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Ruling

Subject: Investment in a forestry managed investment scheme as a wholesale investor

Question 1

Can you claim a deduction for the establishment fee pursuant to Division 394 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Can you claim a deduction for interest incurred on a loan used to finance the establishment fee pursuant to section 8-1 of the ITAA 1997?

Answer

Yes

Question 3

Can you claim a deduction for the fees payable to the Manager in accordance with the Management Agreement pursuant to Division 394 of the ITAA 1997?

Answer

Yes

Question 4

Will the Commissioner exercise his discretion pursuant to paragraph 35-55(1)(b) of the ITAA 1997 to allow you to claim a deduction for non-commercial business losses in the year in which they are incurred?

Answer

Not applicable

Question 5

Will section 82KL of the Income Tax Assessment Act 1936 (ITAA 1936) apply to deny the deductibility of all or part of otherwise deductible expenditure incurred by you?

Answer

No

Question 6

Will section 82KZM of the ITAA 1936 apply to deny the deductibility of all or part of otherwise deductible expenditure incurred by you in the income year in which it is incurred?

Answer

No

Question 7

Will Part IVA of the ITAA 1936 apply to deny the deductibility of all or part of otherwise deductible expenditure incurred by you?

Answer

No

Relevant facts and circumstances

1. You have entered into a 'forestry managed investment scheme' ('the Project') as defined in subsection 394-15(1) of the ITAA 1997.

2. You will be an 'initial participant' in the Project as defined in subsection 394-15(5) of the ITAA 1997.

3. The purpose of the Project is the establishment, tending and harvesting of Trees in Australia.

4. You will be entitled to the net proceeds of sale from the growing and harvesting of the Trees.

5. You executed the following documents in connection with the Project:

a. Management Agreement between you, the Manager and the Trustee; and

b. Loan Agreement between you, as the borrower, and the Lender.

1. The Lender is your associate pursuant to section 318 of the ITAA 1936.

Management Agreement

2. You have appointed the Manager to perform, or cause to be performed, the services required to be performed under the Management Agreement and the Manager accepts that appointment.

3. You will acquire suitable land located in Australia ('the Plantation') for the Project. The Manager will select the Plantation on the basis of expert advice to ensure that it is suitable for growing the Trees.

a. The Manager will cause the establishment services set out in the Management Agreement to be completed within 18 months of the end of the income year you entered into the Project.

b. The Manager will cause all other services specified in the Management Agreement to be carried out over the term of the Project.

Fees and expenses

1. Pursuant to the Management Agreement you are required to pay the Manager certain amounts in consideration for:

a. the establishment of the Plantation;

b. the services to be carried out over the term of the Project;

c. above average returns;

d. the selling and marketing of forest produce; and

e. the harvest and processing of the trees.

Establishment

1. You have paid the establishment fee.

Services over the term on the Project

2. You can elect to pay these fees on a quarterly or annual basis, upfront for the duration of the Project or defer payment.

3. If you elect to defer these fees the Manager will be entitled to a percentage of the gross proceeds of sale for each financial year you elect to defer the fees.

Performance fee

4. You will be required to pay to the Manager a performance fee equal to a percentage of the amount of the gross proceeds of sale exceeding the Project's expected rate of return.

Selling and marketing fee and costs of harvest and processing

5. You are entitled to the gross proceeds of sale from the Trees less the costs of harvesting, processing and selling and marketing fees.

6. The following amounts are payable from the Gross Proceeds of Sale:

a. your share of the costs of harvest and processing; and

b. your share of the selling and marketing fees.

1. The Trustee will then pay to you the net proceeds of sale less any outstanding fees due and payable pursuant to the Management Agreement.

Finance

2. To finance part of the establishment fee you entered into a Loan Agreement.

3. The Term of the Loan is 84 months commencing the date you entered into the Loan Agreement.

4. The first 48 payments (four years) will be interest only; thereafter, you will make payments of principal and interest.

