Business structures, cash flow management and tax effective debt reduction - what are some keys to ongoing success?

Author: | Date: 13 Feb 2014

Take home messages: 

  • To successfully manage and run a family farm business you need to establish a solid foundation.  This foundation is composed of various structures and strategies, what we call “tools in the shed” along with a sound understanding of how these tools should be used for the betterment of the business and the family.  
  • The stronger the foundation, the better the business and the more likely it is the family will achieve their life long goals.

General disclaimer

The information contained in this presentation is educational information for general circulation and is not specific professional advice. Prior to contemplating the use of any of these concepts or strategies readers need to discuss their personal circumstances with their professional advisers and tax agents.

Wibberleys Pty Ltd or Active Ag Consulting Pty Ltd accepts no liability of any kind and provides no guarantee or warrantee to any person or organisation who relies on the information contained in this presentation.

In the event that anyone wants to discuss the application of these concepts and strategies in relation to their personal and business affairs they will need to make a separate appointment with one of our professional advisers to discuss their circumstances.

Reference to:   ITAA - Refers to the Income Tax Assessment Act either 1936 or 1997.

                        SIS Act – Refers to the Superannuation Industry (Supervisory) Act 1993 & Regulations.

                        CGT – Capital Gain Tax.

                        SMBT – Small Business Taxpayer

Introduction – the family farm business game

As this topic suggests there are various aspects involved when it comes to managing a family farm.

These include: - 

  • The human aspects.
  • The science, technology and production aspects.
  • The business and economic aspects.

Failure to adequately address all of these areas may result in the eventual failure of the family business.

Human aspects

No matter what form of primary production you engage in: - 

  • Broad acre cropping.
  • Intensive livestock farming.
  • Dairy.
  • Viticulture.
  • Horticulture.
  • Fishing.
  • Aquaculture.

If you engage in the business as a family farming unit you are faced with similar issues and demands.

“Bill Malcolm and Jack Makeham” “The Farming Game” publication 1981 reprint 1993 stated:-

“One feature of managing farms that distinguish them from managing many non-farm businesses is the close relationship between the household (consumption unit) and the business production unit.  As a result – non-productive issues have a larger role in how the business is managed than with non-farm businesses.”

Given this fact it’s impossible to manage a successful business without taking into account the people and how they feel.

It’s my view successful farming is about 60% emotion and 40% doing the job.  This is because many of the management, production and marketing decisions people make, have financial ramifications for years to come e.g. failure to spray radish weeds in a crop,  failure to feed the ewes and rams before mating , failure to sell grain at the top of the market, etc.

Often these decisions are made in isolation and if the person making these decisions is stressed or worried and they make the wrong decision on this day, the poor decision can affect their bottom line for years to come.  These stresses and worries can arise from health, finance, family, marriage and succession issues.
In practice we often see successful businesses suddenly performing poorly from a production and financial aspect, due to a marital dispute or financial pressure.  The effect of these issues on the successful performance of a farm business cannot be underestimated.

Further to these human issues farming families are faced with uncertainties in relation to production.

Production Aspect

Farmers are in the business of manufacturing food.  Like most manufacturers they take various inputs, apply certain processes, utilise a work place or equipment to come up with a product for sale at a gain.  Unlike most manufacturers, farmers are faced with a wide range of fluctuating production factors driven largely by the climate.  Rainfall and sunlight can play havoc on the production process.  Too little rain, too much rain, too much humidity, no sunlight, too much sunlight can have a dramatic effect on production.  Further to this farmers have to deal with living organisms, crops, pastures, livestock, pests and diseases in an every changing world and climate.

Over the last twenty years we have seen an over emphasis in relation to the science of agriculture.  The focus has been on maximising physical production per unit e.g. per hectare as opposed to focusing on the net profit or financial sustainability of the farm business.  To do this you need to consider the “whole business.”

We understand science is important and coming from an agricultural science background I know this as much as anyone, however experience as a financial adviser to family farming businesses has emphasized the fact that successful farm business is more than just the top line.  It’s about a whole range of complex issues, ranging from the family through to scientific, technology production issues through to the business and economic aspects of the profession. 

Unfortunately like the human aspects of farming one area that is in urgent need of attention is the economic and business aspects of managing the family farm.

Business aspects of managing the farm

In an age where we have seen significant advancements in science and technology in relation to agriculture we have seen little development in business management.

Other than the introduction of the personal computer and laptop and the introduction of the GST, which has forced farmers to process their transactions in a timely manner, many farm businesses operate the same way as their parents did 30 years ago, in relation to managing their farm financial affairs.

One area that some development has occurred in is in produce marketing.  However, given that our produce marketing systems and procedures are still in their infancy the farming community is littered with unfortunate marketing disasters like contract wash outs, etc.  In fact when it comes to grain marketing the removal of the single desk system has catapulted most grain growers back to where their grandparents were some 50 years ago.

So what does the modern family farming unit need to do to survive these challenges?

It’s our view that it is essential that the farming family unit develop a strong foundation upon which to build their business.  We have all heard the story about the importance of building a house on a solid stone foundation as opposed to building a house on sand.  The same applies to a family farming business.

It doesn’t matter how much a family invests in technical advice, financial and legal advice, family succession, counselling, etc, it’s all a waste of time unless you have the right foundations.

What we are talking about here is structures, processes and strategies that the farm business is built upon. How are you going to handle the transfer of the management and ownership of the business to the next generation? How do you protect the farm business and assets in a family dispute between siblings or an impending divorce?  What about your retirement and security in old age? What can you do if faced by financial pressure of a drought, or in good years the potential of a large income tax assessment?

We have always said that to do a job e.g. build a house, operate on a human being, etc, you need the right tools.  Not only do you need these tools you need to know how to use them.  Another analogy we can use is the game of chess.  You can have all the pieces but if you don’t know how to use them then you can’t win the game.  It’s these tools and strategies that are important in establishing the foundation, to then establish a successful family farming business.

Building the foundations for a successful business

In this paper I want to brush over nine key financial management tools and strategies that we believe are essential for any farm business.

Hopefully if we have time I intend to provide simple demonstrations on how these tools and strategies can be used to address the wide range of human, production, marketing and financial issues outlined above.

My intention is that at the end of this talk that you have some idea of what you need to do.

At the end of the day all of these ideas are complex and require considerably more time to fully outline their operation and the benefits they can provide to your family.  However, we have to start somewhere.

The tools in the shed

All successful family farming businesses need: - 

(1)           Appropriate trading and operating structures. 

(2)           Appropriate finance facilities. 

(3)           Financial Risk Management Strategies – FMD’s. 

(4)           Business analysis: - An understanding of flow of business funds. 

(5)           Equipment replacement policy. 

(6)           Establishment of a Self Managed Superannuation - SMSFs. 

(7)           Accumulation of off farm assets. 

(8)           Succession Plans for: - 

-          Unplanned succession

-          Planned succession, and

(9)           Estate plans.

To be able to handle the complex nature of your family business along with all of the production, marketing and financial risks, it is essential that every farm business aspire to building their business foundations on these key concepts.

Note:       This list is not in priority order and is not exhaustive.  Further to this, how and when a family addresses each of these structures and strategies will differ depending upon the families personal requirements.

