House of Representatives

Tax Laws Amendment (2007 Measures No. 3) Bill 2007

Tax Laws Amendment (2007 Measures No. 3) Act 2007

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 8 Investments in forestry managed investment schemes

Outline of chapter

8.1 Schedule 8 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide that initial investors in forestry managed investment schemes (forestry schemes) will receive a tax deduction equal to 100 per cent of their contributions and subsequent investors will receive a tax deduction for their ongoing contributions to forestry schemes, provided that at least 70 per cent of the scheme manager's expenditure under the scheme is expenditure attributable to establishing, tending and felling trees for harvesting (direct forestry expenditure or DFE).

8.2 The new provision retains the existing principle that the managers of forestry schemes must include the investors' contributions in their assessable income in the year in which the deduction is first available to the investor for those contributions.

8.3 This Schedule also provides rules governing the taxation consequences of trading forestry scheme interests. These rules are set out in the following chapter (Chapter 9) of this explanatory memorandum.

Context of amendments

8.4 The deductibility of investors' contributions to forestry schemes is currently determined under the general deduction provision contained in section 8-1 of the ITAA 1997. In addition, an immediate deduction may be claimed for funds contributed in one year for 'seasonally dependent agronomic activities' undertaken during the following year (section 82KZMG of the Income Tax Assessment Act 1936 (ITAA 1936)). This special '12-month prepayment rule' is due to expire on 30 June 2008. Where investors take advantage of the 12-month prepayment rule, scheme managers must include the investor's contribution in their assessable income in the year the investor becomes eligible for the deduction (section 15-45 of the ITAA 1997).

8.5 The test in section 8-1 involves considerable uncertainty as to whether specific expenses relating to managed investment schemes will qualify as a deduction, either because the investor may not be carrying on a business or because the investor's interest in the scheme is capital rather than revenue in nature.

8.6 Accordingly, the Government has decided to provide certainty to investors and the forestry industry by providing a specific deduction for contributions to forestry schemes. At the same time, it has decided to maintain the requirement that scheme managers include investors' contributions in assessable income in the year the investor is entitled to the deduction.

Summary of new law

8.7 Schedule 8 creates a new specific deduction provision for contributions to forestry schemes.

8.8 The provision ensures that initial investors in forestry schemes will receive a tax deduction equal to 100 per cent of their contributions and that secondary investors will receive a tax deduction equal to 100 per cent of their ongoing contributions, provided that there is a reasonable expectation that at least 70 per cent of the scheme manager's expenditure under the scheme, at arm's length prices, is expenditure attributable to establishing, tending and felling trees for harvest (DFE).

8.9 The requirements for the deduction are set out in sections 394-10 and 394-15. These include that:

·
the entity claiming the deduction is an investor in a scheme whose purpose is for establishing and tending trees for felling only in Australia;
·
the investor does not have day-to-day control over the operation of the scheme; and
·
the trees intended to be established in accordance with the scheme have all been established within 18 months of the end of the income year in which the first payment is made by an investor.

8.10 The '70 per cent DFE rule' is set out in section 394-35. The rule provides that the amount of DFE under the scheme (the sum of the net present values of all DFE under the scheme) divided by the amount of payments under the scheme (the sum of the net present values of all amounts that participants in the scheme have paid or will pay) must be greater than or equal to 70 per cent. This is an objective test of what is a reasonable estimate of 70 per cent expenditure on DFE, based on the actions that a reasonable person in the scheme manager's position would take in making such an estimate. A market value substitution rule operates where the expenditure differs from market value.

8.11 The notion of a payment under the scheme excludes payments for:

·
financing (borrowing costs and interest and payments in the nature of interest);
·
stamp duty;
·
goods and services tax (GST), where applicable; and
·
processing forestry produce, for example in-field wood chipping or milling of logs, whether in-field or at a static facility.

8.12 'DFE' is defined in broad terms as:

·
amounts spent by the scheme manager (or an associate of the scheme manager) under the scheme that are attributable to establishing, tending, felling and harvesting trees; and
·
amounts of notional expenditure reflecting the market value of land, goods and services provided by the scheme manager that are used for establishing, tending, felling and harvesting trees.

Certain expenses which are clearly not DFE are listed in subsections 394-45(3) and (4).

Definitions of concepts used in the legislation

8.13 The following meanings of words and phrases (and legislatively defined terms) are used in Chapters 8 and 9:

·
amounts paid by investors are referred to as 'contributions' or 'fees', whereas amounts paid by scheme managers (and their associates) are referred to as 'expenditure' or 'expenses';
·
the term 'investor' is used to describe an entity which makes a contribution to a scheme - in the legislation, an investor in the scheme (other than the manager, if the manager invests in the scheme) is referred to as a 'participant';
·
'scheme' is as defined in subsection 995-1(1) of the ITAA 1997;
·
'forestry managed investment scheme', 'manager', 'interest', 'participant' and 'initial participant' are as defined in section 394-15:

-
The forestry managed investment scheme may be registered or unregistered under the Corporations Act 2001 ,

·
'associate' is as defined in section 318 of the ITAA 1936;
·
'Australia' is as defined in section 17 of the Acts Interpretation Act 1901 and the ITAA 1936; and
·
'payment' is defined in section 394-20 to include constructive payments, such as a payment made to the scheme manager by a financier at the direction of an investor.

