Is the Leasing of Dairy Cows Worthwhile?

Is the Leasing of Dairy Cows Worthwhile?

INTRODUCTION

In 1973, Tom du Plessis, the then extension officer in Underberg, brought the idea back to KZN from New Zealand. The way in which a dairy cow lease should, in principle, work is as follows:-

The Lessor (the investor) buys say, 10 Heavy in Calf (HIC)  crossbred dairy heifers, for say R12 000 per heifer and leases these heifers to the farmer (the Lessee) for say 5 years. The Lessor invoices the Lessee a monthly rental in arrears, which is calculated at 1/12th of the original investment amount at an interest rate of say 10% or 12% per annum. The monthly lease amount is increased at the end of each year by the CPI or PPI % index because the value of the heifers is likely to have increased by this amount during the year. At the end of the lease ie after 5 years the Lessee (farmer) keeps the original cows (which are now 5 years older) and returns to the Lessor (the investor) 10 HIC heifers as similar as possible to the original group of heifers leased. The Lessor then sells this group of heifers or re-leases them to the original Lessee or another 3rd party.

A correctly structured,  legally binding lease,  is entered into between the Lessor and the Lessee and the Lessee (the farmer) must provide the Lessor with a list of equivalent HIC heifers each year as security.

If implemented correctly, the leasing of dairy heifers or cows has significant advantages to both the Lessor and the Lessee.

1.     Advantages to The Lessor (the investor)

The Lessor gets a considerable Income Tax advantage at the time of investment. A HIC crossbred dairy heifer currently costs approximately R12 000/ heifer and SARS values the heifer at R40 (FORTY RAND). The difference creates a big tax loss against which the rental income (if the lease document is correctly drawn up) can be offset. However, the opposite occurs when the heifers are returned to the Lessor and the Lessor sells them – it is therefore in the Lessors’ interest not to sell them but to re-lease them.

The Lessor therefore gets a greatly tax delayed return at a good interest rate on his investment. He also gets an annual capital gain as the value of the heifers increases and  gets a return on the increased capital amount.

NOTE: For the above to happen, the lease must be drawn up so that the Lessor is exposed to the normal production risks of farming. The monthly rental must be linked to the cow’s production and the annual increase in rental should be linked to an official cost index. If at the end of the lease the Lessor is to be paid out, the price must be at the then going rate for HIC dairy heifers. Modified leases have been drawn up and many are not correctly worded or structured. If the normal production risks of farming are not included in the lease, ie;  if a fixed capital payment per heifer at the end of the leaseis stipulated or if monthly rental payments are fixed  and not linked to the risks of farming, SARS may render these amounts to fall outside their defined ring fence. These amounts will then not be offset against the original investment tax loss, which will make the whole procedure a financial disaster from the Lessors’ point of view.

2.     Advantages to The Lessee (the farmer)

a)     The Lessee effectively obtains the say 10 HIC crossbred dairy heifers, at no capital cost. If the heifer/cow produces say 5000 litres per annum, and the Lessee is getting a gross income of R4.50/litre, the leased heifer will earn the farmer a gross increased income of R 22 500 per cow p.a. at a rental cost (calculated at say 12% ) of R1440/annum.

b)     The total leased capital amount is not listed on the Lessee’s balance sheet as a liability – this can significantly and positively affect the farmers total debt ratio as well as future borrowings.

c)     At the end of the lease the Lessee keeps the original cow (currently worth say R9000 as a cull) This amount covers the variable costs of growing out the replacement heifer to be returned. If the lease stipulates a pay out at the end, this amount goes a long way in the covering of this cost. The Lessee therefore pays mainly interest which, of course is tax deductible.

d)     The Lessee keeps and owns the progeny from the leased cow which, over five years, should be 5 calves.

CONCLUSION

I have personally successfully leased heifers both in and out over the last 40 years. The problem is that the farmer (Lessee) has to be honest, ethical and honourable and must adhere to the terms of the lease. My experience is that most farmers are honest and cow leases therefore work well. However, some Lessees are dishonest and fraudulent and supply Lessors with annual ‘security’ lists of heifers where some of the numbered heifers are non-existent or even worse where heifers are duplicated on lists given to two or more Lessors. This sadly is increasing lately in the current economic downturn and in the SA climate of corruption. The above constitutes a fraudulent act and the farmer, if prosecuted, can end up with a jail sentence. Dishonest Lessees also sometimes sell off Lessors animals to cover rent or other costs and ear tag the replacements in their own names. If the farmer then goes insolvent the Lessor can only claim back the animals he can positively identify (usually by way of an ear tag number). The Lessor thus cannot legally  get access to the animals which have been listed in the farmers name. The Lessor can (and many have) consequently suffered a substantial capital loss. The law does not support the Lessor nor do the liquidators, who get a substantial commission payment on animals that are sold in the farmer’s name. The above mentioned  fraudulent activity is too easy to carry out and has occurred often in recent times. The result is that the leasing out of heifers is proving to be a high risk investment for Lessors and very few leases, which should be to the advantage of both parties, are being entered into.

Derek Broom
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