Income tax: TFS Sandalwood Project 2010

This Product Ruling sets out the Commissioner's opinion on the way in which the relevant provisions identified in the Ruling section (below) apply to the defined class of entities, who take part in the scheme to which this Product Ruling relates. In this Product Ruling this scheme is referred to as the 'TFS Sandalwood Project 2010', or simply as 'the Project'.

All legislative references in this Product Ruling are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated. Where used in this Product Ruling, the word 'associate' has the meaning given in section 318 of the Income Tax Assessment Act 1936 (ITAA 1936). In this Product Ruling, terms defined in the Project agreements have been capitalised.

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 in this Product Ruling as Growers.

Growers are those entities that: • meet the definition of 'initial participant' in subsection 394-15(5); and • are accepted to take part in the scheme specified below on or after the date this Product Ruling is made and on or before 30 June 2010.

A Grower will have executed the relevant Project Agreements set out in paragraph 51 of this Ruling on or before 30 June 2010 and will hold a 'forestry interest' in the Project.

The class of entities who can rely on this Product Ruling does not include: • entities who are accepted into this Project before the date of this Product Ruling or after 30 June 2010; • entities who participate in the scheme through offers made other than through the Product Disclosure Statement or who enter into an undisclosed arrangement with: - the promoter or a promoter associate; or - an independent adviser, that is interdependent with scheme obligations and/or scheme benefits (which may include tax benefits or harvest returns) in any way; • entities whose Establishment Fees, including all loan money, are not paid in full to TFS Properties Ltd by 30 June 2010; • entities who enter into finance arrangements with Arwon Finance Pty Ltd (Arwon), other than as specified in paragraphs 93 to 101 of this Ruling; or • entities who elect to collect and market their own produce.

This Product Ruling does not address the provisions of the Superannuation Industry (Supervision) Act 1993 (SISA). The Australian Taxation Office (ATO) 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.

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 51 to 102 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 24 March 2010, the date this Product Ruling is made. It therefore applies only to the specified class of entities that enter into the scheme from 24 March 2010 to 30 June 2010 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 all income years up to the income year in which the scheme is terminated in accordance with the Constitution.

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.

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 ATO suggests that promoters and advisers ensure that investors 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 Product Ruling as a Grower) to be entitled to claim input tax credits for the GST included in any creditable acquisition that it makes, it must be registered or required to be registered for GST and hold a valid tax invoice.

The Project is a 'forestry managed investment scheme' as defined in subsection 394-15(1). Its purpose is the establishment and tending of Sandalwood Trees for felling in Australia.

Subject to the stated qualifications, this part of the Product Ruling sets out in detail the taxation obligations and benefits for an 'initial participant' [1] in the defined class of entities (see paragraphs 4 to 7 of this Ruling) who is accepted to participate in the 'forestry managed investment scheme' described at paragraphs 51 to 102 of this Ruling on or after 24 March 2010 and on or before 30 June 2010.

An entity that takes part in the Project as a 'subsequent participant' [2] is not covered by this Product Ruling but may request a private ruling on their participation in the Project. A 'subsequent participant' is an entity that does not meet the definition of 'initial participant' in subsection 394-15(5).

Although not relevant for the purposes of Division 394, a Grower (as described in paragraphs 4 to 7 of this Ruling) who will stay in the Project until it is completed will be considered to be carrying on a business of primary production. Such Growers who are individuals will be subject to the operation of Division 35 (see paragraphs 46 to 49 and 142 to 148 of this Ruling).

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 Product Ruling.

The taxation obligations and benefits set out below have been determined using the information provided to the Commissioner by the Responsible Entity (referred to as the 'forestry manager' in Division 394). On the basis of that information, the Commissioner has decided that on 30 June 2010 it will be reasonable to expect that the '70% DFE rule' [4] will be satisfied. The ATO may undertake review activities during the term of the Project to verify the information relied on for the purposes of the '70% DFE rule'.

The Product Ruling will only apply if the Responsible Entity establishes all of the Trees that were intended to be established under the Project within 18 months of the end of the income year in which the first 'participant' in the Project is accepted. [5] For this Project the Trees must be established before 31 December 2011.

In the context of this Project the Trees will be established when they are planted on the land acquired for the purposes of the Project at the average rate of 420 Trees per hectare. The Responsible Entity is required by section 394-10 of Schedule 1 of the Taxation Administration Act 1953 (TAA) to notify the ATO if the Trees are not established by 31 December 2011.

