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Ruling

Subject: Forestry joint venture

Questions and Answers:

1. If you purchase the property, in relation to the Joint Venture Agreement, will you be carrying on a business of forestry operations?

Answer: No

2. If you enter into the above mentioned joint venture, will the Commissioner exercise his discretion under section 35-55 of the Income Tax Assessment Act 1997 (ITAA 1997) so the loss deferral rule in section 35-10 of the ITAA 1997 does not apply due to a required lead time between the commencement of the activity and the production of any assessable income?

Answer: No

3. If you enter into the above mentioned joint venture, will you be able to deduct ongoing interest expenses against your ordinary income in the respective financial years the annual income expenses are incurred?

Answer: No

4. If you enter into the above mentioned joint venture, will any profit and loss made from forestry operations be in relation to an 'isolated transaction', resulting in the portion of relevant interest expense only being deductible only at the completion of the isolated transaction, that is, in the financial year when the final income is received from the final clear felling of the trees?

Answer: Yes

This ruling applies for the following periods:

Year ending 30 June 2012

The scheme commenced on:

1 July 1998

Relevant facts and circumstances

You are interested in purchasing a property that is currently under a joint venture agreement with a another party.

Thinning is anticipated from age 15 years to final felling at age approximately 35 years. Thinning for small sawlog, poles and veneer may be undertaken between year 15 and 30, with final harvest for veneer and sawlog between year 30 and 45, conditional on growth rates and markets. Harvesting is to be organised by the other party. Site restoration and marketing costs are to be deducted from royalties at the time of stand realisation.

You may choose to tend (but not thin) the trees, which you will do if you purchase the property, but, only if in the opinion of the other party, you can perform the work to the standard required by them.

Your major expenditure would be interest expense on your borrowings, council rates and minor costs would be for equipment, such as chainsaws and whipper snipers, fuel, transport and any fencing maintenance.

Based on a recent harvest in the area, the other party advised of a possible final yield and price. This revenue amount excludes any income revenue from thinning operations.

Included as facts are the contents of the documents 'Deed of Novation' and 'Joint Venture Deed', which were lodged with your private ruling application.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 35-55

Reasons for decision

Summary

Under the Joint Venture Agreement, you, as the property owner would not carry on a business because the forestry activity would be conducted under the control of the other party rather than at your behest. The Joint Venture Agreement is similar to a property owner giving rights to the use of the land for a royalty.

As you would not carry on a business, section 35-55 of the ITAA 1997 is not applicable.

As no regular returns are contemplated and as there is only one significant return when the property is clear felled, revenue derived from the Joint Venture Agreement will be from an 'isolated transaction'.

When profit or loss is from an 'isolated transaction', the expenses can only be deducted at the completion of the transaction (that is, when the final income is received from the final tree felling).

Your portion of the interest expense related to the purchase value of the trees would be deductible in the financial year when the clear felling and isolated transaction is completed.

As the land would not be a business or rental asset, your portion of the interest expense related to the land and property would form part of the cost base of that capital gains tax (CGT) asset since the land is not being used to derive business or rental income.

Detailed reasoning

Carrying on a business

Income Tax Ruling TR 95/6 discusses primary production and forestry. Paragraph 4 of TR95/6 states a person who is engaged in 'forest operations' is a primary producer for income tax purposes if those forestry activities constitute the carrying on of a business.

Paragraph 5 of TR 95/6 defines 'forest operations' in terms of section 6(1) of the Income Tax Assessment Act 1936 (ITAA36) as:

the planting or tending in a plantation or forest of trees intended for felling; or the felling of trees in a plantation or forest.

In terms of TR 95/6, the operations carried out on the property would be considered to be forest operations. However, whether they constitute a business must be considered in terms of paragraphs 86 to 89 of TR 95/6.

Paragraph 87 of TR 95/6 states in determining whether particular activities constitute the carrying on of a business, courts and tribunals have considered the following indicators to be relevant:

§ whether the activities have a significant commercial purpose

§ the scale of the activities (a person may carry on a business in a small way)

§ the nature of the activities, particularly whether they have the purpose of profit making (however, profit making in a particular year is not essential)

§ repetition and regularity of the activities

§ whether the activities are organised in a business-like manner

§ volume of the operations and the amount of the capital employed

§ whether the activities may properly be described as the pursuit of a hobby or recreation

§ the degree of control held by the person over the development and maintenance of the land (Case L1 79 ATC 1; (1979) Case 8 23 CTBR (NS).

In Case L1 79 ATC 1; (1979) Case 8 23 CTBR (NS), the taxpayer entered into an agreement with a management company under which the company was to prepare two hectares of land for planting, to supply radiata pine seedlings and to plant them and thereafter for nine years to tend the area planted. The company further undertook, on request, to cut and market the timber and deliver it to a sawmill or processor. It was decided the taxpayer was carrying on a business because the management company did the work at the behest of the taxpayer. It was the taxpayer and not the company which was regarded as carrying on the business of afforestation.

Application of law in your case

The information you have supplied shows there would be a positive response to some of the above indicators used in determining whether particular activities constitute the carrying on of a business. For example, it is accepted that there is a significant commercial purpose to the activities and that the nature and scale of the activities appear to be sufficient to considered a business.