5. The interest rate payable is fixed at 11% per annum for the term of the Loan.

6. The finance provided by the Lender is made on a full recourse commercial basis and normal debt recovery procedures, including legal action, will be taken in the case of a default by you.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 82KL

Income Tax Assessment Act 1936 section 82KZM

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 section 177A

Income Tax Assessment Act 1936 paragraph 177C(1)(b)

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 318

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 subsection 8-1(1)

Income Tax Assessment Act 1997 subsection 8-1(2)

Income Tax Assessment Act 1997 paragraph 8-1(2)(a)

Income Tax Assessment Act 1997 section 8-5

Income Tax Assessment Act 1997 section 12-5

Income Tax Assessment Act 1997 section 17-5

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 paragraph 35-55(1)(b)

Income Tax Assessment Act 1997 section 170

Income Tax Assessment Act 1997 Division 394

Income Tax Assessment Act 1997 subsection 394-10(1)

Income Tax Assessment Act 1997 paragraph 394-10(1)(f)

Income Tax Assessment Act 1997 subsection 394-10(2)

Income Tax Assessment Act 1997 subsection 394-10(4)

Income Tax Assessment Act 1997 subsection 394-10(5)

Income Tax Assessment Act 1997 subsection 394-10(5A)

Income Tax Assessment Act 1997 subsection 394-10(6)

Income Tax Assessment Act 1997 subsection 394-15(1)

Income Tax Assessment Act 1997 subsection 394-15(2)

Income Tax Assessment Act 1997 subsection 394-15(3)

Income Tax Assessment Act 1997 subsection 394-15(5)

Income Tax Assessment Act 1997 section 394-20

Income Tax Assessment Act 1997 section 394-25

Income Tax Assessment Act 1997 subsection 394-25(2)

Income Tax Assessment Act 1997 section 394-35

Income Tax Assessment Act 1997 subsection 995-1(1)

Taxation Administration Act 1953 Schedule 1 subsection 394-10(1)

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Section 8-5 of the ITAA 1997 allows certain specific deductions to be claimed against the assessable income of a taxpayer. The list of specific deductions is shown in the table in section 12-5 of the ITAA 1997 and includes payments under a 'forestry managed investment scheme' pursuant to subsection 394-10(1) of the ITAA 1997.

You can deduct an amount pursuant to subsection 394-10(1) of the ITAA 1997 where the following requirements are satisfied:

a. you hold a 'forestry interest' in a 'forestry managed investment scheme'; and

b. you pay an amount under the scheme; and

c. the scheme satisfies the '70% DFE rule' on the last day of the income year you entered into the Project; and

d. you do not have day to day control over the operation of the scheme; and

e. at least one of these conditions is satisfied:

i. there is more than one participant in the scheme;

ii. the 'forestry manager' of the scheme, or an associate, manages, arranges or promotes similar schemes; and

a. the Trees intended to be established under the scheme will be established within 18 months of the end of the income year you entered into the Project.

You hold a 'forestry interest' in a 'forestry managed investment scheme'.

You were required to pay an establishment fee in satisfaction of your obligations under the Project. You paid the establishment fee.

On the basis of the information you supplied, the Commissioner has decided that on the last day of the income year you entered into the Project it was reasonable to expect that the '70% DFE rule' set out in section 394-35 of the ITAA 1997 was satisfied.

You have contracted the Manager to carry out the day to day operation of the Project. You are the only participant in the scheme; however, the Manager, who meets the definition of 'forestry manager' in subsection 394-15(2) of the ITAA 1997, manages, arranges and promotes similar schemes.

The Manager will establish the Trees within 18 months of the end of the financial year in which you entered into the Project in satisfaction of the requirement in paragraph 394-10(1)(f) and subsection 394-10(4) of the ITAA 1997. If the Trees are not established within this period, the Manager must notify the Commissioner pursuant to subsection 394-10(1) of Schedule 1 of the Taxation Administration Act 1953 (TAA).

Conclusion

The Project as described in this Ruling will satisfy the requirements of subsection 394-10(1) of the ITAA 1997. Therefore, you can deduct the establishment fee in the financial year in which it was paid to the Manager (subsection 394-10(2) of the ITAA 1997).

However, the deductibility of the establishment fee is subject to the requirement that:

a. the Manager establishes all the Trees that are intended to be established under the Project within 18 months of the end of the income year you entered into the Project; and

b. a 'CGT event' does not happen in relation to your 'forestry interest' within four years of you entering into the Project.

Question 2

Subsection 8-1(1) of the ITAA 1997 allows a deduction for any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income unless an exclusion in subsection 8-1(2) of the ITAA 1997 applies.

You borrowed funds to fund part of the establishment fee paid to the Manager in consideration for the Manager establishing the Plantation. Your interest in the Project will produce assessable income for you in the form of gross proceeds of sale or proceeds resulting from the disposal of you interests.

For the purposes of this Project, only the capital exclusion in paragraph 8-1(2)(a) of the ITAA 1997 is relevant. However, interest expenses are recognised as being incurred on revenue and not capital account.

Therefore, interest incurred on the loan between you and the Lender will be deductible in the year in which it is incurred pursuant to paragraph 8-1(1)(a) of the ITAA 1997.