Comparison of key features of new law and current law

New law Current law
Initial investors in forestry schemes receive a 100 per cent tax deduction for their contributions (both initial and ongoing) and secondary investors in forestry schemes receive a 100 per cent deduction for their ongoing contributions in the year that they pay amounts under the scheme, provided that at least 70 per cent of the scheme manager's expenditure under the scheme is expenditure directly related to establishing, tending and felling trees for harvesting (DFE). Initial investors in forestry schemes may be considered to be 'carrying on a business' for the purposes of section 8-1 of the ITAA 1997. If they are considered to be carrying on a business, then they may be entitled to claim deductions for their expenditure on lease and management fees, except where these expenses are capital in nature: hence not deductible. Subsequent investors do not receive deductions for their ongoing costs.
Other requirements include:

·
the trees must be planted in Australia; and
·
the trees must all be planted within 18 months.

There is no specific requirement that the trees be planted in Australia.
Section 82KZMG will not apply to forestry schemes after 30 June 2008. To ensure the intent of the legislation is implemented, the normal provisions which restrict the deductibility of prepayments (sections 82KZL to 82KZO of the ITAA 1936) will not apply to payments which satisfy the specific deduction provision.

While it may be possible to trade interests in forestry schemes, this has not occurred in practice due to a view that an investor's contributions may not have been deductible if there is evidence that the investor did not intend at the time of entering into the scheme, to remain in the scheme until harvest.

Where disposals of forestry scheme interests have occurred (ie, in hardship cases), such sales have been treated as a disposal of trading stock (standing trees) outside the ordinary course of business, with the proceeds included in the investor's assessable income at market value (section 70-90 of the ITAA 1997).

Section 82KZMG will not apply to forestry schemes after 30 June 2008. To ensure the intent of the legislation is implemented, the normal provisions which restrict the deductibility of prepayments (sections 82KZL to 82KZO of the ITAA 1936) will not apply to payments which satisfy the specific deduction provision. A prepayment is available for expenditure in one year in respect of 'seasonally dependent agronomic activities' which are undertaken in the following year (section 82KZMG of the ITAA 1936). Seasonally dependent agronomic activities include ripping and mounding a plantation site, applying fertiliser, tending the seedlings prior to planting and the actual planting.
There is no requirement for taxpayers to demonstrate that they are 'carrying on a business' in order to access the deduction or that the amount paid is of a revenue nature. Due to case law developments, there is uncertainty as to whether any of these expenses will qualify as a deduction, because the expenses may be capital in nature.

The initial investor's sale and harvest proceeds are treated as assessable income on revenue account.

The secondary investor's proceeds from sale and harvest are deemed to be held on revenue account to the extent that they 'recoup' prior forestry deductions and the balance is deemed to be held on capital account (with the cost base increased to reflect the income deemed to be held on revenue account), provided that the secondary investor does not hold the forestry scheme interest as an item of trading stock.

While it may be possible to trade interests in forestry schemes, this has not occurred in practice due to a view that an investor's contributions may not have been deductible if there is evidence that the investor did not intend at the time of entering into the scheme, to remain in the scheme until harvest.

Where disposals of forestry scheme interests have occurred (ie, in hardship cases), such sales have been treated as a disposal of trading stock (standing trees) outside the ordinary course of business, with the proceeds included in the investor's assessable income at market value (section 70-90 of the ITAA 1997).

Under new section 15-46 of the ITAA 1997, when a scheme manager of a scheme receives an amount from an investor and all the requirements of section 394-100 are satisfied, the amount must be included in the scheme manager's assessable income in the year in which the investor is first able to claim the corresponding deduction. Under section 15-45, when a scheme manager of an agreement receives an amount from an investor and all the requirements of section 82KZMG are satisfied, the amount must be included in the scheme manager's assessable income in the year in which the investor is first able to claim the corresponding deduction.
A market value substitution rule will apply in determining the value of DFE. There is no arm's length rule or market value substitution rule.
DFE means, in a general sense:

·
amounts spent by the scheme manager (or an associate of the scheme manager) under the scheme that are attributable to establishing, tending, felling and harvesting trees; and
·
amounts of notional expenditure reflecting the market value of land, goods and services provided by the scheme manager that are used for establishing, tending, felling and harvesting trees.

No equivalent.

'Establishing' a plantation includes planting and coppicing activities.

The provision will extend to harvesting costs. Harvesting costs include transportation costs from the site of the tree to the earlier of:

·
sale;
·
mill door;
·
port;
·
or processing.

Harvesting costs do not include:

·
in-field processing such as chipping or milling;
·
marketing;
·
sale costs;
·
stockpiles;
·
port handling; or
·
ship loading.

Transport from in-field chipping to mill or port is allowed.

No equivalent.

Detailed explanation of new law

8.14 This measure inserts a specific deduction into the ITAA 1997 to provide initial investors with a tax deduction equal to 100 per cent of their payments under the scheme, provided that there is a reasonable expectation at 30 June in the year in which an amount is first paid under the scheme that at least 70 per cent of that expenditure (using market value) qualifies as DFE. Secondary investors are also entitled to a tax deduction equal to 100 per cent of their on-going contributions under the scheme.

8.15 The specific deduction provisions will be located in Division 394 of the ITAA 1997. If a taxpayer would be eligible for deductions under both section 8-1 and the specific deduction provision, then pursuant to section 8-10 of the ITAA 1997, the taxpayer will be able to claim a deduction only under the provision that is more appropriate. If the taxpayer qualifies under the specific deduction provision, then this would be the most appropriate provision. If a forestry scheme does not qualify under the new Division 394, but may do so under section 8-1, section 8-1 may continue to apply.

8.16 There is no requirement for taxpayers to demonstrate that they are 'carrying on a business' in order to access the deduction or that the amount paid is revenue in nature.

