Four pillars of wisdom – a farm accountant's take– Pita Alexander

Pita Alexander is a specialist farm accountant at Alexander’s Chartered Accountant in Christchurch. He shares his thoughts with NBR ONLINE on how the agricultural commodity cycle, capital gains tax, escalating volatility and New Zealand’s debt quagmire may affect the economy in the coming years.

12.15 on the clock of the agricultural commodity cycle

“I find that five to seven years is the average cycle over the last 40 years. It just cycles. It’s nobody’s fault. I will be very surprised if those cycles change much. Maybe they will get a bit shorter, such as four to six year, but who knows.”

“Thinking of it as an economic clock, I would suspect right now we are about 12.15 o’clock. It’s a matter of opinion, of course but we are close to the top.

“Within three years, for various reasons, things will turn on us and we need to be ready for it. We need to make money when things are going up on this side of the cycle but we need to make sure we are building our reserves.

“When we get a lot of other countries building up their milk production you will find that China will have a few more choices, which will tend to start a cycle in itself.”

Capital gains tax threat

“We are one of the few countries that doesn’t have some form of capital gains tax, so I would suspect that in the next 10 years we will see more of it.

“In Australia, which has had it since 1985, if you sit around with accountants and solicitors over there - as I’ve done - once you get a few drinks into them, they admit that the indexing and the effect of the capital gains tax has increased incomes for accountants and solicitors but it hasn’t had an enormous effect out on the commercial table with real estate and business.”

“It might end up being similar to the gift tax in that there might not be as much in it for government as you might think.”

Volatility will only get worse

Mr Alexander says he believes volatility will be worse over the coming decade than it was for the last. But why?

"Several countries will face an increase in food prices. Interest rate will rise over the next two years, both at home and overseas. Europe and the US will increase their dairy output and a 4-5% increase in farm working expenses each year will begin to pinch.

"And no, there is nothing we can do about it either, according to the widely respected farm accountant.

“New Zealand as a whole is a price taker, not a price maker. The only thing we can is to make sure that our farming and business people and our government are building up their financial reserves. The best thing to cope with volatility is having a strong balance sheet, strong reserves and a sustainable, bankable, tangible net profit.”

Good debt, bad debt, ugly debt

“It’s very hard to make money today without borrowing, no matter what business you are in.  As with your house, if you don’t borrow for your farm you are probably never going to own one. 

“That is unavoidable but it needs to be sensible in terms of interest rate and income tax deductibility. If you can, it should be borrowed against an asset that is inflation-proof. That sort of debt is usually what I call ‘good debt.’

“There is no question about it being good debt because it helps you grow. In 95% of cases, you won’t grow without it.

“The moment a debt is not income tax-deductible its real cost increases. In America, for example, in the main, most of their house debt is income tax deductible in their tax returns.

“Government, for example, has good debt because it pays low interest, has good security and, if it runs short, it takes what it needs from you and me via income taxes and all sorts of other quite devious charges.

“Bad debt is debt where the interest cost is not income tax deductible, it goes forever and controls your life but still lets you live because the lender needs you to pay interest on a regular basis. It's what I call ‘life support debt’ and much residential debt is like this.

“Really ugly debt is where the interest rate is very high, the interest cost is not income tax deductible, the asset over which the debt is secured doesn't appreciate in value on a regular basis and the lender is not worried about keeping the borrower alive because the lender will grab back the asset itself the moment the borrower hiccups.

“Many New Zealanders get themselves involved in this type of debt. It really should be called ‘treadmill borrowing,’ and even small debts of this type can really control you badly.

“Except in very special circumstances, never give guarantees to your bank that are unlimited. If you have to do this, then re-look at borrowing the money in the first place.

“In the US they have what is called non-recourse loans, that is no personal guarantees. So when things go really wrong, the homeowner simply deposited the keys with their bank manager who a few years ago had a whole box full in the corner of his office.

“Whatever you do, limit your personal guarantees to a certain figure, as you will find it surprisingly difficult to get rid of these personal guarantees.”

“Debt reduction gets more appealing as interest rates rise. If the average New Zealand farm borrowing rate rises from, say, 5.5% to 8.25% over the next two or three years, then this represents an increase of 50%.

“This makes debt reduction much more useful in terms of interest savings for future years - a $100,000 term debt reduction would save $8,250 in the following year, and $8250 for every future year as well.”