A Grower in the Project can claim deductions, on a per Sandalwood Lot basis, for the amounts shown in the Table below that are paid to the Responsible Entity (sections 8-5 and 394-10). Fee Amount Income year(s) deductible (see Note) Establishment Fee $12,925 for up to 5 Sandalwood Lots; $12,375 for 6 or more Sandalwood Lots 2010 income year Annual Fees payable under the Annual Investment Option $1,045 per annum (increased by 3% annually from the 2011-12 income year onwards) The income year in which the Annual Fee is paid Annual Rent payable under the Annual Investment Option $275 per annum (increased by 3% annually from the 2011-12 income year onwards) The income year in which the Annual Rent is paid Amounts payable under the Annual Deferred Investment Option for the 2010-11 to 2011-12 income years 3.3% of the Gross Proceeds of Sale for each income year where Annual Fees and Annual Rent are deferred The income year in which the Grower is entitled to proceeds and the Deferred Fee is paid from those proceeds Amounts payable under the Annual Deferred Investment Option for the 2012-13 to 2015-16 income years 2.2% of the Gross Proceeds of Sale for each income year where Annual Fees and Annual Rent are deferred The income year in which the Grower is entitled to proceeds and the Deferred Fee is paid from those proceeds Amounts payable under the Annual Deferred Investment Option for 2016-17 to 2022-23 income years 1.1% of the Gross Proceeds of Sale for each income year where Annual Fees and Annual Rent are deferred The income year in which the Grower is entitled to proceeds and the Deferred Fee is paid from those proceeds Costs of Harvest and Processing Actual costs The income year in which the Grower is entitled to proceeds and the Costs of Harvest and Processing is paid from those proceeds Selling and Marketing Fees 5.5% of the Gross Proceeds of Sale The income year in which the Grower is entitled to proceeds and the Selling and Marketing Fees are paid from those proceeds Incentive Fee 33% of the amount by which the Net Proceeds of Sale exceed the Target Net Proceeds of Sale The income year in which the Grower is entitled to proceeds and the Incentive Fees are paid from those proceeds Note: the Responsible Entity will inform Growers of the income year in which fees set out in the Table above have been paid from proceeds and Growers are therefore entitled to claim deductions.

The deductibility of these amounts remains subject to a requirement that a CGT event [6] does not happen in relation to the Grower's 'forestry interest' before 1 July 2014.

Each amount is deductible in the income year in which it is paid, or is paid on behalf of the Grower (subsection 394-10(2) and section 394-20). This requires cash to flow from the Grower, or from another entity on the Grower's behalf, to TFS Properties Ltd bank account in the year in which the deduction is claimed. Any form of payment that does not involve the movement of cash into TFS Properties Ltd bank account will not qualify for a deduction under subsection 394-10(2).

Where a Grower does not fully pay an amount, or it is not fully paid on their behalf in an income year, it is deductible only to the extent to which it has been paid. Any unpaid amount is then deductible in the year or years in which it is actually paid.

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.

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

Deductions for the Establishment Fee, Annual Fees and Rent are not allowable where a 'CGT event' happens in relation to the 'forestry interest' of a Grower before 1 July 2014 (subsection 394-10(5)).

Where deductions for these amounts have already been claimed by a Grower, the Commissioner may amend their assessment at any time within two years of the 'CGT event' happening (subsection 394-10(6)). The Commissioner's power to amend in these circumstances applies despite section 170 of the ITAA 1936.

Growers whose deductions are disallowed because of subsection 394-10(5) are still required to include in assessable income the market value of the 'forestry interest' at the time of the 'CGT event' or the decrease in the market value of the 'forestry interest' as a result of the 'CGT event'.

A Grower in the Project can claim deductions for interest incurred on a loan to fund their investment in the Project (subsection 8-1(1)) in the income year in which the interest is incurred. This Product Ruling only applies to loans between a Grower and Arwon as described in paragraphs 93 to 101 of this Ruling. Growers who borrow from other financiers may apply for a private ruling on the deductibility of loan interest or may self assess the deductibility of the interest.

Any amounts incurred by a Grower to insure their Trees will be deductible under section 8-1. Deductions for insurance premiums are allowable in the year in which the insurance costs are incurred. The Responsible Entity will advise the Grower each year of the cost of the insurance premiums.

This Product Ruling only applies if the insurance provided is on the same terms as described in the Forestry Insurance Policy provided with the application for a Product Ruling.

