Financial structure determines ACC payments
Freddy does very little work on the farm these days, thanks to taking on a 50/50 sharemilker, so why is he still handing over a chunk of his earnings to ACC?
It all comes down to structure. Freddy's dairy farm operates as a company from which he receives a shareholder salary - on which the company pays an ACC levy even though his physical involvement in the daily operation of the farm is more or less nil.
Yet, if he was a sole trader or in a partnership that was running the farm and enjoying not being involved physically, Freddy could avoid these ACC levies - by simply treating his self-employed income as 'passive' and putting it in the tax return as 'other income'.
However, if Freddy wanted to continue odd-jobbing around on the farm, he'd remain liable for ACC levies - although lower cover premiums could be negotiated by moving to Cover Plus Extra on the grounds there would be no loss of income and the sharemilker would run the farm just as easily without Freddy's vital contribution, (or so Freddy thinks).
But, because Freddy receives a shareholder salary from the dairy farm company, things are a little more complex. There are a number of options for a farming company to get a non-dividend, non-interest income stream through to a shareholder-employee.
For the 2013/14 income year, the after-tax ACC levy cost on a $40,000 income stream varies between $708 and $1365, depending on the option chosen.
Pay Freddy a PAYE-deducted salary of $40,000 gross. He'll have the ACC earner premium of $680 deducted with his PAYE, being 1.7 per cent of his salary. The company is required to pay Workplace Cover levies totalling $1398 GST inclusive. The company can claim GST, and the net balance will be income tax deductible.
The after-tax (at 28 per cent) ACC cost including the earner premium is thus $1365.
Pay a shareholder salary of $40,000 at the end of the year and ACC picks up the information through the company's tax return, invoicing the company for $2078 including GST. The company can claim GST and the net balance will again be income tax deductible to the company. The after-tax (at 28 per cent) ACC cost is then $1300.
Although Freddy, as a shareholder employee, is not self-employed, there is a concession under which ACC will deem him to be self-employed so he can take ACC CoverPlus Extra. This lets Freddy negotiate his cover level downwards.
Assuming his salary stays consistent around $40,000 pa, cover could be arranged at the ACC minimum level ($22,464 for the 2013/14 year).
The levy includes GST but can't be claimed by the company as it is invoiced to Freddy in his own name.
Freddy can claim an income tax deduction though. Assuming this is Freddy's only income, the after-tax cost of CoverPlus Extra on $22,464 is $1132. And the company will be invoiced for residual levies of $215 including GST, which will be able to be claimed for GST and will be income tax deductible. The total after-tax ACC cost is then $1267.
There is a fourth option that involves looking at the duties Freddy performs. As a shareholder-employee on CoverPlus Extra, Freddy can be levied at a different rate to the other people who work on the farm.
Depending on what Freddy actually does, it may be appropriate for him to be levied under "holder investor farms and livestock" rather than "dairy farming", which would offer a much lower levy rate.
In this case, the GST inclusive levies invoiced to Freddy on the ACC minimum would be $730. The company would be invoiced for residual levies of $170 including GST. The after-tax ACC cost would be $708.
While this is all based on Freddy and his dairy farm, it could just as easily be applied to any of his mates involved in sheep and beef farming.
It is lucky that Pebbles is grown up and off Freddy's hands though - if he goes for the third option and dials down his ACC cover he also reduces the level of accidental death benefits his family would be entitled to from ACC.
Not such an issue for Freddy - but for his mates with young families it could have a bigger impact.
- This column was written by BDO Taranaki chartered accountant and ACC adviser Leisa Kelsen.