Product Ruling

PR 1999/20

Income tax: Timber Capital Plantation Prospectus 1999

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FOI status:

May be releasedFOI number: I 1018769

Preamble

What this Product Ruling is about

1. This Ruling sets out the Commissioner's opinion on the way in which the 'tax laws' identified below apply to the defined class of persons, who take part in the arrangement to which this Ruling relates. In this Ruling this arrangement is sometimes referred to as Timber Capital Plantation Prospectus 1999, or just simply as 'the Project', or the 'product'.

Tax law(s)

2. The tax law(s) dealt with in this Ruling are section 8-1 of the Income Tax Assessment Act 1997 ('ITAA 1997') and sections 82KL and 82KZM and Part IVA of the Income Tax Assessment Act 1936 ('ITAA 1936').

Class of persons

3. The class of persons to whom this Ruling applies is those who enter into the arrangement described below on or after the date this Ruling is made. They will have a purpose of staying in the arrangement until it is completed (i.e., being a party to the relevant agreements until their term expires), and deriving assessable income from this involvement as set out in the description of the arrangement. In this Ruling these persons are referred to as 'Growers'.

4. The class of persons to whom this Ruling applies does not include persons who intend to terminate their involvement in the arrangement prior to its completion, or who otherwise do not intend to derive assessable income from it.

Qualifications

5. The Ruling provides this specified class of persons with a binding ruling as to the tax consequences of this product. The Commissioner accepts no responsibility in relation to the commercial viability of this product, and gives no assurance the prices charged for the product are reasonable, appropriate, or represent industry norms. A financial (or other) adviser should be consulted for such information.

6. The Commissioner rules on the precise arrangement identified in the Ruling.

7. The class of persons defined in the Ruling may rely on its contents, provided the arrangement (described below at paragraphs 12 to 30 ) is carried out in accordance with details described in the Ruling. If the arrangement described in the Ruling is materially different from the arrangement that is actually carried out:

•

the Ruling has no binding effect on the Commissioner, as the arrangement entered into is not the arrangement ruled upon; and

•

the Ruling will be withdrawn or modified.

8. A Product Ruling may only be reproduced in its entirety. Extracts may not be reproduced. As each Product Ruling is copyright, apart from any use as permitted under the Copyright Act 1968, no Product Ruling may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the Manager, Legislative Services, AusInfo, GPO Box 1920, Canberra ACT 2601.

Date of effect

9. This Ruling applies prospectively from 12 May 1999, the date this Ruling is made. However, the Ruling does not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Ruling (see paragraphs 21 and 22 of Taxation Ruling TR 92/20).

10. If a taxpayer has a more favourable private ruling (which is legally binding), the taxpayer can rely on the private ruling if the income year to which the private ruling relates has ended, or has commenced but not yet ended. However, if the arrangement covered by the private ruling has not begun to be carried out, and the income year to which it relates has not yet commenced, this Ruling applies to the taxpayer to the extent of the inconsistency only (see Taxation Determination TD 93/34).

Withdrawal

11. This Product Ruling is withdrawn and ceases to have effect after 30 June 2001. The Ruling continues to apply, in respect of the tax law(s) ruled upon, to all persons within the specified class who enter into the specified arrangement during the term of the Ruling. Thus, the Ruling continues to apply to those persons, even following its withdrawal, who entered into the specified arrangement prior to withdrawal of the Ruling. This is subject to there being no change in the arrangement or in the persons' involvement in the arrangement.

Arrangement

12. The arrangement that is the subject of this Ruling is described below. This description incorporates the following documents:

•

application for a Product Ruling, dated 6 November 1998;

•

Draft Prospectus Timber Capital Plantation Prospectus 1999;

•

The Timber Capital Plantation Project Deed between Timber Capital Limited (the Manager ('TCL')) and Burke Bond Securities Limited (as Representative) formerly Burke Bond Queensland Limited;

•

Draft Lease Agreement between TCL, the Lessor and the Grower as provided on 12 April 1999;

•

Draft Preparation and Planting Agreement between TCL and the Grower as provided on 12 April 1999;

•

Draft Maintenance Agreement between TCL and the Grower as provided on 12 April 1999;

•

letters from Timber Capital Limited dated 14 December 1998, 5 February 1999, 18 February 1999, 5 March 1999, 12 April 1999, 21 April 1999, 26 April 1999;

•

letter from Timber Capital Limited dated 12 April 1999, which contains a proposed loan agreement with a large Australian Bank and correspondence from Laton Securities Pty Ltd.

NOTE: certain information received from Timber Capital Limited has been provided on a commercial-in-confidence basis and will not be disclosed or released under Freedom of Information legislation.

13. The documents highlighted are those Growers enter into. There are no other agreements, whether formal or informal, and whether or not legally enforceable, that a Grower, or any associate of the Grower, will be a party to. The effect of these agreements is summarised as follows.

