For farming clients who are in the process of moving away from the day-to-day farming activities, the question of whether they are still actively farming comes up annually when the ACC invoice arrives.
This tends to affect older clients who may have employed a 50/50 sharemilker, a farm manager or are leasing out their farm. The client is no longer actively farming - they are no longer milking, shearing, doing stock work or the general day to day farm activities. But is their involvement in the business still enough for their income to be subject to ACC premiums?
It can create particularly strong feelings when the taxpayer is a superannuant. They have to pay ACC levies on their business income but will not receive any loss of income compensation from ACC if injured.
ACC considers passive income to be income which continues to generate without there being any need to put in physical exertions or manage the farm on a day-to-day basis.
In short, passive income is income which is not affected by the client’s incapacity.
Legislation requires ACC to consider any income dependent on personal exertions to be liable for ACC levies. Any income generated from either physical or non-physical activity (mental) contributions to the day-to-day running of the business is liable for ACC.
For a farmer that has ceased to do physical day-to-day farm work, the income may still be subject to ACC due to the farmer’s mental exertion involved in the management, administration and planning of the business.
The key issue is the difference between how ACC and many farmers define the active/passive distinction. For many of our farming clients, active farming involvement is seen as hands-on farm work, while the administrative running of the business is perceived to be a passive role.
In reality, the administrative/management role is still active, but could possibly be subject to ACC levies at a lower levy rate.
What is Considered Passive Income?
Whether an ‘ex-farmer’s’ income from the land is considered passive will depend on the specific facts of their situation. What is their involvement in the farm, what contracts exist, and who is operating the farm. There needs to be proof that an individual has no physical or mental involvement in the farming activity to ensure that income is passive.
If farm land is leased out for a long-term period with fixed terms and conditions, and there is no expectation of either management or physical function in managing the lease, then it is likely to be passive income.
However, where the lease is to be renewed periodically with new terms and conditions, and it is required to be regularly monitored, the same activity can come under the scope of active income.
Other factors considered by the ACC as indicators of active/passive involvement:
• Taxpayer’s age (older is more likely passive)
• Residential location (living in town more likely passive)
• Taxpayer’s health (are they physically able to be actively involved)
• Taxpayer’s historical role in the business
What can be problematic is when an older farmer, who receives passive income, helps out on-farm or fills in as relief labour. If the farmer then gets injured, it may raise questions on the legitimacy of the passive nature of previous years’ income.
What To Do
As the financial statements and tax returns are prepared, there is an opportunity to review the client’s situation and their active/passive role in the business. It is easier to ensure that ACC invoices are correct at this stage, rather than after the ACC invoice has been received by the client. As business and taxpayers change, we should review this regularly and keep good file notes.
ACC levy rates need to be reviewed to ensure that the business industry description is appropriate. If the farm owner is no longer actively involved in the day-to-day farming but still has a mental exertion involvement, then the appropriate ACC category could be “holder investor farms and livestock”. For a shareholder employee or self-employed person, the levy rate is $0.77 per $100 dollars versus $2.51 for dairy farming or $2.49 for sheep/beef farming.
Are all individuals actively or passively involved in the business? In some partnerships, one partner may be active and the other passive. If so, only the active person’s income should be subject to ACC.
ACC CoverPlus Extra allows taxpayers the ability to have an agreed level of ACC cover. This can provide those farmers who are still somewhat actively involved in the farming business a minimum level of cover while reducing the ACC levy.
Farming companies have the ability to allocate income via a dividend (passive) rather than shareholder salaries (active). This can be useful when the farming business has greater than usual income from one-off activity such as timber sales, depreciation recovered or sale of livestock. However, the IRD generally expect someone in the business to be deriving an active income at an appropriate fair market value, such as a PAYE or shareholder salary.
For taxpayers with in-fund current accounts or loans to the business, interest on these balances can be charged to the business. This will be passive income to the individuals, but will expose the business to RWT if interest paid exceeds $5,000 per annum. As mentioned above, the IRD will generally require one of the individuals in the business to be deriving active income at an appropriate fair market value.
Correction to ACC Invoices
To get an ACC invoice corrected when passive income is incorrectly returned as active income in a tax return, now requires correspondence with the IRD. Previously, this could be sorted with a phone call to the ACC helpdesk. Now the correction requires written correspondence with the IRD to get the tax return corrected. Once corrected, the IRD will then pass on the amended income details to ACC, who will then issue an amended levy invoice. A call needs to be made to ACC to advise them of the changes to the tax returns to avoid recovery proceeding for the unpaid ACC levies. Clients require us to be actively involved in managing this process.
Reproduced from the Busing Russell Farm Accounting NZ Newsletter