However, some of the indicators have a negative response.

The activities of the joint venture are organised in a business like manner. However, this is being done by the other party in accordance with clauses of the Deed. The other party is required to keep records of all inputs by the parties, the volume and grade of all produce taken from the plantation and the cost of and the proceeds of the sale of the harvest. This matter is also covered in a schedule which states that the other party is to carry out a review and report of the plantation's progress (growth rates, weed, insect, disease control) at years 1, 2, 3, 5 and subsequently at 5 yearly intervals or as necessary.

In terms the degree of control over the development and maintenance of the land, the deed of profit prendre has given all of this to the other party. The deed states where any provision of the deed requires a determination regarding proper forest management, the other party is to determine what constitutes proper forest management, although they will consult with you if so requested in writing.

The Deed states that the sale of produce is to be directed and controlled by the other party. The Deed places restrictions on transfer of title and the granting of mortgages, leases, easements or other interests over or in respect of the property. The Deed states that the rights, duties, obligations and liabilities of the parties are in every case to be several and not joint, nor joint and several. It clearly states that the relationship of the parties is one of co-venturers for the limited purpose of carrying out the project and that neither party has the authority to act for, or to create or assume any responsibility or obligation on behalf of the other party.

Finally, the deed states if there is work to be performed on the property in respect of the establishment, maintenance and harvesting of the crop, the other party will offer the work to you first at a rate equivalent to the market rate for such work if they are of the opinion that you could perform the work to the standard they require. If you do not accept the work, then they may undertake the work with employees or call tenders to perform the work on a contract basis.

In summary, it is clear from the terms of the deed, particularly concerning the degree of control, that the forestry operations are being carried on by the other party on the land.

Any contribution you may make to the 'tending' of the trees remains under the control of the other party. Further, you would not be totally 'tending' the trees given you are personally prohibited from thinning the trees. Thus, it is arguable you would not be tending the trees at all. Where a taxpayer is not planting, tending or felling trees, they are not carrying on a business.

In brief, unlike Case L1 79 ATC 1; (1979) Case 8 23 CTBR (NS), the other party is not working at your behest.

Isolated transaction & deductibility of interest expenses

The Joint Venture Agreement gives the impression it consists of renting the land to the other party for them to carry out their forestry activities. However, because any income you may receive from the joint venture is not calculated by reference to the use of the land for a fixed term, the income cannot be regarded as rental and the purchase of the property cannot be regarded as a rental property (see ATO ID 2003/339).

Taxation Ruling TR 92/3 is about whether profits on isolated transactions are income. In general, if a taxpayer not carrying on a business, a transaction will be an isolated transaction when a taxpayer has the purpose of profit-making at the time of acquiring the property and when the property has no use other than as the subject of trade.

For example, the buying of land for the explicit purpose of subdivision and resale, by a person not carrying on a business of land subdivision, is an example of an isolated transaction.

Taxation TR 2007/8 is about registered agricultural managed investment schemes. It was withdrawn as a result of the Full Federal Court's decision in Hance v. FC of T; Hannebery v. FC of T [2008] FCAFC 196; 2008 ATC 20-085. However, the withdrawal was not related to the Commissioner's view found in paragraphs 13 and 14 of TR 2007/8, which said:

….some investors may neither carry on business as a result of their involvement in the scheme, nor will they be passive investors. Rather, their involvement will have a profit making purpose which marks them out as a participant in a profit making undertaking or plan, carried out on their behalf. The profit or loss (computed at the completion of the scheme), will be, respectively, ordinary income under section 6-5, or an allowable deduction under section 8-1.

…this view has application only to those schemes like afforestation schemes, where no regular annual returns are contemplated and there is only one significant return, at the completion of the scheme, although there may be some incidental returns prior to this (for example, those connected with the thinning of the trees).

In your case, if you purchase the property, any profit or loss you derive from the felling of the trees will be from an isolated transaction because no regular annual returns are contemplated. There is only one significant return contemplated, when the property is clear felled.

As any profit or loss you derive from the felling of the trees will be from an isolated transaction, the profit or loss must be computed at the completion of the scheme. As the profit or loss must be computed at the completion of the scheme, any on-going annual interest expenses cannot be deducted against your annual ordinary income in the financial years in which they are incurred.

The on-going annual expenses related to the purchase of the trees can only be deducted at the completion of the scheme.

As the land would not be a business or rental asset, your portion of the interest expense related to the land and property would form part of the cost base of that capital gains tax (CGT) asset since the land is not being used to derive business or rental income.

The Commissioner's Discretion

Division 35 of the ITAA 1997 is an integrity measure to prevent losses from non-commercial activities that are carried on as businesses by individuals being offset against other assessable income in the income year the loss is incurred.

A discretion in section 35-55 of the ITAA 1997 may be exercised by the Commissioner for a business activity that has started to be carried on, where, for the income year(s) in question, because of its nature, it has not satisfied, or will not satisfy, any of the tests in Division 35 of the ITAA 1997 and there is an objective expectation, based on evidence from independent sources (if available) that, within a period that is commercially viable for the industry concerned, the activity will satisfy one of the tests or produce a tax profit.

In your case, as you would not carry on a business, section 35-55 of the ITAA 1997 is not applicable.

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