8.17 Interest and borrowing costs paid by an investor will not be covered by the specific deduction provision and will continue to be deductible under the relevant provisions of the ITAA 1936 and the ITAA 1997 (eg, sections 8-1 and 25-25 of the ITAA 1997, respectively), provided the relevant tests for those provisions are met.

Objects clause

8.18 The objects clause is intended to provide guidance as to parliament's precise objectives in enacting these rules and to limit the parameters of the rules.

8.19 The objectives of the legislation is to direct investment to commercial plantation forests, to help achieve the industry's goals as set out in Plantations for Australia : the 2020 Vision :

·
In particular, the intention is to grow trees to be felled. Schemes involving trees that are grown for their produce other than timber (eg, avocadoes, olives or macadamia nuts) do not generally qualify except in a case such as sandalwood which is felled and subsequently exploited for its oil as well as its timber.

8.20 The objective is to be achieved by:

·
ensuring that investors will only qualify for the deduction if certain conditions are met (for instance if there is a reasonable expectation that 70 per cent of their contributions (on a market value basis) will be spent on direct forest expenditure); and
·
allowing secondary market trading of scheme interests whilst minimising tax arbitrage opportunities and providing certainty of taxation treatment for investors.

[Schedule 8, item 2, section 394-5]

Requirements for the scheme

8.21 The prerequisites for obtaining the deduction are that:

·
the entity claiming the deduction holds an interest in a forestry managed investment scheme [Schedule 8, item 2, paragraph 394-10(1)(a )]:

-
such an entity is referred to in the legislation as a 'participant';
-
'participant' does not include contractors or subcontractors that are engaged by the scheme manager. It also does not include employees of the scheme manager or any contractors engaged to carry out activities under the scheme. However, investors are not denied deductions when they invest separately to their capacity as a contractor, sub-contactors or employee of the scheme manager;

·
the purpose of the scheme is for establishing and tending trees for felling in Australia [Schedule 8, item 2, subsection 394-15(1 )]:

-
this requirement is intended to preclude deductions for horticulture trees that are grown for their produce apart from timber, for example almond and avocadoes;

·
the investor pays an amount under the scheme [Schedule 8, item 2, paragraph 394-10(1)(b )]:

-
this is effectively the time when the cash flows from the investor to the scheme manager. The use of the word 'paid' (rather than 'incurred') denotes this cash concept. The word 'pay' is defined further below; and
-
the acquisition of shares in forestry companies, or units in a forestry unit trust, falls outside the wording of this provision. Accordingly, taxpayers who acquire such shares or units are not entitled to the deduction;

·
the scheme satisfies the 70 per cent DFE rule on 30 June in the income year in which an investor in the scheme first pays an amount under the scheme [Schedule 8, item 2, paragraph 394-10(1)(c )];
·
the investor does not have day-to-day control over the operation of the scheme (whether or not the investor has the right to be consulted or give directions) [Schedule 8, item 2, paragraph 394-10(1)(c )]:

-
the legislative requirement that the investor be a 'participant' in a forestry scheme is wide enough to encompass investors, forestry scheme managers and forestry contractors. The requirement that the investor does not have day-to-day control over the operation of the scheme ensures that managers of forestry schemes cannot access this concession. The preceding requirement, that the investor pays an amount under the scheme, ensures that contractors who supply goods or services to the scheme manager cannot access this concession;

·
at least one of these conditions is satisfied [Schedule 8, item 2, paragraph 394-10(1)(e )]:

-
there is more than one investor in the scheme; or
-
the scheme manager, or an associate of the manager, manages, arranges or promotes similar schemes for other entities;

·
the trees intended to be established in accordance with the scheme have all been established within 18 months of the income year when expenditure was first paid under the scheme by an investor [Schedule 8, item 2, paragraph 394-10(1)(f) and subsection 394-10(4 )]:

-
this ensures that the intent of the specific deduction, to establish trees for felling, is met;
-
this provision is worded in a manner that it is deemed to be fulfilled unless it is subsequently found that the trees are not planted. As a consequence, investors should be able to claim a deduction when they pay their contribution. Should the trees not be planted within 18 months, then the investor's deduction may be denied, in addition to potentially applying the promoter penalty provisions against the scheme manager; and
-
a forestry scheme would meet paragraph 394-10(1)(f) where replanting of unsuccessful seedlings extends past 18 months;

·
the investor is an initial investor that holds the interest under the scheme for four years from the end of the income year in which they first paid an amount under the scheme. (The concept of an initial investor is explained further in Chapter 9 of this explanatory memorandum.) [Schedule 8, item 2, subsections 394-10(5) and (6 )]:

-
a breach of this requirement will result in the investor losing a deduction and being assessed on the proceeds. The investor may also be liable to pay the general interest charge and penalties; and

·
sections 82KZMD and 82KZMF of the ITAA 1936 do not apply to expenditure which qualifies for the new specific deduction. Those provisions relate to the rules which normally govern the period over which prepaid expenditure can be deducted [Schedule 8, item 2, subsection 394-10(7 )].

8.22 The investor claims the deduction for the income year in which the investor pays the amount. [Schedule 8, item 2, subsection 394-10(2 )]

Subsequent investors cannot deduct the costs of acquiring their interest

8.23 An investor who acquires an interest in the scheme from another investor (eg, by purchasing the interest from the initial investor on the secondary market) is specifically prevented from claiming the specific deduction in respect of the market value that they pay to acquire that interest. Given that the objective is to establish trees, secondary investors should not need to obtain a deduction for the establishment costs of trees. [Schedule 8, item 2, subsection 394-10(3 )]

Meaning of 'payment'

8.24 For the purposes of paragraph 394-10(1)(b), 'payment' includes an amount paid at the direction of an investor in the scheme, such as a financial institution paying the scheme manager an amount as part of funding a loan to the investor. [Schedule 8, item 2, section 394-20]

Example 8.1 Investor A instructs Finance Coy to pay Australian Forest Ltd (AFL) $10,000 for an interest in a 2008 pulpwood project. Finance Coy deposits this amount into AFL's account. This satisfies 'pay' for the purposes of paragraph 394-10(1)(b).

