Edited version of your private ruling

Authorisation Number: 1012504836671

Ruling

Subject: Managed Investment Scheme- Forestry

Question 1

Will the establishment fee for the tree lots paid by you on execution of the project agreement on or before 30 June be an allowable deduction under Division 394 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, subject to all project trees being planted by 31 December, 18 months after the execution of the project agreements, and no CGT event within your control has taken place by 30 June within four years of the execution of the project agreement.

Question 2

Will the following fees paid under the project agreement be an allowable deduction under Division 394 of the ITAA 1997 for you as an initial participant in the project?

· The services fee

· The performance fee

· The selling and marketing fee

· The property management fee

· Amounts payable under the annual deferred options

· Rent incurred under the lease agreement

Answer

Yes

Question 3

Will the interest incurred on funds borrowed by you as the initial participant to pay the establishment fee be an allowable deduction under section 8-1 of the ITAA 1997?

Answer

Yes

Question 4

Will the Commissioner exercise his discretion under Division 35 of ITAA 1997 to defer losses from non-commercial business activities?

Answer

Yes with conditions

Question 5

Does sections 82KL and 82KZL to 82KZMF of the Income Tax Assessment Act of 1936 (ITAA 1936) apply to deny the deductions otherwise allowable under section 8-1 or Division 394 of the ITAA 1997 or other relevant provisions?

Answer

No

Question 6

Does Part IVA of the ITAA 1936 apply to deny deductions for the expenditure incurred by you under the project arrangements?

Answer

No

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The project is a forestry managed investment scheme as defined by subsection 394-15(1) of the Income Tax Assessment Act 1997 (ITAA 1997) in which you are an initial participant. The project is not a registered managed investment scheme.

The project will be established, within the 18 month period to 31 December after the execution of the project agreement, as a tree plantation. The project will operate for a 15 year term. You are entitled to receive the net proceeds of sale (as defined by the project agreement) from the growing and harvesting of the trees.

A responsible entity has not been appointed to the project. An entity has been appointed as the manager by you under the project agreement dated and effective at commencement.

Fees and services

Pursuant to the project agreement, the manager will provide establishment services to you for the purpose of managing the project prior to 31 December, 18 months after the execution of the project agreements. In consideration for payments made by you to the manager during the relevant period, the manager will perform, or cause to be performed:

· establishment services

· services

· property management services

The establishment services include; acquiring appropriate seeds and seedlings, weed control, surveying, ground preparation, planting of trees and host trees, and irrigate, cultivate, tend cull, prune, fertilise, spray, fumigate and poison vermin in support of planting.

The manager will provide the services.

A trustee will provide the selling and marketing services.

Lease agreement

The trustee is, or will be, the registered proprietor of the project land located within Australia ("Land") upon which the project trees will be planted for the purpose of conducting the afforestation business.

Payment for rent per hectare is outlined in the lease agreement. The first payment will be due 1 January after the commencement of the project.

Project duration

The project was entered into upon execution of the project agreement. The length of the project is approximately 15 years.

Finance

Finance for the establishment fee is being provided to you by a finance entity. You have entered into a loan agreement with the finance entity to borrow funds for the project.

The finance entity is entitled to a charge over the assets of the Investor as security for repayment of the advanced funds.

The project does not involve any form of non-recourse or limited recourse financing pursuant to which an Investor can leverage its tax deductions but not be at risk with respect to its financial obligations.

Relevant Supporting Documents

The following supporting documents are provided:

· project agreement between the taxpayer, the manager and the trustee

· loan agreement between the taxpayer as borrower and a finance entity as lender

· bank statement for the finance entity showing debit for the establishment fee

· bank statement for the trustee showing credit for the establishment fee

· the direct forestry expenditure calculations

· correspondence.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 8-5

Income Tax Assessment Act 1997 Section 8-10

Income Tax Assessment Act 1997 Section 12-5

Income Tax Assessment Act 1997 Division 394

Income Tax Assessment Act 1997 Section 394-10

Income Tax Assessment Act 1997 Section 394-20

Income Tax Assessment Act 1997 Section 394-25

Income Tax Assessment Act 1997 Subsection 394-35

Income Tax Assessment Act 1936 Section 82KZL

Income Tax Assessment Act 1936 Section 82KZM

Income Tax Assessment Act 1936 Section 82KZME

Income Tax Assessment Act 1936 Section 82KZMF

Income Tax Assessment Act 1936 Part IVA

Reasons for decision

These reasons for decision accompany the Notice of private ruling for

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

Will the establishment fee for the tree lots paid by you on execution of the project agreement on or before 30 June be an allowable deduction under Division 394 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Question 2

Will the following fees paid under the project agreement be an allowable deduction under Division 394 of the ITAA 1997 for you as an initial participant in the project?

· The services fee

· The performance fee

· The selling and marketing fee

· The property management fee

· Amounts payable under the annual deferred options

· Rent incurred under the lease agreement

Detailed reasoning for question 1 and 2

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 a table in section 12-5 and includes payments under a 'forestry managed investment scheme' that meet the requirements of subsection 394-10(1) of the ITAA 1997.

