Agribusiness product rulings (forestry and non-forestry)
Outlines the issues we consider when reviewing an application for a product ruling.
This information is supplementary to Applying for a product ruling.
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Forestry managed investment schemes (Div 394)
Application checklist
You must provide all information in the Division 394 application checklist. You should check the date of the version you are working from, because checklists are updated from time to time.
We will only provide a ruling for a project starting in the immediate income year.
Direct forestry expenditure (DFE) calculations and spreadsheets must be provided electronically in Microsoft Excel format.
Make sure:
- sufficient evidence is provided to verify the figures and assumptions used for DFE calculations
- the information provided is current (for example, independent land valuations).
We will request this information if it's outdated or not provided.
Specific interest in land
A specific interest in land, such as a lease, is not required – the only requirement is that investors hold a 'forestry interest', which is a right to benefits produced by the scheme.
Terms payment option
We have found that several projects have included a terms payment option (see our financing principles) in a Division 394 Product Ruling application. If a grower does not actually fully pay an amount, or the amount is not actually fully paid on their behalf in an income year (see section 394-20 of the ITAA 1997), it is deductible only to the extent to which it has been paid (subsection 394-10[2] of the ITAA 1997). The unpaid balance is then deductible in the income year(s) it is paid. Under terms payment options, usually no amount is paid until the subsequent income year. As a result, a grower taking this option would not be entitled to claim a deduction in the year the scheme commences.
Direct forestry expenditure (DFE) amounts
Goods and services tax
Goods and services tax (GST) should be excluded from the DFE calculation: Section 394-40 of the ITAA 1997 excludes payments of GST by participants. Subsection 394-35(6) of the ITAA 1997 reduces amounts paid by a forestry manager to the extent to which that amount can reasonably be expected to be recouped (for example, by way of input tax credits).
Deferred fees
We have been asked how deferred fees set as a percentage of harvest proceeds should be treated for the purposes of the DFE calculation. Our view is that the amounts should be estimated based on the best available evidence at the time of estimation.
Consumer price index
We accept that future costs can be increased by Consumer price index (CPI) before calculating the net present value of all costs for the DFE calculation. CPI rates are published by the Australian Bureau of Statistics and reproduced by us to provide figures based on 'All groups CPI weighted average of eight capital cities'. You can access these figures from the Consumer price index (CPI) rates that we provide.
Notional amounts for the use of land
If a forestry manager, or associated entity, owns the land on which the trees will be planted, the DFE calculation may include a notional rent amount – this is calculated by applying a rental yield to the land value. We expect applicants to provide acceptable market-based research to support the rental yield and land value used in calculating notional rent, taking into account the location and suitability of the land relevant to the type of forestry project, as well as the term of the project.
Land appreciation
We do not accept amounts for 'Land appreciation' for the purposes of determining whether a forestry managed investment scheme meets the 70% DFE rule under section 394-45 of the ITAA 1997. Land appreciation is a notional uplift percentage applied to the land in addition to the CPI factor. The intent of the legislation is to allow for the market value of the notional use of land, that being the market value of rent – rent being payment for the use of the land. Therefore, we accept a reasonable valuation, as at the time the product ruling application is lodged, of the land the scheme applicant owns, and apply a market-value rent to the land to calculate the notional rent amount. The current market value of the land is accepted because it is a fair and reasonable approach, and minimises the compliance costs to promoters.
Sale of standing timber
We have been asked whether participants will be an 'initial participant' for the purposes of subsection 394-15(5) of the ITAA 1997 if the return on their investment will be made by the sale of standing timber. We consider that payments by the participant should result in the establishment of trees for felling. It does not matter who is to fell the trees or whether felling is undertaken by or for a participant in the scheme.
Guaranteed returns including buy-back mechanisms
We have been asked whether a promoter can provide a guaranteed rate of return for a scheme that qualifies under Division 394, given that there is no requirement for individual participants to be carrying on their own business.
Guaranteed returns remove or significantly reduce investor risk. If a guaranteed return is part of a scheme, we will consider it as part of the entire arrangement to determine whether there is any wider impact that will give us cause for concern. One aspect we will examine is whether the guaranteed return is based on the anticipated market value at the time of disposal.
A buy-back mechanism refers to a means by which the participant's interest in the scheme can be acquired from them under an agreement related to the operation of that scheme. An example is a put option offered to a participant to allow them to dispose of all or part of their interest, for consideration, to an entity associated with the promoter or manager, prior to the participant deriving income from the sale of timber (on completion of the scheme).
We are concerned about buy-back mechanisms in a Division 394 arrangement if they provide a guaranteed return. We will examine whether there are any concerns regarding the dominant purpose and whether it may trigger the anti-avoidance provisions of Part IVA of the ITAA 1936.
We will also review the timing of any buy-back mechanism, as participants must hold their forestry interest for at least four years from the end of the income year in which the first payment was made to acquire that interest to be able to claim deductions for initial and ongoing payments made to a Division 394 forestry scheme.
Finance principles
The financing principles were introduced because some financing arrangements give rise to concerns as to the potential application of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936). Division 394 was enacted after the issue of the financing principles. However, the same Part IVA concerns of some financing arrangements can also apply to arrangements to which Division 394 applies. Therefore, any consideration of an application for a ruling in relation to Division 394 that includes financing arrangements will also consider whether those financial arrangements are consistent with the financing principles.
Agribusiness managed investment schemes (non-Division 394 schemes)
Capital expenditure
In the past, we have had concerns where amounts of expenditure incurred by the participants in an agribusiness managed investment scheme (MIS) were presented as deductible under section 8-1 of the ITAA 1997, when the true nature of the expenditure was capital.
