2013 technical amendments to the law regarding livestock support earlier legislation that made elections to exit the herd scheme irrevocable.
Sections EC 4B, EC 4C, EC 7, EC 8, EC 11, EC 20, EC 21, FB 15, YB 1 and Schedule 17 of the Income Tax Act 2007
These amendments follow on from the 2012 Budget legislation that made herd scheme elections irrevocable. The original proposals were announced on 28 March 2012, but were then subject to further consultation and refinement. The changes in the new legislation reflect the results of this further consultation.
It became apparent that some farmers were taking inappropriate advantage of the ability to exit the herd scheme with a short period of notice to achieve tax-free increases in livestock values under the herd scheme, and tax deductible decreases in values under a cost-based regime. Along with this, a few farmers were doing associated parties transactions to achieve the same result.
Officials released an issues paper on the problem and potential reforms on 18 August 2011. While there was debate on alternative solutions, there was complete acceptance of the problem, both at a high level and in detail. This led to the Government's 28 March 2012 announcement that, from 18 August 2011, elections to exit the herd scheme could not be made.
These technical amendments in the new legislation follow on from the Budget 2012 amendments that made an election to use the herd scheme irrevocable. While the new legislation generally follows the pattern of the 28 March 2012 announcement, a number of enhancements have been made.
The amendments deal with specified livestock only (sheep, beef and dairy cattle, deer, pigs and goats). They deal with:
- associated persons transactions where and to the extent that the vendor is using the herd scheme - essentially the purchaser assumes the vendor's herd scheme elections, base numbers and values;
- exceptions from associated persons rules for inter-generational transfers - the effect being that the qualifying purchaser is free to make their own valuation elections;
- refinements to the rules for ceasing farming other than by way of an associated persons transaction when the vendor is using the herd scheme;
- an exception to the irrevocable herd scheme election rule when the farming operation changes to a fattening operation;
- there is some rationalisation of specified livestock classes; and
- a number of supporting detailed amendments.
In summary the amendments are:
- Section EC 4B makes the use of the herd scheme compulsory for associated party transfers of livestock the vendor would otherwise have valued in the herd scheme, and provides an exception for inter-generational sales.
- Section EC 4C provides the values at which these herd scheme livestock are to be worth transferred at.
- Section EC 7 is a clarifying amendment.
- Section EC 8, which deals with restrictions arising from the use of the herd scheme, has been replaced in two tranches. The first tranche, which applies from 18 August 2011, introduces an exception to the herd scheme election being irrevocable if the farming operation changes to a fattening operation. The second tranche, which applies from 28 March 2012, adds mechanical issues to do with base herd scheme numbers.
- Section EC 11, which deals with restrictions on making elections, has been consequentially amended.
- Section EC 20, which deals with valuations upon ceasing farming has been amended to introduce a before or after 1 November date for the compulsory use of opening or closing herd scheme values.
- Section EC 21, which used to deal with herd scheme valuation elections on a farmer's death, is repealed as its purpose has been subsumed by the associated persons transaction rules.
- Section FB 15, which deals with matrimonial property transfers, has been amended to make it clear that one party steps into the other party's position when a matrimonial property settlement involved livestock valued under the herd scheme.
- Schedule 17 is amended to rationalise certain classes of livestock.
Associated party transfers of herd scheme livestock
Sections EC 4B, EC 4C, EC 8, EC 11 and FB 15
Some farmers used associated party transactions in an attempt to exit the herd scheme without giving the required advance notice. Inland Revenue questioned some of these transactions and it became clear that a legislative response to associated persons was required when the vendor used the herd scheme.
However, as a result of submissions it became apparent that this could inappropriately impose tax on inter-generational transfers of herd scheme livestock, and it was agreed to exempt these in appropriate circumstances - these circumstances are limited.
The amendments apply from 28 March 2012.
The core rule
The new rules provide that for associated persons transfers of herd scheme livestock the acquirer steps into the position of the vendor for the herd scheme election, herd scheme base numbers and herd scheme values.
The general definition of "associated person" applies.
The associated persons rules only apply where the transfer is not in the ordinary course of business. Thus a father and son situation where the son runs the back country breeding farm and the father runs a front country fattening farm will generally not come under rule if the father buys stock from the son to fatten. However, if the father doubles the size of his farm and buys some breeding stock (other than stock that the son would have ordinarily been culled) from the son, then that stock will be subject to the new rules. Given the various potential scenarios this has been deliberately left up to the parties' judgement. Common sense should apply.
In qualifying circumstances, the transferee will be treated as having made a herd scheme election (section EC 4B(4)). This overrides the more general herd scheme election rules.
These circumstances are where the vendor would otherwise have valued those livestock in the herd scheme at the end of his or her income year. This is controlled by the formula in section EC 4B(5). The steps involved are as follows:
Step 1: The vendor calculates hypothetical year-end numbers for a class as if the associated persons sale had not taken place.
Step 2: These are then compared with the vendor's opening herd scheme tallies for that class.
Step 3: The lowest of these numbers (being the minimum that the vendor could value in the herd scheme in the year of transfer if the transfer had not occurred) becomes the "hypothetical year-end herd scheme amount".
Step 4: From this is subtracted the actual year-end numbers of the class that the vendor has on hand.
Step 5: The balance is then the number of livestock of that class that the associated person acquirer must value in the herd scheme.
Note that the calculations focus on the class that the livestock would be (or would have been) at year-end, not as at the date of the transfer.