14. This arrangement is called The Timber Capital Plantation Prospectus 1999. Growers participating in the Project enter into a Lease Agreement. Growers lease an area of land called a 'Hectare' from TCL. Under the Preparation and Planting and Maintenance Agreements the Growers have certain pine trees (Pinus radiata) planted on the Hectare for the purpose of eventual felling and sale.

15. There is no minimum amount that must be raised under the Prospectus. A minimum of 1,000 trees per Hectare will be planted in the first 13 months following execution of the Lease, Preparation and Planting and Maintenance Agreements. Possible projected returns for Growers are outlined on page 14 of the Draft Prospectus. The projected returns depend on a range of assumptions and TCL does not give any assurance or guarantee whatsoever in respect of the future success of or financial returns associated with entering into the Lease, Preparation and Planting and Maintenance Agreements being offered pursuant to the Prospectus. Based on the example set out on page 15 of the Draft Prospectus, a Grower could expect to achieve an internal rate of return of 10.9% per Hectare. Growers may execute a power of attorney enabling TCL to act on their behalf as required, when they make an application for a Hectare.

Preparation and Planting Agreement

16. TCL shall perform the work within 13 months of the commencement of the Agreements. TCL may delegate responsibilities.

17. The work to be done is:

•

site preparation;

•

initial development works (surveying, set out firebreaks and access ways, ripping and ploughing, weedicide, supply and plant seedlings, Consultant Forester fees for first year); and

•

fire and public risk insurance of first year.

18. The commencement date is 30 June 1999.

Maintenance Agreement

19. TCL may delegate its responsibilities. If any amount is not paid by the due date interest may be charged and the Agreement terminated.

20. Work to be done is:

•

2nd year (replanting, treat regrowth, fertilise, general maintenance, attend to access roads and firebreaks);

•

3rd and 4th year (general maintenance of roads and plants);

•

general maintenance - 5th to 25th year (fertilise and general maintenance; and

•

fire insurance to year 10 and public risk to year 25.

21. The commencement date is 30 June 2000.

Lease Agreement

22. The lease is for 25 years from 30 June 1999 at a cost of $100 per Hectare per annum. The lease may be extended by 5 years.

23. The lessee shall not use the land jointly with anyone else and retains the right to say when the trees are to be planted. The land can only be subleased or disposed of with the lessor's approval. If the lessee defaults, the lessor can take possession of the land. If the lessee breaches any conditions, the lessor may enter the land to remedy the breaches at cost to the lessee. If the trees are destroyed and insurance proceeds obtained but not used for replanting, the Lease Agreement may be cancelled and no further obligations exist.

Investment Deed

24. Within 30 days of execution of application TCL should advise the Applicant and the Representative of the acceptance or rejection. Where the application is accepted, the Manager has two months to place the Grower on the register and provide the Grower with a copy of the various agreements. At the conclusion of the Project the Representative has 180 days to sell all of the assets and pass on the net proceeds, after covering costs, to the Growers. The Grower may transfer any of their interest in the Project.

25. The Grower may complete a Power of Attorney to enter into the agreements on the Grower's behalf and to execute and deliver the agreements. The Power of Attorney is to last until 30 June 2000.

Fees

26. The fees payable under the Lease, Preparation and Planting and Maintenance Agreements are:

(i)

Grower leases one or more Hectares of land for a term of twenty five years with annual rental payable;

(ii)

Grower, on leasing the plantation land, enters into an agreement to develop, establish and maintain the plantation over the period of the lease. The outlays in relation to one Hectare are as follows:

Finance

27. Growers can fund their investment in the Project themselves, borrow from an independent lender, or borrow through finance arrangements organised by TCL. Finance arrangements organised directly by a Grower with independent lenders are outside the arrangement to which this Ruling applies. TCL has engaged the services of Laton Securities Pty Ltd ('Laton'), a company not associated with TCL or any associates of TCL, to arrange loans with a large Australian Bank ('the Bank') to cover the fees payable to TCL.

28. The loans facilitated by Laton with the Bank will be on normal commercial terms; they will be both in form and substance, full recourse, and borrowers will be obliged to make the regular repayments regardless of any income being derived from the Project. TCL will be put in funds directly as a result of these loans, on the Grower being accepted as a borrower. Neither TCL nor any associated entity or person will be putting funds back on deposit with Laton, or any of the financiers in question, or any associated persons, but will substantially use these funds, subject to the Representative's approval, in carrying out its obligations under the Management Agreement.

29. Under the Laton loan with the Bank, a Grower may borrow a minimum of $5,000 and a maximum of $30,000, though higher amounts may be considered. The term of the loan will be either:

(i)

5 years, with payments of interest only, and repayment of the principal at the end of the 5th year; or

(ii)

up to 10 years, with payments of interest only for the first 5 years, and payments of interest and repayment of the principal thereafter.