(1)           Flexible operating structure and separate asset owning structures

There are a number of ways to trade and own assets:  

  • Sole Trader or sole ownership
  • Partnerships  or jointly held assets
  • Company
  • Trust structures.

We recommend the Family Discretionary Trust with a Corporate Trustee.

Why we believe that partnerships of individuals are limited?

Partnerships are excellent structures that have served many farming families well in the past.  There comes a time however, when the family evolves, that the benefits provided by a partnership structure of individuals or assets held jointly or as tenants in common, begin to decline.

At this stage the family need to consider what other options are available that suit their needs.

(a)           Partnership Legal Structure

Partnerships are fixed structures in which each partner shares in their share of the business income or asset ownership in a set proportion e.g. 25% each, in a four person partnership.

With a fixed structure like this it provides little opportunity for each partner to share their share of the income and capital of the business with their domestic partners, children or other entities e.g. companies etc.

As a result partnerships are very inflexible when it comes to the management of income tax and the transfer of asset value to the next generation.

(b)          Alterations to the Partnership Structure

Another issue that arises with partnerships and their fixed nature relates to any alteration to the make-up of the partnership.

When people exit partnerships, by death or retirement, or enter partnerships, by the addition of new partners such as wives and children, the old partnership dissolves and a new partnership is created.

This event can create both income tax and stamp duty liabilities.

Further to this, the Income Tax Assessment Act (ITAA) stipulates various market value rules.  What the rules specify, is that any assets or interests in assets e.g. partnership fractional interests, transferred from one person or entity, to another person or entity, has to be transferred at current market value even if no consideration is paid.

This creates two issues:

One with capital assets: -

e.g.           Dad owns some BHP shares acquired for $10 in 1990, current market value of $32.  If Dad gives Mum half of his shares for no consideration he will pay tax on 50% of the $22 capital gain.

The other issue that arises for people who are classified as large tax payers (not under the STS system), is with depreciable assets and trading stock: -

e.g.           Market Value of a Tractor                                                                                      $80 000

                Tax written down value                                                                                           (10 000)

                Assessable income on transfer                                                                               $70 000

e.g.           Merino Ewe Market Value                                                                                          $120

                Tax value in financials                                                                                                  (10)

                Assessable income on transfer                                                                                   $110

An important issue here is that at some stage someone will die , retire or the family will want to separate in which case there will be a transfer of assets that will involve the market value rules and trigger either a capital gain or assessable income on transfer.

When it comes to the re-organisation of family partnerships there is relief offered under Div 40 ITAA , Subdivision 328-D  (both in relation to Depreciable Plant), and Division 70 ITAA (Trading Stock) that can be utilised to overcome these issues.

Finally to add insult to injury each State Government may raise stamp duty under their respective Stamp Duty Acts on the conveyance of asset value e.g. depending upon the State this may include interests in partnerships, or asset conveyance from one person or entity to another person or entity.  The net result is that any alteration to partnership capital e.g. departing partners or addition of new partners or conveyance of capital assets may result in a stamp duty assessment.

Each State’s “Duty Acts “of parliament provide various reliefs in regards to farming assets and family farm re-organizations. You will need to consult with an appropriately qualified professional to determine the respective law for your State.

(c)       Asset Protection

In addition to the above issues, partnerships and direct ownership of assets provide little asset protection in the event of legal, financial or marital disputes.  With partnerships, each partner is seen to personally own a fractional interest in the partnership and as such their share of their assets can become embroiled in their personal dispute.  This can be exceptionally disturbing to the other members of the partnership.  Further to this all partners are jointly and severally liable to the activities and actions of the other partners in the partnership.

Although not really a major concern for small family partnerships of Mum and Dad and their children it can be of considerable concern when “in-laws” join the business.  These outsiders come with a whole different range of what we call life values that may or may not correlate with the rest of the family e.g. different education levels, religions, beliefs etc.

We strongly advise our clients not to expose their personal assets to these new comers until such a time that they either retire from the business or are happy that their children’s relationships are stable.  This may seem a little hard, at the start for new wives and husbands, however it is generally not long before they themselves, are faced with these issues with their own children.

Another issue of concern with people trading personally or in partnerships relates to personal liability.  Farming is a risky commercial business.  In the event the business suffers an accident e.g. creates a road accident, spray overdrift, or is subject to a legal dispute, each of the partners are personally liable.  If the partnership assets and insurance cover is insufficient to cover the claim, each partners personal assets e.g. houses etc. can be liable to satisfy these claims.

The moral of the story is that you should ensure that the business is conducted in a structure separate and independent from yourself and that your assets are held in a structure(s) that provide control and ownership rights however are held separately from you as an individual.

Why not trade via a Company?

Often you hear people talk about farming businesses being conducted in a company.  Companies are very poor structures in which to conduct farming business as they are not eligible for a range of primary production concessions:

They can’t use FMD’s

  • They are ineligible for Primary Production Averaging.

Further to this, companies are faced with a range of income tax issues such as: 

  • You can’t stream income
  • Companies pay tax at a rate of 30 cents in the dollar
  • They are subject to a range of Capital Gains tax issues
  • There are restrictions on loans to shareholders and their associates
  • There are tax issues on eventual wind up

Companies can be useful to cap your tax rate at 30% however, you need to explore all of the other options that are available to you before using a company.

So what do we recommend?

Where there is a single family e.g. Mum and Dad and maybe a son or daughter we would suggest that the business be conducted in single family discretionary trust with a separate corporate trustee.

Family Discretionary Trusts

A trust estate is a way in which to own an asset.  This asset can be a business, an investment or a property.

In a trust structure the assets of the family are held by the trustee on behalf of the trust beneficiaries or family members.  The trustee is responsible for the day to day activities of the trust.  This involves making decisions about the assets and the undertakings of the trust business or investments.  The trustee does this on behalf of the trust beneficiaries, who are the people or family members that benefit from the income and assets of the trust estate.

A typical family trust structure appears as follows:

The Key Elements of a Family Trust

The Key Elements of a Family Trust

All trusts have a “trust deed” or book of rules like a company constitution that determines what the trustee can and can’t do and how the various participants e.g. the trustee and the beneficiaries should behave.

The trust deed nominates a person called the “appointor” whose role is to ensure that the trustee acts in the best interests of the beneficiaries.  This person is the ultimate controller of the trust as they can remove the trustee and appoint a new trustee in the event that the old trustee is not acting in the best interests of the beneficiaries.

This feature of trusts is very useful when it comes to succession, asset protection and estate planning.

Features and Issues

Unlike individuals, joint ownership and companies, where the assets are owned directly by the person or entity, trusts are different.  In a trust structure the assets are owned by a third party (e.g. a person or entity) independent from the beneficial owners.

This feature of an independent trustee provides a range of advantages for families in that the assets can be owned on behalf of the whole family as opposed to specific individuals.  In a family discretionary trust individual beneficiaries only end up owning assets directly when the trustee of the trust exercises their discretion to distribute income or assets to a specified beneficiary.

