Learn how NZ dairy farmers can reduce tax burdens and manage income highs and lows with the Income Equalisation Scheme—maximised during $10 milk payouts.
How Does Income Equalisation Work in New Zealand? A Guide for Dairy Farmers
Income fluctuations are part of life for dairy farmers in New Zealand. Milk prices, weather, and demand can lead to years of high incomes followed by years of lower incomes. While these fluctuations are normal parts of a farmer’s life, they complicate financial planning and tax obligations.
That’s where New Zealand’s Income Equalisation Scheme comes in—a financial tool designed to help farmers balance their income over the years. This guide will explain how income equalisation works, its benefits, and why dairy farmers should consider it.
What is the Income Equalisation Scheme?
The Income Equalisation Scheme is a tax mechanism that allows farmers and other eligible agricultural businesses to “deposit” some of their income from profitable years into a special account with Inland Revenue. This deposit is tax-deductible for that year, effectively reducing the taxable income.
When the funds are withdrawn, they are treated as taxable income for that year. The scheme allows farmers to transfer income between different tax years, helping level out taxable income.
Here’s a simple breakdown of how it works:
1. Deposit Income: Farmers deposit into their Income Equalisation account during high earning years.
2. Receive a Deduction: The deposit is tax-deductible in the year it’s made, lowering taxable income for the year.
3. Withdraw Funds: Withdrawals from the account at a later date are treated as taxable income.
It’s important to note that deposits must usually be left in the account for at least 12 months unless Inland Revenue approves early withdrawal under certain circumstances (e.g., planned development work or financial hardship).
Why Dairy Farmers Should Consider Income Equalisation
1. Smoothing Out Fluctuations
For all dairy farmers, income will spike in years of high milk payouts, these peaks are often followed by years of lower earnings. Farmers can manage these fluctuations through income equalisation by deferring income from peak years to offset leaner ones.
For instance, consider a year with a $10 payout for milk solids—this might result in significantly higher income. Instead of paying a large tax bill for one profitable year, income equalisation allows you to spread that income into lower-earning years, reducing tax liabilities overall.
2. Tax Efficiency
A deposit into income equalisation will reduce the taxable income for that year, which may push a farmer into a lower tax bracket. By strategically using the scheme, you could lower the overall amount of tax you pay across multiple years.
Example:
1. Year 1 (High Income): A $250,000 taxable income might place you in a higher tax bracket without income equalisation. By depositing $50,000 into the income equalisation account, you reduce taxable income and potentially shift into a lower bracket.
2. Year 2 (Lower Income): Withdraw the $50,000 when income drops to $100,000, helping balance earnings and keep taxation predictable.
3. Farm Development
Withdrawals from the scheme can also be used to fund farm investments, such as purchasing livestock, infrastructure, or expansion. When combined with the tax benefits, income equalisation is a powerful tool for long-term planning.
4. Preparing for Uncertainty
As we have mentioned before, farming is an unpredictable beast, and having access to cash is key to navigating tough times such as droughts, storms, or market downturns. Income equalisation acts as a financial buffer, ensuring funds are available when they’re needed the most.
How the Scheme Works in Detail
Step 1: Eligibility
You can only use the Income Equalisation Scheme if you:
1. Running a farming or agricultural business in New Zealand.
2. Operate under the proper business structure (individuals, partnerships, trusts, and certain companies are generally eligible).
Step 2: Making a Deposit
Deposits can only be made during or shortly after the tax year. The minimum deposit is $200, and deposits cannot exceed your total net income derived from farming or agriculture in that year.
For example, if a dairy farmer has a peak year with net earnings of $200,000, they could decide to deposit up to this amount into the scheme for that tax year.
Step 3: Withdrawals
Funds in the account must generally stay there for at least 12 months before being withdrawn. However, early withdrawal is possible for specific purposes, such as:
1. Buying or replacing livestock.
2. Undertaking planned development or maintenance work.
3. Avoiding financial hardship.
Farmers may need to provide supporting evidence to the IRD if early withdrawal is requested.
Step 4: Taxation
When withdrawals are made, they are taxable income in the year they are withdrawn. This allows a farmer to maximise tax advantages during years when income would otherwise be lower.
The Potential Impact of a $10 Milk Payout
The $10 milk payout creates a unique opportunity for dairy farmers to maximise the benefits of income equalisation. A record-high payout translates to potential tax liabilities, but depositing part of that income into the scheme can safeguard against paying excessive taxes during the peak year.
For example:
1. Without Income Equalisation, A farmer earning $350,000 during a $10 payout year could face a higher tax burden in that single year.
2. With Income Equalisation: Depositing $100,000 into the scheme could bring taxable income down to $250,000 for the current year and defer the $100,000 to future, lower-income years, creating significant tax savings.
This approach ensures farmers retain more money, which can be reinvested into their farms or set aside.
Tips for Getting Started with Income Equalisation
1. Consult a Tax Advisor
Every farmer’s situation is different. An accountant can help you understand the implications of income equalisation based on your financial position.
2. Plan Ahead
Deposits must be timed carefully based on your balance date and the Inland Revenue deadlines. Speak with your accountant, and they will ensure you get it right!
3. Keep Records
Maintain your records of all deposits and withdrawals. It will make your life easier when applying for early withdrawals or dealing with any IRD questions.
4. Use for Strategic Goals
Using the income equalisation scheme to align with your farm’s long-term goals. Whether it’s expansion, gear upgrades, or succession planning, this tool can help make smart financial moves.
Why Consider Income Equalisation Today?
Income equalisation isn’t just about managing taxes—it’s a tool for gaining control of your farm’s and family’s financial future.
By using the scheme, dairy farmers can smooth out unpredictable earnings, reduce tax burdens, and more confidently reinvest in their farms.
With the $10 payout making headlines, there’s no better time to get strategic about managing your income. Contact your tax advisor or contact Inland Revenue today to explore how income equalisation can work for you and your dairy operation.