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Sikich Agriculture Newsletter - Spring/Summer 2015 Edition

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Disruptions of corn trade with China is having an impact on Grain and DDGS prices. Also learn about succession planning for country elevators, T&D tax credis and used equipment.

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Sikich Agriculture Newsletter - Spring/Summer 2015 Edition

  1. 1. Copyright © 2015, Sikich. All Rights Reserved. www.sikich.com DisruptionsofCornTradewithChina, the Impact on Grain and DDGS Prices and Related Lawsuits Against Syngenta By Scott Roberts, Partner and Dan Bukovac, Partner; Stinson Leonard Street LLP U.S. corn exports were suddenly disrupted in November 2013 when China began to reject U.S. shipments after testing detected a bio-engineered genetic trait that China had not approved. The USDA reported that corn exports to China before the rejections had reached 4.0 million tons in the early months of the 2013-2014 marketing year (September 2013 through August 2014) and projected U.S. corn exports to China to reach 7.0 million tons for the marketing year. But the U.S. corn exports to China all but stopped after December 2013, and those exports have never recovered. According to a March 2015 Reuters article, Chinese buyers have shown little interest in U.S. corn so far in 2014-2015 but booked more than 600,000 tons of corn from Ukraine, which became China’s largest corn exporter in January 2015. As of mid-April 2015, the U.S. Grains Council reported a decrease of more than 95 percent in exports of U.S. corn to China from 2013-2014 to 2014-2015. With the loss of a major export market, demand for U.S. corn has weakened. And U.S. corn prices have been at four-year lows, as noted in the Sikich Agribusiness Update last fall. What has caused the continued disruption of the corn export market? And what can businesses do if they have suffered from decreased demand and lower prices for U.S. corn? GMOs and U.S. Grain Exports First, some background on these issues may be helpful. Before seeds and crops with bio- engineered genetic traits (commonly referred to as GMOs) can be commercialized in the U.S., the USDA/APHIS must provide regulatory approval, making a determination of “nonregulated status” under GMO regulations after conducting environmental impact assessments. However, deregulation by APHIS does not result in automatic approval of GMOs in other countries that have their own regulatory approval procedures. Additionally, certain importing countries, including China, have “zero-tolerance” policies for unapproved GMOs and will reject imports of U.S. grain if even trace amounts of unapproved GMOs are detected after testing. Commercialization of GMOs in the U.S. after U.S. approval but before approval by countries that are major export markets poses risks to grains approved for export resulting from the potential for traces of the unapproved GMOs finding their way into U.S. grain supplies. In This Issue Syngenta Update.................... 1 Succession Planning for Country Elevators................... 3 R&D Tax Credit.......................... 4 Used Equipment...................... 5 CLIENT SPOTLIGHT: Jenner Sales Learn how Sikich has helped Jenner Sales, an agricultural equipment sales company, with accounting- related challenges, particularly when the IRS selected Jenner for an unplanned audit. Watch the video at sikich.com/jenner-sales Agribusiness Update Thought Leadership Experts Spring/Summer 2015 ...certain importing countries, including China, have “zero-tolerance” policies for unapproved GMOs and will reject imports of U.S. grain if even trace amounts of unapproved GMOs are detected after testing. continued...