30. The interest rate will be:

(i)

8.55 % pa variable if loan insurance is taken out and borrower is a bank shareholder (subject to conditions);

(ii)

9.55% pa variable if loan insurance is taken out; or

(iii)

10.05% pa variable if loan insurance is not taken out.

31. The Grower will pay Laton a fee of $345 if their application for finance is successful.

Ruling Section 8-1

32. For the year ended 30 June 1999 section 8-1 will apply to Growers entering into this Project as follows:

(i)

the Preparation and Planting fee of $6,000 per Hectare incurred by a Grower on execution of the Preparation and Planting Agreement on or before 30 June 1999 will be an allowable deduction; and

(ii)

where a Grower borrows funds from the large Australian Bank in order to fund their obligation to pay the Preparation and Planting fee, and incurs interest on such borrowings on or before 30 June 1999, that interest will be an allowable deduction.

33. For each of the years ending 30 June 2000 and 30 June 2001 section 8-1 will apply to Growers entering into this Project as follows:

(i)

annual maintenance of $150 per Hectare, indexed, incurred by a Grower on or before 30 June 2001 will be an allowable deduction;

(ii)

annual lease rental of $100 per Hectare, indexed, incurred by a Grower on or before 30 June 2000 and 30 June 2001 respectively, will be an allowable deduction; and

(iii)

where a Grower borrows funds from the large Australian Bank in order to fund their obligation to pay the Preparation and Planting fee, and incurs interest on such borrowings on or before the end of the respective year, that interest will be an allowable deduction.

Section 82KZM

34. The expenditure incurred by Growers, as described in paragraphs 27 and 28 above, does not fall within the scope of section 82KZM.

Section 82KL

35. Section 82KL does not apply to deny the deductions otherwise allowable under section 8-1.

Part IVA

36. The provisions of Part IVA will not be applied to the arrangement described in this Ruling.

Explanations Section 8-1

37. Consideration of whether fees payable under the Constitution are deductible under section 8-1, begins with the first limb of the section. This view proceeds on the following basis:

•

the outgoings in question must have a sufficient connection with the operations or activities that directly gain or produce the taxpayer's assessable income;

•

the outgoings are not deductible under the second limb of section 8-1 if they are incurred when the business has not commenced; and

•

where all that happens in a year of income is a taxpayer contractually commits themself to a venture that may not turn out to be a business, there can be doubt about whether the relevant business has commenced, and hence, whether the second limb applies. However, that does not preclude the application of the first limb and determining whether the outgoings in question have a sufficient connection with activities to produce assessable income.

38. An afforestation scheme can constitute the carrying on of a business. Where there is a business, or a future business, the sale proceeds from the sale of timber from the scheme will constitute gross assessable income in their own right. The generation of 'business income' from such a business, or future business, provides the backdrop against which to judge whether the outgoings in question have the requisite connection with the operations that more directly gain or produce this income. These operations will be the planting, tending, maintaining and harvesting of the trees.

39. Generally, an investor will be carrying on a business of afforestation where:

•

the investor has an identifiable interest in specific growing trees coupled with a right to harvest and sell the timber;

•

the afforestation activities are carried out on the investor's behalf; and

•

the weight and influence of the general indicators of a business as used by the Courts point to the carrying on of a business.

40. For this Project Growers have, under the Preparation and Planting, Maintenance and Lease Agreements, rights in the form of a lease over an identifiable area of land consistent with the intention to carry on a business of growing trees. Under the Preparation and Planting, Maintenance and Lease Agreements Growers appoint TCL, as Manager, to provide services such as planting, cultivating, tending, culling, pruning, fertilising, replanting, spraying, maintaining and otherwise caring for the Trees. Growers control their investment. The specific cost of these services provided in the first thirteen months will total $6,000. Growers may either collect the forest produce and arrange for its sale or they have the option of TCL arranging marketing and sale for a proportion of the proceeds.

41. The Preparation and Planting, Maintenance and Lease Agreements give Growers more than a chattel interest in the timber on harvest. The Project documentation contemplates Growers will have an ongoing interest in the growing trees - the trees are the Growers' property and Growers have a legal interest in the land being the lease itself.

42. Growers have the right to use the land in question for afforestation purposes and to have TCL come onto the land to carry out its obligations under the Preparation and Planting, Maintenance and Lease Agreements. The Growers' degree of control over TCL ,as evidenced by the Agreements and supplemented by the Corporations Law, is sufficient. Under the Project, Growers are entitled to receive regular progress reports on TCL's activities. Growers are able to terminate arrangements with TCL in certain instances, such as cases of default or neglect. The afforestation activities described in the Preparation and Planting, Maintenance and Lease Agreements are carried out on the Growers' behalf.

