House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer,the Hon Ralph Willis, MP)

Chapter 2 - Farm Management Bonds

Overview

2.1 This Chapter explains the amendments contained in Schedule 2 of the Bill, which amend the Loans (Income Equalization Deposits) Act 1976. These measures are to make farm management bonds (FMBs) a more attractive investment vehicle for farmers. FMBs provide a greater return if they are repaid to meet certain sources of serious financial difficulties, and so help farmers to prepare for difficulties including commodity price collapse and drought.

Summary of the amendments

Purpose of the amendments

2.2 The purpose of the amendments is to make FMBs more attractive to farmers so that they will be more self sufficient in times of drought and the collapse of commodity prices, and will not be so reliant on Government for help.

2.3 The measure increases the 'default' investment component of FMBs to 100%, increases the maximum amount of FMBs to $150,000 for each farmer, eliminates withholding tax on withdrawal of FMBs, and brings the treatment of FMBs where a farmer ceases to be engaged in primary production into line with other repayments unrelated to serious financial difficulties.

Background to the legislation

2.4 Income equalization deposits (IEDs) are made from primary producers' before-tax income. They earn interest at the short term bond rate which the primary producer may claim each year or may redeposit in the IEDs. Any amounts repaid, as interest or otherwise, are taxable.

2.5 Because IEDs are deposits of income on which tax has not been paid, they earn interest only on an investment component. Otherwise, primary producers would both defer tax and earn interest on it. For IEDs generally, the investment component is 61%, corresponding to an average tax rate of 39%. For FMBs, the investment component is 80%, corresponding to an average tax rate of 20%. Although the rate can be varied by regulation, the default rate set in the law has not been varied.

2.6 IEDs generally may be repaid in a range of circumstances. An amount of 20% is withheld from them to anticipate income tax to be paid later. Withholding tax generally helps to prevent the cash flow problem of income from an IED during a year, followed by a balance of tax outstanding later.

2.7 The National Drought Policy of 1992 introduced FMBs as a new concessionary IED. FMBs earn higher returns than IEDs because of their higher investment component if they are repaid to meet serious financial difficulties due to commodity price collapse, or due to drought, disease, flood, fire or the like. Farmers have not yet used FMBs to prepare for disaster to a great extent

2.8 FMBs are not 'locked in'. However, if primary producers seek repayment in circumstances other than the kind of serious financial difficulties for which they provide, the FMBs are repaid only as IEDs, and any overpaid interest reduces the balance date. So FMBs are likely to be repaid in years when total income is especially low, and when financial need is exceptional.

Explanation of the amendments

2.9 There are three changes which make FMBs more attractive:

that proportion of a deposit in the FMB scheme which attracts interest has been increased from 80% to 100% [item 1]

the maximum amount that may be held as a FMB has been increased from $80,000 to $150,000 [item 2]

the 20% withholding tax that was imposed on withdrawals of FMBs has been eliminated entirely [item 3].

2.10 FMB deposits are not a form of superannuation. These measures ensure that they are not withdrawn as FMBs on the retirement of the primary producer. Currently, when someone stops being a primary producer and does not become a primary producer again within 120 days, all their IEDs and FMBs must be withdrawn. At present, FMBs withdrawn because of retirement from primary production are withdrawn as FMBs, with interest on a larger component of the deposit than for IEDs (section 19 of the Loan (Income Equalization Deposits) Act 1976).

2.11 The amendment has the effect that when a taxpayer retires from primary production any deposits that person has made after these changes take effect will be treated as being IEDs and as always having been IEDs. This means that they will have earned a lower level of interest and any interest that has accrued on the FMBs will have to be recalculated and any excess interest that has been paid in the past will have to be repaid [item 5]. This is the same treatment that applies:

if a taxpayer requests repayment of the deposit within 12 months of making the deposit specifies that he is experiencing serious financial difficulties that do not relate to a fall in commodity prices or natural disaster and his circumstances have changed since making the deposit; and;

if a taxpayer requests repayment of the deposit, 12 months after making it, and gives no reason for withdrawal (section 15A of the Loan (Income Equalization Deposits) Act 1976).

Application

2.12 FMBs will earn interest on 100% of their value after the Bill receives Royal Assent. [Subitem 8(1)]

2.13 Depositors will be able to reinvest their interest on their FMBs provided that the amount they have deposited does not exceed the maximum limit of $150,000 after the Bill receives Royal Assent. [Subitem 8(2)]

2.14 Depositors will be able to invest in FMBs up to a maximum limit of $150,000 after the Bill receives Royal Assent. [Subitem 8(3)]

2.15 Any requests for repayment of FMBs after the Bill receives Royal Assent need no longer include a statement of the amount of how much of the deposit that is being repaid should be included in the taxpayer's assessable income. [Subitem 8(4)]

2.16 Where a primary producer ceases to be one and does not resume the business within 120 days and requests repayment of FMBs that were deposited after the Bill receives Royal Assent, the person authorizing the repayment will treat the FMB deposit as always having been an IED deposit and any interest that has accrued on the FMBs will have to be recalculated and any excess interest that has been paid in the past will have to be repaid. [Subitem 8(5)]

2.17 Where a request for repayment of FMBs is made after the Bill receives Royal Assent, the Secretary to the Department of Primary Industries and Energy no longer has to advise the primary producer of the requirement that the primary producer may notify the Secretary of the amount to be included in the primary producer's assessable income as a result of withdrawal of the FMB or the amount of withholding tax applicable. [Subitem 8(6)]

2.18 Withholding tax will not be subtracted from FMBs where the request for repayment was made after the Bill receives Royal Assent. [Subitem 8(7)]