The loan Application Fee of $300 plus 0.5% of the Principal Sum payable to Arwon and stamp duty for the loan are borrowing expenses and are deductible under section 25-25.

The deduction for the borrowing expense is spread over the period of the loan or 5 years whichever is shorter on a straight line basis from the date the loan begins.

The deductibility or otherwise of borrowing costs arising from loan agreements entered into with financiers other than Arwon is outside the scope of this Product Ruling.

Where a 'CGT event' happens to a 'forestry interest' held by a Grower in this Project the market value of the 'forestry interest', or the decrease in the market value of the 'forestry interest', is included in the assessable income of the Grower (sections 6-10 and 394-25), less any GST payable on those proceeds (section 17-5).

The relevant amount is included in the Grower's assessable income in the income year in which the 'CGT event' happens (subsection 394-25(2)).

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

An amount received by a Grower as insurance proceeds is a distribution of ordinary income that arises as a result of a Grower holding a 'forestry interest' in the Project. Growers include their share of any insurance proceeds in their assessable income in the income year in which the amounts are derived (section 6-5) less any GST payable on those proceeds (section 17-5).

For each of the income years from 2009-10 to 2023-24, the Commissioner will exercise the discretion in subsection 35-55(1) once the following conditions are satisfied for the year concerned: • the Grower 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 Product Ruling; and • the Grower 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 a Grower in the Project who satisfies the income requirement in subsection 35-10(2E); and; • paragraph 35-55(1)(c) for a Grower 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 Grower will be informed of that decision and the reasons. In any year where the discretion is not exercised, losses incurred by a Grower will be subject to the loss deferral rule in section 35-10 and the Grower will not be able to offset the losses from the Project against other assessable income.

The issue of this Product Ruling of itself does not constitute the exercise of the Commissioner's discretion in subsection 35-55(1) for any income year.

Where a Grower is accepted to participate in the Project set out at paragraphs 51 to 102 of this Ruling, the following provisions of the ITAA 1936 have application as indicated: • interest paid by a Grower to Arwon and insurance costs do not fall within the scope of sections 82KZM, 82KZME and 82KZMF; • 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 Product Ruling.

The scheme that is the subject of this Product Ruling is specified below. This scheme incorporates the following: • Application for a Product Ruling as constituted by documents provided on 2 December 2009, 9 December 2009, 7 January 2010, 29 January 2010 and 4 February 2010; • Draft Product Disclosure Statement (PDS) for the TFS Sandalwood Project 2010 issued by TFS Properties Ltd (Responsible Entity), received 2 December 2009; • Draft Constitution for the TFS Sandalwood Project 2010, received 2 December 2009; • Draft Lease and Management Agreement between the Responsible Entity, TFS Leasing Pty Ltd (Lessor) and the Grower, received 2 December 2009; • Draft Agreement for Sub-Lease between the Responsible Entity, TFS Leasing Pty Ltd and the Grower, received 29 January 2010; • Draft Compliance Plan for the TFS Sandalwood Project 2010, received 2 December 2009; • Draft Plantation Management Agreement between the Responsible Entity and Tropical Forestry Services Ltd, received 2 December 2009; • Draft Head Lease between the Responsible Entity, TFS Leasing Pty Ltd and the Security Holder, received 29 January 2010; • Draft Loan Agreement between Arwon Finance Pty Ltd and the Borrower, received 2 December 2009; and • Draft Forestry Insurance Policy , received 4 February 2010. Note: certain information has been provided on a commercial-in-confidence basis and will not be disclosed or released under Freedom of Information legislation. 52. All Australian Securities and Investment Commission (ASIC) requirements are, or will be, complied with for the term of the agreements.

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

The documents highlighted are those that a Grower may enter into. For the purposes of describing the scheme to which this Product 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 as follows.

The main features of the Project are as follows: Location Land surrounding Kununurra, Western Australia, including Kingston Rest Species of Trees to be planted under the scheme Indian Sandalwood ( Santalum album) Term of the Project Approximately 15 years Date all Trees are due to be planted on scheme land 31 December 2011 Number of Trees per hectare Targeted survival rate of approximately 420 Trees per hectare Number of hectares offered for cultivation Up to 900 hectares Size of each 'forestry interest' (Sandalwood Lot) 0.167 hectares Minimum allocation of 'forestry interests' per Grower One forestry interest Minimum subscription Nil Initial cost $12,925 per Sandalwood Lot for up to 5 Sandalwood Lots and $12,375 per Sandalwood Lot for 6 Sandalwood Lots or more Ongoing costs and other costs Annual Fee; Rent; Insurance premiums; Costs of Harvest and Processing; Selling and Marketing Fees; 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 land surrounding Kununurra, Western Australia including 'Kingston Rest' a property located approximately 70 kilometres south west of Kununurra.