Payments under the forestry scheme

8.25 This concept encompasses everything paid by an investor to a scheme manager under a forestry scheme. However, the following payments are excluded from the deduction [Schedule 8, item 2, sections 394-10 and 394-40] :

·
borrowing costs;
·
interest and payments in the nature of interest (such as a premium on repayment or redemption of a security, or a discount on a bill or bond);
·
stamp duty;
·
GST (where applicable); and
·
processing costs.

The first time an amount is paid under the scheme

8.26 'The first time an amount is paid under the scheme' for the purposes of the paragraph 394-10(1)(c) test, will either be when the first amount is paid by an investor to become a participant in the scheme or, if there is a contingency such as a minimum subscription requirement, when the contingency occurs. To determine this question, it will be necessary to examine the terms of the agreement. Under some forestry agreements, this will be the time at which minimum subscription is achieved and the application fee is transformed into an establishment fee. The issue arises because there is a question as to when the first investor actually becomes a participant in the scheme. Many schemes have an application fee that is held in trust until a minimum subscription level is reached, at which point it may then be transformed into an establishment fee.

Example 8.2 Australian Forests Ltd (AFL) issues a product disclosure statement for its 2009 pulpwood project on 31 March 2008. Investor A pays an application fee on 20 June 2008 which is held in trust by AFL until minimum subscription occurs. The issue is fully subscribed on 25 June 2008 and AFL applies the investor's application fee together with an additional establishment fee to establish the 2009 pulpwood project on 25 June 2008.The scheme must satisfy the 70 per cent DFE rule on 30 June 2008 which is in the income year where the establishment fee was paid. This constitutes the first payment under the scheme.

Meaning of 'establishing'

8.27 The concept of 'establishing' a plantation includes planting, coppicing and grafting activities and other methods of plant propagation that result in a forest being established. Coppicing is a process in which new shoots from the stumps of harvested trees are culled and the selected shoots are managed to produce a new tree crop. 'Establishing' does not include acquiring an immature forest.

8.28 Site preparation costs (such as ground and fence clearing, deep ripping and mounding, pre-planting fertilisation, initial weed control and channel irrigation and road or fire-break creation), which are necessary to enable trees to be established and survive, are included in the concept of establishing.

8.29 In addition, some 'pre-establishment' costs (such as site selection costs) will be able to be claimed to the extent they are attributable to DFE. Such costs may need to be apportioned, for example, where they relate to more than one project covered by the same site selection exercise.

Meaning of 'tending'

8.30 'Tending' includes inspection, measuring and monitoring, pest control, fire hazard reduction and fire management, re-planting, coppice management, fertilising, pruning and thinning, which are all part of tending the forest until harvest.

Meaning of 'felling'

8.31 For the purposes of Division 394, felling trees includes harvesting activities (whether for final harvest or earlier commercial thinnings) such as felling trees, de-limbing or lopping off branches and heads, the removal of bark or the cross-cutting into manageable lengths to facilitate on-site storage or transport. 'Harvesting' trees does not include substantial transformation into a different product such as through in-field chipping or milling. [Schedule 8, item 2, subsection 394-45(4 )]

8.32 Certain 'post-harvesting activities' are excluded from DFE. These are outlined in paragraphs 8.66 and 8.67.

Initial investor's sale and harvest proceeds held on revenue account

8.33 To provide symmetry between the upfront revenue deduction and the proceeds of sale or harvest, where you are an initial participant in the scheme and can deduct or have deducted an amount under Division 394 (or could have done so if you had not disposed of your interest within four years), and a CGT event occurs in relation to your interest, the proceeds arising from the CGT event will be treated as assessable income on revenue account in the income year of receipt. [Schedule 8, item 2, section 394-25]

8.34 This is achieved by requiring the assessable income of the investor to include the market value of the interest when a CGT event happens to your interest under the scheme. A CGT event will happen in relation to your interest if that interest is sold, is extinguished or ceases, or if the CGT event reduces the value of the interest. The market value that is included in your income is the value of the interest just before the event, or if you continue to hold your interest after the CGT event, the amount by which the market value of your interest is reduced. [Schedule 8, item 2, subsection 394-25(2 )]

8.35 Treating the initial investor's interest as capital would result in the initial investor obtaining a double benefit of a 100 per cent deduction (on revenue account) on acquiring the interest and the potential application of concessional CGT treatment, including the CGT discount for individuals and trusts and the application of capital losses to their proceeds on disposal.

Direct forestry expenditure (DFE) and the 70 per cent DFE rule

8.36 To ensure that most of the funds contributed by investors are spent on activities directly related to establishing, tending and felling trees for harvesting, the scheme manager of the scheme must ensure that no less than 70 per cent is spent on 'direct forestry expenditure'. [Schedule 8, item 2, section 394-35]

8.37 The principle will only measure contributions and expenditure that are undertaken under the scheme. For example, supplies that are made by related entities (rather than by the scheme manager) direct to the investor will only be captured if they are within the scheme. Equally, payments by investors must be made under the scheme to be included in the test.

