Reshaping the land can have tax pitfalls

After putting up with the scrappy, steep, swampy paddock at the back of his farm for several years, Freddy Farmer has decided that now's the time, with drier conditions and extra cash floating around, to make it pretty.

Freddy's aware that plenty of other local farmers are making the most of good conditions to bring in bulldozers and carry out all manner of renovations, from flattening hills and filling in creeks and gullies to pushing hillocks into hollows.

Freddy's planning to flatten the steep land on his plot and fill in the swamp so he can plant some ryegrass before winter. It's going to create a large expense invoice, and Freddy's not certain about whether it will be a fully deductible operating expense or an item of capital expenditure that he has to capitalise and amortise.

"My accountant tells me the rules aren't clear about this sort of thing," Freddy explains to Jack. "What I have to do is put it through a whole batch of tests to work out how much I can claim."

Some of the questions to be asked include:

Is this a one-off or regular expenditure?

Does it create an enduring benefit?

Is it ordinary or extraordinary?

Is it part of the business structure or part of business process?

Does it expand the capacity of an existing facility?

Freddy's project passes some tests that show his expenditure is capital. Recontouring costs such as flattening and filling generally fall under capital expenditure.

His project is also a one-off that will create an enduring benefit, is extraordinary, expands the capacity of his farm, and is part of the business structure rather than process.

"So, what can I claim back? Well, Jack, it's not that simple. There's a whole swag of farm development tax deductibility bits in the tax rules you have to plough through to work out what's the best outcome for you."

While Freddy's land-flattening capital expenditure doesn't qualify for 100 per cent, there's a section in the rules that means he has to capitalise and amortise the costs to receive a tax deduction of 6 per cent per annum of the diminishing value (DV) of the expenditure.

"Then there's the problem of working out what I can get back on the costs of cultivating the ryegrass. Normally all the cultivating, sowing, fertilising and so on bits of farming are regular operating costs, and so fully deductible."

However, in this case it's not so clear. The question is whether the cultivation of the newly contoured land is an operating cost or a development cost that needs to be capitalised and amortised.

"From what my accountant says, it seems that because this land's always been a useless eyesore and this is the first time I've sown anything on it, it's a capital expenditure that I have to capitalise and amortise. If I was re- grassing it, however, then it would be a normal operating cost and fully deductible."

Well, not necessarily. Where re- grassing is done as part of a significant capital outlay - such as dairy conversion - then re-grassing costs have to be capitalised as repairs and maintenance, and amortised at a rate of 45 per cent of the DV of the asset.

This all raises more questions about what is a significant capital activity and what isn't.

"It's enough to cause nightmares, Jack. So, if you're planning to do some contouring work and plant some grass and hoping to claim it back on tax, get some help from your accountant first to make sure you're on track with tax."

Mark Irving is a principal, specialising in rural services, with BDO Taranaki, an independent member firm of BDO New Zealand's network of independent chartered accounting and advisory firms. He also heads BDO New Zealand's rural special interest group. Mark writes a fortnightly column on financial issues affecting farmers. For more information, contact Mark on 06 759 9034 or see