Edited version of private ruling

Authorisation Number: 1011727966997

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Ruling

Subject: Non-commercial Loss Extension for Multiple Rulees

Question 1

Are Management Fees deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in the income year in which they are incurred?

Answer

Yes

Question 2

Are Lease Fees deductible under section 8-1 of the ITAA 1997 in the income year in which they are incurred?

Answer

Yes

Question 3

Will income derived by the Grower from their participation in the project be assessable income under section 6-5 of the ITAA 1997 from carrying on a business of primary production?

Answer

Yes

Question 4

Will the general anti-avoidance provision of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) being Sections 177A to 177G of the ITAA 1936 apply?

Answer

No

Question 5

Will the Management Fees and Lease Fees referred to in question 1 and 2 above be subject to Sections 82KZME to KZMF of ITAA 1936?

Answer

No

Question 6

Will the Commissioner exercise his discretion under paragraphs 35-55(1)(b) and 35-55(1)(c) of Division 35 of the ITAA 1997 to allow losses from the Project to be offset against income from other sources?

Answer

Yes

Question 7

Will the Management Fees referred to in question 1 above be subject to section 82KL of the ITAA 1936?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 2010

Year ending 30 June 2011

Year ending 30 June 2012

Year ending 30 June 2013

We considered these to be the relevant facts

The rulees (growers) each commenced their participation in the project by applying under a prospectus for the project.

The grower has a purpose of deriving assessable income from the sale of timber and staying in the arrangement until the projects agreement expire.

The project is located on specified project land. Growers participating in the arrangement have entered into a lease and management agreement with the responsible entity (in its capacity as both Manager and Lessor). Each grower has leased a portion of land known as a timber lot for a defined period ending when the trees are harvested and sold and net income distributed. Each timber Lot is a certain size and a certain number of trees have been planted on the project land.

At all times the grower has full right, title and interest in the forest product and the right to have the forest product sold for their benefit. The manager is irrevocably appointed to sell the forest produce at the maximum practicable price available on behalf of the growers. The trees are expected to be harvested in the relevant income year.

Upon application growers executed a power of attorney enabling the manager to act on their behalf as required. Through the lease and management agreement, each rule engaged the manager to provide services and maintain a plantation on the leased area. The manager will also be responsible for the harvesting of the timber. Harvesting of the trees is expected to be completed in the relevant income year. A grower may have elected to take the timber produced from their particular timber lots (the forest produce) thereby becoming and electing grower or the manager will sell the produce on their behalf (non-electing grower). The ruling does not apply to electing growers.

Constitution

The constitution for the project sets out the terms and conditions under which the responsible entity as trustee of the scheme agrees to act for the growers and the manager agrees to manager the project. Both the responsible entity and the manager are obliged to act in the best interests of the growers. Growers are bound by the constitution by virtue of their participation in the project. Pursuant to the constitution, the responsible entity will keep a register of the growers.

The constitution was modified in accordance with a resolution passed by growers at a meeting. The effect of this was to restructure the annual management fees for existing growers. The constitution has been further modified in order to correctly implement the changes approved by the resolution.

Lease and Management Agreement

Each grower must pay rent to the lessor in an amount specified in the lease and management agreement. The agreement also provides that each grower appoints the manager to perform services. The services to be performed are specified in the schedule to the agreement. The manager will supervise and manage all silvicultural activities on behalf of each grower.

Fees

All fees and expenditure include the Goods and Services Tax (GST) where applicable. In order to be entitled to claim input tax credits for the GST in expenditure the investor must be registered or required to be registered for GST and hold a valid tax invoice.

The fees payable for the project are specified on a per timber lot basis. Growers are required to pay the manager the annual fees for each year of the project to date as specified by the lease and management agreement. The amounts payable for annual fees on a per timber lot basis were modified.

As at 30 June of the relevant income year fees are subject to indexation as per the lease and management agreement, and the numbers have an assumed indexation factor.

Harvesting and Sale

The manager must procure a suitably qualified person to harvest and process the trees at market rates. Harvesting is expected to take place on a specific date. However, if the responsible entity reasonably believes that it would be in the best interest of the growers for the harvesting to be deferred to a later date, such date to be no later than a certain amount of years from the commencement date.

The gross proceeds of sale from the forest produce will be paid direct to the manager who must deposit the proceeds into the proceeds fund. The manager must pay to itself the costs incurred for harvesting, processing and selling the forest produce, and any other fees or amounts owing. The remainder will be distributed to the non-electing grower.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Division 328

Income Tax Assessment Act 1997 Section 328-105

Income Tax Assessment Act 1997 Section 17-5

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 Section 35-10

Income Tax Assessment Act 1997 Sub-section 35-55(1)

Income Tax Assessment Act 1997 Sub-section 35-10(2E)

Income Tax Assessment Act 1997 Sub-sections 35-10(2)

Income Tax Assessment Act 1997 Sub-section 35-10(2C)

Income Tax Assessment Act 1997 Paragraph 328-105(1)(a)

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

Income Tax Assessment Act 1997 Paragraph 35-55(1)(c)

Income Tax Assessment Act 1936 Section 82KZME

Income Tax Assessment Act 1936 Section 82KZMF

Income Tax Assessment Act 1936 Section 82KL

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 Section 177D

Reason for decision

Is the Grower carrying on a business?

