Farm management deposits: An important tool for farmers

FARM management deposits have become an important tool for farmers, writes PETER HEMPHILL

Useful for all: Most agree farm management deposits are a good way to manage risk.

“I LOVE a sunburnt country, a land of sweeping plains,

Of ragged mountain ranges, of droughts and flooding rains”

THESE lines from Dorothea Mackellar’s iconic poem, My Country, published about 110 years ago, accurately encapsulate the recurring natural phenomena in Australia’s rural sector of “floods and fire and famine”.

Natural disasters, particularly droughts, have been a feature of farming since settlement, causing heartache to farmers with income varying widely from year to year.

Federal governments sought to ameliorate the problem by introducing income-smoothing mechanisms — such as drought bonds in 1969, and its successor, the income equalisation deposit scheme in 1975 — to varying degrees of success.

In 1999, the Federal Government replaced that scheme with another focused on risk management: farm management deposits.

FMDs allow farmers to defer income from a bountiful year to a future financial year of lower cash flow. Income tax is then paid when the deposit is withdrawn.

The basic rule is that money can only be deposited in an FMD in an individual farmer’s name, not in a farm company, partnership or trust account, and must be held in the account for more than 12 months.

Drought bonds in the 1960s were only available to livestock producers, but FMDs probably have their greatest use to farmers growing grain because their income can fluctuate wildly due to seasonal conditions, particularly drought.

Last year, the Federal Government introduced three major changes to the FMD system: an increase in the cap on deposits from $400,000 to $800,000; allowing financial institutions to offer offset accounts; and allowing farmers to withdraw their deposits within 12 months if they suffer unusually dry weather.

FMD offset accounts operate in much the same way as they do in the home loan sector.

They allow primary producers to offset funds held in an FMD account against the balance owing on eligible loans, which may assist in reducing primary production business costs. The jury is still out on what impacts the three changes will have this year.

Department of Agriculture and Water Resources data shows a spike in deposits every June, as farmers wait until the end of the financial year before deciding what to do with their spare cash.

In an almost ritual pattern, the level of FMDs fall every July, as farmers withdraw deposits made 13 months previously, or even longer.

But, generally, the annual withdrawals in July are not as much as the deposits a month or so earlier, meaning the level of FMDs gradually increase over time.

Last June, the level of FMDs peaked at a record of more than $5 billion.

With the beef industry setting record prices, the sheep meat and wool industries going through a purple patch and the grain sector reporting a record crop, all eyes will be focused on deposits this June to see if another record is set.

Already, the level of deposits for the September, December and March quarters are consistently about $350 million higher than those for the corresponding periods a year earlier. That indicates a new record for deposits is likely next month.

The Agriculture and Water Resources department says fluctuations in FMD deposits can be attributed to a variety of factors, such as seasonal or market conditions.

It says the government’s changes to the scheme last July are also likely to have an effect on the level of FMD holdings.

Rural Bank managing director Alex Gartmann says FMD deposits may top $5.5 billion this year. She says there may be competing priorities for spare cash, with some livestock producers opting for herd rebuilding after years of drought and other farmers looking to build capital infrastructure.

Nationally, grain-sheep and grain-beef producers are the biggest users of FMDs, usually accounting for about 24-26 per cent of total deposit value. Producers of only grain make up the next biggest category, with 21-23 per cent of total FMD deposits.

There are variations between each state, with Victorian dairy producers accounting for 20-22 per cent of their state’s total deposits.

Grain-only farms in Victoria usually account for about 15-17 per cent of total state deposits, although it slumped to an unusually low level of less than 13 per cent in February, possibly reflecting tightness in cash flow prior to last harvest.

While the growing level of deposits can be an indicator of the success of the FMD scheme, some growers can get blinded by what they should do with their hard-earned money in good seasons.

Swan Hill accountant Noel Meney, a partner in Pooles Accountants and Tax Specialists, says some clients he took on a few years ago had high levels of FMDs but no superannuation.

Meney says those clients progressively withdrew their FMDs over about four years to put their deposit into self-managed superannuation funds.

It was done at a time when the concessional contribution cap for super deposits for an individual was $50,000 a year at a tax rate of 15 per cent. The “shifting sands” of government policy has seen that concessional contribution cap whittled down to $30,000 a year for people under 49 years of age to $35,000 for those over 49. From July 1 this year, the maximum contribution rate for all ages will be $25,000 a year. Ten years ago, the cap was $100,000.

Meney believes farmers should still contribute the maximum amount to super funds to take advantage of the 15 per cent tax rate, then consider how much to place into a FMD account.

He says, with the gradual reduction in superannuation concessional contribution rates, farmers will place more emphasis on FMDs in the next few years if they have plenty of cash after a good season.

But Meney also says there are other ways farmers can reduce their tax bill in big windfall years without having to use FMDs. These include forward buying farm inputs, such as herbicides, the year before use or delaying grain sales until the following year.