Question 3

As discussed in response to Question 1, above, the Project as described in this Ruling will satisfy the requirements of subsection 394-10(1) of the ITAA 1997.

Therefore, you are entitled to claim a deduction for the amounts shown in the table below in the income year in which the amount is paid by you, or on your behalf, in satisfaction of your obligations under the Management Agreement.

An amount will be paid during a financial year when cash flows from you, or from another entity on your behalf, to the Manager's bank account in the year in which the deduction is claimed. Where you do not fully pay an amount, or it is not fully paid on your behalf, in an income year, it is deductible only to the extent to which it has been paid. Any unpaid amount is then deductible in the year or years in which it is actually paid.

However, and as discussed in response to Question 1, above, deductibility is subject to the requirement that:

a. the Manager establishes all the Trees that are intended to be established under the Project within 18 months of the end of the income year you entered into the Project; and

b. a 'CGT event' does not happen in relation to your 'forestry interest' within four years of you entering into the Project.

Question 4

Subsection 35-55(1) of the ITAA 1997 applies to individuals carrying on a business alone or in partnership.

You are not an individual. Therefore, you are not subject to the non-commercial loss rules contained in Division 35 of the ITAA 1997.

Question 5

The operation of section 82KL of the ITAA 1936 depends, among other things, on the identification of a certain quantum of 'additional benefit(s)'. Insufficient 'additional benefits' will be provided under the Project to trigger the application of section 82KL of the ITAA 1936.

Therefore, section 82KL of the ITAA 1936 will not apply to deny otherwise allowable deductions claimed by you in connection with the Project.

Question 6

Section 82KZM of the ITAA 1936 applies to deny the deductibility of all or part of expenditure otherwise deductible under sections 8-1, 355-205 and 355-480 of the ITAA 1997 in certain circumstances. Therefore, section 82KZM of the ITAA 1997 does not apply to deductions allowable under Division 394, discussed in response to Questions 1 and 3, above.

The Loan Agreement between you and the Lender does not require the prepayment of interest. Therefore, section 82KZM of the ITAA 1936 has no application.

Question 7

Part IVA of the ITAA 1936 will apply to deny the deductibility of all or part of otherwise deductible expenditure incurred by you where you have entered into a 'scheme' for the 'sole or dominant purpose' of obtaining a 'tax benefit'.

The Project constitutes a 'scheme' pursuant to section 177A of the ITAA 1936 and you will obtain a 'tax benefit' from entering into the 'scheme' pursuant to paragraph 177C(1)(b) of the ITAA 1936, being allowable deductions that would not have been obtained but for the 'scheme'.

You will derive assessable income in connection with the scheme in the form of gross proceeds of sale or proceeds from the disposal of your interests. No adverse taxation consequences arise from the fact that parties to the arrangement are not dealing at arm's length.

Having regard to the matters listed in section 177D of the ITAA 1936, it cannot be concluded at the time this Ruling is issued that the scheme was entered into or carried out with the sole or dominant purpose of obtaining the tax benefit.

Therefore, Part IVA of the ITAA 1997 does not apply to deny the deductibility of all or part of otherwise deductible expenditure incurred by you in connection with the Project.

Further issues for you to consider

'CGT event' within four years

Deductions for the fees and expenses discussed in response to Questions 1 and 3 of this Ruling, above, are not allowable where a 'CGT event' happens in relation to your 'forestry interest' within four years of you acquiring your interest (subsection 394-10(5) of the ITAA 1997).

Where you have already claimed deductions for these amounts the Commissioner may amend your assessment at any time within two years of the 'CGT event' happening (subsection 394-10(6) of the ITAA 1997). The Commissioner's power to amend in these circumstances applies despite section 170 of the ITAA 1997.

Where your deductions have been disallowed pursuant to subsection 394-10(5) of the ITAA 1997, you are still required to include in you assessable income the market value of the 'forestry interest' at the time of the 'CGT event' or the decrease in the market value of the 'forestry interest' as a result of the 'CGT event' (sections 6-10 and 394-25 of the ITAA 1997) less any GST payable on those proceeds (section 17-5 of the ITAA 1997) in the income year in which the 'CGT event' happens (subsection 394-25(2) of the ITAA 1997).

However, deductions will not be affected where the 'CGT event' happens because of circumstances outside of your control and you could not have reasonably foreseen the 'CGT event' happening when you acquired you 'forestry interest' (subsection 394-10(5A) of the ITAA 1997).

Other references (non-ATO View, such as court cases)

Australian National Hotels Ltd v FCT (1988); 19 FCR 234; 88 ATC 4627; (1988) 19 ATR 1575

Steele v FCT (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139

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