Section 8-1 - of the ITAA 1997

For the management fees and lease fees of the grower's business to constitute allowable deductions, your afforestation activities as a participant in the project must amount to the carrying on of a business of primary production.

Where there is a business, the gross proceeds from the sale of the timber will constitute gross assessable income in their own right. The generation of business income from such a 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.

For schemes such as this project, Taxation Ruling TR 2000/8 sets out in paragraph 89 the circumstances in which the growers activities can constitute the carrying on of a business. As TR 2000/8 sets out, these circumstances have been established in court decisions such as FCT v Lau 84 ATC 4929; (1984) 16 AT 55.

Generally, you will be carrying on a business of afforestation, and hence primary production, if:

You have an identifiable interest in the land (by lease) or hold rights over the land (by licence) on which your trees are established;

· you have a right to harvest and sell the timber from those trees;

· the afforestation activities are carried out on your behalf;

· your afforestation activities are typical of those associated with an afforestation business; and

· the weight and influence of general indicators point to the carrying on of a business.

Although TR 2000/8 has been withdrawn with effect from 1 July 2008, TR 2000/8 will continue to apply to investors who enter into investment schemes prior to 1 July 2008.

In this project, each grower enters into a lease and management agreement. Under the agreement you have rights over a specific and identifiable area of land. The agreement provides you with an ongoing interest in the specific trees on the leased area for the term of the project. Under the lease, you must use the land in question for the purpose of carrying out afforestation activities, and for no other purpose. The lease allows the manager to come onto the land to carry out its obligations under the lease and management agreement.

Under the agreement, the manager is engaged by you to establish and maintain a timber lot on your identifiable area of land during the term of the project. The manager has provided evidence that it holds the appropriate professional skills and credentials to provide the management services to establish and maintain the timber lot on your behalf.

The manager is also engaged to harvest and sell, on your behalf, the timber grown on your timber lot.

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 projects description for all the indicators.

The activities that will be regularly carried out during the term of the project demonstrate a significant commercial purpose. Based on reasonable projections, you will derive assessable income from the sale of the timber that will return a before-tax profit, i.e, a profit in cash terms that does not depend in its calculation on the fees in question being allowed as a deduction.

For growers who are non-electing growers, the pooling of timber grown on your timber lots with the timber of other growers is consistent with general afforestation practices. Each growers proportionate share of the sale proceeds of the pooled timber will reflect the proportion of the trees contributed from their timber lot.

The manager's services are also consistent with general silvicultural practices. They are of the type ordinarily found in afforestation ventures that would commonly be said to be businesses. While the size of a timber lot is relatively small, it is of a size and scale to allow it to be commercially viable.

Each grower's degree of control over the manager as evidenced by the lease and management agreement, and supplemented by the Corporation Act 2001, is sufficient. During the term of the project, the manger will provide you with regular progress reports on your timber lot and the activities carried out on your behalf. You are able to terminate arrangements with the manger in certain instances, such as cases of default or neglect.

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. For the purposes of this private ruling, your afforestation activities in the project will constitute the carrying on of a business.

The management fees and lease fees of the grower's business associated with the afforestation activities will relate to the gaining of income from your business of afforestation. Therefore have sufficient connection to the operations by which income from harvesting and sale of timber is to be gained from this business. They will thus be deductible under the first limb of section 8-1 of the ITAA 1997.

Small Business Entities (SBE)

Division 328 of the ITAA 1997

From the 2007-08 income year, a range of concessions previously available under the Simplified Tax System (STS), will be available to an entity if it carries on a business and satisfies the $2 million aggregated turnover test (a 'small business entity').

A small business entity can choose the concessions that best suit its needs. Eligibility for some small business concessions is also dependent on satisfying some additional conditions. Because of these choices and the eligibility conditions the application of the small business concessions to Growers who qualify as a 'small business entity' is not able to be dealt with in this private ruling.

Assessable Income

Sections 6-5 of the ITAA 1997

The part of the gross sales proceeds from the project attributable to the growers produce, less any GST payable on those proceeds (section 17-5 of the ITAA 1997), will be assessable income of the grower under section 6-5 of the ITAA 1997.

