Income tax: TFS Sandalwood Project 2008 - pre 30 June 2008 Growers

This Product Ruling sets out the Commissioner's opinion on the way in which the relevant provision(s) identified in the Ruling section (below) apply to the defined class of entities, who take part in the scheme to which this Ruling relates. All legislative references in this Ruling are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated. In this Product Ruling the scheme is referred to as 'TFS Sandalwood Project: 2008 (pre 30 June Growers' or simply as 'the Project'.

This part of the Product Ruling specifies which entities are subject to the taxation obligations and can rely on the taxation benefits set out in the Ruling section of this Product Ruling.

The members of the class of entities who are subject to those taxation obligations and who can rely on those taxation benefits are referred to as Growers.

Growers will be those entities that are accepted to participate in the scheme specified below as initial participants [1] on or from the date this Product Ruling is made. They will have executed the relevant Project Agreements set out in paragraph 35 of this Ruling on or before 30 June 2008.

The class of entities who can rely on the tax benefits set out in the Ruling section of this Product Ruling does not include entities who: • participate in the scheme other than as initial participants; • are accepted into this Project before the 16 January 2008, the date on which this Product Ruling is made, or after 30 June 2008; • participate in the scheme through offers made other than through the Product Disclosure Statement (PDS); • have elected to market and sell the timber grown on their Woodlot(s); • enter into finance arrangements with entities associated with this Project, other than those specified in paragraph 75 of this Ruling; • have not paid the Application Price by 30 June 2008, where they have not entered into a finance arrangement; or • have their application conditionally accepted by TFS Properties Ltd subject to finance for the payment of the Application Price, where the finance has not been approved by the lender or the finance has been approved but the funds have not been made available to TFS Properties Ltd by 30 June 2008.

This Product Ruling does not address the provisions of the Superannuation Industry (Supervision) Act 1993 (SISA 1993). The Tax Office gives no assurance that the product is an appropriate investment for a superannuation fund. The trustees of superannuation funds are advised that no consideration has been given in this Product ruling as to whether investment in this product may contravene the provisions of SISA 1993.

The class of entities defined in this Product Ruling may rely on its contents provided the scheme actually carried out is carried out in accordance with the scheme described in paragraphs 35 to 85 of this Ruling.

If the scheme actually carried out is materially different from the scheme that is described in this Product Ruling, then: • this Product Ruling has no binding effect on the Commissioner because the scheme entered into is not the scheme on which the Commissioner has ruled; and • this Product Ruling may be withdrawn or modified.

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This Product Ruling applies prospectively from 16 January 2008, the date this Product Ruling is made. It therefore applies only to the specified class of entities that enter into the scheme from 16 January 2008 until 30 June 2008, being the closing date for entry into the scheme. This Product Ruling provides advice on the availability of tax benefits to the specified class of entities for the income years up to 30 June 2010.

However the Product Ruling only applies to the extent that: • there is no change in the scheme or in the entity's involvement in the scheme; • it is not later withdrawn by notice in the Gazette; or • the relevant provisions are not amended.

If this Product Ruling is inconsistent with a later public or private ruling, the relevant class of entities may rely on either ruling which applies to them (item 1 of subsection 357-75(1) of Schedule 1 to the Taxation Administration Act 1953 (TAA)).

If this Product Ruling is inconsistent with an earlier private ruling, the private ruling is taken not to have been made if, when the Product Ruling is made, the following two conditions are met: • the income year or other period to which the rulings relate has not begun; and • the scheme to which the rulings relate has not begun to be carried out.

If the above two conditions do not apply, the relevant class of entities may rely on either ruling which applies to them (item 3 of subsection 357-75(1) of Schedule 1 to the TAA).

Although this Product Ruling deals with the laws enacted at the time it was issued, later amendments to the law may impact on this Product Ruling. Any such changes will take precedence over the application of this Product Ruling and, to the extent of those amendments this Product Ruling will be superseded.

Entities who are considering participating in the scheme are advised to confirm with their taxation adviser that changes in the law have not affected this Product Ruling since it was issued.

Product Rulings were introduced for the purpose of providing certainty about tax consequences for entities in schemes such as this. In keeping with that intention the Tax Office suggests that promoters and advisers ensure that participants are fully informed of any legislative changes after the Product Ruling is issued.

All fees and expenditure referred to in this Product Ruling include the Goods and Services Tax (GST) where applicable. In order for an entity (referred to in this Ruling as a Grower) to be entitled to claim input tax credits for the GST included in its expenditure, it must be registered or required to be registered for GST and hold a valid tax invoice.

Subject to the stated qualifications, this part of the Product Ruling sets out in detail the taxation obligations and benefits for a Grower in the defined class of entities who enters into the scheme described at paragraphs 35 to 85 of this Ruling. The Grower's participation in the Project must constitute the carrying on of business of primary production. Provided the Project is carried out as described below, the Grower's business of primary production will commence at the time of execution of their Lease and Management Agreement.

A Grower is not eligible to claim any tax deductions until the Grower's application to enter the Project is accepted and the Project has commenced.

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 Ruling.