8.38 The concept embodies an objective test of what is a reasonable estimate of 70 per cent expenditure on DFE over the life of the project, using a net present value calculation for past and future expenditure. The deduction is available if there is a reasonable expectation that DFE will be equal to or exceed 70 per cent at 30 June of the income year in which an investor first makes a contribution to the scheme. [Schedule 8, item 2, paragraph 394-10(1)(c) and subsection 394-35(1 )]

8.39 It should be noted that:

·
the standard of reasonableness is that of a reasonable person standing in the shoes of the scheme manager and taking reasonable steps to gather relevant information to establish that the expectation exists; and
·
the scheme manager will need to prepare, for the duration of the project, sufficient evidence to document that this reasonable expectation existed at the required time.

Example 8.3 In year 1 a scheme manager of a 10-year bluegum project has a reasonable expectation that the proportion of DFE under a particular scheme will be 75 per cent. This includes an expectation that the annual rent in net present value terms over the life of the project is $50,000 based on the scheme manager's knowledge of the relevant technology and prevailing economic conditions.In the subsequent years, the following events occur which have the effect, based on actual data, of reducing the relevant proportion below 70 per cent. However, as the examples illustrate, the actual proportion does not directly impact on whether the expectation was reasonable at the time it was made.

·
The scheme manager estimated that the cost of felling and loading the plantation in 10 years time in net present value terms will be $4,000 per hectare. Subsequent technological advances in the methods for felling that were not foreseeable when the project was planned result in the cost of felling being reduced by 25 per cent to $3,000, which means that the actual DFE on the project during its life would be below 70 per cent of total fees charged to investors. The scheme manager became aware of this in year 8 of the project. The scheme manager could not reasonably have expected such a technological advancement to happen at the time of making the estimate for the purposes of subsection 394-35(1). Therefore the reasonable expectation test in subsection 394-35(1) was met at the time of the estimate.
·
The scheme manager's estimated labour costs for the project based on the future value of current costs of similar size projects, including labour costs for pest control. During the three years prior to the commencement of the project, the use of advanced methods of pest control had increased steadily from 10 per cent of industry projects to 30 per cent. Industry reports in the year before the project commenced indicated the expectation that in the next 10 years this method would spread to all parts of the industry. This method of pest control is adopted in the project from commencement and significantly reduces labour costs below that used in the estimates of DFE. A reasonable estimate of the proportion of DFE based on the use of the advanced pest control method would be below 70 per cent. The scheme manager of the scheme could reasonable have expected that these methods would come to be used in this project during its life. Therefore, the reasonable expectation test in subsection 394-35(1) was never met and the investors in the scheme were never entitled to the specific deduction under section 394-10.
·
As a result of an unexpected drought in the region where the project is located, the growth of trees is substantially less than originally projected and harvest costs are only $2,000 per hectare, which means that the actual DFE on the project during its life would be below 70 per cent of the total fees charged to investors. As this drought was unexpected at the time of making the estimate for the purposes of subsection 394-35(1), therefore the reasonable expectation test in subsection 394-35(1) was met at the time of the estimate and the project continues to meet the test in subsection 394-35(1).

8.40 Once it is found that there was not a reasonable expectation at the relevant time, any participant contributions will not be deductible, subject to the period of review for the participant in respect of relevant income years.

8.41 The amount of DFE under the scheme is the sum of the net present values (at the date of the test) of all DFE under the scheme that the scheme manager has paid or will pay under the scheme. [Schedule 8, item 2, subsection 394-35(2 )]

Example 8.4 On 30 June 2009 the manager spends $2,000 on site selection costs. On 15 March 2010 the first investor's payment under the scheme becomes final. On 30 June 2010, the manager will be required to calculate the net present value of the site selection expenditure using the figure prescribed in subsection 394-35(7) for the purposes of estimating the 70 per cent DFE amount.

8.42 The amount of payments under the scheme is the sum of the net present values of all amounts that participants in the scheme (other than the manager) have paid or will pay under the scheme. [Schedule 8, item 2, subsection 394-35(3 )]

8.43 Expenses are recognised on a 'net cost' basis. For example, where expenditure is undertaken and a grant is received (such as for the costs of training/employing apprentices), only the net expense of the scheme manager is taken into account. [Schedule 8, item 2, subsection 394-35(6)]

Net present value basis

8.44 The amount spent on DFE over the life of the project will be determined in 'net present value' terms. Net present value is a way of converting past and future costs into today's dollars. Discounting is the technique used to make the conversion. Discounting recognises that a dollar today is not worth the same as a dollar in the future because (even in the absence of inflation) today's dollar can be invested.

8.45 This concept applies to both past and future expenditure of the scheme manager under the scheme.

8.46 If:

(Net present value of DFE unde the arrangement / Net present value of fees paid by investor under the arrangment) >= 70%

then it is a qualifying scheme. [Schedule 8, item 2, subsections 394-35(1) to (3 )]

8.47 For the purpose of working out the net present value of an amount paid on or before the day on which the 70 per cent DFE rule is calculated, the amount is to be treated as having been paid on 30 June in the income year in which the amount was actually paid. [Schedule 8, item 2, subsection 394-35(4 )]

8.48 For the purpose of working out the net present value of an amount expected to be paid after the day on which the 70 per cent DFE rule is calculated, the amount is to be treated as having been paid on 1 January in the income year in which the amount was actually paid. [Schedule 8, item 2, subsection 394-35(5 )]

8.49 Present values will be calculated by discounting future expenditures using the yield on Commonwealth Government Securities that are Treasury bonds with the maturity closest to 10 years (as published by the Reserve Bank of Australia). The scheme manager can use the current quoted rate as an approximation of the rate on 30 June. [Schedule 8, item 2, subsection 394-35(7 )]

Example 8.5 On 30 June 2008, a scheme manager is seeking to establish the net present value of future expenditure. The manager consults the Indicative Mid Rates of Selected Commonwealth Government Securities as published by the Reserve Bank of Australia for that day. According to the Reserve Bank, a Treasury Fixed Coupon Bond with a yield of 5.910 per cent will mature in February 2017 and another Treasury Fixed Coupon Bond with a yield of 5.880 per cent will mature in March 2019. No other bonds with a longer maturity are listed. The bond maturing in March 2019 should be chosen as it has the maturity closest to 10 years.