Whether any expenditure incurred by a participant is deductible under section 8-1 of the ITAA 1997 or is capital expenditure will depend on the facts of each situation.
The following are examples of ATO concerns and capital expenditure.
Example 1:
A horticultural scheme provides for fees to be paid to a responsible entity/manager to perform services to supervise or inspect the establishment of the agribusiness MIS.
Whether such fees are deductible under section 8-1 of the ITAA 1997 will depend on the specific facts such as, at what stage of the establishment of the agribusiness MIS were these services performed and the expenditure incurred by the participants.
The establishment of an agribusiness MIS typically includes capital infrastructure items such as irrigation, trellising and the establishment of horticultural plants. This type of expenditure itself is generally capital in nature, and as such is not deductible under section 8-1 of the ITAA 1997.
Generally, to the extent that services to supervise or inspect the establishment of the agribusiness infrastructure are provided prior to the full establishment of the business infrastructure, they would be regarded as part of that establishment and, as a result, capital in nature.
It must be clear or we must be satisfied that the capital structure required to conduct the business is expected to be fully established prior to the entry of the participant into the business. Only then, will such expenditure incurred by the participant be deductible.
If it is not certain (or we cannot satisfy ourselves sufficiently) that the capital structure required to conduct the business will be fully established at the time the participant enters the scheme, any expenditure incurred for supervision or inspection may be capital in nature, because it will be considered to be part of the establishment of the business.
In the latter case, it will be necessary to establish the component that is capital and apportion that amount from the deductible management fee. If we are unable to determine the amount of the capital component, we will refuse to rule, on the grounds that we cannot provide certainty to all participants.
End of example
Example 2:
A participant acquires an interest in an established scheme where the olive grove was planted prior to the participant commencing in the scheme.
The cost for acquiring the interest in the scheme may include lease fees and management fees that would generally be deductible under section 8-1 of the ITAA 1997. However, it will be necessary to establish whether or not there is also a capital component for the cost of acquiring an interest in an established olive grove, and if so apportion that amount from the deductible fees.
End of exampleSee also:
High profit margins
We use benchmark information on the costs of establishing a plantation, vineyard or similar. We often see proposals where the profit margin appears to be very high relative to this benchmark information.
We make no judgment about this issue, of itself. However, we are mindful that such profit margins may indicate the existence of an undisclosed collateral arrangement. Collateral arrangements are other transactions that a participant may enter into that are not presented as part of the facts of the arrangement that we are being asked to rule on. Collateral arrangements that raise concerns include arrangements that artificially inflate deductions and/or hide refunds to investors, for example via a 'round-robin' transaction or a commission rebate.
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Before issuing any ruling, we will need to be satisfied that the profit margin represents nothing more than profit. That is, it is not associated with collateral agreements or mechanisms designed to artificially inflate any tax deductions.
Establishing just what the proposed or anticipated profit margin is commonly involves a full and true disclosure of the anticipated expenses, together with supporting documentation showing how those expenses have been arrived at. An application may be able to be expedited with such a disclosure.
If your proposed profit margin is above the benchmark, you should expect to be asked for an explanation of why this is so (assuming the answer is not already provided).
We have found that the structure of some managed investment schemes have undergone some variations. One of the most common variations is the lease or licence of an established agribusiness to participants in circumstances where the nature of services to be provided is substantially, if not totally, the same in the year of entry as it is in subsequent years.
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Usually, with these schemes, the level of management fees charged in the first or initial period is very high relative to the level of services provided in that same period. Also, the initial period management fee is significantly higher than the fee charged for the same services in later years. These 'excessive fee' situations require thorough examination by us. This examination will include an analysis of cash flow, and comparisons of the fees to the services and to the cost of providing them in each year of the scheme, to determine whether the initial management fee contains a prepayment.
If we decide to conduct such an examination of your application, this may delay our final consideration of that application. In some instances, this may mean we will refuse to rule because the issue cannot be resolved to a point of providing certainty to potential participants.
Initial period fees
We have found that the level of the initial fee charged in some agribusiness managed investment schemes has brought into question whether the full amount of the fee may be claimed as a deduction by participants in the initial year. The fee structure of these schemes will be examined to ensure that the Commissioner can provide certainty to participants in relation to the application of the prepayment provisions.
The concerns about these schemes relate to the latest date on which participants are permitted to enter a scheme and the capacity for certain services to be provided within the specified period. This is discussed in further detail under Closing date to accept participants into a scheme. The schemes are categorised as either established schemes or unestablished schemes.
Closing date to accept participants into a scheme
Established schemes
These are schemes where participants lease/licence an area of land which already has an established agribusiness in place - for example, a participant leases an area of land which has an olive grove planted on it prior to the participant commencing in the scheme.
We have found with these schemes that the nature of the services to be provided is substantially, if not exactly, the same in the year of entry as it is in subsequent years. The level of management fees charged in the first or initial period is generally very high by comparison to the level of services provided in that same period. We have also found in those cases that the management fee for the initial period is significantly higher than the fee charged for the same services in later years.
The concern about these schemes arises as a result of the date to which participants may be accepted into the scheme. If this is late in the income year, there is substantial doubt as to whether any services of significance will be provided. In this case, we cannot be certain that the initial fee is paid for the provision of services within the same income year only.
Such cases will be thoroughly examined to ensure that we can provide certainty to participants about the application of the prepayment provisions. If we have concerns about the provision of services and the length of the service period it may not be possible to provide certainty to participants and, as a result, we may not be able to rule.
If we can provide a ruling, the closing date for applications into the scheme must be determined, having regard to the level of services to be provided and the quantum of fees paid. For established schemes, we may accept a closing date of 15 June or earlier, depending on the facts of the case and the level of services to be provided. A closing date after 15 June will generally not be accepted.
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