Other than where a 'CGT event' [3] happens to their interest within four years of 30 June 2008 (see paragraph 24 of this Ruling), a Grower who is an initial participant in the scheme may claim tax deductions for the following amount on a per Woodlot basis. Fee Type 2007-08 Income Year 2008-09 Income Year 2009-10 Income Year Fee for land preparation and tree planting $12,650 for up to 5 Woodlots $12,100 for over 6 Woodlots See Notes (i) & (ii) Nil Nil Notes: (i) If the Grower is registered or required to be registered for GST, amounts of outgoing would need to be adjusted as relevant for GST (for example, input tax credits): Division 27. (ii) Under section 82KZMG of the Income Tax Assessment Act 1936 (ITAA 1936), the fee for land preparation and tree planting is expenditure for 'seasonally dependent agronomic activities' (see paragraphs 100 to 105 of this Ruling) and is deductible in the income year in which it is incurred.

A deduction for the fee for land preparation and tree planting is not allowable where a 'CGT event' happens in relation to a Grower's interest before 1 July 2012 (subsection 82KZMGA(1) of the ITAA 1936).

Where deductions for these amounts have already been claimed by a Grower the Commissioner may amend their assessment at any time within two years after the end of the income year in which the 'CGT event' happens. The Commissioner's power to amend in these circumstances applies despite section 170 of the ITAA 1936 (subsection 82KZMGA(2) of the ITAA 1936).

Growers whose deductions are disallowed are still required to include in their assessable income the market value of the interest at the time of the 'CGT event' or the decrease in the market value of the interest as a result of the 'CGT event' (see paragraphs 106 to 108 of this Ruling).

A Grower who is an initial participant in the scheme may also claim tax deductions for the following fees and expenses on a per Woodlot basis, as set out in the table below. Fee Type 2007-08 Income Year 2008-09 Income Year 2009-10 Income Year Annual Management Fees Nil See Notes (i), (iii) & (iv) See Notes (i), (iii) & (iv) Rent Nil See Notes (i), (iii) & (iv) See Notes (i), (iii) & (iv) Loan application fee and stamp duty for loan with Arwon Finance Pty Ltd or MIS Funding No. 1 Pty Ltd See Note (v) See Note (v) See Note (v) Interest on Loan with Arwon Finance Pty Ltd or MIS Funding No. 1 Pty Ltd Nil As incurred As incurred Notes: (iii) The Annual Management Fee and Rent incurred by a Grower are deductible in the year in which they are incurred under section 8-1. (iv) No deduction is available for the annual Management Fee and Rent in a year in which they have been deferred under the annual Deferred Investment Option. (v) (v) The Loan Application Fee and stamp duty payable to Arwon Finance Pty Ltd or MIS Funding No. 1 Pty Ltd are a borrowing expense and is deductible under section 25-25. The deduction is spread over the period of the loan or 5 years, which ever is the shorter. The deductibility or otherwise of borrowing costs arising from loan agreements entered into with financiers other than Arwon Finance Pty Ltd or MIS Funding No. 1 Pty Ltd is outside the scope of this Ruling.

Where a 'CGT event' (other than a 'CGT event' in respect of a thinning [4] - see paragraph 32 of this Ruling) happens to the interest held by a Grower who is an initial participant in this Project, the market value of the interest, or the decrease in the market value of the interest, is included in the Grower's assessable income (section 6-10 of the ITAA 1997 and section 82KZMGB of the ITAA 1936), less any GST payable on those proceeds (section 17-5 of the ITAA 1997).

The amount is included in the Grower's assessable income in the income year in which the 'CGT event' happens (subsection 82KZMGB(2) of the ITAA 1936).

'CGT events' for these purposes include those relating to: • a clear-fell harvest of all or part of the trees grown on the Grower's Woodlot(s); • the sale, or any other disposal of all or part of the 'interest' in the Project held by the Grower; or • any other 'CGT event' that results in a reduction of the market value of the 'interest' in the Project held by the Grower.

Where an amount arising from a 'CGT event' is included in the assessable income of a Grower by section 82KZMGB of the ITAA 1936 the anti-overlap provisions in section 118-20 of the ITAA 1997 will operate to exclude that amount from the capital gains provisions in Part 3-1 of the ITAA 1997.

An amount received by a Grower in respect of a thinning of the trees grown in this Project is not an amount received as a result of a 'CGT event' and is not otherwise assessable under section 82KZMGB of the ITAA 1936. The amount is a distribution of ordinary income that arises as an incident of the Grower holding an interest in the Project. Growers include amounts received for thinning the trees in their assessable income in the income year in which the amounts are derived (section 6-5 of the ITAA 1997) less any GST payable on those proceeds (section 17-5 of the ITAA 1997).

A Grower who is an individual accepted into the Project in the 2007-08 income year may have losses arising from their participation in the Project that would be deferred to a later income year under section 35-10. Subject to the Project being carried out in the manner described above, the Commissioner will exercise the discretion in paragraph 35-55(1)(b) for Growers for the 2007-08 to 2021-22 income years. This conditional exercise of the discretion will allow those losses to be offset against the Grower's other assessable income in the income year in which the losses arise.