An offer to participate in the Project will be made through a Product Disclosure Statement (PDS). The offer pertains to approximately 5,400 Sandalwood Lots of 0.167 hectares each. 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, which will consist of a minimum of one Sandalwood Lot, on or before 30 June 2010.

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, which includes the Lease and Management Agreement and any other documents required to hold an interest in the Project.

The Sandalwood Lots will be planted out with sandalwood seedlings at a rate which, at the end of the third year after the Commencement Date, would reasonably be expected to produce an average survival rate of 420 Trees per hectare. Water for the Project will be supplied from Lake Argyle or in the case of the Kingston Rest property, from a private dam.

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

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

The Constitution establishes the Project and operates as a deed binding all Growers and TFS Properties Ltd. The Constitution sets out the terms and conditions under which TFS Properties Ltd agrees to act as Responsible Entity and thereby 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 'forestry interests' in accordance with clauses 11.2 and 11.3. Among other things, the Application has to be completed in a form approved by the Responsible Entity, signed by or on behalf of the Applicant, lodged at the office of the Responsible Entity (or such other places as the Responsible Entity may nominate from time to time), and be accompanied by payment of the Application Money in a form acceptable to the Responsible Entity.

Under the terms of the Constitution, the Responsible Entity will create two separate funds. Application Money will be paid into an Application Fund and the proceeds of the sale of Forest Produce will be paid into a Proceeds Fund (clause 2.5).

The Application Money 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.

The Constitution also sets out provisions relating to: • project property (clause 3); • complaints handling (clause 5); • winding up the Project (clause 6); • distribution of the proceeds (clause 16); • retirement and removal of the Responsible Entity (clause 25); and • register of Growers (clause 26).

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 (the Responsible Entity or an unrelated entity) of the Project land will enter into a Head Lease with TFS Leasing Pty Ltd, as the Lessee, in respect of land required for the Project.

The Lessee must use the land only for the commercial silviculture of the Indian Sandalwood Trees (clause 5.2 and item 6 of the Schedule).

The Lessee will sub-lease the land to Growers in the Project. The sub-lease must be entered into in the form of a Lease and Management Agreement contained in the Schedule to the Constitution.

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 to use their Sandalwood Lot(s) for the purposes of conducting their afforestation business. The Term of the Lease will be for a period of approximately 15 years commencing on the date on which the Grower's Application is accepted (Commencement Date) and ending when the final distribution of sale proceeds is made to the Grower or when the Project is terminated. Growers are specifically granted rights to harvest timber on their Sandalwood Lot(s) 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 Establishment Services (item 7A) and Ongoing Services (item 7B) to be performed by the Responsible Entity.

The Establishment Services include: • the acquisition of appropriate seeds and seedlings; • carrying out weed control, surveying and ground preparation for each Sandalwood Lot; • planting sandalwood seedlings on each Sandalwood Lot at a rate which, at the end of the third year after the Commencement Date, would reasonably be expected to provide an average survival rate of 420 Trees per hectare; • planting short term host Trees on the Sandalwood Lot; • irrigation, cultivation, tending, culling, pruning, fertilising, and spraying, as required in support of planting; and • use all reasonable measures to keep the Sandalwood Lot free of infestation from rabbits and other vermin.

The Ongoing Services include: • the irrigation, cultivation, tending, culling, pruning, fertilising, replanting, spraying, maintenance and otherwise caring for the Trees as and when required; • planting on the relevant Sandalwood Lot such other Trees as may considered to be necessary to enable or encourage the growth of the sandalwood seedlings; • replanting the relevant parts of the Plantation with sufficient seedlings or Trees if the Responsible Entity deems it necessary, with the replanting costs to be paid by the Responsible Entity; • the use of all reasonable measures to keep the Sandalwood Lot free of infestation from rabbits and other vermin; • furnishing the Grower with reports as and when required; • carrying out, or arranging to be carried out, the Harvest and Processing of the Trees in a manner which maximises the return for the relevant Grower; and • arranging for the sale of the Forest Produce.