  2. 2. Agribusiness Update – Spring/Summer 2015 Copyright © 2015, Sikich. All Rights Reserved. www.sikich.com Syngenta MIR 162 The latest disruption of exports to China demonstrates that the risk is real. On April 12, 2010, APHIS deregulated Syngenta’s Agrisure Viptera™ MIR 162 (“MIR 162”). Syngenta commercialized MIR 162 for the 2011 U.S. growing season before having regulatory approval from China necessary for exports to that country. In November 2013, enforcing its zero- tolerance policy, China tested for the presence of MIR 162 in corn imports from the U.S., and MIR 162 was soon detected in U.S shipments of corn. As a result, U.S. corn was almost completely shut out of China’s corn import market by early January 2014. By July 2014, MIR 162 had also been detected in nearly 1,000 batches of imports from the U.S. of Dried Distillers Grains with Solubles (DDGS), totaling 425,600 tons, according to a notification from Chinese authorities to the USDA. The result was the U.S. corn export disruptions mentioned above. Not until December 2014 did Chinese authorities finally grant import approval for MIR 162 covering both corn and DDGS. But even after the Chinese approval of MIR 162, U.S. corn exports to China have not recovered, as discussed above. Syngenta Event 5307 The disruption in the U.S. corn export market appears to have continued because of another Syngenta GMO. On April 12, 2010, APHIS deregulated Syngenta’s Agrisure Duracade™ Event 5307 (“Event 5307”), and Syngenta commercialized Event 5307 for the 2014 U.S. growing season before having regulatory approval from China necessary for exports to that country, as it had MIR 162. But unlike MIR 162, Event 5307 has not yet received approval from Chinese authorities. The March 2015 Reuters article, mentioned above, suggests that Event 5307 is the reason that Chinese buyers have continued to avoid U.S. corn imports, even though the price of U.S. corn is more competitive than the price of corn from other sources, such as Ukraine. The Reuters article reports that U.S. suppliers have revised their contract terms to place the risk of future rejections by Chinese authorities on the Chinese buyers, and those buyers, apparently unwilling to accept that risk, are looking to alternative sources. Estimated Impact on U.S. Corn Prices On April 16, 2014, the National Grain and Feed Association (NGFA) and the North American Export Grain Association (NAEGA) published their joint analysis assessing the economic impact of China’s rejection of U.S. corn and DDGS shipments containing MIR 162. The NGFA/NAEGA analysis estimated that the total economic damage to U.S. sellers of corn, DDGS and soybeans from Syngenta’s commercialization of MIR 162 before Chinese import approval—and the trade disruptions that ensued after China detected MIR 162 and rejected shipments under its zero-tolerance policy—ranged from $1 billion to $2.9 billion for the 2013/14 marketing year. Using a conservative mathematical model that forecasts the national average corn price based on U.S. corn ending stocks, the NGFA/NAEGA analysis also estimated that the trade disruption depressed U.S. corn, DDGS and soybean prices. A second NGFA/NAEGA analysis, also published in April 2014, predicted that U.S. growers, grain handlers and exporters could sustain a similar economic impact during the current marketing year (that began in September 2014), given Syngenta’s decision to commercialize 5307 before the earliest regulatory-approval timelines in key U.S. corn export markets (including China). The Reuters article and U.S. Grains Council reports (showing a 95 percent decrease in corn exports to China) indicate that the NGFA/NAEGA prediction has come true. In August 2014, NGFA/NAEGA announced that their analyses had been updated to provide an assessment of China’s feed grain import decisions in the months following the rejections of U.S. corn shipments containing MIR 162. The NGFA/NAEGA update concluded that contrary to some speculation, China’s rejections of U.S. corn imports were not motivated by either adequate or surplus Chinese domestic feed grain supplies or a motivation to obtain prices lower than the negotiated U.S. corn contract prices. Rather, Chinese importers actually purchased higher-priced alternative feed grains and corn, including Australian barley and wheat, U.S. grain sorghum and Canadian barley. China’s reliance on alternative sources has continued into the current marketing year as evidenced by the purchases of corn from Ukraine, mentioned above. Lawsuits Against Syngenta Responding to these trade disruptions, farmers and large agribusiness companies alike have filed individual actions and class actions against Syngenta for damages that they allege have been caused by Syngenta’s conduct, including the early commercialization of MIR 162 and Event 5307. Most of those lawsuits have been filed by farmers and farm entities that never planted Syngenta seed corn but allege that they suffered damages from the impact on corn prices. The lawsuits have been filed in state and federal courts across the United States. Syngenta has been “removing” the state court lawsuits to federal court based on federal statutory provisions that Syngenta argues authorize such removals. All of the federal court lawsuits (and the state court lawsuits after removal) are being transferred to Judge John W. Lungstrum in the United States District Court for the Copyright © 2015, Sikich. All Rights Reserved. www.sikich.com Disruptions of Corn Trade with China, continued... continued...