43. The general indicators of a business, as used by the Courts, are described in Taxation Ruling TR 97/11. Positive findings can be made from the arrangement's description for all the indicators. The Independent Forester's report is that the Project is realistic and commercially viable. Growers to whom this Ruling applies intend to derive assessable income from the Project. This intention is related to projections contained in the Draft Prospectus that suggest the Project should return a 'before-tax' profit to the Growers, i.e., a 'profit' in cash terms that does not depend in its calculation, on the fees in question being allowed as a deduction.

44. Growers will engage the professional services of a Manager with appropriate credentials. There is a means to identify which trees Growers have an interest in. These services are based on accepted silvicultural practices and are of the type ordinarily found in afforestation ventures that would commonly be said to be businesses.

45. Growers have a continuing interest in the trees from the time they are acquired until harvest. The afforestation activities, and hence the fees associated with their procurement, are consistent with an intention to commence regular activities that have an 'air of permanence' about them. The Growers' afforestation activities will constitute the carrying on of a business.

46. The fees associated with the afforestation activities will relate to the gaining of income from this business, and hence have a sufficient connection to the operations by which this income (from the sale of timber), is to be gained from this business. They will thus be deductible under the first limb of section 8-1. Further, no 'non-income producing' purpose in incurring the fee is identifiable from the arrangement. The fee appears to be reasonable. No capital component is identifiable. The tests of deductibility under the first limb of section 8-1 are met. The exclusions do not apply.

Section 82KZM

47. Under the Preparation and Planting Agreement the fee of $6,000 per Hectare will be incurred on execution of that Agreement. This fee is charged for providing a number of specified services to a Grower only for the period of 13 months from the execution of the Agreement. For the purposes of this Ruling, it is accepted that no part of the fee of $6,000 is for TCL doing 'things' that are not to be wholly done within 13 months of the fee of $6,000 being incurred. The basic precondition for section 82KZM's operation is not satisfied and it will not apply to the expenditure by Growers of $6,000 per Hectare.

Section 82KL

48. Section 82KL's operation depends, among other things, on the identification of a certain quantum of 'additional benefit(s)'. Here, there may be a loan provided by the Bank to the Grower. The loan is provided on a full recourse basis, and on commercial terms. Insufficient 'additional benefits' will be provided to trigger the application of section 82KL. It will not apply to deny the deduction otherwise allowable under section 8-1.

Part IVA

49. For Part IVA to apply there must be a 'scheme' (section 177A); a 'tax benefit' (section 177C); and a dominant purpose of entering into the scheme to obtain a tax benefit (section 177D). Timber Capital Plantation Prospectus 1999 will be a 'scheme'. The Growers will obtain a 'tax benefit' from entering into the scheme, in the form of the deduction for the amount of $6,000 per Hectare, allowable under section 8-1, that would not have been obtained but for the scheme. However, it is not possible to conclude that the scheme will be entered into or carried out with the dominant purpose of obtaining this tax benefit.

50. Growers to whom this Ruling applies intend to stay in the scheme for its full term and derive assessable income from the eventual harvesting of the trees. Further, there are no features of the Project, for example, such as the initial fee of $6,000 or the annual fees of $250 being 'excessive', and uncommercial, and predominantly financed by a non-recourse loan, that might suggest the Project was so 'tax driven', and so designed to produce a tax deduction of a certain magnitude that would attract the operation of Part IVA.

Interest deductibility

51. Some Growers intend to finance their investment through a loan facility. Whether the interest fees are deductible under section 8-1 depends on the same reasoning as that applied to whether the Preparation and Planting Fee of $6,000 to be incurred in the year ended 30 June 1999 will be deductible. The interest fees incurred in the years ended 30 June 1999, 2000 and 2001 will be in respect of a loan to finance the operations - the tending, maintenance and harvesting of the trees, and the lease of the land on which the trees will have been planted - that will continue to be directly connected with the gaining of 'business income' from the Project. These fees will, thus, also have a sufficient connection with the gaining of assessable income. No capital, private or domestic component is identifiable in respect of them.

Detailed contents list

52. Below is a detailed contents list for this Ruling:

Commissioner of Taxation
12 May 1999

No draft issued

References

ATO references:
NO 99/267-4

Related Rulings/Determinations:

PR 98/1
TR 92/1
TR 97/11
TR 97/16
TD 93/34

Subject References:
afforestation expenses
carrying on a business
commencement of business
fee expenses
forestry
interest expenses
management fees expenses
plantation forestry
primary production
primary production expenses
producing assessable income
product rulings
public rulings
schemes and shams
taxation administration
tax avoidance
tax benefits under tax avoidance schemes
tax shelters
tax shelters project

Legislative References:
ITAA1936 82KL
ITAA1936 82KZM
ITAA1936 Pt IVA
ITAA1936 177A
ITAA1936 177C
ITAA1936 177D
ITAA1997 8-1