In most discretionary trust deeds there is a wide range of potential beneficiaries.  The first class of beneficiaries are called Primary Beneficiaries – usually Mum and Dad or the principals of the business.  The second class of beneficiaries are called secondary beneficiaries which include – Mum and Dad’s children, their spouses, their grandchildren, etc.  However, it can also include parents, brothers, sisters, nieces, nephews, eligible companies and trusts. All trust deeds are different and you need to review each deed to identify eligible beneficiaries.

None of these potential beneficiaries are entitled to any assets or income of the trust estate until the trustee exercises their discretion, as specified in the deed, to a nominated beneficiary.  This provides great flexibility in relation to asset ownership, dealing with trust income and asset protection.  For instance, a son and daughter-in-law can join the family business and enjoy a share of business profits without actually owning anything directly.

This is very different when compared with a partnership where a new partner obtains direct access and a share of the family assets, or a company where the new partner ends up owning a direct share in the family company.  In this type of structure family members can come and go as they wish.

Another important feature of a trust structure, when it comes to succession planning, is the ability to commence handing over day to day control to the next generation without losing control.

For instance Mum and Dad can hand over the control of the trustee to their daughter and son in law.  Mum & Dad would remain as the trust’s appointors.  The daughter and son in law run the farm and distribute the annual profits to themselves.  In the event of a marriage break down Mum and Dad can exercise their discretion as appointors and remove the current trustees (the children) and appoint a replacement trustee.  By doing this they can protect the underlying business assets of the family.

Care needs to be exercised in this process as the family law court has wide powers in relation to trusts.  From our experience however, provided the assets belong to the wider family and not to specific individuals, this form of asset protection works well.  If the daughter and or son in law are sole appointors then they may be considered as controllers of the trust and the assets of the trust would fall into their marital assets.  Loan accounts or unpaid present entitlements in the trust always belong to the specific beneficiary and will be a personal asset of these people.

Trusts also provide a very valuable form of asset protection.  In the event that someone has a business that is subject to a degree of risk or financial exposure, it is best the business is conducted via their family trust.  In the event that the business fails, it is the trustee that is liable for the loss.  The trustee is indemnified out of the assets of the trust, (they can sell up the assets of the trust) to fund the short fall.  Once these funds are exhausted the trustee is personally liable.  If the trustee is a $2 company then there are no more assets.  None of the beneficiaries of the trusts are liable and their individual separate assets are protected. The same applies to the directors and shareholders of the trustee company who are protected by limited liability.

Hence the reason why we don’t recommend that people be individual trustees of their trusts.  This is especially true if the individuals operate a farm business in their own name or a partnership of individuals.

Business Ownership

Trusts can own specific assets or conduct a business.  Where there is a business such as a farm that can be subject to business and financial risk we recommend that the business is conducted in a trust with a separate corporate trustee from the other asset owning trusts with a second separate corporate trustee.

For example:

Figure 2. Business Ownership

You will note that often we recommend more than one asset owning trust.  In fact each separate asset, provided they are not closely connected, should be owned in a separate trust to assist with succession and estate planning.  The main reason is the flexibility of being able to hand over the control over these asset owning trusts to various family members as a part of the family succession at various times and at death.

Partnership of Trusts

In a situation where you have a multi sibling family of say two or three children and their families, and if it is likely that the business will eventually divide into two or more separate units, we would recommend a partnership of two or three discretionary family trusts as follows: -

Figure 3. Partnership of Trusts

Alternatively if you believe a division in the family business is going to occur sooner rather than later you may create your new partnership with two new Corporate Trustees of the two new trusts:

Figure 4. Partnership of Two Trustees

Control over Trusts

In normal circumstances we would suggest that the parents be the appointors of these new trusts along with each respective son or daughter e.g. the appointors for Trust (1) would be – Mum, Dad & child and the same for the other trust, all to act jointly. This provides both generations with a degree of control.

Alternatively the family may be happy for some other arrangement.  We leave these decisions up to the client.  In some cases for asset protection the power of appointment and ultimate control remains with Mum and Dad until they are ready to hand over the control.  This is important in the event that one of the family marriages is unstable.

Business Restructuring

So how, given the market value rules in the Income Tax Assessment Act and the State Stamp Duty provisions can you restructure from your existing entity, say a partnership of four individuals, into a new structure?

This is done via the establishment of what we call an interim partnership between the old entity (the partnership entity of Mum and Dad) and the new entity (the partnership of the children).

Division 40-340(3) and Subdivision 328-D of the ITAA (1997) says that, provided the transferor and the transferee elect for rollover relief to apply and the restructure involves family members with no consideration, the depreciating assets can be transferred from one entity to another via an interim partnership at tax written down value.

Division 70-100 of the ITAA (1997) follows along a similar line where it states provided the original owner of the livestock owns at least 25% or more of the asset after the transfer then trading stock can be transferred at tax written down value.  In the 1997 rewrite of the Tax Act trading stock includes operating assets such as growing crops.

Note the real key to this type of restructuring, whether it is from a single entity to another single entity, is the creation of a partnership. It is only with the creation of a partnership that these provisions work.

Care needs to be taken with Stamp Duty to ensure that your transactions do not attract unwanted tax liabilities.  You will need to consult with an appropriately qualified professional in this regard.

So what benefits will you achieve by restructuring in this fashion?

The family will be eligible for a wide range of benefits that they currently don’t enjoy.

These include: - 

(1)           Solutions to their current and future succession issues

As the family will be farming in a partnership of family trusts when they decide to split, they need to decide on who is going to take what assets and what cash adjustment needs to be made.  They then simply sign Income tax elections for plant, equipment and stock and go their separate ways.

It is as simple as that.

(2)           The use of a corporate trustee and the two trusts operating separately from the family individuals and other asset owning structures in the family will provide valuable asset protection.

(3)           As each family will have their own trust and eventually their own trustee company, they will also benefit from a succession and asset protection point of view when it comes to handing over control and ownership of the farm business to their children in an orderly controlled and protected fashion. 

(4)           As each family’s trust will effectively be a clone of each other the family will have complete legal ability to stream income throughout the family group.  

(5)           The use of a corporate trustee provides for an opportunity for family members to have an employer.  This can provide a range of benefits if needed. 

Individual partners cannot employ themselves. 

(6)           A little known benefit of trading in primary production trusts is the ability of older members of the family to own farm management deposits. 

             Currently to be an FMD depositor you need to be engaged in primary production.

             In the event that you implement a Farm Management Deposit Strategy (and we would strongly recommend that the family does) and the parents retire from a partnership of individuals  they would need to withdraw their FMDs as they are no longer primary producers.  If however they are eligible beneficiaries of a primary production trust, they can retain the FMD’s until they die.  As a result this can provide excellent tax planning opportunities for the family.

What’s more, by progressively drawing the FMD’s down in their retirement, they can redeem the FMD’s without paying excessive tax.  This is possible by utilising the increased tax free threshold (despite them being on averaging) and utilising a range of retiree tax offsets.  The net result is the family gets to keep the original tax benefit enjoyed at the time the initial deposits were made. 

(7)           In addition to this the ability of streaming primary production to other family members provides the opportunity of distributing income to wives, partners and children who in turn, provided they are over age of 18 can also use FMD’s etc.