For a Grower who commences participation in the Project and incurs expenditure as required by the Lease and Management Agreement, the following provisions of the ITAA 1936 have application as indicated: • section 82KL does not apply to deny the deductions otherwise allowable; and • the relevant provisions in Part IVA will not be applied to cancel a tax benefit obtained under a tax law dealt with in this Ruling.

The scheme that is the subject of this Ruling is specified below. This scheme incorporates the following: • Application for a Product Ruling as constituted by documents provided on 24 August 2007, 31 August 2007, 12 September 2007, 13 September 2007, 10 October 2007; 15 November 2007; 20 November 2007 and 5 December 2007; • Draft Product Disclosure Statement (PDS) for the 'TFS Sandalwood Project 2008 Growers' project issued by TFS Properties Ltd (Responsible Entity), received 14 August 2007; • Draft Lease and Management Agreement between TFS Properties Ltd (as Responsible Entity') and TFS Leasing Pty Ltd (the 'Lessor') and the Grower, received 14 August 2007; • Draft Constitution for the TFS Sandalwood Project, received 14 August 2007; • Draft Compliance Plan for the TFS Sandalwood Projects, received 28 November 2007; • Draft Independent Foresters report for the TFS Sandalwood Projects, received 14 August 2007; • Draft Finance Application Form for Arwon Finance Pty Ltd including Loan Agreement received 28 November 2007; • Additional correspondence received 13 February 2008; • Draft Supplementary Product Disclosure Statement of the TFS Sandalwood Project 2008, received 13 February 2008; • Draft Terms agreement for the TFS Sandalwood Projects received 28 November 2007; • Document titled 'Amendment and restatement deed' and Annexure A therein titled - 'Multi Option Facility Agreement' for the TFS Sandalwood Project received 22 August 2007; • Additional correspondence received 19 June 2008, 14, 29 and 30 July 2008 and 20 August 2008; and • Draft Second Supplementary Product Disclosure Statement for the TFS Sandalwood Project 2008 received 19 June 2008. Note: certain information has been provided on a commercial-in-confidence basis and will not be disclosed or released under Freedom of Information legislation.

All Australian Securities and Investment Commission (ASIC) requirements are, or will be, complied with for the term of the agreements.

The documents highlighted (in bold) are those that a Grower may enter into. For the purposes of describing the scheme to which this Ruling applies, there are no other agreements, whether formal or informal, and whether or not legally enforceable, which a Grower, or any associate of a Grower, will be a party to, which are a part of the scheme. The effect of these agreements is summarised in the following paragraphs.

The main features of the Project are as follows: Location Kununurra Western Australia Type of business to be carried on by each Grower Commercial growing and cultivation of Indian Sandalwood (Santalum album) trees for the purpose of harvesting and selling timber Term of the Project Up to 15 years Number of Woodlots offered for cultivation 4,740 Woodlots Size of each Woodlot 0.167 hectares Minimum allocation per Grower 1 Woodlot Minimum allocation per Joint Venture Growers 2 Woodlots Minimum subscription None Initial cost $12,650 for up to 5 lots and $12,100 for 6 lots or more Ongoing and other costs Annual Management Fee and Rent (if not deferred) and insurance premiums. Harvest and processing costs, Selling and Marketing Fee and Incentive Fee

The Project will be a registered managed investment scheme under the Corporations Act 2001. TFS Properties Ltd has been issued with an Australian Financial Service Licence 241192 and will be the Responsible Entity for the Project.

The Project involves establishing an Indian sandalwood plantation. Approximately 14 years after the Establishment Period the sandalwood will be Harvested, Processed and then sold.

The Project will be conducted on the Ivanhoe Plains area of the ORIA on farmland situated approximately 20 Kilometres north of Kununurra or on other suitable land.

An offer to participate in the Project will be made through a Product Disclosure Statement (PDS). The offer pertains to 4,740 Woodlots of 0.167 hectares each. The term of the Project is 15 years. There is no minimum subscription for the Project.

An entity that participates in the Project will do so by acquiring an interest in the project on or before 30 June 2008, which will consist of a minimum of one Woodlot. For Joint Venture Growers, the minimum allocation is two Woodlots.

Applicants execute a power of Attorney contained in the PDS. The Power of Attorney irrevocably appoints the Responsible Entity to execute, on behalf of the Grower, the Constitution, the Lease and Management Agreement and any other documents required to hold an interest in the Project.

The Woodlots will be planted at the rate of approximately 510 trees per hectare. Water for the project will be from Lake Argyle.

The Manager of the Project will provide the irrigation system in accordance with silvicultural standards suitable for sandalwood plantations.

Each Grower will use their Woodlot(s) for the purpose of carrying on a business of cultivating and harvesting sandalwood trees and selling the harvested timber.

This Ruling only applies in respect of '2008 Growers', that is, Growers who enter the Project from 16 January 2008, the date this Product Ruling is made, to 30 June 2008.

The Constitution establishes the Project, and sets out the terms and conditions under which TFS Properties Ltd agrees to act as Responsible Entity and manage the Project. Upon acceptance into the Project, Growers are bound by the Constitution by virtue of their participation in the Project.

In order to acquire an interest in the Project, the Grower must make an application for a Woodlot(s) pursuant to the PDS.

Under the terms of the Constitution, Application Moneys will be paid into an Application Fund and the proceeds of the sale of Forest Produce will be paid into a Proceeds Fund.