Semi-retired Quambatook grain grower Doug Williamson has used FMDs since they were introduced and still has some deposits with his financial institution.

Williamson says it is just another tool to use to level out income. “But you’ve really got to wish for a drought to get it out,” he says. “One of the problems is that if you die, the FMDs have to automatically come out, so it can load up your estate.

“And if you retire, it’s got to come out straight away. So if you don’t look ahead, it can really backfire on you.”

There is some doubt whether FMD offset accounts will be popular in their first year of operation. Rural Bank, a subsidiary of the Bendigo and Adelaide Bank, is the first financial institution to offer offset accounts. No other financial institution has a widely available offset scheme for FMDs.

ANZ agribusiness head Mark Bennett says the bank has an offset scheme but it is only available to eligible customers “on a case-by-case basis”. “This will ultimately develop into a broad-scale product solution that aligns to current legislation,” Bennett says.

Gartmann says it is easy to understand why other financial institutions are not offering FMD offset accounts. “It is not a product which is a real profit driver for us because you are essentially giving away interest income,” she says.

“For larger institutions, where agri is just a small component of their portfolio, it may be more challenging to do the back-end IT, policy and system changes (needed to put offsets in place). Because we are smaller and nimbler and wholly focused on agri, it made sense for us to do this.”

The coming weeks will determine the level of interest in the offset product as the traditional demand for FMDs peaks.

Meney says he was initially excited by the proposal to introduce offsets to FMD accounts. But now he is not so sure of its benefits. “Farm management deposits can only be placed in individuals’ names,” he says. “But the reality is that many farming structures are in family trusts.

“As such, farming loans are usually in the name of the family trust.”

Rural Bank says about 80 per cent of its customer base are family partnerships or sole traders, who could be linked to an offset account. The bank says the financial services industry has been lobbying for further changes to the FMD system to allow farm trusts and other corporate structures access to offset accounts.

While improvements could be made, most agree FMDs are a useful risk management tool. Meney thinks that, with grain farmers facing higher than normal profits this financial year — particularly those that grew pulse crops — FMDs will be an important tool.

“Core of my heart, my country!

Land of the Rainbow Gold.

For flood and fire and famine,

She pays us back three-fold.”

If only farm management deposits were introduced 110 years ago. They might have saved a bit of grief over the decades.

Keep the cream

VICTORIAN dairy farmers have nearly $170 million stacked away in farm management deposits, despite one of the worst industry downturns in decades.

About 20 per cent of the state’s FMD deposits are held by dairy farmers, raising questions about the extent of financial stress suffered by milk suppliers after Murray Goulburn and Fonterra reduced their farmgate milk prices in April last year.

Indeed, within two months of the dairy giants announcing the milk-price cut, prompting an industry outcry, Victorian milk producers plunged an extra $20 million of spare cash into FMD accounts.

And they did so, knowing the money would be tied up for more than 12 months to gain the taxation benefits for which the system was designed.

Department of Agriculture and Water Resources data shows Victorian dairy farmers topped up nearly 2300 FMD accounts to a record $204 million in June 2016.

There are now nearly 2000 Victorian dairy accounts with about $168 million sitting in them — about the same level as they were two years ago.

Jim Pickersgill, principal of Leongatha accounting and financial planning firm Fawcett and Pickersgill, says he is surprised by the level of FMDs held by dairy farmers.

“That’s not what we’re noticing in our practice,” Pickersgill says.

“Our (dairy farmer) clients would have withdrawn their FMDs (over the past year). In fact, we actively encouraged them to do so.”

Pickersgill says dairy farmers could have relatively high levels of FMDs still stacked away due to historically low interest rates making it cheaper to fund their shortfalls by borrowings. Banks allow farmers to use FMDs as security against borrowings.

Rural Bank managing director Alex Gartmann says dairy farmers don’t use FMDs as much as other rural industries.

Gartmann says dairy farmers generally run well-established, profitable and secure businesses and have “wriggle room” to move when times get tough.

She says that, while a few of the bank’s dairy clients have withdrawn FMDs to help bridge the current price/cost gap, most have not moved due to the availability of other levers milk producers can pull before “adding income” back to the business through the release of FMDs.

“Dairy farmers have the ability to adjust their inputs very quickly to meet a reduced income stream and avoid drawing down on FMD deposits, as happened with price adjustments in 2008 and 2013,” she says.

“Consequently, through good farm management, most dairy farmers will manage small net profits without having to touch their FMD reserves.

“For example, in Gippsland the latest spring season was exceptional, with most dairy farmers producing twice the fodder requirements, thus building up significant fodder reserves and reducing the need to buy in feed.

“Add in reduced grain costs and dairy farmers have been able to manage their operations very well.

“Therefore, no further dairy farmers (with FMDs) have been identified as under stress in the Gippsland region.”