As a capital-intensive industry heavily affected by Australia’s volatile and unpredictable weather conditions, farming requires an incredibly strategic approach when it comes to managing cash flow.
One of the most important objectives for financial planners working with farmers is to find ways to mitigate risk.
Many farmers choose to use a company structure to help do that by using the company to pay taxes during good years, then get a refund in bad years using franking credits.
This works in a similar way to farm management deposits (FMD).
The FMD scheme lets farmers make tax-deductible deposits in good years, then redraw (and pay tax on) those funds during less prosperous years.
This is an effective way to put cash away for when it’s needed.
However, it does tie up cash flow for at least 12 months.
If farmers lose access to franking credit refunds, they’ll need to seriously reconsider the risk mitigation measures they have in place.
- Judy Snell, RSM Australia
The benefit of using a company is that it can be easier to access tax refunds or offset losses.
It puts the risk to the farmer at arm’s length, because it’s an entity considered completely separate to the individual.
When using FMDs, it’s not possible to offset losses against the farm income.
While it can be a useful tool to manage risk, it’s not as flexible as a company structure where tax is paid by the company.
This way funds are kept in the cash flow as opposed to tied up in a FMD.
Recently, however, there has been discussion about scrapping franking credit refunds.
If farmers lose access to franking credit refunds, they’ll need to seriously reconsider the risk mitigation measures they have in place.
It’s not all bad news.
The government’s changes to the definition of a small business means farms turning over less than $10 million a year can now access small business tax concessions which may not have been available in the past.
This can free up funds through offering more deductions for tax prepayments, which is a positive risk mitigation strategy.
Another option for broadacre farmers is to defer grain sales so that, rather than prepaying expenses, the farm business defers its income.
This can be complicated because it requires farmers to predict what the market will do, then lock in prices or play the market depending on what they think is most likely to happen.
The downside of both these options is they carry higher cash flow implications.
And, in farming, cash flow is important, so any decisions made must take cash flow into account.
For farmers planning to use franking credit refunds to fund their retirement, succession planning may need to be reconsidered.
In many cases, retirees have negotiated access to these franking credits as part of the farm handover.
Losing franking credits could, therefore, have a very real impact on these farmers’ quality of life and ability to fund their retirement effectively.
Therefore, it might be necessary to restructure succession plans.
It is also important to remember the much-debated prospect of a lower company tax rate will lead to lower franking credit amounts.
This will reduce the potential refunds from franking credits and could, in some cases, mean they are no longer a viable risk mitigation tool.
Farmers therefore need to investigate their options with a business adviser or financial planner before any changes to franking credits are confirmed.
That way, they can make sure they’re covered if circumstances do change.
For some farmers it may make sense to pay dividends sooner.
Prepaying expenses or deferring grain sales could be valid approaches depending on funding requirements.
However, every risk mitigation option has some effect on cash flow, so a good first step is to talk to the bank to understand the farm’s funding requirements and budget.
- Judy Snell is a director of business advisory with financial services group, RSM Australia