The Application Moneys will be released from the Application Fund and applied towards payment of the fees payable under the Lease and Management Agreement when the Responsible Entity is reasonably satisfied that the criteria specified in clause 14 of the Constitution have been met.

As required by the Corporations Act 2001, the Responsible Entity has prepared a Compliance Plan. The purpose of the Compliance Plan is to ensure that the Responsible Entity manages the Project in accordance with its obligations and responsibilities contained in the Constitution and that the interests of Growers are protected.

The owner of the Project land is the Responsible Entity and will enter into a Head Lease with the TFS Leasing Pty Ltd, in respect of this land.

TFS Leasing Pty Ltd will sub-lease the project land to the Growers in the project, for the commercial silviculture of Indian Sandalwood Trees.

Growers participating in the scheme will enter into a Lease and Management Agreement with TFS Leasing Pty Ltd as the Lessor and TFS Properties Ltd as the Responsible Entity. Growers are granted an interest in the land in the form of a Lease for a period of 15 years to use their Woodlots for the purposes of conducting their afforestation business until the final distribution of sale proceeds is made to the Grower or until the Project is terminated. Growers are specifically granted rights to harvest timber on their Woodlots for this purpose. The Lease is granted upon the terms and conditions outlined in the Lease and Management Agreement.

Under the Lease and Management Agreement each Grower appoints the Responsible Entity to perform the Services and the Responsible Entity accepts the appointment. The Responsible Entity will supervise and manage all silvicultural activity on behalf of the Grower in accordance with good silvicultural practice. Item 7 of the Schedule to the Lease and Management Agreement specifies the Initial Services and On-going Services to be performed by the Responsible Entity.

The Initial Services include: • ploughing, ripping and other soil preparation works for each Woodlot; • procurement of seedlings; • tending to seedlings prior to planting; • planting the Sandalwood seedlings on the Leased Area at a rate equivalent to 510 trees per Woodlot not later than 12 months after Allotment; • applying fertilisers, herbicides and pesticides; and • reduction and eradication of disease, vermin and other pests.

The Ongoing Services include: • cultivating, tending, pruning, fertilising, replanting, spraying and otherwise caring for the Trees as and when required; • maintaining and keeping in good repair access laneways within the Leased Area; • maintaining the Leased Area according to good silvicultural and forestry practices; • replacing any Trees that fail to establish or that die during the first twelve months of the Project; • harvesting Trees grown on the Leased Area in Years 13 and 14 and processing the timber in accordance with clause 17 of the Lease and Management Agreement; and • carrying out any other obligation to be performed by the Responsible Entity pursuant to the terms of any agreement entered into by the Responsible Entity for the sale of the Forest Produce.

The Responsible Entity will maintain a public risk insurance policy in respect of the Plantation and arrange for insurance of the Leased Area, including the Trees and Forest Produce, on behalf of all Growers (clause 22 of the Lease and Management Agreement). This insurance is compulsory. The insurance premium will be divided proportionally over all Woodlot interests in the Project and invoiced annually to the Growers.

In Year 14 the trees will be harvested and processed. The Responsible Entity will Harvest and Process, or engage a suitably qualified person to Harvest and Process the percentage of trees as set out in the Lease and Management Agreement, unless the Responsible Entity believes that it would be in the best interests of the Growers to defer the Harvests to a later date.

The Responsible Entity is appointed to market and sell the Forest Produce on behalf of the Growers who do not make an election under clause 16 of the Lease and Management Agreement (defined for the purposes of this Ruling as 'Non-Electing Growers') on such terms and conditions as the Responsible Entity considers appropriate.

The Lease and Management Agreement sets out provisions relating to the pooling of Growers' Timber and the distribution of proceeds from the sale of the Timber (clause 18 of the Lease and Management Agreement). This Product Ruling only applies where the following principles apply to those pooling and distribution arrangements: • only Growers who have contributed Timber to the pool making up the proceeds are entitled to benefit from distributions of harvest proceeds from the pool; and • Timber can only be pooled with the Timber of Growers who are of the same Project class.

The Responsible Entity must ensure that the Gross Sale Proceeds are deposited into the Proceeds Fund (clause 18 of the Lease and Management Agreement). From the Proceeds Fund the Responsible Entity will pay: • the Grower's proportional share of Harvesting and Processing Costs; • the Incentive Fee equal to 30% of the amount (if any) by which the actual Net Proceeds of Sale exceed the Target Net Proceeds of Sale; • any Annual Contribution then due and payable by the relevant Grower; • any other amounts owed to the Responsible Entity or the Lessor by the relevant Grower; and • 5.5% of the Gross Sale Proceeds for Selling and Marketing Fees

The remaining balance is to be paid to the Grower in accordance with each Grower's Proportional Share.

In the event that the Trees on the Grower's Woodlot(s) are destroyed (either fully or partially), the Grower's Proportional Share in the Project and in the sale proceeds will be reduced in accordance with clause 21 of the Lease and Management Agreement.

The Application Price payable to the Responsible Entity on application is $12,650 per 1-5 Woodlots and $12,100 per lot for 6 lots or more.

