Disposal of livestock to an associated person
(Clauses 26, 28(2), 31, 57(8) and (11))
Summary of proposed amendments
New section EC 4B of the Income Tax Act 2007 will provide that the acquirer will be required to use the disposer’s herd scheme elections and base numbers, if any, if the two parties are associated persons. This is to prevent an associated person’s disposal being used to circumvent an election to use the herd scheme.
An exception will be made if there is an inter-generational disposal in certain circumstances. To qualify, children or grandchildren must have had no direct or indirect interest in income from the livestock before the transaction (as a discretionary beneficiary or otherwise) and the disposer will be required to cease farming and have no remaining interest in income from the disposal of the livestock after the transaction.
Proposed new section EC 4B will contain the core associated person’s transaction rule and the inter-generational exception. Section EC 8 will be amended so that when a farmer has acquired herd scheme livestock from an associated person, the “alternative valuation” rule works by increasing the minimum number of livestock the farmer is required to have to be in the herd scheme.
The amendments will apply from 28 March 2012, the date they were announced.
Subsection EB 4B(1) proposes that the section applies when livestock that otherwise would have been valued under the herd scheme are transferred to an associated person other than in the ordinary course of business.
Subsection (2) proposes that an exception applies when the transfer is inter-generational and the “person” making the transfer is either the parents or the grandparents of the person receiving the livestock. The major requirements will be that:
- the person making the transfer ceases owning and earning income directly or indirectly from the disposal of specified livestock as a result of the transfer; and
- before the transfer, the person receiving the livestock had no direct or indirect interest in the livestock except through the blood relationship with their parents or grandparents.
The sale or other disposal by a dairy farmer of dairy cows to his or her children who then begin 50/50 sharemilking would typically qualify for the exception (because the transferor would not be receiving income from the disposal of specified livestock). Likewise, earning interest or rent from the new farming enterprise would also typically qualify for the exception.
However, because of the common use of companies (or sometimes, trusts) for farming purposes, this exception is conceptually complex. It applies to a transfer by an entity associated with the parents or grandparents so long as the children or grandchildren have no association with the entity (for example, they aren’t shareholders or beneficiaries) other than by way of the blood relationship they have with their parents or grandparents.
Likewise, the transferee can be an entity associated with the children or grandchildren so long as the parents or grandparents have no association with the entity other than by way of the blood relationship they have with their children or grandchildren.
Subsection (3) proposes that, when section EC 4B applies, the transferee is considered to have made an election to use the herd scheme.
Subsections (4) and (5) contain the mechanics of the section, as follows:
- The classes of livestock transferred to the associated person are classified into the classes they would have been in at the end of the transferor’s income year if the transferor still had them on hand.
- The actual number of livestock of that class that the transferor has on hand at the end of that income year is increased by the reclassed number transferred to the associated person determined immediately above.
- Then the transferor’s actual number of livestock on hand at the end of this year is subtracted from the lesser of the adjusted number on hand determined immediately above and the number actually on hand at the end of the last year.
If positive, any base “alternative valuation” number that the transferee has from the previous year will be increased by this amount. This increase in base number is effected by clause 28(2), which proposes new subsections EC 8(3) and (4) (and subsection EC 8(4) (part of the 18 August 2011 rewrite of section EC 8) is renumbered subsection EC 8(5).
The inter-generational exception is handled by way of new definitions of “descendant” and “descended associate” in sections EC 4B(6) and YA 1.
The associated persons rules will apply to subparts FB (matrimonial property transactions and FC (death and distributions).
Section EC 21 will be consequentially repealed.
Examples of the associated persons rule and its inter-generational exception
Example 1: Associated persons rule
Joe has 250 mixed age (MA) dairy cows on hand that he sells to Joe Farm Limited, a company he owns. Joe would have had to value these cows in the herd scheme at year-end if he hadn’t sold them.
Regardless of how it values any other livestock it might own, Joe Farm Limited must value these 250 MA dairy cows in the herd scheme and, if necessary, will be deemed to have made an election to use the herd scheme in the year of acquisition. Joe Farm Limited will be, for the purposes of what is called the “alternative valuation method”, be deemed to have a minimum number of herd scheme livestock on hand at the end of last year and will be required to have regard to that minimum number at year-end.
Further, Joe will have to make an opening herd scheme livestock adjustment so that the tax values that Joe and Joe Farm Limited are the same in the year of the sale. This neutralises any taxation impact.
For example, Joe Farm Limited might already own 450 MA dairy cows and have valued 300 of those in the herd scheme at the end of the previous year. Joe Farm Limited will be required to value 550 (300 + 250) MA dairy cows in the herd scheme at year-end.
Example 2: Inter-generational exception
Jill Farm Limited is solely owned by Jill, the daughter of Jack. Further, Jack is ceasing farming as a result of the sale of his 250 dairy cows to Jill Farm Limited. So long as Jill Farm Limited makes the appropriate election, Jill Farm Limited may value the 250 dairy cows using the national standard cost regime under the inter-generation exception to the associated persons rule.
Jack may leave part of the purchase price in and derive interest on this and, as well, may work for Jill Farm Limited for wages (so long as these arrangements did not amount to profit sharing). Further, Jill Farm Limited and Jack could enter into a 50/50 sharemilking arrangement. None of these transactions will disturb the inter-generational exception.
The key point is that Jill Farm Limited and Joe are not associated persons except for the blood relationship between Jack and Jill. However the exception would not be available if Jack was also a shareholder in Jill Farm Limited, or a beneficiary of a trust that was a shareholder, as both of these ownership models would make him an associated person of Jill Farm Limited other than by the blood relationship.