No. 15 Taxation of forestry
NZFFA Information leaflet No. 15 (2005).
Over the past couple of decades, a number of different regimes have provided for the taxation of forestry ventures. The following provides an overview of the main aspects of the taxation of forestry income and expenditure under current law.
When a person sells or disposes of any timber, or sells or disposes of the right to take any timber, they will be assessed for income tax on the proceeds of such a sale. Therefore, the Income Tax Act 1994 taxes not only the sales of harvested timber, but also standing timber and the granting of cutting rights for any standing timber.
Although the sale of a right to take timber is taxable, where a forestry owner grants a forestry right to himself or herself under the Forestry Rights Registration Act 1983, this will not be taxed. Where timber is sold for a price that is less than the market value of the timber, the Commissioner of Inland Revenue is entitled to assign a market value to the sale of such timber.
Although gross income is normally derived in the year that the timber is sold or disposed of, the Act allows a vendor to elect to spread the proceeds of sale over a period of four years, being the year of sale and the previous three income years. The sale proceeds may be spread over any of those four income years in whatever proportion is selected. To be able to spread this income, the taxpayer must give the Commissioner of Inland Revenue a written notice electing to spread the income, within twelve months of the end of the income year in which the sale takes place.
A vendor is entitled to deduct the ‘cost of timber’ from the proceeds realised from the sale of such timber. The cost of timber includes the purchase price of the timber where it is purchased as standing timber, or the acquisition cost of a right to take timber. The cost of timber does not include:
- deductible expenditure;
- capital expenditure which has given rise to depreciation deductions, for example, expenditure on plant and machinery used in the planting or maintaining of trees;
- expenditure on land contouring or other land improvements, which are treated as capital expenditure.
If a taxpayer receives a compensation payment, for example insurance proceeds for the damage or loss of timber, this payment will be included in the assessable income of the taxpayer. However, the taxpayer will be entitled to a deduction for an amount equal to the cost of the timber. This deduction is able to be claimed in the income year in which the loss or damage occurs.
Generally, indirect and administrative costs, together with depreciation in respect of forestry plant and machinery are deductible in the income year in which the taxpayer incurs such expense. In addition, land development costs are able to be deducted on a diminishing value basis, akin to a depreciation deduction.
However, pre-acquisition costs and the acquisition cost of forestry land will generally not be deductible.
To be able to claim a deduction for expenditure incurred from forestry operations, a taxpayer must ‘carry on a forestry business’ in New Zealand. Therefore, this raises the issue of whether forestry investors who are only passive investors, in that they only provide equity to the forestry partnership, can be said to be carrying on a forestry business.
Following a couple of high level decisions in the courts, the following factors should be taken into account when entering into a partnership agreement to ensure that the fund provider can be said to be carrying on the business of forestry:
- there should be a requirement that funds provided by the investor should be used for the forestry activities, e.g. planting;
- the investor should be given a right to direct employment of forest advisers;
- the investor should receive regular management reports;
- the investor should have a right to be physically involved in the forestry activities, by way of site visits, inspections and discussions;
- the investor should have entitlement to the tree crop and not just the proceeds.
The combination of some or all of these factors is necessary to ensure that the investor can be shown to be carrying on business operations, and not merely making an investment in the forestry activity.
This article by Jeff Morrison and Joanne Ziegler of Russell McVeagh, appeared in the August 2000 issue of the New Zealand Tree Grower.