Note:       Their non primary production has to be less than $65 000 in the year of deposit.

We trust you can see that trust structures go a long way to assisting farmers in addressing a range of their succession issues.

Asset Owning Structures

Where land is held in people’s own names or as joint tenants there are issues that need to be addressed if the family wishes to transfer land to the next generation.  There are two issues involved with transferring parcels of land between individuals and entities e.g. trusts and SMSF’s, when it comes to family succession.  The first is stamp duty and the second is capital gains tax.

From a stamp duty point of view each State provides certain relief for the transfer of farming land within family groups.  These provisions, especially in relation to trusts and companies, are complex and considerable care needs to be taken when interpreting how these provisions apply to your family.  Seek professional advice.

From a capital gains tax (CGT) point of view all land acquired after the 19th of September 1985 will be subject to the effects of capital gains tax on any increase in value of that land.

e.g.

Capital Gain is the difference between: -

             Current Market Value                                                     $XXXX

             Less: Original purchase or transfer value                            ($XX)

             Gross Capital Gain                                                            $XX

Provided the asset is not owned by a company this gross gain can be reduced by the 50% general discount, to half - $X.  Tax is payable on this amount at the tax payers marginal rate or average rate of tax, despite no consideration being paid.

In the event that you qualify as a Small Business Taxpayers then you may be able to apply a number of further CGT concessions such as:

  • 15 year exemption – where the land has been owned and farmed in excess of 15 years - 100% of the capital gain is exempt provided the tax payer retires,
  • Further 50%, capital gain discount.
  • Rollover to a new active asset with a two year period – delaying the capital gain, or;
  • Rollover to an eligible superannuation fund where 100% of the capital gain is exempt.

Obviously these concessions are very valuable if you qualify.

To qualify as a small business tax payer your:

  • Net combined asset value needs to be less than $6 000 000, or;
  • Gross farm income needs to be less than $2 000 000.

Note:  Complex rules apply to family trusts and companies.

In the event that you don’t qualify as a small business taxpayer you can always consider restructuring with some formal planning to see if you can comply in the future.

Purpose

The main reasons to operate your trading entity in a family trust and own assets in family trusts is for:

  • Succession, estate and retirement  planning
  • Asset Protection
  • Taxation management

(2)       Appropriate finance facilities

These need to be flexible so you can pay off the debt and redraw the balance.

Figure 5.

Purpose:

  • Provide  flexible financing for operations
  • pProvide flexible funding for FMDs
  • Provide flexible funding for retirement and succession
  • Provide flexibility when required to acquire assets at short notice
  • 30th June tax planning cash flow

(3)       Build up farm management deposits – as a risk management strategy

Figure 6.

There is a real problem in Australia, in that a vast majority of the farming population and accountants don’t really understand what these products are or how you can use them in a family farming business!

So what are they?

Schedule 2G – Division 393 of the Income Tax assessment act states, FMDs are: -

(1)           A term deposit – which pays interest; 

(2)           For which for a primary producer e.g. Farmer or Fisherman, gets a tax deduction for 100% of the amount provided the deposit if left on deposit for a period of 12 months and that their non primary production income does not exceed $65 000 in the year of deposit. 

(3)           Thereafter when the deposit is redeemed the funds come back into the individual’s personal tax return as assessable income. 

(4)           The maximum deposit per person is $400 000. 

(5)           You can have FMDs in different bank institutions; and

(6)           You are actively engaged in primary production or an entity that engages in primary production.

 

So why do people use farm management deposits?

In the first instance they are useful in managing individual’s income tax and this is where a lot of farmers and their advisers leave this strategy.  This is unfortunate!  I always hear people say: “We don’t like using FMDs.  They save us tax in high income years and all that happens is that we pay the tax in a later year when we withdraw them.”  This is a very one dimensional view and I can understand why these people don’t favour FMDs.  Unfortunately their experience and understanding is limited to tax.

Our view of FMDs is much broader.  The opportunities that these deposits can provide and the benefits of utilising these tools strategically in your business can be incredible and are really only limited by imagination.  We see FMDs as much more than just a means of reducing tax in high income years.  We see them as an essential wealth creation and risk management tool absolutely essential in any farm business.

Once we introduced this strategy to our clients not only did it save them tax initially we noticed another interesting phenomenon and this is demonstrated in the figure below.

Figure 7.

Benefits of an FMD Strategy

(1)           Positive cash flow strategy

Provided your FMDs have been on deposit in excess of 12 months (unless you are drought declared) you can withdraw your FMDs.  They become assessable income to the individual depositor.  In the event that the FMD is redeposited before the end of the final year, the redeposit offsets the initial withdrawal and the net result is nil.

e.g.

Figure 8. FMDs Positive Financing

The advantage of this is that the equity you have tied up in your FMDs can be used to assist with annual cash flow financing during the year e.g. reducing your overdraft.  Care needs to be taken when doing this as any new deposits have to remain on deposit for a further 12 month period.  As a result we recommend that people only withdraw 50% of their balance so they have access to other 50% for additional funding if required.  Other issues can include PAYG instalments, etc.

(2)         This leads us on to our next strategy and that is obtaining further tax benefits over time.

Figure 9. FMDs Shuffle - keeping the deduction moving forward.

By doing this people can maintain their reduced tax status for years to come.

Now that we have put some of the issues to bed in relation to “establishing an FMD strategy” how can these tools be used in addition to just saving tax.

(3)           Little risk and less tax to pay

The first significant benefit of an FMD is that it provides financial insurance.  It can always be withdrawn and used to repay the loan finance used to fund it originally.  The money is always there, so there is little risk.

All that happens is:

  • You end up paying the tax you would have anyway.  Furthermore due to the loss of purchasing power of money over time e.g. inflation the value of this delayed tax is less
  • Also as a result of utilising your FMD Strategy your primary production average is less, so you enjoy a greater averaging rebate on withdrawal, which is another form of tax reduction provided to primary producers that is rarely used to its full potential especially in large family groups.
(4)       Financial Risk Management

The next major benefit of FMDs financial insurance is that it can assist and take the heat out of future financial decisions.

For instance if you have $1 000 000 in FMDs, your overdraft is still $500 000 and a property purchase comes up you can borrow $1 500 000 to purchase the property with the knowledge that you always have your $1 000 000 of FMDs up your sleeve to assist you with paying interest and if need be principal payments if this business is unable to meet these commitments, at any time in the future.

This is very powerful and can apply to the acquisition of all sorts of assets e.g. off farm property, more farms etc.

(5)           Provision for commitment in the future

Another benefit of FMDs is they can act as what we call a sinking fund or provision for an outlay at some time in the future.

For instance the family want to start providing over time for the eventual retirement of Mum and Dad.  To do this they would like to deposit cash into a superannuation fund.  However, once the money is in the superannuation fund it is unavailable to the business.  The first step is to use a FMD.

e.g.

Figure 10

Once the family is happy with the level of FMDs and they feel they are sustainable, they can then transfer the excess over to the SMSF.  The initial withdrawal amount is subject to tax in the individuals name and is offset as a concessional member contribution to the superannuation fund which is taxed as 15% contributions tax or less in the superannuation fund.