8.50 The yield on Commonwealth Government Securities is a risk-free rate. The rate is chosen for simplicity and to reduce compliance costs. The use of a risk-free rate is balanced by a number of risk-related items being excluded from DFE, such as insurance.

Example 8.6 The following scenarios assume that Australian Forests Ltd (AFL) issues a product disclosure statement for its 2008 project. Investors acquire a one hectare interest in a 10-year plantation. It is assumed that the initial investor holds until harvest. The discount rate specified in the legislation to calculate the net present value of AFL's future expenditure is the interest rate on Commonwealth Government Securities that are Treasury bonds with the maturity closest to 10 years which at 1 January 2008 is 7 per cent per annum. In each scenario the base year is year 1. Scenario 1 In the first scenario, in year 1 the investor acquires an interest for $10,000. The scheme manager pays $8,000 in DFE. There are no further anticipated or actual expenses or contributions over the life of the project. Applying the formula:

(Net present value of DFE under the arrangment / Net present value of fees paid by the investor under the arrangment)

the relevant figure is: 8000 / 10,000 = 80% (ie, the test is passed). Scenario 2 In year 1 the investor acquires an interest for $10,000. The scheme manager pays $7,000 in expenses. In year 10 the investor pays a further $1,000 in fees and the scheme manager pays $700 in DFE. The net present value of the investor's fees in year 1 terms is $10,544. The net present value of the scheme manager's expenses is $7,381. Applying the above formula:the relevant figure is: 7,381 / 10,544 = 70% (ie, the test is passed). Scenario 3 In year 1 the investor acquires an interest for $10,000. The scheme manager pays $6,000 in expenses. The investor pays no further fees. In year 10 the scheme manager pays $1,000 in DFE (in net present value terms, this is $544). Applying the above formula:the relevant figure is: 6,544 / 10,000 = 65.44% (ie, the test is failed). Scenario 4 In year 1 the investor acquires an interest for $10,000. In years 2 to 9 the investor is required to pay an annual fee of $500. In year 10, the investor pays $2,000 in fees. The investor's total outlay in nominal terms is $16,000, the net present value of which is $14,074.In year 1, the scheme manager outlays $8,000 in DFE. In years 2 to 9 the scheme manager's expenditure on DFE is $300 per annum and in year 10 it is $2,000. The scheme manager's total outlay in nominal terms is $12,400, the net present value of which is $10,879.Applying the formula:the relevant figure is: 10,879 / 14,074 = 77.30% (ie, the test is passed).

Recognition of costs of assets used in multiple projects

8.51 There will be no requirement that the scheme manager's expenditure be exclusively revenue. However, capital expenditure will only be able to be counted to the extent that the amount is attributable to establishing, tending, felling and harvesting trees. As a consequence, in carrying out the DFE calculation, capital costs of assets whose effective life is greater than the projects, or which are used in multiple projects, are only to be incorporated to the extent that the assets are used in the relevant project. The same consideration requiring apportionment to the extent that an expense is attributable to DFE also applies to non-DFE expenses, particularly labour costs.

Example 8.7 A scheme manager purchases harvesting equipment for $100,000. The equipment will be used equally on five forestry scheme projects for the whole of its life. $20,000 is allocated to each of the five projects.

Market value substitution rule where expenditure differs from market value

8.52 Where:

·
the scheme manager has paid or will pay amounts under the scheme;
·
the transaction is not at arm's length; and
·
the amount paid is or will be more or less than the market value of what the amount is for,

the market value is to be substituted for the prices actually used in determining the amount of DFE. [Schedule 8, item 2, subsection 394-35(8 )]

8.53 This provision will often be used when a related party of the manager charges an inflated price for a good or service. This provision will operate to reduce the price to the market price.

8.54 It should be noted that a discounted price where parties are dealing at arm's length is a market value price. This includes discounts for volume of purchases, confirmation of advance orders and prompt payment.

Example 8.8 Teak Pty Ltd, a company which manages a forestry scheme which is based in north-western WA, decides to purchase teak seedlings from Unique Teak Ltd (UTL), a wholly-owned subsidiary, for $10,000. UTL is one of a number of suppliers of teak seedlings in Australia.On investigation, there is evidence that the normal market value for the seedlings is $4,000. For the purpose of calculating the 70 per cent test, the amount of $4,000 is substituted.

8.55 In cases where there is no local market for a good or service, regard should be given to the standards used in comparable industries in Australia or overseas in determining whether an applicable market value should be substituted.

8.56 The arm's length prices for internally provided forestry services (eg, tree felling services) will include the normal profit margin that an arm's length supplier would require. This ensures that there is no distinction between 'in-sourced' and 'out-sourced' services.

Definition of direct forestry expenditure

8.57 DFE under a scheme means, in a general sense:

·
amounts spent by the scheme manager (or an associate of the scheme manager) under the scheme that are attributable to establishing, tending, felling and harvesting trees; and
·
amounts of notional expenditure reflecting the market value of use of land, goods and services provided by the scheme manager that are used for establishing, tending, felling and harvesting trees.