Where the Responsible Entity has not secured suitable land for the Project, it can still accept Growers into the Project under the Agreement for Sub-Lease. Under this Agreement, the Responsible Entity must secure suitable land and arrange for the Grower to enter into a Lease (the sub-lease of the Leased Area) with the Lessor in sufficient time for the Responsible Entity to perform the Establishment Services within the initial 18 month establishment period from the Commencement Date.

The Trees will be harvested and processed in Year 14. The Responsible Entity may also decide to harvest some Trees in Year 13. 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 Harvest Plan, 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 15 of the Lease and Management Agreement (Non-Electing Growers), on such terms and conditions as the Responsible Entity considers appropriate (clause 17 of the Lease and Management Agreement).

The Constitution and the Lease and Management Agreement set out provisions relating to the pooling of Growers' timber and the distribution of proceeds from the sale of the timber (clause 16 of the Constitution and clause 18 of the Lease and Management Agreement).

The Responsible Entity must ensure that the Gross Proceeds of Sale are deposited into the Proceeds Fund (clause 18 of the Lease and Management Agreement). The Responsible Entity will pay any outstanding fees from the Proceeds Fund, with the remaining balance to be paid to the Grower in accordance with each Grower's Proportional Share.

Under the terms of the Lease and Management Agreement, a Grower will make payments as described below on a per Sandalwood Lot basis.

The Establishment Fee payable to the Responsible Entity on application is $12,925 per Lot for up to 5 Sandalwood Lots and $12,375 per Sandalwood Lot for 6 Sandalwood Lots or more (item 9A of the Schedule to the Lease and Management Agreement).

Growers can elect to pay the Annual Fee and the Rent on an annual basis (the Annual Investment Option) or can elect to defer payment of these amounts (the Annual Deferred Investment Option). Where a Grower has not elected to pay annually they will be taken to have elected to pay the fees under the Annual Deferred Investment Option.

For those Growers who have elected to pay under the Annual Investment Option the amount of the Annual Fee is $1,045 per Sandalwood Lot and the Rent is $275 per Sandalwood Lot. These amounts, increased by a fixed 3% per annum, are payable on or before 14 January in each financial year, following the year in which the Establishment Period ends (clause 19.2(b) and item 9B of the Schedule to the Lease and Management Agreement).

Alternatively, for those Growers who have elected to defer these fees under the Annual Deferred Investment Option the Responsible Entity is entitled to a percentage of Gross Proceeds of Sale as follows (clause 19.2(c) and item 9C of the Schedule to the Lease and Management Agreement): Years 1 - 2 3.3% per year Years 3 - 6 2.2% per year Years 7 -12 1.1% per year

If all, or substantially all of the Trees on the Grower's Sandalwood Lots are destroyed before the Harvest can take place, any Grower who has deferred their Annual Fee and Rent will be liable to pay an amount equal to 55% of the Annual Fees and Rent for all years prior to the destruction (clause 22.6 of the Lease and Management Agreement).

The following amounts are payable to the Responsible Entity from the Project's proceeds: • Costs of Harvest and Processing payable from the Grower's Gross Proceeds of Sale (clause 18.2 of the Lease and Management Agreement); • Selling and Marketing Fees, being 5.5% of the Grower's Gross Proceeds of Sale (clause 18.2 of the Lease and Management Agreement); and • an Incentive Fee equal to 33% of the amount (if any), by which the Grower's Net Proceeds of Sale exceed the Target Net Proceeds of Sale for each Sandalwood Lot (clause 18.3 of the Lease and Management Agreement).

The Responsible Entity will insure the Plantation against fire until the end of the Establishment Period. Thereafter, if so requested, the Responsible Entity will arrange insurance of the Sandalwood Lot(s) on behalf of the Grower to cover the Sandalwood Lot(s) against fire and other usual risks. The cost of such insurance will be payable to the Responsible Entity by the Grower (clause 22 of the Lease and Management Agreement).

To finance all or part of the cost of their forestry interest a Grower can: • apply for a '12 Months Interest Free Loan' with Arwon; • enter into a Loan Agreement for a principle and interest loan with Arwon; 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 that materially differs from that set out in the documentation provided with the application for this Product Ruling. A Grower who enters into a finance arrangement with a lender other than Arwon may request a private ruling on the deductibility or otherwise of interest incurred under finance arrangements not covered by this Product Ruling.