  3. 3. Copyright © 2015, Sikich. All Rights Reserved. www.sikich.com District of Kansas in Kansas City, Kansas. Judge Lungstrum has been assigned to preside over federal “multidistrict” proceedings, a common procedure in such circumstances. Steps for Businesses Potentially Impacted by Export Market Disruptions If you believe that your business suffered damages from the corn trade/export disruptions that began in November 2013 (including declining corn prices), there are some steps that you should consider taking to protect your potential claims. � Consult with your accountant to determine whether your business has been impacted and what damages you may have suffered from the corn trade disruptions. � Consult with a lawyer to determine whether you have a claim and whether you need or want to file a separate lawsuit to preserve your claim. � Preserve all of your records that relate to your operations that you believe have been adversely affected by the recent export/ trade disruptions. Scott Roberts and Dan Bukovac, partners in the law firm of Stinson Leonard Street LLP (www.stinsonleonard.com), are currently representing clients with claims against Syngenta. Before joining the firm in 2012, Scott served as in-house counsel to one of the world’s largest ag companies. Scott is in the firm’s Decatur office and co-chairs the firm’s agribusiness industry group. In litigation and regulatory proceedings, Dan has represented a variety of agribusiness clients, including seed producers, animal feeding and production companies, animal health companies, grain, feed and ingredient suppliers, manufacturers of farm and processing equipment and farm and farm cooperative businesses. He has been representing clients in lawsuits related to various GMOs since 2000. Dan is in the firm’s Kansas City office. A 2014 Business Enterprise Institute survey of U.S. business owners found that 69 percent of business owners expect to exit their business in the next 10 years. This is a reflection of the demographic shift we are experiencing, as many business owners and leaders are nearing retirement. This reality exists in agribusinesses as well. One of the business succession planning questions many country elevators ask is related to enterprise value. As many of us know, there are many rules of thumb circulating related to the value of country elevators. There are many factors that impact value: 1. Profitability of elevator operation: Profitability is a reflection of the customer’s willingness to deliver grain at a fair price, pay service fees for drying, storage and cleaning services. It is a further reflection of the people and processes that exist in that operation that create that customer experience. Lastly, it is a reflection of the elevator’s ability merchandise and deliver a quality product at a price that allows them to generate a profit on that sale. An elevator that has been profitable is also an elevator that has had the resources to reinvest in the facility, which improves the customer experience and enhances its market share. 2. Market opportunities: The market refers to the amount of supply of grain in a market territory as well as the market that exists to sell that grain, driven by proximity to a customer or to efficient means of delivery, such as rail or river barge. The existence of a rail siding or a barge loading facility allows an elevator access to additional markets that drives higher pricing opportunities. 3. Storage capacity: Storage capacity is a driver of value. It is a reflection of the revenue potential as well as the amount of invested capital in tangible assets. Construction type of facilities, whether it is steel bins, concrete bins or flat storage, also impacts value, because of the life and utility of each of these. Elevators with higher inventory turns can further enhance their value, including elevators that have an aspect of direct shipping from the farm to the market. 4. People: It would be easier to describe this as the key management team or the board of directors but there are many key people who touch customers or provide a service to a country elevator that need to be considered. Trained people perform a service to a country elevator. They maintain relationships with customers. If a company has a succession plan for each key position, the value will increase. 5. Logistical capacities: The efficiency of an elevator to receive grain at harvest is an increasingly important factor to value. Are its facilities located strategically so the farmers can efficiently truck their grain? Is the leg capacity adequate to handle receipt of grain to avoid long wait times during the busiest harvest days? Does the elevator have adequate drying capacity to handle wet grain? Is the traffic flow convenient? 6. Additional retail operations: If the elevator has other retail operations such as fertilizer and chemical sales, seed sales or fuel sales, these can be viewed as separate businesses that would add value to the country elevator. Country Elevators: Planning for Business Succession By Tom Bayer, CPA, CSPM, CExP; Partner, Sikich Disruptions of Corn Trade with China, continued... continued...