Subsections EC 8(3)-(4) as they apply from 28 March 2012 provide that the acquirer's minimum herd scheme numbers for that class and that year are increased by the number obtained from the section EC 4B(5) formula that is illustrated immediately above.
Matrimonial property settlements
Section FB 15 has been consequentially amended as the associated persons herd scheme rules should apply to these settlements.
Associated party transfer values for income tax purposes
Section EC 4C provides that for income tax purposes the transfer of livestock that the acquirer is required to value in the herd scheme is deemed to take place at herd scheme values that apply at the end of the year of the transfer, presuming that both parties are in the same tax year when the transfer takes place. If this is not the case, it depends on which of the parties is in a later tax year, but the objective is to ensure that there is one herd scheme adjustment to opening herd scheme livestock valuations for each tax year.
If the acquirer is in an earlier tax year than the transferor's, the values are the vendor's opening herd scheme values for the vendor's year of transfer. That is, the acquirer acquires the transferred herd scheme livestock at the herd value that applies at the end of the acquirer's tax year.
If the acquirer is in a later tax year than the vendor, the values are the vendor's closing herd scheme values for the vendor's year of transfer. For the purposes of the herd scheme adjustment in the year the acquirer received the herd scheme livestock, only the acquirer is deemed to own them at the end of their previous year.
For GST purposes, the sale is taxed at the values it actually occurs at. Where the vendor is a company, any difference between sale values and deemed tax values is regarded as an increase or decrease to retained earnings and under current law is taxable upon distribution.
For tax purposes any other livestock transfer at the usual market values.
Intra-generational exception to the associated persons rule
Where there is a clear transfer of herd scheme livestock down the generations (parents or grandparents to children or grandchildren) then in qualifying circumstances the associated persons rule does not apply.
- the lower generation should have had no interest in the livestock before the transfer;
- the higher generation should cease deriving income from the disposal of specified livestock; and
- the transaction should be at market values and, except for financing, market terms.
To make this work there is a complicated application of the associated persons rules. Essentially, where the only connection up the generations is the blood relationship between the generations then the exception can apply. Thus if the lower generation are not associated with a trust, or a company or a partnership or a sole trader which is the livestock owning entity, other than by the blood relationship, the exception can apply.
Examples of non-association include where the lower generation are not:
- beneficiaries of the higher generations' trust that owns and farms the livestock;
- associated with the higher generations' company that owns and farms the livestock except through the blood relationship; and
- associated with the higher generations' blood relations (and their entities) where there is no other association and the blood relations (and their entities) carry on a separate farming business.
Ceasing deriving income from livestock
The higher generation should cease deriving income directly or indirectly from the disposal of specified livestock that is part of a business for the next four years. Thus the vendor can graze a few animals on a lifestyle block (for the freezer or whatever), or can retain the land and enter into a 50/50 sharemilking arrangement with the next generation, or can start farming non-specified livestock, all without disturbing the exception.
The "indirectly" reference is to the situation when the livestock are owned by a trust or company that the vendor is associated with. The four-year period was chosen because it should be long enough to confirm there was a genuine intention to cease deriving income from livestock.
Deceased farmers and their estates
Section EC 4B(3) provides that the associated persons exception will apply to a deceased estate if:
- the more general associated persons exception would have applied had the deceased (or a person associated with the deceased) transferred the herd scheme livestock to the next generation, who are capital beneficiaries of the will, immediately before his or her death; and
- the estate does not have a life tenant.
Section EC 21, which governed herd scheme values where the farmer died, has been repealed as the associated party rules, and the exception thereto, will, as appropriate, apply.
Change of use exception to the irrevocability of herd scheme election rule
When the farming operation changes from a breeding operation to a fattening operation, a one-off election to leave the herd scheme is available. This recognises that a cost-based regime is likely to be more appropriate for a fattening operation.
Specifically, for a type of specified livestock where the farmer's intention is that they cease to be used for a breeding business, and instead are used in a fattening business, a written election to exit the herd scheme for that type of livestock may be given.
This election applies from 18 August 2011, the date that the revocation of the more general election to exit the herd scheme applies from.
Cessation of farming by third party sale
Section EC 20, which used to provide that farmers who were using the herd scheme could elect, in qualifying circumstances, whether to make an opening herd scheme valuation adjustment, has been amended to make it compulsory not to adjust opening herd scheme values. The amendment means:
- it applies when the farmer ceases deriving income from the disposal of specified livestock (that is, they could still own land subject to a 50/50 sharemilking agreement);
- the sale is not an associated persons sale, except where the inter-generation exception applies;
- it is compulsory when the cessation occurs before 1 November; and
- the notice requirement has been repealed.
This applies from the start of the 2012-13 income year.
Rationalisation of some classes of livestock
There has been some concern expressed about the uncertainties of whether dairy cattle are Friesian or Jersey, and whether some deer are Red or Wapiti. The 17th Schedule has been amended to combine these breeds. This is effective from the 2014-15 year. It is acknowledged that this will result in some averaging of herd scheme values (eg, Friesian values will decrease a bit and Jersey values will increase).
As an interim measure, for the 2012-13 and 2013-14 years, these breeds are regarded by section EC 8 as being combined. This section, among other things, deals with minimum livestock numbers in the herd scheme. Where dairy cattle or deer change from one breed to the other (for example Friesian to Jersey), the minimum numbers for each class are added together.