Background

The Ministry for Primary Industries launched the Farm Debt Mediation Scheme in 2020.  It operates when a farmer is in financial difficulties.  It allows the farmer and the bank to enter into mediation, rather than have a forced sale of the farm. This may allow the farmer a dignified exit off the farm and may also allow the bank to get a higher price for the asset.

The outcome of mediation can be that the bank forgives some of the debt owing on the farmland.  Sometimes, the bank will also offer a “facilitation payment” to help the farmer leave the farm.  Otherwise the farmer would walk away with nothing – no car, no house, no job.

Often the debt forgiven is in the millions of dollars.  The “facilitation payment” may be a few thousand dollars to allow the farmer to “start again” – to rent a house and purchase a second-hand car.

Tax treatment

When someone forgives a debt you owe them, the tax system says that forgiveness is income to you.  That is because you have received value – you longer need to pay back the debt.

In the case of a farm debt mediation, the debt forgiveness will create a tax bill for the bankrupt farmer.

For the businesses going through farm debt mediation, assets held on capital account (for example land and cooperative shares) which the bank debt was used to assist in purchasing are likely to have devalued.  When the assets are sold they may lead to both a shortfall to the bank but also a shortfall in losses available (as there is no deduction for capital asset value reduction).  The farmer will have remission income because of the debt forgiveness, with no offsetting deductions.  This usually means the farmer will have tax to pay. 

The farmer will have no means to pay the tax owing, except the facilitation payment.

The facilitation payment itself will also be taxable income.  This is confirmed in the recent IR statement.  This is consistent with current tax rules.  Therefore, it is likely that any facilitation payment would need to be grossed up to cover the tax owing.

However, the issue is not that the farmer must pay tax on the facilitation payment, as this can be managed through a gross-up.  The issue is that the entire facilitation payment may be taken by Inland Revenue as tax on the debt remission income occurring because of the loan being forgiven by the bank.

One of the issues with the mediated settlement process is that the loan forgiveness arises prior to bankruptcy – and as a result there may be no bankruptcy – so any funds remaining or income coming in may be drawn on to settle the debt.

CA ANZ’s view

In our view, the tax system should not allow the facilitation payment to be swallowed up as tax paid to Inland Revenue.  This defeats the purpose of the facilitation payment. The farmer needs the payment to “start again”.

If the farmer cannot access the facilitation payment, the mediation may end in a stalemate; or the parties may not go through with the agreed settlement.  

We have suggested to tax officials that the Government should not take an entire facilitation payment to settle a tax bill arising from a mediated settlement under the Farm Debt Mediation Scheme. 

The release of the statement on facilitation payments should have been accompanied by a policy response to limit the tax on remission income as a result of a Farm Debt Mediation under the Ministry of Primary Industries (MPI) scheme.

There should only be tax on the remission income to the extent the farmer does not have losses carried forward.  Otherwise the facilitation payment may disappear.  We hope that IR will make a change to the tax rules to treat the loan as paid to the extent the facilitation payment would be needed to cover the tax on the debt remission income.  This would allow the Farm Debt Mediation scheme to operate as it was intended to do.