[Schedule 8, item 2, subsection 394-45(1 )]

8.58 Expenditure under the first category includes actual costs, including actual rent paid by the scheme manager for land used to establish trees.

8.59 Expenditure under the second category includes notional expenditure, such as notional rent (where the scheme manager owns the land used to establish trees) or the notional charges for goods or services that the scheme manager provides in-house rather than purchasing the equivalent good or service from an external provider.

8.60 Where DFE relates to notional amounts, the amount is calculated as if it were paid annually for each income year based on the market value of the use of the land, good or service. The day on which the notional amount is taken to be paid is:

·
unless one of the following applies - 1 January in the income year; or
·
if the first time an amount is paid under the scheme is later than the first day of the income year - the last day of the income year; or
·
if the scheme comes to an end on a day before the end of the income year - that day.

[Schedule 8, item 2, subsection 394-45(2 )]

8.61 DFE includes road transport to the first stages of milling or processing. While DFE does not include the cost of in-field chipping, it does include the first leg of transport after in-field chipping to a mill or wharf. This will ensure consistent treatment across forestry operations, where it may be more economical to conduct initial processing on-site prior to road transport. It should be noted that the chipping and other forms of processing are outside of the scheme under section 100.

8.62 The costs of research and development (R & D) that are attributable to establishing, tending, felling and harvesting trees are allowable. Where R & D costs are difficult to apportion, a reasonable apportionment method will be acceptable. For example, where R & D has been undertaken that relates to multiple projects, it is permissible to apportion the cost on a reasonable basis, such as in proportion to the area under plantation or the value of the projects.

8.63 The expenditure is net of recoverable tax (eg, input tax credits under the GST). In relation to GST, it should also be noted that section 960-405 of the ITAA 1997 reduces the market value of an asset at a particular time by the amount of an input tax credit to which the taxpayer would be entitled.

Specific exclusions from DFE

8.64 The legislation provides that the following types of expenditure are expressly excluded from DFE:

·
marketing of the scheme (including expenditure related to advertising, sales, sponsorship and entertainment);
·
insurance, contingency funds or provisions (other than for employee entitlements);
·
financing;
·
lobbying;
·
general business overheads (but not overheads directly attributable to forestry);
·
subscriptions to industry bodies;
·
commissions for financial planners or financial advisers;
·
compliance with requirements related to the structure and operations of the forestry manager of the scheme (including product design and the preparation of product disclosure statements);
·
supervision and auditing of contracts, other than direct supervision of direct forestry activities; and
·
legal fees relating to any matter mentioned in the subsection.

[Schedule 8, item 2, subsection 394-45(3 )]

Examples illustrating activities that are or are not direct forestry activities (and where apportionment is required)

Example 8.9 Greentrees Ltd's sole business is the management of bluegum forestry projects. The costs of an employee of Greentrees Ltd who only carries out the following tasks would be regarded as corporate overheads and not included in DFE: chief executive officer, personnel manager or accounts manager. Example 8.10 The costs of an employee who only carries out the following tasks would be included in DFE:

·
a 'project coordinator' who undertakes community liaison, education programmes and land purchase;
·
a 'case and systems manager' located at head office who operates Private Plantation Management Information System (PPMIS) allocations, mapping services, geology, planning applications, remote sensing and survival analysis;
·
a 'resource manager' who undertakes harvest scheduling, inventory, survival analysis, mill liaison and in-field project analysis;
·
a 'head of forestry operations' who undertakes final land approval, seedling/cutting strategy, plantation and base design and government and community liaison (noting that there is a specific exception for lobbying); and
·
an 'in-field technical supply officer' who undertakes satellite operations, personal digital assistant (PDA) support, mapping and taping out and reserve monitoring.

Example 8.11 An entity engaged in forestry projects employs a person to supervise its team of foresters and accounting staff. If a scheme manager includes the cost of this supervisor in the calculation of DFE for the 70 per cent rule then it must apportion the costs (including the labour costs of employing the supervisor) between DFE and general overheads. Only the portion directly relating to supervision of the foresters is DFE. Example 8.12 The cost of legal advice, or wages for legal staff involved in drawing up contracts for forestry and harvesting contractors, is DFE. However, the cost of legal advice, or wages for legal staff in assisting in regulatory compliance, investor relations, and business structuring and financing would not be DFE. Example 8.13 Wages for accounts-payable staff who deal with both the payment of invoices directly related to forestry and other invoices can be apportioned. Example 8.14 The cost of compliance with forest certification and/or forestry codes and prescriptions, including the wages of office staff that are paid to monitor compliance with these codes is DFE (and is to be apportioned where appropriate).

8.65 The concept of DFE ends when the earliest of the following activities takes place:

·
sale;
·
transport to a mill within Australia;
·
transport to a wharf within Australia; or
·
processing.

8.66 Harvesting costs do not include:

·
in-field processing such as chipping or milling;
·
marketing;
·
sale costs;
·
stockpiles; or
·
port handling and ship loading.

[Schedule 8, item 2, subsection 394-45(4 )]

8.67 While the concept of harvesting is exclusive of processing, including the costs of 'in-field chipping', a scheme manager may claim costs of transport to a mill or wharf subsequent to in-field chipping (but not the costs of the chipping, or where transport is after the sale).

