Edited version of private ruling

Authorisation Number: 1011636137351

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Ruling

Subject: Investment in managed investment scheme (MIS)

Questions

1. Is the taxpayer entitled to a deduction in the 2006-07 income year for establishment fees for the purchase of woodlots in an MIS?

2. Is the taxpayer entitled to claim a deduction for a payment to their financer under the deed of settlement?

3. Does execution of the deed of settlement result in a disposal of trading stock outside the ordinary course of business under section 70-90 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answers

1. Is the taxpayer entitled to a deduction in the 2006-07 income year for establishment fees for the purchase of woodlots in an MIS?

Yes.

2. Is the taxpayer entitled to claim a deduction for a payment to their financer under the deed of settlement?

No.

3. Does execution of the deed of settlement result in a disposal of trading stock outside the ordinary course of business under section 70-90 of the ITAA 1997?

Yes. Therefore, the market value of the trees, as at the date of disposal, will be included in the taxpayer's assessable income for the relevant year.

Relevant facts

On 30 June 2007 the taxpayer purchased woodlots in an MIS.

In the taxpayer's income tax return for the 2006-07 income year the taxpayer claimed a deduction for the total cost of their investment, less GST.

In the taxpayer's business activity statement for the relevant period the taxpayer claimed an input tax credit for the GST included in the total cost of their investment.

The MIS is covered by a Product Ruling. The taxpayer is a member of the class of entities to whom that ruling applies.

The taxpayer's investment in the MIS was financed using a loan from a financier. However, the taxpayer defaulted on the taxpayer repayments. As a result, the financier has offered the taxpayer a settlement.

Terms of the deed of settlement include -

§ the taxpayer will pay an amount to the financer

§ the taxpayer and the financer will then release each other from all liabilities and obligations in respect of the loan

§ upon signing the settlement, the taxpayer's interest in the MIS will be terminated

The financier has not provided a breakdown of the settlement amount or an explanation of how it was calculated.

Reasons for decisions

Question 1. Is the taxpayer entitled to a deduction in the 2006-07 income year for establishment fees for the purchase of woodlots in an MIS?

The relevant Product Ruling states that growers who are accepted to participate in the project on or before 30 June are entitled to claim a tax deduction for establishment fees in the income year in which it is incurred. However, no deduction is allowed for any input tax credit claimed (Division 27 of the ITAA 1997).

There is no evidence to suggest that at the time of the taxpayer's investment, the taxpayer did not intend to remain in the scheme for its duration. Therefore, the taxpayer is entitled to a deduction in the 2006-007 income year for establishment fees (net of any input tax credit claimed) for the purchase of woodlots in the MIS.

Question 2. Is the taxpayer entitled to claim a deduction for a payment to their financer under the deed of settlement?

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent that they are incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature.

For a settlement sum to constitute an allowable deduction, it must be shown that it was incidental or relevant to the production of the taxpayer assessable income. Also, in determining whether a deduction for the settlement sum is allowable, the nature of the expenditure must be considered. The nature or character of the settlement sum follows the advantage that is sought to be gained by incurring the expenditure.

In Foley Brothers Pty Limited v. FC of T (1965) 13 ATD 562, a payment was made by a taxpayer under terms of settlement to obtain a release from obligations undertaken by a previous agreement was held to be a payment on capital account. In the course of their judgment, Kitto, Taylor and Menzies JJ said: 'The freedom thus acquired was clearly enough an enduring advantage.'

Taxation Determination TD 93/58 allows where a taxpayer receives an undissected lump sum which includes assessable and non-assessable or capital components that cannot be identified or quantified, the whole of the lump sum amount is treated as a non-assessable or capital receipt.

In this case, the taxpayer will pay an undissected amount as settlement in full of a dispute under a deed of settlement between the taxpayer and the financier. The deed fully and forever releases each party to the deed from all claims, suits, actions and demands each may have against each other. The advantage that the taxpayer will obtain upon signing the deed of settlement is that of an enduring benefit which allows the taxpayer to continue without the burden of the dispute and is considered capital in nature. Therefore, the payment to be made under the deed is considered capital in nature and is not an allowable deduction.

Question 3. Does execution of the deed of settlement result in a disposal of trading stock outside the ordinary course of business under section 70-90 of the ITAA 1997?

Subsection 70-90(1) of the ITAA 1997 applies to any disposal of trading stock that is not in the ordinary course of carrying on business. Under subsection 70-90(1):

If the taxpayer disposes of an item of the taxpayer trading stock outside the ordinary course of a business:

a) that the taxpayer are carrying on; and

b) of which the item is an asset;

the taxpayer assessable income includes the market value of the item on the day of the disposal.

Carrying on business

As a grower in the MIS the taxpayer has established, and is managing, a commercial plantation of trees and is carrying on a commercial business of afforestation. This is outlined in the relevant Product Ruling.

Trading stock

Under the management agreement the taxpayer signed with responsible entity for the MIS, trees were planted on the taxpayer's woodlots for the purpose of eventual felling and sale in approximately 20 years. Trees planted and tended for sale which are disposed outside the ordinary course of business are treated as trading stock of your commercial afforestation business.

Disposal

When the taxpayer executes the deed of settlement with the financer, the taxpayer will be released from all obligations in respect of the project, the product disclosure statement, the sub-forestry agreement, and the management agreement. This means that the taxpayer's interest in the MIS will be terminated. The termination results in the effective disposal of the taxpayer's trees and the cessation of the taxpayer's afforestation business.

Outside the ordinary course of carrying on that business

The final condition requires that the disposal of trading stock is not in the ordinary course of carrying out the taxpayer's commercial business of afforestation.

The question of whether or not a sale is outside the ordinary course of business carried on by a taxpayer is a question of fact. In Downs Distributing Co Pty Ltd v. Associated Blue Star Stores Pty Ltd (in liq) (1948) 76 CLR 463 at p.477, Rich J said:

… It speaks of the course of business in general. But it does suppose that according to the ordinary and common flow of transactions in affairs of business there is a course, an ordinary course. It means that the transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary course of business as carried on, calling for no remark and arising out of no special or particular situation.

The character of the transactions that could reasonably be expected to be called for in the course of a business of afforestation include; planting, maintaining, felling, and selling trees. The disposal of the taxpayer's trees is considered to be outside the ordinary course of an afforestation business because it occurs in a manner that is not part of the common flow of transactions. That is, it arises out of the special situation of the taxpayer defaulting on the loan and the subsequent execution of the deed of settlement.

In conclusion, execution of the deed of settlement will result in a disposal of trading stock outside the ordinary course of business under section 70-90 of the ITAA 1997. This means that the taxpayer's assessable income for the income year in which the taxpayer executes the deed of settlement will include the market value of the trees on the day of disposal in accordance with subsection 70-90(1) of the ITAA 1997. The day of disposal will be the day that the taxpayer signs the deed of settlement.