A Grower cannot rely on any part of this Product Ruling if the Establishment Fee is not paid in full on or before 30 June 2010, by the Grower or, on the Grower's behalf, by a lending institution.

A Grower choosing to pay the Establishment Fee by entering into a 12 Month Interest Free Loan arrangement with Arwon must complete the application form attached to the PDS.

Growers who enter into such a Loan Agreement with Arwon are required to pay a deposit of 20% of the Establishment Fee on Application.

The balance remaining after the 20% deposit has been paid is repayable in equal monthly instalments commencing on 30 July 2010 and must be paid in full within twelve months of the Application being accepted.

A Grower can finance the cost of their Establishment Fee by borrowing that amount from Arwon.

The Grower will be bound by the terms and conditions of the Loan Agreement entered into with Arwon.

The finance from Arwon is available as a principal and interest loan for a term of up to 10 years.

The following conditions apply to these loan arrangements: • monthly repayments of principal and interest; • interest payable as a fixed rate calculated by taking the cash rate as determined by the Reserve Bank of Australia, plus a margin of up to 9% per annum; • an Application Fee of $300 plus 0.5% of the Principal Sum up to a maximum of $1,250; and • stamp duty, as applicable.

Arwon will only provide loans to Growers where it has sufficient funds to do so.

The loans from Arwon are made on a full recourse commercial basis and normal debt recovery procedures, including legal action, will be taken in the case of defaulting borrowers. The loans will be secured by a charge over the Grower's interest(s) in the Project.

This Product Ruling does not apply if a finance arrangement entered into by the Grower includes or has any of the following features: • there are split loan features 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 section 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 but will be transferred (by any mechanism, directly or indirectly) back to the lender or any associate of the lender; • lenders do not have the capacity under the loan agreement, or a genuine intention, to take legal action against defaulting borrowers; or • entities associated with the Project, other than Arwon, are involved or become involved in the provision of finance to Growers for the Project.

In return for payment of the Establishment Fee and the other fees and expenses required under the Project agreements during the term of the Project, Growers will hold a 'forestry interest' in a 'forestry managed investment scheme'. The Project qualifies as a 'forestry managed investment scheme' because its purpose is for 'establishing and tending trees for felling in Australia' (see subsection 394-15(1)).

Under the Constitution of the Project and the other supporting agreements, the holding of a 'forestry interest' in the Project gives each Grower a right to a share in the proceeds of the harvest of the Trees grown on the Project land. That share of proceeds is determined using the number of 'forestry interests' held by a Grower as a proportion of all 'forestry interests' held by 'participants' [7] in the Project.

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

More recently, and in relation to a managed investment scheme similar to that which is the subject of this Product Ruling, the Full Federal Court in Hance v. FC of T ; Hannebery v. FC of T [2008] FCAFC 196; 2008 ATC 20-085 applied these principles to conclude that 'Growers' in that scheme were carrying on a business of producing almonds (at FCAFC 90; ATC 90).

Application of these principles to the arrangement set out above leads to the conclusion that Growers (as described in paragraphs 4 to 7 of this Ruling), who stay in the Project until its completion, will be carrying on a business of primary production involving afforestation activities.

Section 8-5 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).

The threshold test for Growers in the Project to be entitled to deductions under subsection 394-10(1) is the '70% DFE rule' in paragraph 394-10(1)(c). Under that rule, it must be reasonable to expect that on 30 June 2010, the amount of 'direct forestry expenditure' [8] under the scheme will be no less than 70% of the amount of payments under the scheme. [9]

The amount of all 'direct forestry expenditure' is the amount of the net present value of all 'direct forestry expenditure' that the Responsible Entity, as 'forestry manager' [10] of the Project, has paid or will pay under the scheme (subsection 394-35(2)).

The 'amount of payments under the scheme' is the amount of the net present value of all amounts (that is, the fees and expenses) that all current and future 'participants' in the scheme have paid or will pay under the scheme (subsection 394-35(3)).

Both of the above amounts are determined as at 30 June 2010 taking into account: • the timing requirements in subsections 394-35(4) and 394-35(5); • any amounts that can reasonably be expected to be recouped (subsection 394-35(6)); • the discount rate in subsection 394-35(7); and • the market value rule in subsection 394-35(8).

Applying all of these requirements to the information provided by the Responsible Entity of the Project, the Commissioner has determined that the Project will satisfy the '70% DFE rule' on 30 June 2010.

