OPINION: In April 2018, the IRD rolled out the Accounting Income Method, or Aim, a new method for paying provisional tax.
Aim spreads provisional tax payments over six or 12 payments rather than the current three. Also, rather than basing provisional tax on the previous year's income plus an uplift of 5% or 10%, the payments are based on income and expenses within the period by utilising information in the business' approved accounting software. IRD has actively promoted Aim on the basis that tax payments will match cash flow, which will make paying provisional tax more manageable.
While this seems like a great concept, in practice it is much more complex and farmers especially can be disadvantaged by the scheme. While the IRD might argue provisional tax is not a final tax and it is all squared up at the end, the fact is businesses do not want to pay tax earlier than they have to when that cash could be put to better use in their business.
The eligibility to use the Aim scheme is limited, and only companies and individuals are able to participate. Some may also be excluded due to other factors related to their income.
The Aim system uses the profit and loss information in the accounting software to establish a monthly or two monthly taxable profit. However, when a typical end of year tax return is calculated, many adjustments are applied to determine the taxable income figure. This includes things like shareholder salary, the use of tax losses and stock valuation There is some capability within Aim to make some adjustments.
This is where things might get time-consuming and complicated and start to skew payments. Of particular note is that you are unable to take into account any losses offset from other companies, making this unsuitable for any more complex family structures. The management of shareholder salaries is also administratively burdensome and might carry some risk for the shareholder in determining whether to continue to meet their provisional tax obligations or not.
The old uplift method of paying provisional tax takes these issues into account automatically by assuming the business will do what it did last year. So where do things go wrong for farmers? One of the key disadvantages under Aim is the way livestock is treated when determining the taxable income and we believe this would cause tax to be paid earlier than is appropriate during the year for farmers with a home breeding business.
In general, farmers have late balance dates, e.g. May and June. The typical annual cycle for a farmer is that lambs/calves are born early in the year after balance (for example August/September), the livestock are fattened and then those not being retained are sold in the later part of the year.
Aim requires the farmer to undertake a physical stocktake at each instalment, every two months (unless operating a perpetual inventory system) and value stock using the herd scheme values or national standard costs. These values are based on mature year-end livestock.
Farmers using Aim and the herd scheme will end up paying tax on livestock in the GST period the animals are born based on year-end market values. Future loss due to deaths will be adjusted in later periods. In addition, as there are likely to have been little in the way of sales in those first months, there is likely to be no cashflow to pay the tax. This seems to be the opposite outcome to what has been promoted under the scheme.
Sam uses the herd scheme to value livestock and has 100 lambs in the first period July/Aug, with the most recently announced national average market value for ewe hoggets being $123 per head.
Assuming no other stock movements, this will create $12,300 of income in his first Aim period. In his Sept/Oct period, Sam has lost five lambs, and sold 30 for $80 a head, leaving a total of 65 lambs. This creates a loss of $1905 ($7995 of stock value, less the opening stock value of $12,300, plus income from sales, $2400). This will result in a small tax refund.
If we compare this to an uplift basis, (assuming income was the same or less) no provisional tax would have been paid until November 28. Farmers should be wary before electing into the Aim regime. We believe it will not work well for livestock farmers until the IRD rethinks its treatment of the livestock adjustment rules.
- Michael Turner is a taxation partner of Polson Higgs.