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Taxation of Primary Producers and Landholders -
Improving Natural Resource Management Outcomes

A report for the Rural Industries Research and Development Corporation

By R.G. Ashby and L.N. Polkinghorne

March 2004

RIRDC Publication No 04/026 RIRDC Project No ASH-2A

Executive Summary
Aims and methodology

• This book provides a summary and analysis of the income and other tax laws in Australia that are likely to affect investment and management of natural resources (NRM).
• It also provides an overview of innovative tax policies and recommends changes to tax laws, that are targeted at increasing investment in NRM.
• It has been prepared after wide consultation with many people with diverse expertise especially in the fields of tax law and natural resource management.


 NRM Issues in Australia

• Australia has an extremely diverse and complex natural environment which has been damaged by inappropriate land management. Salting in Western Australia and parts of Eastern Australia and river catchments in poor condition are the results of many years of bad management, once encouraged by income tax laws.
• The Federal, State and local governments all have responsibility for the natural environment which results in complex administrative arrangements for direct government investment into NRM. Nonetheless governments are committed to direct investment to help repair the environment.
• Agricultural activities occupy 60% of Australia’s land area. Many of the entities conducting these activities are unprofitable and therefore do not have sufficient cashflow to invest adequately into natural resources.
• Tax laws affect investment decisions made by taxpayers, either by providing a deduction for an expense, by providing a tax deferral mechanism for example Farm Management Deposits, or by providing an incentive such as those available in mass marketed tax driven investment schemes.


The Income Tax System

• Taxation law is extremely complex and as a consequence it is difficult to grasp a complete understanding of how it applies in all situations.
• The Tax Act distinguishes between different types of taxpayers. The taxpayers relevant to NRM are businesses, PAYG salaried taxpayers and primary production businesses. Primary production businesses represent 5% of all taxpayers and trade as sole traders, partnerships, trusts and companies.
• Many deductions are only available to businesses.
• Tax is assessed on taxable income. Taxable income is derived by taking all allowable deductions from all assessable income for the taxpayer entity.
• Tax rates are progressive with the lowest being 17% plus 1.5% Medicare levy and the highest 47% plus 1.5% Medicare levy. A taxpayer on a higher income obtains a greater saving for a tax deduction than one on a lower income.
• Taxpayers must keep records and can prepare accounts using the cash or accrual systems of accounting. The cash system is mandatory for those taxpayers who use the Simplified Tax System or STS.


Relevant Tax Provisions – Primary Producers

• A primary production business may claim all general deductions available to businesses and many special deductions.
• Primary production is defined in the Act, and a business is described in Tax Ruling 97/11.
• Primary production businesses are required to complete livestock schedules to determine the income from livestock trading.
• The specific and significant deductions available to primary production businesses are associated with landcare operations, water facilities, Farm Management Deposits (FMDs) and income averaging.
• Averaging influences both the short and long term marginal tax rates. When income is rising, averaging usually has the effect of reducing the tax otherwise payable. The opposite occurs when income is falling – the tax liability is greater than it would be for a primary producer not in averaging.


Relevant Tax Provisions – All taxpayers

• All taxpayers may claim a tax deduction for a gift of money or property provided the gift is made to environmental organisations entered on The Register of Environmental Organisations. When the gift is $5,000 or more in value, the deduction may be spread over five years.
• All landholders who enter a perpetual conservation covenant may claim a tax deduction for the loss of value created by the covenant. The tax provisions relating to covenants are complex as is the procedure involved in entering into a covenant.
• For a property acquired after September 1985 entering into a covenant triggers a capital gains tax event.
• Non-commercial loss provisions may impact directly on small landholders who wish to claim a loss against other income.


Capital and other taxes

• Capital gains tax (CGT) is payable on all capital gains derived from assets acquired after September 1985.
• The CGT provisions are complex and allow for certain concessions for small businesses and active assets.
• Stamp duty is a State tax payable on a large range of transactions. Stamp duty payable on the purchase of land is very significant, however an exemption is available in all states to facilitate inter generation transfer. This exemption does not apply to CGT.
• In addition to income tax, CGT and stamp duty, land holders need to be aware of land tax (state tax) and rates (a local government tax).
• Deductible contributions to superannuation funds attract a 15% tax when entering the fund.