Examples 8.15: Establishing, tending and felling The scheme manager of a forestry project engages a 3rd party to fell, delimb and chip logs in the field. For the purposes of Division 394 the amount of the cost that relates to felling and delimbing constitutes DFE. The amount that relates to infield chipping does not constitute DFE.The scheme manager of a forestry project engages a 3rd party to selectively cull coppice shoots on harvested stumps after previous forestry operations. The cost of coppicing is an establishment or planting cost for the purposes of Division 394.The scheme manager instructs his forestry employees to use a mobile timber mill to cut timber into slabs as the customer requires the wood for use as dining room tables. The cost of this activity is regarded as processing and does not constitute DFE.

Amounts paid to the scheme manager under a forestry scheme

8.68 Section 15-46 of the ITAA 1997 explains that when a scheme manager (or an associate of the scheme manager) receives an amount from an investor and all the requirements of section 394-10 are satisfied (disregarding subsection 394-10(5)), the amount must be included in the scheme manager's assessable income in the income year in which the participant is first able to claim the corresponding deduction. This is the same principle as is used in section 15-45. [Schedule 8, item 15, section 15-46]

Compliance and administration issues

Notification requirements

8.69 A scheme manager must make a statement to the Commissioner of Taxation (Commissioner) regarding the first amount of income the manager receives that is included in the manager's assessable income under section 15-46. The statement must be in the approved form and must be given to the Commissioner within three months after the end of the income year in which the manager receives the amount. [Schedule 8, item 3, section 394-5 of the Taxation Administration Act 1953 (TAA 1953 )]

8.70 If the 18-month requirement in subsection 394-10(4) is not met, the scheme manager must give the Commissioner a statement in relation to the reasons why the condition was not satisfied. The statement must be in the approved form and must be given to the Commissioner within three months after the end of the 18-month period. [Schedule 8, item 3, section 394-10 of the TAA 1953]

8.71 Both notification requirements apply to managers of schemes whether or not the scheme is covered by a product ruling. These requirements are not limited by whether or not a scheme qualifies as a managed investment scheme, or for registration, for the purposes of the Corporations Act 2001 .

Record keeping requirements

8.72 Investors will be required to keep records for five years from the date when a relevant event (eg, the claiming of a deduction under Division 394) occurs. [Schedule 8, item 7, subsection 262A(2AAA) of the ITAA 1936]

8.73 Managers will be required to keep records for the life of the scheme plus five years. The relevant records to be kept must show:

·
the basis of their reasonable expectation at test time for the duration of the project;
·
expenditure on DFE for the duration of the project; and
·
investor fees collected for the duration of the project.

[Schedule 8, item 7, subsections 262A(2AAB) and (2AAC) of the ITAA 1936]

8.74 For the purpose of section 262A, the following definitions are inserted:

·
'associate';
·
'forestry managed investment scheme';
·
'forestry manager'; and
·
'participant'.

Application and transitional provisions

8.75 This measure commences from the date of Royal Assent. It applies to amounts paid by a participant under a scheme on or after 1 July 2007, provided that no other amounts were paid by the participant or any other participant under the scheme before 1 July 2007. [Schedule 8, item 26, subsections 394-220(1) and (2 )]

8.76 Sections 394-150 and 394-160 (and sections 82KZMGA and 82KZMGB) apply to CGT events that happen on or after 1 July 2007. [Schedule 8, item 26, subsections 394-200(3) and (4 )]

8.77 The purpose of the application provision is to ensure that the specific deduction is available to investors from 1 July 2007.

Consequential amendments

8.78 This Schedule amends paragraph (p) of the definition of 'relevant expenditure' in subsection 82KH(1) of the ITAA 1936 to add a reference to a loss or outgoing in respect of the establishment and tending of trees for felling to the extent to which a deduction would, apart from section 82KL, be allowable to the taxpayer under the new specific deduction provision.

·
The definition of relevant expenditure defines those losses or expenditures to which the 'expenditure recoupment' provisions in Subdivision 3-D of Part III of the ITAA 1936 may apply. That Subdivision was enacted to counter various tax avoidance schemes which involve the effective recoupment of an expenditure so that the loss or outgoing is not really suffered.

[Schedule 8, items 4 to 6 and 10B, paragraphs 82KH(1)(pa), 82KH(1G)(pa) and 82KH(1L)(p) of the ITAA 1936]

8.79 This Schedule amends the item 'forestry agreement' in section 10-5 of the ITAA 1997 to indicate that when, a CGT event occurs in relation to an interest in a forestry agreement section 82KZMGB includes an amount in the investor's assessable income. [Schedule 8, item 12, section 10-5]

8.80 This Schedule inserts a new item 'forestry managed investment schemes' in section 10-5 of the ITAA 1997 to indicate that:

·
a special provision (new section 15-46) applies to an amount received as income by a scheme manager where the new specific deduction applies; and
·
when a CGT event occurs in relation to an interest in a scheme for an initial or a subsequent investor, subsections 394-25(2) and 394-30(2) include an amount in the investor's assessable income.

[Schedule 8, item 13, section 10-5]

8.81 This Schedule amends section 12-5 of the ITAA 1997 to indicate that the ITAA 1997 Act contains a specific deduction provision (Division 394) for contributions made under forestry schemes. [Schedule 8, item 14, section 12-5]

8.82 This Schedule amends subsection 995-1(1) of the ITAA 1997 to insert the following definitions in Part 6-5 (Dictionary definitions):

·
'70 per cent DFE rule';
·
'direct forestry expenditure';
·
'forestry managed investment scheme';
·
'incidental forestry scheme receipts';
·
'initial participant';
·
'forestry interest';
·
'forestry manager';
·
'participant' and
·
'total forestry scheme deductions'.

[Schedule 8, items 17 to 25, subsection 995-1(1) of the ITAA 1997]


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