Primary producers, do you know your five-year average?
Are you paying too much tax?
If you haven’t heard of Primary production averaging (or your ‘five-year average’) before, you’re not alone. It’s a specialised area of agribusiness taxation. If your Accountant doesn’t specialise in primary production accounting, they may not know how to use your five-year average to your tax advantage, ensuring maximum cashflow is kept in your business.
What is a five-year average?
The amount of tax you pay as a primary producer is calculated by the ATO using ‘primary production (PP) averaging’. PP averaging considers your personal taxable income over the previous four-year period and current tax year. This works to “even” out the highs and lows of income that come with farming.
Five-year averaging is a valuable tool as it can be used to your advantage during a good season to avoid paying excessive tax, however it has to be carefully managed to ensure you don’t pay unnecessary tax during a lower income year where your taxable income may be lower than your average.
How does five-year averaging work?
In short, when your average income is less than your basic taxable income, you’ll receive an averaging tax offset. When your average income is more than your basic taxable income, you will need to pay extra income tax called ‘complementary tax’, which is deceptive as it actually means you are paying more tax than the average taxpayer!
Why do you need to be aware of your five-year average?
We have a lot of farming businesses come to us at Smith Shearer where family members have very high five-year averages. What does this mean? It means the family farming business are paying more tax than necessary. This happens when their averaging history isn’t managed properly, or the farming family are utilising the wrong structure for their business.
An example of a farming family with a high five-year average
We recently had a farming family (we’ll refer to them as ‘Bob and Maxine Phillips and co) come to us with very high five-year averages. Their income for the previous financial year was $279,000 each and their five-year average was around $218,000.
In chatting to the Phillips’ about their individual circumstances, we realised Bob and Maxine’s five-year averages were significantly higher than they should be, (they choose to live a fairly simple life, and don’t have significant living expenses).
Bob and Maxine’s five-year averages meant that if they were to experience an income lower than $218,000 the following financial year, they would have been liable for ‘complementary tax’. On the flip side, if Bob and Maxine were to receive an income on par, or higher than their PP Average, they would continue paying a higher rate of marginal tax than what was required.
By looking into the Phillips’ farming business structure, and the way both Bob and Maxine were receiving income we were able to reduce their personal taxable incomes and over time, reduce their five-year average to $55,000 without incurring significant complementary tax. As a result, Bob and Maxine are paying less tax and the family farming business is retaining a higher percentage of profits.
Do you have a high five-year average?
Whether or not your five-year average is considered to be ‘high’ depends on your individual circumstances, and your overall choice of lifestyle.
For example, we have farming clients whose ideal five-year average is $120,000 for each family member, as it enables each family member to maintain their chosen lifestyle.
Generally, if your five-year average is higher than $180,000, it may be too high, (but once again, this depends on your living costs).
If your five-year average seems high, it is important to look at the reasons why. It may be that your business structure isn’t flexible enough to manage fluctuations in your income.
Do you want a FREE assessment of your five-year average?
If you’d like us to look at your five-year average, and advise whether there are ways you can reduce your income average and overall individual tax obligations, book in a FREE consultation (for businesses who are not currently clients of Smith Shearer), or contact us to discuss your concerns.