.10, so that the Milk-Priced Interest rate for the period 1 June 2015 to 31 May 2016 is 2.5%.
    • The average value of the Index at the end of each quarter in the 2016 income year is 95, and the Farmer has a March balance date.
  6. Expenditure for the Farmer under this determination for the Loan for the 2016 income year will be:
    Total Milk-Priced Interest payable to Fund for income year $1M x 7.00% x 2/12 = $11,666.67
    $1M x 2.50% x 10/12 = $20,833.33
    Portion of estimated Land-Priced Interest allocated to income year $1M x ((103-106)/103) =-$29,126
    Portion of Establishment Fee allocated to income year $500
    Total expenditure under Loan Agreement for income year 3,874

This determination is signed by Howard Davis on the 15th day of May 2015.

Howard Davis
Director (Taxpayer Rulings)

Reference
S38
Issued
15 May 2015
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