The requirements under section 394-10(1) of the ITAA 1997 state:

(a)  you hold a * forestry interest in a * forestry managed investment scheme; and

(b)  you pay the amount under the scheme; and

(c)  the scheme satisfies the * 70% DFE rule (see section 394- 35) on 30 June in the income year in which a * participant in the scheme first pays an amount under the scheme; and

(d)  you do not have day to day control over the operation of the scheme (whether or not you have the right to be consulted or give directions); 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 of the forestry manager, manages, arranges or promotes similar schemes; and

(f)  the condition in subsection (4) is satisfied.

The deductibility of the establishment fee remains subject to the requirement that:

· the manager establishes all of the trees under the project within 18 months of the end of the income year in which you become a participant in the scheme, and

· a CGT event does not happen in relation to the initial participant's 'forestry interest' before 1 July within four years of the execution of the project agreement.

The establishment fee is deductible in the income year in which it is paid, or is paid on your behalf as an initial participant (subsection 394-10(2) and Section 394-20). This requires cash to flow from you, or from another entity on your behalf, to the manager's bank account in the year in which the deduction is claimed. Any form of payment that does not involve the movement of cash into the manager's bank account will not qualify for a deduction under subsection 394-10(2).

Paragraph 394-10(1)(c) states that the scheme must satisfy the '70% DFE rule' on 30 June in the income year in which a participant pays an amount under the scheme.

The taxpayer has contracted the manager to carry out the day to day operation of the project. The taxpayer is the only participant in the scheme; however, the manager, who meets the definition of 'forestry manager' is subsection 394-15(2) of the ITAA 1997, manages, arranges and promotes similar schemes.

Pursuant to the project agreement, the manager will cause the establishment services to be completed on or before 31 December within 18 months of the execution of the project agreement, 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 by 31 December the manager must notify the Commissioner pursuant to subsection 394-10(1) of Schedule 1 of the Taxation Administration Act 1953 (TAA).

Accordingly, subject to the qualifications set out below, amounts paid by you to the manager in relation to your 'forestry interests' satisfy all requirements of subsection 394-10(1). The amounts are allowable deductions in the income year in which they are paid (subsection 394-10(2)).

Where an initial participant does not fully pay an amount, or the amount is not fully paid on their behalf in an income year (see section 394-20), it is deductible only to the extent to which it has been paid. The unpaid balance is then deductible in the year or years in which it is actually paid. This may occur, for example, if all or part of the amount is borrowed and the financier fails to transfer the funds to the account of the 'forestry manager' on or before 30 June in an income year.

Loss of deductions previously allowed under subsection 394-10(1)

Two situations may lead to a loss of deductions previously allowed to participants.

The first of these situations will occur if the manager fails to establish the trees on the project land within 18 months. Where this occurs the manager is required to notify the Commissioner within three months of the end of the 18 month period (section 394-10 of Schedule 1 to the Tax Administration Act 1953).

The second situation where a participant may have deductions disallowed is where a 'CGT event' happens to their 'forestry interest' within four years from 30 June of the income year they paid an amount under the scheme, for example, the application price (see subsection 394-10(5)).

For the purposes of this provision, the Commissioner is able to amend the assessment of a participant within two years of the relevant 'CGT event' happening. The Commissioner's power to amend in these circumstances applies despite section 170 of the Income Tax Assessment Act 1936 (subsection 394-10(6) of the ITAA 1997).

Where a 'CGT event' happens to the 'forestry interest' of a participant within four years, 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' is still included in the assessable income of the participant by section 394-25. The amount must be included in assessable income even where an amendment has disallowed or may disallow the deductions previously allowed under section 394-10.

However, subsection 394-10(5) will have no application where the 'CGT event' happens because of circumstances outside the participant's control and the participant could not reasonably have foreseen the 'CGT event' happening when they acquired the 'forestry interest' (subsection 394-10(5A)).

Under the terms of the project agreement, the establishment fee was payable by 30 June.

Therefore, ensuring all of the above requirements are met you can claim deductions for the amount shown in the Table below that is paid to the manager (sections 8-5 and 394-10).

Amounts that are allowable deductions under Division 394 cannot also be claimed as deductions under section 8-1 (section 8-10).

Question 3

Will the interest incurred on funds borrowed by the you as the initial participant to pay the establishment fee on or before 30 June be an allowable deduction under section 8-1 of the ITAA 1997?

Detailed reasoning

For an amount to be deductible it must satisfy conditions set out in section 8-1 of the ITAA 1997, Section 8-1 of the ITAA 1997 which states:

(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

Where an initial participant borrows money to fund their investment in the project the deductibility of the interest incurred on the loan monies falls for consideration under the general deduction provisions of section 8-1. If the interest incurred by the initial participant is deductible under the first positive limb in subsection 8-1(1) there is no requirement to consider whether it is also deductible under the second positive limb of that provision. Court decisions show that the same basic test applies to both limbs (see Ronpibon Tin NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431, at CLR 56; ATD 435).