The same principles can apply to building up a cash provision for the acquisition of plant and equipment. 

(5)           Retirement Funding

Another concept people are unaware of is the ability to assist with funding on individual’s retirement outside of super. 

The Income Tax Assessment Act (ITAA) states for people to maintain FMDs they have to be engaged in the business of primary production or be eligible beneficiaries of a trust engaged in primary production. 

Refer Section 393-25 of the ITAA. 

Provided Mum and Dad are eligible beneficiaries of the farm business trust and receive some primary production income from time to time then they are eligible to retain FMDs.  Further to this, due to their age, the increase in the tax free threshold, the mature age worker tax rebate and the low income rebate, etc, they can earn up to $35 000 each and pay little to no tax.  This enables them to wind down their primary production average and withdraw their FMD’s each year tax free to assist in funding their retirement.  The net result is the tax benefit that was saved in their original deposit is always maintained. 

(6)           Financial Insurance with Plant & Equipment Replacement

The next strategy relates to using FMDs to assist with acquiring replacement and upgrade plant and equipment:

Let’s look at an example: -

A farmer decides that they are going to spend $150 000 on a tractor.  If they were to pay cash for this acquisition, at an average tax rate of 25% they would need to earn $200 000 and pay tax of $50 000 to leave them with the $150 000 to acquire the tractor.  In this scenario they would be up for the $50 000 tax about nine months after the acquisition.  After the tractor purchase they are be able to use the tractor in their business and claim tax depreciation on the original cost of the tractor at say 20% per annum. 

Alternatively the farmer, provided they are eligible, could deposit $150 000 into a farm management deposit.  No tax is payable on the $150 000 which is now treated as a full tax deduction.  At a tax rate of 25% this would reduce the annual tax bill by $37 500.  The farmer would then take out a chattel mortgage loan to acquire the tractor.  Payments on this item of equipment over a 5 year period payment in advance at a rate of 8% would be $34 785 per annum.  In each payment the farmer claims interest and depreciation on the payment.

At any point of time in the future when the farmer encounters a poor year $35 000 of the FMDs could be redeemed to meet the annual payment.  Tax is payable on these redemptions however in the event that it’s a poor year this tax would be less than in the year of initial acquisition. 

The overall outcome of this strategy as opposed to a straight out acquisition is obvious.  In the first scenario the farm has incurred a tax liability of $50 000 along with acquiring a depreciating asset.  In the second scenario the farm has still acquired the machine, there has been an immediate reduction in annual tax liability of $37 500.  This is an excellent turn around in tax and money has been put aside to ensure the machinery payments can always be met in the future.  A low risk strategy.  Furthermore the interest earned on the $150 000 deposit, say $6 000, can be used to offset the chattle mortgage interest on the equipment loan. 

(7)           Unforeseen Events

What’s more the FMDs can be used as a form of financial insurance in relation to other unforeseen events on the farm.  It’s always good to be able to access finance without having to borrow it from a bank. 

The take home message is that farmers need to understand that cash is very important when it comes to risk management and income tax planning.  Do not waste that cash on investing in assets that depreciate in value. Use other people’s money and match the cost, with the value that the asset provides to your business. At the same time do not spend the cash, place it aside as a provision for poor years.  FMDs provide this opportunity. 

Furthermore when it comes to acquiring and funding the purchase of replacement and upgrade plant and equipment, FMDs are essential.  None of our farmers have equipment finance without first ensuring they have back up FMD strategy in place. 

One of the issues we don’t understand is that there are a lot of primary producers out there that do not have maximum FMDs, they pay excessive amounts of tax and have huge exposures to equipment finance.  Where were these people when they were handing this advice out?  Hiding behind the door?  If you are in this position you really need to revisit this strategy because you are missing out on a significant benefit. 

Purpose of an FMD Strategy

  • Delay tax on income to future years
  • Valuable form of financial insurance to cover equipment purchases
  • Provide flexible funding for operations
  • To act as a sinking fund to provide emergency funding for unforseen events and planned events e.g. retirement funding , succession etc
  • An essential risk management tool.  

(4)       Business analysis – understanding the cash flow of your business 

Balance of Funds – “One of the Wonders of Life.”

Every business manager needs to understand that outflows of funds need to be matched by inflows of funds. 

This concept was first identified by Luca Pacioli in the year 1400 who was a great friend of Leonardo da Vinci, and is the basis of double entry book keeping, still to this day. 

Outflows of Funds

 

(1)       Drawings

 

(2)       Production Inputs

 

(3)       Financial commitments

 

(4)       Repayment of debt

 

(5)       Purchase Plant & Equipment, and

 

(6)       Purchase new assets and investments

 

 

 

 

 

$1

 

$1

 

$1

 

$1

 

$1

 

$1

 

 

 

 

=

Inflows of Funds

 

(1)      Business Profits & Salary

 

(2)      Investment Returns

 

(3)      Government Support

 

(4)      Insurance Payments

 

(5)      Sale of Assets, and

 

(6)      Borrowings

 

 

 

 

$1

 

$1

 

$1

 

$1

 

$1

 

$1

TOTAL OUTFLOWS REQUIRED

$6

=

TOTAL INFLOWS REQUIRED

$6

Unfortunately where people and businesses get into trouble is where their outflows of funds exceed their inflows, or as Charles Dickens in his 1850 novel “David Copperfield” Mr Micauber states:  

“Annual income twenty pounds (£20.00), annual expenditure nineteen pounds, nineteen shillings and six pence (£19.975), result

                                                                            happiness!

Annual income twenty pounds (£20), annual expenditure twenty pounds ought and six (£20.025), result

                                                                                        misery!”

In Mr Micauber’s  day failure to pay your debts resulted in you being locked up in a debtors prison. In Australia today things are better.  People are supported by the Government and it is only in situations where there has been fraudulent activity that people end up in prison.

Many people however can empathise with Mr Micauber’s position. 

The key to all of this is:

                                                                                        Balance!

Not only making sure that peoples outflows are balanced by their inflows but also ensuring the various components of the equation are in balance.

For instance, leaving everything else constant, excess drawings can be funded by an increase in borrowings. 