The amount of the Annual Management Fee is $1,100 per lot and the rent is $220 per lot. The amounts are payable on or before 14 January in each financial year, following the financial year in which the Establishment Period ends (Clause 19.2 of the Lease and Management Agreement).

The Annual Management Fee and rent will be indexed in each financial year, following the financial year in which the establishment period ends (clause 9B pf the Schedule of the Lease and Management Agreement).

The Annual Management Fee and Rent are payable until Harvesting is carried out under the Harvest Plan (item 9B of the Schedule of the Lease and Management Agreement).

Where a Grower's Annual Management Fee and Rent are deferred, a percentage of the gross Proceeds of Sale, is payable to the Responsible Entity as follows: Year 1-6 4% plus GST Year 7-10 3% plus GST Year 11-12 2% plus GST If all, or substantially all of the trees on the Grower's Woodlots are destroyed before the Harvest can take place, the grower will be liable to pay an amount equal to 55% of the Annual Management Fees and Rent for all years prior to the destruction (clause 22.6 of the Lease and Management Agreement).

The Project will also allow two Growers to enter into a Joint Venture. They will be bound by the Joint Venture terms set out in the Joint Venture Agreement attached to the PDS. The Joint Venture option is only available for those Growers who enter the Annual Investment Option and do not defer any of the Annual Management Fees and Rent.

Under this Joint Venture: • the first Joint Venture Grower will be responsible for procuring the preparation and establishment of the Woodlot by payment of the Establishment Fee; • the second Joint Venture Grower will be responsible for procuring the ongoing provision of land and maintenance of the Woodlot by payment of the Annual Management Fees and Rent; and • each Joint Venture Grower will be responsible for the fees payable out of the Project proceeds (clause 4 of the Joint Venture Agreement contained in the PDS).

The Joint Venture terms provide that each Joint Venture Grower will be entitled to 50% each of the Joint Venture Property (a minimum allocation of 2 lots) and, in particular, all saleable timber from the Woodlots.

Growers who do not pay the Establishment Fee in full upon Application can pay the amount by the Instalment Option, borrow from Arwon Finance Pty Ltd (an entity associated with the project) or the preferred financier MIS Funding No. 1 Pty Ltd or borrow from an independent lender external to the project.

Only the finance arrangements set out below are covered by this Product Ruling. A Grower cannot rely on this Product Ruling if they enter into a finance arrangement with Arwon Finance Pty Ltd or MIS Funding No. 1 Pty Ltd that materially differs from that set out in the documentation provided to the Tax Office with the application for this Product Ruling. A Grower who enters into a finance arrangement with an independent lender external to the Project may request a private ruling on the deductibility or otherwise of interest incurred under finance arrangements not covered by this Product Ruling.

Growers cannot rely on any part of this Ruling if the Application Price is not paid in full on or before 30 June 2008, by the Grower or, on the Grower's behalf, by a lending institution. Where an application is accepted subject to finance approval by any lending institution other than Arwon Finance Pty Ltd or MIS Funding No. 1 Pty Ltd, Growers cannot rely on this Ruling if written evidence of that approval has not been given to the Responsible Entity by the lending institution and the funds have not been made available to the Responsible Entity by 30 June 2008.

Where the Responsible Entity accepts an application from a Grower to pay the Establishment Fee under the instalment Option, a deposit of 20% is payable on Application. The balance is payable in equal monthly instalments and must be paid within twelve months from the Application being accepted.

On entering the Instalment Option, the grower will be bound by the terms and conditions of the Terms Agreement. Where complete payment is not made to the Responsible Entity within the 12 month period the Grower will be in default of the Term payments and his agreement will be reviewed in accordance with the Terms Agreement.

A Grower choosing to pay the Application Price by entering into a finance arrangement with Arwon Finance Pty Ltd or MIS Funding No. 1 Pty Ltd must complete the Finance Application Form in the relevant Finance Package.

The Grower will be bound by the terms and conditions of the Terms Agreement.

Arwon Finance Pty Ltd or MIS Funding No. 1 Pty Ltd will offer loans on a full-recourse commercial basis only to the extent it has funds available to lend to Growers.

Arwon Finance Pty Ltd or MIS Funding No. 1 Pty Ltd will only provide loans to Growers where it has sufficient funds to do so.

The finance available is under the following arrangement: Arwon Pty Ltd • The interest rate is the 'bill Rate' at the time of application PLUS up to 6%; • a deposit of 10% is required; • regular monthly repayments of principal and interest commencing one month after the Date of Advance of the Principal Sum and with the final payment of all outstanding amounts due at the end of the term of the loan; • a loan Term of 10 years for the Establishment Fee from the Date of Advance of the Principal Sum; and • the loan is secured by a mortgage over the Grower's Woodlot(s) and Project interest. MIS Funding No. 1 Pty Ltd • The interest rate is the Australian Financial Markets Association Base Rate at the first Date of Advance plus a margin of between 2.25% and 4.75% PLUS up to 2%; • regular monthly repayments of principal and interest or interest only up to the first three years commencing one month after the Date of Advance of the Principal Sum and with the final payment of all outstanding amounts due at the end of the term of the loan; and • a loan term of 10 years for the Establishment Fee from the Date of Advance of the Principal Sum.