  4. 4. Copyright © 2015, Sikich. All Rights Reserved. www.sikich.com The other question that often arises is how to retain key employees. Retirement of the general manager or a merger with another elevator or cooperative is a major event and a major change. With any major change, there is risk. To plan for that risk, protecting key assets, including key employees, is crucial. Boards must ensure they offer competitive compensation and benefit packages, along with a workplace culture that attracts employees with the right attitude and work ethic. Many times we take these factors for granted, leading to turnover. Other strategies that can be explored for key employees are stay bonuses or deferred compensation plans. Stay bonuses are designed to incentivize certain employees to continue employment through the transition period. The compensation is deferred for a period of time to force the employee to be employed as of a certain date to receive the bonus. Deferred compensation plans can be in the form of equity or other cash. A vesting schedule designed for each key employee requires him or her to meet certain employment goals or be employed for a specific time to receive the additional compensation. The planning process is one that can never be completed too early. Exposing opportunities to improve the business, or mitigate risks that are discovered, can only be beneficial. The plan needs to be revisited at least annually, and adjusted, as the business changes. Tom can be reached at tbayer@sikich.com or 217.862.1704. In today’s competitive and challenging times, agriculture businesses are constantly adapting, improving and developing new products to bring to the marketplace. At the same time, businesses are ever-striving to refine and improve the methods and processes they utilize in making these products. Congress decided to reward these efforts in the form of the research and development tax credit (“RD credit”). Awareness of this credit may reduce a taxpayer’s overall income tax liability, and thus trim the cost of the overall research expenditures. Research and development tax credits have been available to taxpayers since 1981. Historically, taxpayers have found the RD credit difficult to use and calculate. In recent years, however, new tax laws and IRS regulations have broadened the availability of RD credits by expanding the expenses allowed in computing the credit and by simplifying the calculation of the credit (Please note: The RD credit temporarily expired as of December 31, 2014, which has happened numerous times over the past 30+ years of the credit. It is likely, however, that the credit will be extended retroactively back to January 1, 2015 at some point this year). The RD credit is not just for those in the computer and technology industries, but can also apply to agriculture businesses. Ag businesses have certain activities that they consider “ordinary” functions in their operations, however, several of these might actually qualify as RD projects. For tax purposes, the IRS’ rules define research to include development of new customer products, improvements on existing customer products (2nd generation, 3rd generation, etc.), the improvement or development of a process, software development and many others. The new process or product that is developed must only be new to the taxpayer, and not to the agriculture or farming industry as a whole. Research expenditures from both successful and failed projects can be used to calculate the RD credit. The application of the research could include not only new and improved equipment used in agriculture, but also new methods to improve planting, growing, harvesting or storing of crops and produce, and also to livestock. Some other possible applications in the agriculture industry could include: � Developing new approaches in harvesting � Developing new methods at reducing damaged or spoiled crops � Creating new techniques and methods to enhance crop yield � Develop new products or crops or improve existing products (i.e., higher quality or longer storage) � Develop new fertilizers or techniques, as well as methods of pest-control � Create or discover for livestock new methods of feeding, as well as enhanced breeding � Many more; again, striving to identify new or improved products or processes Field of Tax Dreams: The RD Tax Credit By Jim Brandenburg, CPA, MST; Partner, Sikich Country Elevators, continued... continued...
  5. 5. Agribusiness Update – Spring/Summer 2015 Copyright © 2015, Sikich. All Rights Reserved. www.sikich.com To calculate the RD credit, taxpayers must identify its “qualified research expenses” (“QREs”). QREs must contain the following three elements to secure any RD credit: � The first is the existence of the process of experimentation. This is satisfied when there is uncertainty as to whether a product or process can be produced, or uncertainty exists as to how to accomplish the product or process. The process of experimentation is generally a “trial and error” process. � The second factor requires a project to be technological in nature. This means it must involve the use of physical and biological sciences. This eliminates research relating to social science, humanities and economics. � The final factor specifies that the research focus on developing a new or improved business component. This factor is met when working toward a new or improved product or process. Once the research project meets the above subjective tests, the project costs are further evaluated as only certain costs qualify as QREs. QREs include wages of personnel involved (often engineers, but can include some clerical support staff and even some supervision), supplies used in the project and 65 percent of “contract research” if certain conditions are met. Examples of ineligible costs include market and consumer research, advertising and promotion expenses and ordinary quality control testing. It is critical for taxpayers to document their QREs. An RD credit is allowed only if the business has adequate documentation. Without