Outflows of Funds

 

(1)      Drawings

 

(2)      Production Inputs

 

(3)      Financial commitments

 

(4)      Repayment of debt

 

(5)      Purchase Plant & Equipment

 

(6)      Purchase new assets and investments

 

 

 

$4

 

$1

 

$1

 

$1

 

$1

 

$1

 

 

 

 

=

Inflows of Funds

 

(1)       Business Profits & Salary

 

(2)       Investment Returns

 

(3)       Government Support

 

(4)       Insurance Payments

 

(5)       Sale of Assets

 

(6)       Borrowings

 

 

 

 

 

$1

 

$1

 

$1

 

$1

 

$1

 

$4

TOTAL OUTFLOWS REQUIRED

$9

=

 

TOTAL INFLOWS REQUIRED

$9

The same thing could be said about excessive plant and equipment purchases funded by borrowings:  

Outflows of Funds

 

(1)      Drawings

 

(2)      Production Inputs

 

(3)      Financial commitments

 

(4)      Repayment of debt

 

(5)      Purchase Plant & Equipment

 

(6)      Purchase new assets and investments

 

 

 

 

$1

 

$1

 

$1

 

$1

 

$4

 

$1

 

 

 

 

=

Inflows of Funds

 

(1)      Business Profits & Salary

 

(2)      Investment Returns

 

(3)      Government Support

 

(4)      Insurance Payments

 

(5)      Sale of Assets

 

(6)      Borrowings

 

 

 

 

 

$1

 

$1

 

$1

 

$1

 

$1

 

$4

TOTAL OUTFLOWS REQUIRED

$9

=

TOTAL INFLOWS REQUIRED

$9

Also where business’ losses are covered by increased borrowings: - 

Outflows of Funds

 

(1)      Drawings

 

(2)      Production Inputs

 

(3)      Financial commitments

 

(4)      Repayment of debt

 

(5)      Purchase Plant & Equipment

 

(6)      Purchase new assets and investments

 

 

 

 

$1

 

$1

 

$1

 

$1

 

$1

 

$1

=

Inflows of Funds

 

(1)      Business Profits or Salary

 

(2)      Investment Returns

 

(3)      Government Support

 

(4)      Insurance Payments

 

(5)      Sale of Assets

 

(6)      Borrowings

 

 

 

 

 

($2)

 

$1

 

$1

 

$1

 

$1

 

$4

TOTAL OUTFLOWS REQUIRED

$6

=

TOTAL INFLOWS REQUIRED

$6

As you can see for most people who work for a wage and either pay rent or are paying off a mortgage the equation is quite simple. 

For business people, especially farmers, the equation is much more complex and there is much more that needs to be balanced to maintain a sustainable and viable equilibrium.  It is very easy for farmers to acquire plant and equipment or fund excess drawings by borrowing secured on the value of their farm land assets. 

So how do you work out what your flow of funds is?

Well the first thing you need to do is analyse and assess what your current and historical flow of funds has been.  This includes both outflows and inflows.  Although there is always a danger of concentrating too much on the past, when it comes to managing a dynamic ever changing future, one needs to have a starting point and sound understanding of where they come from before they can make any useful change. 

Unfortunately when it comes to farmers much of the information you require to manage your business is not readily available, or is not presented in an appropriate format, to enable you to assess your position and make meaningful informed decisions.  To be quite frank “accounting and financial reporting” for farmers in Australia at the current time is appalling from a management accounting point of view. 

The main financial reports – prepared for the period 1st July to 30th June are prepared for no other purpose other than for taxation.  Although an accurate report in relation to the inflows and outflows for that period, they do not provide you with any real management information and are especially not presented in a way for the farm business manager to determine and monitor their individual flow of funds throughout the reporting period. 

Further to this there is considerable evidence to suggest farmers do not use these financial statements for this financial management purpose.  In fact it’s our opinion, that if it were not for the fact that these businesses are required to prepare and lodge annual tax returns, very few farmers would pay to have this work performed for them on a regular basis. 

If you are not in a position to determine and assess what your current and historical flow of funds are, then you need to employ someone to calculate this for you from your historical financial statements.  This could be your accountant or farm consultant.  This is particularly important, as we believe many primary producers are funding much of their operations and expenditures out of increased borrowings, under pinned by increasing land values, as opposed to business profits. 

On face value everything appears to be fine in the short term.  All of their outflows are being met and commitments being serviced.  From a long term perspective however, these people are eroding their net equity.  Eventually land values stop increasing or the servicing commitment e.g. interest on their increased borrowings can no longer be met from either increased borrowings or funds from operations.  At this point in time the only solution is to sell assets which in turn destroy the long term viability of the family farming unit.  Is your business in danger of falling into this position?

Purpose of this Strategy
  • Having a sound understanding of your current flow of funds enables you to make controlled decisions to avoid undue financial risk
  • Avoid erosion of your capitalEnsure the long term viability and sustainability of you family farm operation

(5)       Development of an equipment and finance strategy

This has probably been one of the most significant areas that has created financial stress for primary producers in the last 20 years. 

No doubt machinery is essential in doing what you do.  However it comes at a cost.  What farmers need to do is prepare a long term equipment replacement and upgrade policy and budget. 

Developing the Capital Budget 

The first step is undertake an analysis of your major plant and equipment assessing things like:

  • Current Market Value
  • Age & Condition
  • When you think the plant needs to be replaced  

Once you have determined your requirements over the next 8-10 years you need to attribute an estimate of the likely cost of replacing this equipment. 

You then need to work out how you intend to finance these acquisitions.  Are you going to use your own cash, are you going to finance the acquisition, or are you going to use a combination?  The key is to try and keep your annual cash cost to a minimum and to keep the outlay consistent overtime.  Avoid spikes in purchases at all costs. 

It’s all about balance and keeping the annual cost of operations as low as possible while increasing the quality and efficiency of your plant and equipment you use in your business over time.  The annual cash outlay should be monitored in terms of $ per tonne of grain produced, $ per hectare or as a percentage of a gross enterprise revenue e.g. less than 10%.  These are good rule of thumb indicators to monitor your outlays. 

The final step is preparing a projected capital expenditure cash flow budget for the next ten years, detailing annual cash flow commitments to ensure outlays on equipment replacement and up grade are sustainable and viable in the long term. Total annual cash flow outlays should remain within your risk margin indicators e.g. $50/hectare, less than 10% of your gross enterprise income, etc.

Purpose of the Strategy
  • Ensure plant and equipment upgrade and replacement is done in a planned and organised approach to increase production efficiency and reduce production risk
  • Reduce , over time , the annual cost of equipment replacement and up grade Even out annual cash flow commitments , and in turn Reduce the financial risks involved with machinery replacement and up grade  
(6)       Establishment of a Self Managed Super Fund (SMSF)

Although called Self Managed Superannuation Funds (SMSF’s) they are rarely self managed due to the complexity of their administration.  You need an accountant an independent auditor and a financial planner to assist you in their annual administration.  This comes at a cost.  Cost for annual financial statements and tax return preparation, cost for compliance documentation and minutes, cost for audit and cost for financial advice.  As a result of these annual expenses it is generally not worth setting one of these up until there is at least $200,000 in the fund.  As the fund grows the costs decrease in proportion to level of investments under management. 

What are Family Superannuation Funds?

Family superannuation funds, contrary to belief are not investments.  They are structures in which to hold assets to fund your retirement, provide for a death benefit on your death and provide insurance benefits in the event that you suffer an accident, illness or death. 

As a structure they appear very much like a family trust or deceased estate. 

e.g.

Figure 11. Family Superannuation Funds

It is what the Trustee of the Superannuation fund invests its money in, that are the investments.  The Trustees who are the same people as the members (a requirement for SMSF’s) have a wide discretion as to what they can invest in and this is why they are called Self Managed. 

Trustees are required to draw up an investment strategy to take into account: -

  • Goals of the fund
  • Investment diversification
  • Planned investment earnings
  • Risk management, etc

In effect Trustees can invest in a wide range of assets e.g.

  • Cash,
  • Equities – Australian and International
  • Business real property,
  • Residential rental property
  • Other eligible assets.