This Ruling does not apply where: • there are split loan feature of a type referred to in Taxation Ruling TR 98/22; • there are indemnity arrangements or other collateral agreements in relation to the loan designed to limit the borrower's risk; • 'additional benefits' are or will be granted to the borrowers for the purpose of 82KL of the ITAA 1936 or the funding arrangements transform the Project into a 'scheme' to which Part IVA of the ITAA 1936 may apply; • the loan or rate of interest is non-arm's length; • repayments of the principal and payments of interest are linked to the derivation of income from the Project; • the funds borrowed, or any part of them, will not be available for the conduct of the Project; • lenders do not have the capacity under the loan agreement, or an intention, to take legal action against defaulting borrowers; • entities associated with the Project, other than Arwon Finance Pty Ltd or MIS Funding No. 1 Pty Ltd, are involved or become involved in the provision of finance to Growers for the Project; • MIS Funding No. 1 Pty Ltd lends money to Arwon Finance Pty Ltd which is then on lent to the Growers; • the Growers enter into any interest only finance arrangements with any party; and • more than 15% of the Grower's will obtain finance with any internal financier including Arwon Finance Pty Ltd.

For the amounts set out in paragraph 27 of this Ruling to constitute allowable deductions the Grower's afforestation activities as a participant in the Project must amount to the carrying on of a business of primary production.

Two Taxation Rulings are relevant in determining whether a Grower will be carrying on a business of primary production.

The general indicators used by the Courts are set out in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production?

Taxation Ruling TR 2000/8 Income tax: investment schemes, particularly paragraph 89, is more specific to arrangements such as the Project. As TR 2000/8 sets out, the relevant principles have been established in court decisions such as Commissioner of Taxation v. Lau (1984) 6 FCR 202; 84 ATC 4929; (1984) 16 ATR 55.

Having applied these principles to the arrangement set out above, a Grower in the Project is accepted to be carrying on a business of growing and harvesting sandalwood for sale.

The fee for land preparation and tree planting, Management Fees and Rent are deductible under section 8-1 (see paragraphs 43 and 44 of TR 2000/8). A 'non-income producing' purpose (see paragraphs 47 and 48 of TR 2000/8) is not identifiable in the arrangement and there is no capital component evident in the fee for land preparation and tree planting, Management Fees or Rent (see paragraphs 49 to 51 of TR 2000/8).

The tests of deductibility under the first limb of section 8-1 are met. The exclusions do not apply. Subject to the prepayment provisions (see paragraphs 95 to 105 of this Ruling) a deduction for these amounts can be claimed in the year in which they are incurred (Note: the meaning of incurred is explained in Taxation Ruling TR 97/7).

Some Growers may finance their participation in the Project through a Loan Agreement with Arwon Finance Pty Ltd or MIS Funding No. 1 Pty Ltd. Applying the same principles as that used for the above mentioned fees and expenses, interest incurred under such a loan has sufficient connection with the gaining of assessable income to be deductible under section 8-1.

Other than where the prepayment provisions apply (see paragraphs 95 to 105 of this Ruling), a Grower can claim a deduction for such interest in the year in which it is incurred.

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 income year, then it is not expenditure to which the prepayment rules apply.

For this Project, the prepayment provisions that are relevant are section 82KZL of the ITAA 1936 (an interpretive provision) and sections 82KZME, 82KZMF and 82KZMG of the ITAA 1936 (operative provisions).

The expenditure incurred by a Grower in the Project for the Management Fees and Rent for the 2008-09 income year onwards, meets the requirements of subsections 82KZME(1) and (2) of the ITAA 1936 and is incurred under an 'agreement' as described in subsection 82KZME(3). Therefore, unless one of the exceptions to section 82KZME applies, the amount and timing of tax deductions for those fees are determined under section 82KZMF of the ITAA 1936.

Growers may incur prepaid Management Fees or Rent exceeding $1,000. Those Growers will need to calculate the deduction for each year using the formula in subsection 82KZMF(1) of the ITAA 1936. Section 82KZMF will apportion the deduction for prepaid fees over the eligible service period which commences on 1 July of the year following the year of payment and ends on 30 June of that year.

Sections 82KZME and 82KZMF of the ITAA 1936 may also have relevance if a Grower in this Project chooses or is required to prepay interest under a loan agreement (including loan agreements with lenders other than Arwon Finance Pty Ltd).

Expenditure that meets the requirements of section 82KZMG of the ITAA 1936 is excluded from the application of the prepayment rules in sections 82KZME and 82KZMF of the ITAA 1936 that would otherwise apply.

Section 82KZMG of the ITAA 1936 provides a '12 month rule' that, in effect, facilitates an immediate deduction for certain prepaid expenditure [5] incurred under an 'agreement for planting and tending trees for felling' (subsection 82KZMG(3)).

The 12 month rule applies to expenditure for 'seasonally dependent agronomic activities' that will be carried out during the establishment period of a particular planting of trees (subsection 82KZMG(4) of the ITAA 1936). Seasonally dependent agronomic activities are explained in Taxation Determination TD 2003/12.

