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Inland Revenue

Tax Policy

Chapter 3 - High-level analysis of the problem

3.1 The following graph of Friesian cow NAMVs from 1987 (when the herd scheme was introduced) to date shows three significant spikes, two of which have been in the last decade. The 1993 spike was mainly caused by the change of valuation methodology that occurred as part of the 1993 reforms.

National Average Market Values – Friesian M/A Cows

National Average Market Values – Friesian M/A Cows

3.2 In contrast, as illustrated in paragraph 2.12, the NSC scheme offered, from its introduction in the 1992–93 tax year, substantial stability for a home-breeding operation.

3.3 Theoretically these spikes offered dairy farmers using the herd scheme an incentive to exit it. There is evidence that a number of dairy farmers used these opportunities in relation to either, or perhaps even both, of the spikes in the 2000s with the result that their tax liability has been reduced.

3.4 For example, presuming a farmer with 300 cows successfully exited the herd scheme in the 2008–09 income year, as a number did, they could have obtained about $100,000 of net tax savings over the 2008–09 and subsequent income years. This is because the farmer took a tax-free write-up to the 2007–08 peak, and arranged to obtain a tax deduction for the subsequent write-down.

3.5 It seems a number of farmers also took advantage of the earlier 2001–02 spike. This was described in an article titled “Watch your step when stepping out of the Herd Scheme” in the May 2003 issue of The Chartered Accountants Journal. An extract from page 10 of the Journal follows.

“As we worked into the 2002 income year, many of us could see that herd values for sheep and beef cattle were also going to peak, and if there was ever a time to quit the Herd Scheme, this was it.

The legislation requires a two-year written notice of election for taxpayers wishing to quit the Herd Scheme. In fact, the timeframe is somewhat less than two years because, provided a written notice of election to quit the scheme was filed before the closing date for filing the 2001 tax return, it was possible to be out of it for the 2003 income year.

Large numbers of taxpayers filed the appropriate elections prior to filing their 2001 tax return – many of which were delayed until the last few days of March 2002. By that time, we had a fair idea of what the 2002 herd values would be. Those 2002 herd values were announced in May 2002 and though dairy cattle had gone just over the crest, it appeared that sheep and beef cattle had peaked in that year.

It is becoming evident that 2003 herd values will be considerably lower than those ruling for 2002. For those continuing with the Herd Scheme, there will be a very large non-tax-deductible devaluation of stock to be brought to account when preparing the 2003 financial statements for farming clients.

Some of that downward market value trend became obvious for dairy cattle by late autumn/early winter of 2002. The downward trend was also beginning to be reflected in sheep and beef cattle prices with the strengthening of the currency in October 2002.

Those who had not filed elections to quit the Herd Scheme prior to filing their 2001 tax returns probably realised that they had “missed the bus”.

Through the period from the winter of 2002 to the end of January 2003, many decided to use the alternative route for quitting the Herd Scheme.

That alternative involves selling the livestock to a separate entity (not a related partnership) and having that separate entity make its own decision about which valuation system to use for its new livestock.

The old (selling) entity was able to apply a special provision that flows through under section EL 5(6) of the Income Tax Act 1994. That provision applies where a taxpayer that has previously adopted herd values for livestock has now sold all of the livestock and ceased to derive income from it.

In those circumstances, the selling entity is entitled to file an election no later than 1 February in the income year of sale and cessation to use the herd values for the immediately preceding income year.


The result will be that most of these taxpayers will have generated a significant tax loss on disposal of their livestock.”

(Reprinted with permission from the New Zealand Institute of Chartered Accountants.)

3.6 This extract highlights a number of potential problems including:

  • It was seen as being common practice to try to exit the herd scheme when NAMVs were high.
  • “Large numbers” elected out using the election to leave the herd scheme.
  • “Many” farmers were delaying filing their tax returns to keep their livestock election options open.
  • “Many” farmers used “the alternative route for quitting the herd scheme” (or what this paper calls the “sale cease farming election”).

3.7 While there may have been some exaggeration over the numbers of farmers involved, this extract clearly indicates that there is a series of tax policy and operational problems, all seemingly to do with securing a tax advantage by exiting the herd scheme at an opportune moment.

3.8 It appears that there was considerably more use of these options to leave the herd scheme as a result of the 2008 peak in dairy cow prices than there was in relation to the earlier peak discussed in the extract.

The two elections of concern

3.9 There are a variety of livestock valuation elections that allow farmers to select which livestock valuation regime they wish to use for their specified livestock. In particular, there are two elections that are currently causing concern:

  • The election by a continuing farmer to exit from the herd scheme to use another livestock valuation method. This has the practical effect that the opening herd scheme adjustment is not made in the year that the election is effective (thus the opening herd livestock is valued at the last year’s herd values) and another valuation method is used at the end of that year.
  • Where a farming enterprise that uses the herd scheme sells its specified livestock and ceases farming, (or a farmer dies (in which case their livestock is deemed to have been sold)), in qualifying circumstances an election can be made for the tax return that includes the sale, that the opening herd scheme adjustment need not be made (the “sale cease farming election”).

3.10 The practical effects of these elections are illustrated by example in the next two chapters of this paper.

3.11 For continuing farmers, the election to exit has been the most common method for farmers to cease using the herd scheme. However, in relation to the 2008 peak in herd values of dairy cows there is evidence that several hundred farming enterprises used the “sale cease farming election” where the “sale” was to an associated person (that is: there was no real change in economic ownership).


3.12 Of all business taxpayers, it is only farmers of specified livestock that can elect one year to value their stock (typically after land, their biggest asset) as a capital asset (the herd scheme), and in the next year as if it were trading stock held on tax account (the NSC scheme). A number of farmers have used these elections to generate tax savings (from tax-free write-ups and tax-deductible write-downs).

3.13 From a tax policy and fairness perspective, the advantage these farmers are obtaining is inappropriate. A legislative response is required.