When it comes to the administration of the fund the SIS Act and regulations stipulates specific rules for what Trustees can and can’t do.

Some of the main rules and regulations include:

  • The sole purpose test
  • The in-house asset test
  • Prohibition on loans to members or associates
  • Along with a range of other requirements

In reality what the Trustees and their members can do is generally fairly wide and provided the main aim is to provide for the retirement, insurance and death benefits of its members then you are ok.  The key to a good flexible Family Superannuation fund is its “trust deed.”

This is the governing rules of the fund and it is this document that determines in line with the Tax Act and SIS Act what can and can’t happen.  We recommend that people get a good deed with a Corporate Trustee and they ensure the deed is regularly updated.  We also recommend that people obtain appropriate advice from a qualified adviser.

What are the advantages of setting up a family superannuation fund?

A well-constructed SMSF can:

  • Provide a separate pool of investments or assets to independently fund your retirement, provide insurance benefits and to provide for a death benefit on the death of the member.
  • They can also provide valuable tax concessions as follows: -  

    -     People can obtain a tax deduction for making an eligible contribution to the fund.  These are limited by contribution caps as follows: -

 

Concessional Contributions

(Tax deductible)

$   25 000 p.a.

Subject to 15% Contributions Tax

 

 

 

Non Concessional Contributions

(No Tax Benefit)

$   150 000 p.a.

No Tax

Or for people under Age 65

$   450 000

For a 3 year period  – No tax

 

 

 

In the event the taxpayer qualifies as a small business tax payer the following additional contributions can be made: - 

 

15 Year SMB CGT Rollover

$1 315 000 per person

Life Time Limit – No Tax

 

 

 

SMB Retirement CGT Rollover

$   500 000 per person

Life Time Limit – No Tax

 

 

 

    -    The income in the fund is concessionally taxed at a rate of 15% or less. 

    -    When a member elects to take a pension in the income on those assets that fund the pension payments becomes tax free 0%. 

    -    If the member is aged between age 55 – 59 the pension is taxed at their marginal rate however they obtain a 15% pension rebate. 

    -    Once you are over age 60 the pension is tax free and is not included in your assessable income. It is now is included in the pensioner’s adjusted taxable income for Centrelink purposes and eligibility for the Self Funded retiree’s health care card.  This cuts out at $80 000 per couple. 

  • Superannuation funds can be used effectively in the process of business succession.  

When an agreement is made that the family will contribute $xx amount of dollars to the fund and once an amount is arrived at, Mum & Dad sign over the farm to the next generation. 

Alternatively we use the superannuation fund as a tax effective structure in which to accumulate wealth for the provision of non farming children in the overall estate planning and business succession point of view. 

  • Superannuation funds can be used to pay income replacement stream and insurance benefits.  

These can either be self-funded by the superannuation fund or the Trustee can own separate insurance policies in the super fund to fund member’s benefits.  This is particularly important for people with young children or people who are conducting business.  The advantage of this is that the premium for the Life, TPD & income replacement insurance cover can become tax deductible. 

  • Superannuation funds are also very useful as a funding mechanism for the farm. Families can use the superannuation fund to replace the bank and we have a good example of how this can work shortly.  
  • Superannuation funds are also very important when it comes to estate planning.  

The use of binding and non-binding death benefit nominations and SMSF wills is a great way for people to structure and manage their estate.  As a SMSF is a trust, it falls outside the Estate law provisions and as a result cannot be contested, if the trust deed and compliance documentation is correct.

Let’s look at some examples of how Family Superannuation Funds can be used in a primary production setting. 

(1)          Build-up of off farm savings to pay for retirement of the older members of the family.

Build-up of Retirement Funds

Figure 12. Build-up of Retirement Funds

(2)          Acquiring and leasing business real property

Figure 13.

(3)          Limited recourse borrowing arrangement (LRBA)

An LBRA is an arrangement where an SMSF borrows money to buy an asset (e.g. a property).

Sec 67A of the Superannuation Industry Supervision Act (SIS) stipulates that the asset that is acquired has to be a single acquirable asset. What this means is that there can only be one asset or class of assets. 

Sec 66 of the SIS Act allows trustees and members of an SMSF to acquire business real property from themselves, a related party or an independent party and it also allows the SMSF to lease this land to the member or related party.  

Sec 67A also specifies the asset has to be held in what is termed a Security Holding Trust while the loan remains outstanding.   Holding Trusts are also termed bare trusts because they have only one beneficiary and that is the SMSF.  Once the loan is repaid, the asset is automatically transferred from the holding trust to the SMSF. 

Your Structure Appears as follows: -

Figure 14.

(4)      Obtaining a tax deduction by contributing Assets in specie

Contributions in Specie

Figure 15. Contributions in Specie

(5)      Accessing cash from the fund

Access Cash

Figure 16. Access Cash

(1)           Buying a Farm

Step 1 – The Business Buys the Farm first using bank borrowings

Figure 17. Step 1 - The Business Buys the Farm first using bank borrowings

Step 2 –   Super fund then buys the farm by creeping acquisition (overtime) or outright. Cash release repays the bank.

Figure 18. Step 2 –   Super fund then buys the farm by creeping acquisition (overtime) or outright. Cash release repays the bank.

Step 3 – Business Pays Rent to Superannuation Fund

Figure 19. Step 3 – Business Pays Rent to Superannuation Fund

The benefits of these steps are outstanding:

  • You can increase the level of contributions to the fund

They are now not only limited to:

  • Contributions subject to caps, but also;
  • Lease rentals.

Great for young people wanting to increase their super contributions 

  • The rent is tax deductible to the farm business and is concessionally taxed in the superannuation fund, and this is a great way to fund retiring members of the family:  
  • The farm gets the tax deduction
  • The family superannuation fund receives the rent income
  • As Mum and Dad are on a pension and the fund pays no tax on the income
  • Finally Mum and Dad pay no tax on the pension they receive  

Mum and Dad have a range of options: 

  • They can keep all of rent to pay their pension and daily living expenses
  • They can keep some money in the fund to accumulate funds to provide for other non-farming family members in the future – e.g. even up the estate
  • Or they can draw the full amount tax free – live on some of the money and give some of the money back to the farm  

By doing this:

  • Mum & Dad and the family superannuation fund in effect step in the shoes of the bank
  • The family becomes self-funding
  • Why pay interest to the bank.  Isn’t it better to pay the interest into the family superannuation fund
  • The downside of course of putting a farm into the superannuation fund is that it can’t be used as security for borrowings
  • The upside of course is that it is protected

(7)          Development to off farm assets

These can be:

  • Equities
  • Property
  • Cash – FMD’s
  • Other assets.

Research has shown that the most successful 5% of primary producers all have a disproportionally high level of off farm assets when compared with the average Australian farmer.

Let’s look at some examples of how these assets can benefit a farm operation.

Equity Investments

Example (1)

  • We have had clients in the past that buy shares – Blue Chip – BHP, Wesfarmers, Bank shares etc.
  • Over a period of years by making regular contributions they can build these portfolios up, let’s say $250 000.
  • A bad year comes along or they wish to acquire a tractor for $100 000.