Whilst the establishment period itself may exceed 12 months, each seasonally dependent agronomic activity must be completed within 12 months of commencement of its eligible service period (as defined in subsection 82KZL(1) of the ITAA 1936), and by the end of the income year following the 'expenditure year' (see subsections 82KZMG(1) and (2) of the ITAA 1936).

Under the Lease and Management Agreement each Grower incurs a fee for land preparation and tree planting of between $12,100 and $12,650 per Woodlot in the 2007-08 income year for 'seasonally dependent agronomic activities' that will be carried out during the 'establishment period' of the Trees.

The expenditure for 'seasonally dependent agronomic activities' meets all other requirements of section 82KZMG of the ITAA 1936 and, therefore, other than where section 82KZMGA of the ITAA 1936 applies (see paragraphs 106 to 108 of this Ruling), a deduction is allowable in the 2007-08 income year for the full amount of expenditure incurred by the Grower for the fee for land preparation and tree planting.

A Grower who is an initial participant in the Project cannot deduct an amount that meets the requirements of section 82KZMG of the ITAA 1936 if a 'CGT event' happens in relation to the Grower's interest within 4 years of 30 June 2008 (subsection 82KZMGA(1) of the ITAA 1936). In this Project, only the fee for land preparation and tree planting meets the requirements of section 82KZMG. Accordingly, the deduction of $12,100-$12,650 per 'interest' for the fee for land preparation and tree planting will not be allowable if a 'CGT event' happens to the Grower's interest within the 4 year period.

Where subsection 82KZMGA(1) of the ITAA 1936 applies, the Commissioner may amend any affected Grower's assessment within 2 years after the end of the income year in which the 'CGT event' happens. The Commissioner's power to amend in these circumstances applies despite section 170 of the ITAA 1936 (subsection 82KZMGA(2) of the ITAA 1936).

A Grower whose deduction for the fee for land preparation and tree planting is disallowed because of section 82KZMGA of the ITAA 1936, is still required to include in their assessable income the market value of the interest at the time of the 'CGT event' or the decrease in the market value of the interest as a result of the 'CGT event' (section 82KZMGB of the ITAA 1936).

Section 6-10 of the ITAA 1997 includes in assessable income amounts that do not constitute ordinary income. These amounts, called statutory income, are listed in the table in section 10-5 of the ITAA 1997 and include amounts that are included in the assessable income of a Grower by section 82KZMGB of the ITAA 1936.

Where a 'CGT event' (other than for a 'CGT event' in respect of a thinning [6] ) happens to an interest held by a Grower who is an initial participant in this Project, section 82KZMGB of the ITAA 1936 includes an amount in the assessable income of the Grower if: • the Grower can deduct or has deducted the fee for land preparation and tree planting; and • subsection 82KZMG(1) of the ITAA 1936 applies to the timing of the deduction of the fee for land preparation and tree planting (or would apply if section 82KZMGA of the ITAA 1936 were disregarded - see above).

If, as a result of the 'CGT event' the Grower either: • no longer holds the interest; or • otherwise - where the Grower continues to hold the 'forestry interest' but there is a decrease in the market value of the interest, then the market value of the interest at the time of the event, or the decrease in market value of the interest as a result of the event, is included in the assessable income of the Grower (subsection 82KZMGB(2) of the ITAA 1936). A market value rule applies rather than the amount of money actually received from the CGT event (subsection 82KZMGB(3) of the ITAA 1936). However, the market value and the actual amount of money received may be the same.

The market value amount included in the assessable income of a Grower is the value of the interest just before the 'CGT event', or where the Grower continues to hold their interest after the 'CGT event', the amount by which the market value of the interest is reduced by the 'CGT event' (subsection 82KZMGB(2) of the ITAA 1936).

This provision will apply where the interest is sold, is extinguished, or ceases, and will include 'CGT events' such as a full or partial sale of the interest or from a full or partial clear-fell harvest of the trees grown under the Project.

Generally, where as a result of a 'CGT event' a capital gain would otherwise be included in a taxpayer's assessable income, section 118-20 will apply to reduce the capital gain if, because of the event, a provision of the ITAA other than the CGT provisions includes an amount in the taxpayer's assessable income.

In the case of interests held by Growers who are initial participants in this Project, the market value, or the reduction in the market value of the interest from a CGT event is included in assessable income by section 6-10 of the ITAA 1997 and section 82KZMGB of the ITAA 1936. Therefore, section 118-20 of the ITAA 1997 will operate to reduce to nil any capital gain that would otherwise be assessable under the CGT provisions in Part 3-1 of the ITAA 1997.

Section 82KZMGB of the ITAA 1936 specifically excludes from its operation a 'CGT event' that happens in respect of a thinning (see paragraph 82KZMGB(1)(d) of the ITAA 1936).

Thinning amounts received by a Grower who is an initial participant in this Project do not arise as a result of a 'CGT event' and are not otherwise assessable under section 82KZMGB of the ITAA 1936. The receipt of an amount arising from a thinning of the Project trees is a distribution that arises as an incident of the Grower holding an interest in the Project. It is an item of ordinary income and is assessable under section 6-5 of the ITAA 1997 in the year in which it is derived.

A deduction is allowable for expenditure incurred by a Grower in borrowing money to the extent that the borrowed money is used for the purpose of producing assessable income (subsection 25-25(1)).