Many primary producers average their income and therefore investing in superannuation is not very tax effective for them.
 

• Many primary producers use their farm land as a retirement fund, by charging rent to the next generation. By using this form of retirement income farmers are not availing themselves of tax rebates available from complying superannuation funds.


Primary Producer Issues

• The number of broadacre farms in Australia has halved over the past forty years, consequently farms are increasing in size.
• There is a direct relationship between farm size and profitability – the larger the farm the better the returns. Economies of scale can be achieved by leasing land, syndicates or joint venture.
• Many small farmers do not make sufficient income to provide a reasonable living income. Most of these farmers would be better off financially by leasing out their farm and investing some of the rental income into NRM.
• A sustainable and profitable farm business will not only have economies of scale but will also invest on-farm into NRM, off farm for retirement and estate planning, and will have a clearly defined succession and estate plan.
• Best practice land management is demonstrated by the preparation and implementation of a land plan that is linked to a regional NRM strategy, and is likely to contain a forestry component.


Analysis of the current tax system

• The tax system is designed to raise revenue for the Commonwealth government to enable it to run services for the whole community.
• Many analysts do not like using the tax system to provide a benefit to a particular group of taxpayers. However if the tax system is used to encourage sustainable land use it would provide a public benefit via an improved environment.
• Currently the tax system denies certain deductions to land holders who are not running a business for example a landholder who leases out land cannot access the landcare provision.


Also a landholder who fails the non-commercial loss provisions may not claim a deduction for NRM or any expense against other income in the current year.
 

• Tax deductions in general are of no immediate benefit to individuals who do not make a profit.
• The landcare provision of the Act is not widely enough defined to include nature conservation as part of a farm system. This landcare provision is not well known nor understood by most farmers and many accountants.
• An approved land plan is only required where different land classes are fenced off.
• The provision relating to water facilities can either be used to conserve water or to increase production (for example travelling irrigators) and needs revision with a clearer policy objective.
• Farm Management Deposits are a vital tax planning tool available to farmers, the cost of which seems to be significantly overstated by Treasury.
• Income averaging applies to the advantage and disadvantage of primary producer taxpayers.
• CGT exemptions are not available to family businesses with assets in excess of $5m. This limit does not apply on the CGT exemption relating to a principal residence.
• When land is transferred from generation to generation it is a CGT event on which CGT may be payable.
• Superannuation is not an attractive investment for many farmers who often continue to draw a living from the farm in retirement.


Conclusions and issues for policy analysis

• The tax system influences taxpayers’ decisions, including their willingness to invest in NRM.
• Policy decisions need to focus more on encouraging private investment in NRM that is linked to regional strategies, in order to complement the direct investment into NRM made by governments.
• Encouraging the development of large profitable farm businesses that have adequate funds to invest into NRM, via appropriate tax deductions is likely to be a cost effective means of improving the environment in the long term.
• Landholders who currently cannot access tax deductions also need to be encouraged to invest into NRM in a tax effective manner.


Recommendation
That irrespective of any changes to the tax act that primary producers and landholders be given sufficient tax incentive to encourage them to develop and adopt a land plan linked to the regional NRM strategy.

Proposed issues for further policy analysis
It is proposed that the following changes to tax laws are exposed to detailed policy analysis in order to provide increased stimulus to all landholders to invest into NRM.
 

Landcare provision	- Deduction may be claimed at the rate of at least 120% of cost - Apply to all landholders with an approved land plan - Definition widened to include nature conservation
Water Facilities	- Be subject to revision
Profit on sale of plant	- Allow write down of replacement plant by profit on traded plant
Land lease	- Landholders (as lessors) may access landcare provision
Non-commercial losses	- Landholders may access landcare provision
Capital Gains Tax	- No CGT payable on transfer to next generation
Superannuation	- That tax incentives be provided to primary producers to encourage them to invest in superannuation
Administration management	- DAFF publish a list of qualified land planners by regions - Each region produce a list of principles linking NRM strategies to land plans. - Assistance be provided “one on one” to landholders to complete land plans. - Tax practitioners be consulted widely about any proposed changes and their implementation.

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Last updated: 8 March 2004
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