Under the first positive limb of subsection 8-1(1) the interest incurred by an initial participant will be deductible if it is incurred in gaining or producing an initial participant's assessable income and is not excluded by one of the negative limbs in subsection 8-1(2):

The question of whether an outgoing [is] ... incurred in gaining or producing the assessable income is a question of characterisation' (Fletcher & Ors v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613, at CLR 17; ATC 4957; ATR 621).

To the extent that ... outgoings of interest ... can properly be characterised as of a kind referred to in the first limb of [section 8-1] they must draw their character from the use of the borrowed funds (Fletcher , at CLR 19; ATC 4958; ATR 623).

The characterisation of interest will generally be ascertained by reference to the objective circumstances of the use to which the borrowed funds are put (Federal Commissioner of Taxation v. Roberts (1992) 37 FCR 246; 92 ATC 4380; (1992) 23 ATR 494, at FCR 257; ATC 4388; ATR 504).

Initial participants use the borrowed funds to acquire a 'forestry interest' in a 'forestry managed investment scheme'. The holding of that 'forestry interest' is intended to produce assessable income for an initial participant in the form of the proceeds of a full or part disposal of the 'forestry interest' or, as a proportionate share of the harvest proceeds. The tests for deductibility of interest under the first limb of subsection 8-1(1) are, therefore, met unless one of the exclusions in subsection 8-1(2) apply.

For the purposes of this project, only the capital exclusion in paragraph 8-1(2)(a) is relevant. The use of borrowed funds to purchase a capital asset, such as a 'forestry interest', does not mean that the interest outgoings are on capital account (see Steele v. Federal Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139, at CLR 470; ATC 4249; ATR 148):

Interest is a periodic payment for the use, but not the permanent acquisition of a capital item. Therefore, a consideration of the often-cited three matters identified by Dixon J in Sun Newspapers Ltd v. FC of T ... assigns interest ... to revenue (Australian National Hotels Ltd v. Federal Commissioner of Taxation (1988); 19 FCR 234; 88 ATC 4627; (1988) 19 ATR 1575, at FCR 241; ATC 4633-4634; ATR 1582).

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

Question 4

Will the Commissioner exercise his discretion under Division 35 of ITAA 1997 to defer losses from non-commercial business activities for the 15 years ended 30 June?

Detailed reasoning

For each of the 15 income years of the project the Commissioner will exercise the discretion in subsection 35-55(1) once the following conditions are satisfied for the year concerned:

· the initial participant carried on their business of afforestation during the income year; and

· the business activity that is carried on is not materially different to that in the scheme described in this ruling; and

· the initial participant has incurred a taxation loss for the income year from carrying on that business activity.

If these conditions are met for a given year, the Commissioner will exercise the discretion for that year under:

· paragraph 35-55(1)(b) for an initial participant in the project who satisfies the income requirement in subsection 35-10(2E); and

· paragraph 35-55(1)(c) for an initial participant in the project who does not satisfy the income requirement in subsection 35-10(2E).

If the Commissioner determines that the discretion will not be exercised for a particular year or years the initial participant will be informed of that decision and the reasons. In any year where the discretion is not exercised losses incurred by an initial participant will be subject to the loss deferral rule in section 35-10 and the initial participant will not be able to offset the losses from the project against other assessable income.

Question 5

Does sections 82KL and 82KZL to 82 KZMF of the ITAA 1936 apply to deny the deductions otherwise allowable under section 8-1 or Division 394 of the ITAA 1997 or other relevant provisions?

Detailed reasoning

The following provisions of the ITAA 1936 have application as indicated:

· interest paid by an initial participant to the finance entity, do not fall within the scope of sections 82KZM, 82KZME and 82KZMF

· section 82KL does not apply to deny the deductions otherwise allowable.

Question 6

Does Part IVA of the ITAA36 apply to deny deductions for the expenditure incurred by the initial participant under the project arrangements?

Detailed reasoning

For Part IVA of the ITAA 1936 to apply there must be a 'scheme' (section 177A of the ITAA 1936), a 'tax benefit' (section 177C of the ITAA 1936) and a dominant purpose of entering into or carrying out the scheme to obtain a tax benefit (section 177D of the ITAA 1936).

The project will be a 'scheme' and you will obtain a 'tax benefit' from entering into the 'scheme', in the form of tax deductions for the amounts detailed in the table above. However, it is not possible to conclude the scheme will be entered into or carried out with the dominant purpose of obtaining this tax benefit.

You will derive assessable income from holding or disposing of their 'forestry interest' in the project. There are no facts that would suggest that you have the opportunity of obtaining a tax advantage other than the tax advantages identified in this Ruling. There is no non-recourse financing and no indication that the parties are not dealing at arm's length or, if any parties are not dealing at arm's length, that any adverse tax consequences result. Further, having regard to the factors to be considered under paragraph 177D(b) of the ITAA 1936 it cannot be concluded, on the information available, that you will enter into the scheme for the dominant purpose of obtaining a tax benefit.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).