Deferral of losses from non-commercial business activities (NCL)

Division 35 of the ITAA 1997

Based on information provided with the private ruling application, a grower accepted into the project who carries on a business of afforestation individually (alone or in partnership) is expected to incur losses from their participation in the project which will be subject to Division 35 of the ITAA 1997 (Division 35 of the ITAA 1997 does not apply to growers who do not carry on a business or who carry on a business other than as individuals (alone or in partnership)). These losses will be subject to the loss deferral rule in section 35-10 of the ITAA 1997 unless an exception applies or, for each income year in which losses are incurred, the Commissioner exercises the discretion in subsection 35-55(1) of the ITAA 1997 on 30 June of that specific income year.

The exceptions to the loss deferral rule depend upon the circumstances of individual growers and are outside the scope of this Ruling.

The Commissioner will apply the principles set out in Taxation Ruling TR 2007/6 Income tax: non commercial business losses: Commissioner's discretion when exercising the discretion.

Where a Grower with income for NCL purposes of less than $250,000 (i.e., the grower satisfies the income requirement in subsection 35-10(2E) of the ITAA 1997) incurs a loss in an income year from carrying on their business activity in a way that is not materially different to the scheme described in this private ruling, and the discretion in paragraph 35-55(1)(b) of the ITAA 1997 is exercised for that year, the Commissioner will be satisfied that:

· it is because of its nature that the business activity of the grower will not satisfy one of the four tests in Division 35 of the ITAA 1997; and

· there is an objective expectation that within a period that is commercially viable for the afforestation industry, the grower's business activity will satisfy one of the four tests set out in Division 35 of the ITAA 1997 or produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C) of the ITAA 1997.

Where a grower with income for NCL purposes of $250,000 or more (i.e., the grower does not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997) incurs a loss in an income year from carrying on their business activity in a way that is not materially different to the scheme described in this private ruling, and the discretion in paragraph 35-55(1)(c) of the ITAA 1997 is exercised for that year, the Commissioner will be satisfied that:

· it is because of its nature that the business activity of the grower will not produce assessable income greater than the deductions attributable to it; and

· there is an objective expectation that within a period that is commercially viable for the afforestation industry, the grower's business activity will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C) of the ITAA 1997.

A grower will satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 where the sum of the following amounts is less than $250,000:

· taxable income for that year (ignoring any loss arising from participation in the project or any other business activity);

· total reportable fringe benefits for that year;

· reportable superannuation contributions for that year; and

· total net investment losses for that year.

For each of the individual income years the Commissioner will exercise the discretion in subsection 35-55(1) of the ITAA 1997 for a grower who would otherwise be required to defer a loss arising from their participation in the project under section 35-10 of the ITAA 1997 until a later income year is able to offset that loss against their other assessable income.

Section 82KZME - 82KZMF of the ITAA 1936

The prepayment provisions contained in Subdivision H of Division 3 of Part III of the ITAA 1936 affect the timing of deductions for certain prepaid expenditure. These provisions apply to certain expenditure incurred under an agreement in return for the doing of a thing under the agreement (for example, the performance of management services or the leasing of land) that will not be wholly done within the same year of income as the year in which the expenditure is incurred. If expenditure is incurred to cover the provision of services to be provided within the same year, then it is not expenditure to which the prepayment rules apply.

In this scheme the relevant grower must pay the management fees on or before 1 February in each financial year, as agreed between the relevant grower and the manager.

The lease fees will also be paid to the lessor by the relevant grower on or before the commencement of the financial year to which the rent relates.

Under the scheme to which this private ruling applies management fees and lease fees are incurred annually. Therefore the prepayment provisions in sections 82KZME and 82KZMF of the ITAA 1936 have no application to this scheme.

Section 82KL of the ITAA 1936 - Recouped Expenditure

The operation of section 82KL of the ITAA 1936 depends, among other things, on the identification of a certain quantum of additional benefits. Insufficient additional benefits will be provided to trigger the application of section 82KL of the ITAA 1936. It will not apply to deny the deduction otherwise allowable under section 8-1 of the ITAA 1997.

Part IVA of the ITAA 1936 - General Tax Avoidance Provisions

For Part IVA to apply there must be a scheme (section177A of the ITAA 1936), a tax benefit (section 177C of the ITAA 1936) and a dominant purpose of entering into the scheme to obtain a tax benefit (section 177D of the ITAA 1936).

The project will be a scheme. You will obtain a tax benefit from entering into the scheme, in the form of tax deductions that would not have been obtained but for the scheme. 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 intend to stay in the scheme for its full term and derive assessable income from the harvesting and sale of the timber produce. 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 private ruling. There is no non-recourse financing or round robin characteristics, and no indication that the parties are not dealing at arms length or, if any parties are not dealing at arms 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 participants have entered into the scheme for the dominant purpose of obtaining a tax benefit.