In this Project, the Loan Establishment Fee payable to Arwon Finance Pty Ltd or MIS Funding No. 1 Pty Ltd is incurred to borrow money that is used or is to be used solely for income producing purposes during each income year over the term of the loan.

The deduction for the borrowing expense is spread over the period of the loan or 5 years, whichever is the shorter (subsection 25-25(4)).

In deciding to exercise the discretion in paragraph 35-55(1)(b) on a conditional basis for the 2007-08 to 2021-22 income years, the Commissioner has applied the principles set out in Taxation Ruling TR 2007/6 Income tax: non commercial business losses: Commissioner's discretion. Based on the evidence supplied, the Commissioner has determined that for those income years: • it is because of its nature the business activity of a Grower will not satisfy one of the four tests in Division 35; and • there is an objective expectation that within a period that is commercially viable for the afforestation industry, a Grower's business activity will satisfy one of the four tests set out in Division 35 or produce a taxation profit.

A Grower who would otherwise be required to defer a loss arising from their participation in the Project under subsection 35-10(2) until a later income year is able to offset that loss against their other assessable income.

The exercise of the Commissioner's discretion under paragraph 35-55(1)(b) is conditional on the Project being carried on in the manner described in this Ruling during the income years specified. If the Project is carried out in a materially different way to that described in the Ruling a Grower will need to apply for a private ruling on the application of section 35-55 to those changed circumstances.

The operation of section 82KL of the ITAA 1936 depends, among other things, on the identification of a certain quantum of 'additional benefits(s)'. 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.

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

The Project will be a 'scheme'. A Grower will obtain a 'tax benefit' from entering into the scheme, in the form of tax deductions for the amounts detailed at paragraph 27 of this Ruling that would not have been obtained but for the scheme. However, it is not possible to conclude that the scheme will be entered into or carried out with the dominant purpose of obtaining this tax benefit.

Growers to whom this Ruling applies intend to stay in the scheme for its full term and derive assessable income from the harvesting and sale of the Trees. There are no facts that would suggest that Growers have the opportunity of obtaining a tax advantage other than the tax advantages identified in this Ruling. There is no non-recourse financing or round robin characteristics, 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 participants will enter into the scheme for the dominant purpose of obtaining a tax benefit.

The following is a detailed contents list for this Ruling: Paragraph What this Ruling is about 1 Class of entities 2 Superannuation Industry (Supervision) Act 1993 6 Qualifications 7 Date of effect 10 Changes in the law 15 Note to promoters and advisers 17 Goods and Services Tax 18 Ruling 19 Application of this Ruling 19 Concessions for 'small business entities' 21 Deduction for the fee for land preparation and tree planting 23 Section 8-1 and Division 27 of the ITAA 1997 and section 82KZMG of the Income Tax Assessment Act 1936 23 'CGT event' within 4 years for Growers who are 'initial participants' 24 Section 82KZMGA 24 Deductions for Management Fees, Rent, loan interest and borrowing costs 27 Section 8-1, section 25-25 and Division 27 of the ITAA 1997 and sections 82KZME and 82KZMF of the ITAA 1936 27 Assessable income from 'CGT events' for Growers who are initial participants 28 Sections 6-10, 17-5 and 118-20 of the ITAA 1997 and section 82KXMGB of the ITAA 1936 28 Amounts received by Growers where the Project trees are thinned 32 Sections 6-5 and 17-5 32 Division 35 - deferral of losses from non-commercial business activities 33 Section 35-55 - exercise of Commissioner's discretion 33 Anti-avoidance provisions 34 Section 82KL and Part IVA 34 Scheme 35 Constitution 49 Compliance Plan 53 Head Lease 54 Lease and Management Agreement 56 Pooling of Timber and Grower's Entitlement to Net Proceeds 61 Fees 67 Establishment fee 67 Annual Management Fee and Rent 68 Joint Venture 72 Finance 75 Instalment option 78 Finance offered by Arwon Finance Pty Ltd 80 Appendix 1 - Explanation 86 Is the Grower carrying on a business? 86 Deductibility of the fee for land preparation and tree planting, Management Fees, Rent and loan interest 91 Section 8-1 91 Prepayment provisions 95 Sections 82KZL to 82KZMG 95 Application of the prepayment provisions to this Project 97 Sections 82KZME and 82KZMF 97 Section 82KZMG 100 'CGT event' within 4 years for Growers who are initial participants 106 Section 82KZMGA 106 Assessable income from 'CGT events' for Growers who are initial participants 109 Sections 6-10, 10-5 and 118-20 of the ITAA 1997 and section 82KZMGB of the ITAA 1936 109 Section 82KZMGB 110 Market value rule applies to 'CGT events' 111 Anti-overlap provisions 114 Section 118-20 114 Amounts received by initial participants where the Project trees are thinned 116 Section 6-5 116 Borrowing costs 118 Section 25-25 118 Sections 35-10 and 35-55 - deferral of losses from non-commercial business activities and the Commissioner's discretion 121 Section 82KL - recouped expenditure 124 Part IVA - general tax avoidance provisions 125 Appendix 2 - Detailed contents list 128