any documentation to support its research efforts and related costs, any research credit is generally disallowed. Documentation should describe and illustrate all the test results, the trial-and-error process of the testing, changes and modifications made during the process and what product improvements or new product was developed. It is important to document successful attempts, as well as failed attempts. Again, documentation is essential in obtaining the RD credit. Once the research projects are identified and QREs determined, the next step is to calculate the RD credit, and this calculation recently changed. The “original” formula to calculate the RD credit requires taxpayer to gather information as far back as 1982. It also dictates an increasing level of QREs in order to receive the credit. While this original method is still available, many taxpayers find the new “alternative simplified credit” (“ASC”) calculation to be less complex. Additionally, the ASC method does not require an increase in QREs to receive the credit. The RD credit using the new ASC method is calculated as follows: 14 percent of the excess of current year QREs over 50 percent of the average QREs for the previous three years. For example, assume XYZ Company incurs QREs of $400,000 in 2014. Further, XYZ averages QREs of $400,000 in the years 2011-2013. The RD credit in this situation using the ASC would be $28,000 [14% x ($400,000 - (400,000 x 50%))]. Thus, with the ASC method, an RD credit of $28,000 is allowed even though the QREs did not increase. Taxpayers with no QREs in the previous three years are still allowed an RD credit if they incur QREs in the current year. The calculation of the research credit in this case is equal to 6 percent of its QREs for the current year. Using the previous example with XYZ Company with $400,000 QREs in 2014 (and assuming no prior years’ QREs), the credit would be $24,000 ($400,000 x 6%), slightly less than the $28,000 credit. With the variety of activities qualifying for the RD credit and with the simplification of the credit calculation, the RD credit is more attractive to taxpayers than in the past. In addition, many states also offer their own RD tax credits (some Midwestern states with RD incentives are Wisconsin, Illinois, Indiana, Iowa, Missouri and Minnesota). Ag businesses should analyze their operations to identify RD projects and the costs associated with these projects to determine the possible tax saving opportunities. Jim can be reached at jbrandenburg@sikich.com or 262.754.9400 x261. As commodities prices have fallen over the last two-and-a-half years, so too have used equipment prices. Commodities prices reached recent peaks in the fall of 2012 when corn was around $8, wheat was $9 and soybeans were $17.50. As of publication time, corn was at $3.58 (down 55 percent), wheat at $4.76 (down 47 percent) and soybeans at $9.83 (down 44 percent). The silver lining, for some, is that used equipment prices have also been declining. According to Machinery Pete, auction data shows prices for large, late-model used equipment have decreased nearly 25 to 30 percent over the last two years. While commodity prices are generally not expected to recover in 2015, it may still be a good time to find a deal on used equipment. Agricultural machinery has seen significant technological advances in recent years with equipment guidance and automatic steering, variable rate application, optical crop sensing and telematics, to name a few. But as the machinery has been built to increase capacity and efficiency, there has also been added size It’saGoodTime to Be an Equipment Buyer By Greg Fiedler, CPA; Manager, Sikich Field of Tax Dreams, continued... continued...
  6. 6. and weight. The strong commodities prices leading up to early 2013, coupled with significant technological advances, caused many farmers to trade in late-model equipment and upgrade to equipment able to cover more acres, improve yield and mitigate soil compaction. The increased sales of new equipment led to a growing supply of quality late-model used equipment. Equipment dealers are adjusting prices of used equipment down to reflect market conditions and take advantage of tax benefits of writing inventories down to market values. Dealers with significant service operations also have incentives to turn over used equipment inventory to keep demand for parts and repairs. To maintain high-quality used inventory and consumer confidence, the agriculture equipment industry is beginning to adopt the certified pre-owned concept the automotive industry has been using for years. While certified equipment will carry a price premium, buyers will be assured equipment experiences thorough inspections and receives necessary repairs or refurbishments. In many cases, certified equipment may also come with a warranty. Some farmers see the down equipment market as an opportunity. While budgets may be tight for many over the next few years, farmers may save $20,000 or more, depending on their needs, by buying equipment this year rather than waiting for commodity prices to turn around. Farmers may also see cost savings through reduced input costs for seed, fertilizer, etc., as well as improved yields that the newer, more technologically advanced equipment will bring. Machinery Pete has identified the third quarter as the time that typically sees the weakest auction prices. Now is the time to assess equipment needs, evaluate current market pricing and start looking for deals. We may not see the bottom of the agriculture equipment market in 2015, but waiting for another drop could cause farmers to miss out on other savings and yield enhancements now. It’s a good time to be a buyer, but we’ll keep our fingers crossed that Congress sweetens the pot by retroactively increasing the Section 179 limit for 2015. Greg can be reached at gfiedler@sikich.com or 217.862.1861. 1415W.DiehlRoad,Suite400 Naperville,Illinois60563 It’s a Good Time to Be a Buyer, continued...

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