Farm Management Deposits - Are they useful?
The Farm Management Deposit (FMD) Scheme was introduced by the Australian Government, to help farmers manage financial risk associated with cash flow variability by holding cash reserves. The scheme allows eligible farmers to set aside pre-tax primary production income in years of high income and redraw the cash in years of low income to meet business costs.
The scheme effectively has two components:
Holding cash reserves to manage cash flow
Tax minimisation benefit
It appears that too often the tax minimisation benefit of making an FMD is the only aspect of the scheme that is considered. Before making a Farm Management Deposit, it is important that the objective of the deposit is understood, to ensure that it is effectively addressing the specific situation. This involves discussion with the client's Accountant and RMS consultant together, plus calculation of the cash flow and taxation position of the business, to assess the appropriateness of an FMD. This should occur well before the end of June, to avoid making rushed or ill-timed decisions based purely on taxation.
A farm business must be profitable to have sufficient funds to hold an FMD. The more profit generated in a financial year, the more likely the business is able to set aside cash for years of reduced income and the greater the incentive to decrease the immediate tax liability. The FMD should be used as a cash flow management tool and not an investment strategy, so a farm business with a low level of cash flow variability may find it difficult to benefit from an FMD over time. Conversely, a business with high cash flow variability, such as a dryland continuous cropping operation, may derive significant benefits from the strategic use of FMDs.
To participate in the FMD Scheme an individual must:
Be a sole trader, a partner in a partnership or a beneficiary of a Trust, which conducts a primary production business in Australia
Receive primary production income with no more than $65,000 in non-primary production taxable income in the year the deposit is made (increasing to $100,000 on 1 July 2014)
Deposit $1,000 or more each time
Hold no more than $400,000 in an FMD at any time
Hold the deposit for at least 12 months to access taxation benefits (except under special circumstances)
Only deposit primary production income into an FMD account
Farm Management Deposits are held at the individual level and not by the business, so the effectiveness of FMDs can vary depending on the business structure being used to operate the farm. If a farm business operates as a Sole Trader or Partnership, all business transactions are at an individual or shared level, so FMDs can be used quite easily to manage cash flow and taxation, providing the business has sufficient cash flow variability. If a Company or Trust structure is being used to operate the farm business, the value of FMDs becomes less clear due to the business being a separate entity and the FMD being held at a personal level. This creates a disconnect between the cash flow within the business and the FMD as cash being held external to the business.
From a cash flow management perspective, Companies now have the ability to carry back losses to receive a refund against tax previously paid, so this may achieve a similar aim to the FMD scheme within the Company.
If a Trust structure is used to operate the farm business, all profit generally has to be distributed from the Trust, while losses are retained by the Trust and off-set against future income. While the individual can loan money back to the Trust to address cash flow issues, it may or may not assist with their taxation situation at the time. If significant sums are held in FMDs by beneficiaries of a primary production Trust that is operating profitability, difficulties can arise in bringing the deposits back into income at an individual level, without incurring a large tax liability in one year. However, if sufficient income variability exists or income can be distributed to other beneficiaries, taxation benefits of the scheme can be realised by smoothing income over time with FMDs. Alternatively, consideration might be given after taking cash flow into account, to paying the taxation when it naturally occurs and moving on with the operation of the business, such as retiring external debt.
Farm Management Deposits are a useful tool for financial risk management, but a coordinated approach to making FMDs needs to be taken, so that the business can obtain the benefits without indirectly creating another level of complexity for the business and its owners.