Options: 

  • They sell the shares to buy the asset, and pay CGT, or:
  • They lend against the shares borrowing $100 000 against the $250 000 in equity gearing ratio of 40%.  

The benefits of the second option is that:

  • They get to keep the shares, the dividend income, the tax credits and the future capital growth
  • They avoid the CGT on the sale of the shares, and:
  • They get to use the equity in cash to buy their tractor

I have seen people run farm overdrafts against a share portfolio.  What could be better than to make money, knowing that your shares are earning tax effective income and capital, while you are using the equity in your farm business to grow crops.  If the year fails just sell the shares and pay out the debt.  What have you got to lose?

Example (2)

After building up your share portfolio you can transfer the shares to your family superannuation fund as a tax deduction.

In doing this you:

  • Wash out the CGT with a super deduction
  • Claim the balance of the equity as a tax deduction against current year income, and:
  • You get to keep the shares in a concessionally taxed environment

Property Investments

Example (3)

One of the main issues facing many farm families that wish to hand their farm over to the next generation is retirement housing.  It always seems that retirement housing is left to the last minute.  Why?

All farming businesses should go out and secure a housing loan and buy a rental property.

The rent on the house will assist with repaying the debt and the negative cash flow can be used as a valuable tax deduction.  When the retiring people decide to leave the farm they can move into the property, or sell it and build a new home.  By buying the asset early they have a stake in the housing market which if house values go up, and it always seems to go up, their asset value will go up, so that the changeover figure is less in the future.  Surely this is only common sense for people who know their children will take over running and owning the business in the future.

Purpose of developing off farm assets?

  • Like FMD’s they are a valuable form of financial insurance
  • They provide choice  and flexibility in the future with regard to succession, retirement funding and housing ,  and estate planning
  • They can be structured to reduce tax via negative gearing
  • It’s also another way to use the equity in your property to diversify your income streams and investments to reduce the family farm’s financial risk

(8)          A succession plan

When does succession occur?

The transfer of a person’s control and ownership over business assets can occur in two circumstances:

  • Planned succession as a result of the gradual or complete retirement of one of the main principals or key family members from the family business, and:
  • Unplanned succession as a result of illness, injury, accident or death of one of the main principals or key family members.

Every family has to have a contingency plan for unplanned succession along with a flexible forward plan for planned succession.

This plan should cover:

  • How you intend to hand over control
  • When is this likely and what’s going to trigger this
  • To what extent is control handed over
  • To whom is the asset going to be handed to
  • How are you going to protect the family wealth?
  • How is this going to affect your Estate Plans?

The relationship between succession planning and estate planning

There is a very close relationship between succession planning and estate planning.  Often when people are developing their succession plans they are also organising their estate plans at the same time.  Both involve the transfer of equity or control over equity from one person to another.  The only difference really is that succession planning occurs while you are alive and estate planning involves dealing with your assets and control over those assets when you die.  A good succession plan will incorporate your estate plans.

To implement a successful succession plan for the family you need:

  • Family trusts to operate the business  and to hold assets,
  • a family superannuation fund
  • Insurance
  • A carefully structured family succession agreement

Purpose of this Strategy

  • Protect all of the family in the event of a major trauma, accident or death
  • Provide for debt reduction to reduce financial risk
  • Provide a process and funding mechanism for equity payouts
  • Provide for the insured’s personal family
  • Provide certainty for the family in the future

(9)          Estate plans

Everyone needs to have an estate plan to ensure that their wishes are adhered to when they die or they become permanently and intellectually disabled, and that their beneficiaries are not subject to excess State and Federal Taxes.

The main elements in an estate plan are:

  • Your will – which should incorporate testamentary trusts
  • Your enduring power of attorney
  • Your enduring powers of guardianship

The purpose of an estate plan is to provide certainty for your family in the future.

Wills

All family members need Wills to deal with their assets and control over assets on death.  In some cases Wills should contain provisions to create a testamentary trust(s) in which to transfer assets which they own in their own names to their children.

Testamentary trusts are trust estates created on a person’s death in which to hold assets on behalf of their nominated beneficiaries.  Like “in vivo trusts,” or trust estates created while you are alive they are essential for future succession and estate planning and asset protection.

With family members that have minor children their Wills should nominate guardians to act on behalf of these children while they are minors.

In addition to Wills all family members should have what we call “Living Wills.” 

Enduring powers of attorney and guardianship

Enduring powers of attorney are estate documents that enable people to appoint another person(s) (attorney) to act on their behalf in relation to property and financial matters in the event that the person (the donor) suffers a mental or physical incapacity or is unable to do this on their own. 

Enduring powers of guardianship are similar however, in that they relate to the person’s physical body in the event they suffer an accident or illness that renders them mentally incapacitated.

Under normal circumstances husband and wives appoint each other and then two reserves to act jointly in the event the first nominated attorney or guardian are unable to act or unwilling to act.

“In Vivo” Trusts

Ideally when it comes to business interests and business property it is our view people should hold these assets in trust structures like family trusts or superannuation funds.

The directions in these instruments, e.g. who you want the power of appointment over a trust estate (e.g. land) to pass to; will override the directions you leave in your Will.

“Wills” can be contested.  Trust structures cannot be contested and provide much greater certainty to your beneficiaries especially where considerable land holdings are involved.

At the end of the day a good estate plan is a simple one and one that will stand the test of time.

Purpose of the Strategy

  • Ensure that the wishes of each individual are followed in the event of a death or incapacity
  • Provide their family with certainty and security
  • Enable a simple stress free administration of each individual’s estate at a difficult time in people’s lives

Conclusion

The main take home messages from today are:

  • Conserve Cash – don’t spend it - Use FMDs to manage future risks
  • You need all of the nine tools outlined during today’s presentation for you to be able to do your job as a business manager
  • You need to know and you need to learn how to use these tools.  Having them is not good enough. You need advice and training on how to use them
  • Your adviser needs to be qualified and up to date.  They must attend regular training to learn new ideas so they can advise you of new strategies and keep you abreast of what you need to know
  • You need to establish appropriate trading and asset ownership structures.  The preferred option is family trusts. Use the small business capital gains tax concession to restructure
  • You need the right finance facilities.  Not all facilities are the same.  Obtain advice
  • Farm Management Deposits are more than just a means of delaying tax.  They are a vital tool in any family farm business to manage risk and make money
  • Conduct an analysis of your farm figures so you understand your flow of funds.  Where do they come from?  Are you eating into your equity?
  • When it comes to buying equipment develop an equipment purchase capital budget and use finance but structure it properly.  Cost/Ha or Cost/Tonne of grain is more important than interest rates.  Always have FMDs before you borrow to buy equipment.
  • A family super fund is more than an investment.  It is a business structure which you can use in your business to do a wide range of valuable things.  Tax savings, succession retirement and estate planning.
  • Start accumulating off farm assets.  Simply start with a house and take out a normal house loan.
  • You must have assets and income protection insurance for your family, especially for unplanned events.
  • Develop a retirement plan with your succession plan using an SMSF.
  • You must have a succession and estate plan.

Your final business structure should look like this:

Figure 20. Final Business Structure

Contact details

Brian David Wibberley

brianD@wibberleys.com.au