The requirement of paragraph 394-10(1)(d) that Growers in the Project not have day to day control over the operation of the Project (despite having a right to be consulted or give directions) is clear from the Project Agreements, as are the alternative elements of paragraph 394-10(1)(e) relating to the number of Growers in the scheme and the Responsible Entity's role in other managed investment schemes.

The final requirement for deductibility requires all the Project Trees to be established within 18 months of 30 June 2010 (see paragraph 394-10(1)(f) and subsection 394-10(4)). The planting timeline provided with the application for this Product Ruling by the Responsible Entity indicates that all the Trees required to be established under the scheme will be planted on the Project land by 31 December 2011.

Accordingly, subject to the qualifications set out below, amounts paid by Growers to the Responsible Entity in relation their '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)).

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

Where a Grower 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.

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

The first of these situations will occur if the Responsible Entity fails to establish the Trees on the Project land within 18 months. Where this occurs, the Responsible Entity is required to notify the Commissioner within 3 months of the end of the 18 month period (section 394-10 of Schedule 1 to the TAA).

The second situation where a Grower may have deductions disallowed is where a 'CGT event' happens to their 'forestry interest' within 4 years from 30 June of the income year they paid an amount under the scheme, for example, the Project Application Money (see subsection 394-10(5)).

For the purposes of this provision, the Commissioner is able to amend the assessment of a Grower within 2 years of the relevant 'CGT event' happening. The Commissioner's power to amend in these circumstances applies despite section 170 of the ITAA 1936 (subsection 394-10(6) of the ITAA 1997).

Where a 'CGT event' happens to the 'forestry interest' of a Grower within 4 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 Grower 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.

Where a Grower borrows the Application Money from Arwon to fund their investment in the Project, the deductibility of the interest incurred on the loan money falls for consideration under the general deduction provisions of section 8-1. Similarly, the costs relating to insuring the Trees fall for consideration under section 8-1. If the interest and the insurance costs incurred by the Grower are deductible under the first positive limb in subsection 8-1(1) there is no requirement to consider whether they are 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 and insurance costs incurred by a Grower will be deductible if they are incurred in gaining or producing a Grower's assessable income and are 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). [T]he 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).

Growers in the Project use the borrowed funds to acquire a 'forestry interest' in a 'forestry managed investment scheme' and the insurance costs protect their 'forestry interest' against certain risks. The holding of that 'forestry interest' will produce assessable income for a Grower 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 of deductibility of the interest and the insurance costs under the first limb of subsection 8-1(1) are, therefore, met unless one of the exclusions in subsection 8-1(2) applies.

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, or insurance to protect, 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, the capital exclusion in subsection 8-1(2) does not apply to the interest and the insurance costs and subject only to the potential application of the prepayment provisions, a deduction for the interest and the insurance costs can be claimed in the year in which they are incurred (Note: the meaning of 'incurred' is explained in Taxation Ruling TR 97/7).

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 that will not be wholly done within the same year of income as the year in which the expenditure is incurred. For schemes such as this Project, the main operative provisions are sections 82KZMD and 82KZMF of the ITAA 1936.

However, subsection 394-10(7) of the ITAA 1997 specifically provides that sections 82KZMD and 82KZMF of the ITAA 1936 do not affect the timing of amounts deductible under section 394-10 of the ITAA 1997.

Accordingly, under the scheme to which this Product Ruling applies, only deductions for interest payable under a loan with Arwon and for insurance premiums will potentially fall within the prepayment provisions. However, the conditions applying to the loans to which this Product Ruling applies (see paragraphs 96 to 101 of this Ruling) do not require any prepayment of interest over the term of the loan. Similarly, nothing provided with the application for this Product Ruling indicates that insurance premiums will be prepaid. Accordingly, the prepayment provisions have no application to Growers who enter into those loans or incur expenses for insurance premiums.

However, if a Grower chooses to prepay the interest on their loans with Arwon or their insurance premiums, these amounts will not be covered by this Product Ruling and that Grower may request a private ruling on how the prepayment provisions will affect the timing of their deductions.

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 Application Fee payable to Arwon 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)).

Section 6-10 includes in assessable income amounts that are not ordinary income. These amounts, called statutory income, are listed in the table in section 10-5 and include amounts that are included in the assessable income of 'initial participants' of a 'forestry managed investment scheme' by subsection 394-25(2).

Where a 'CGT event' happens to a 'forestry interest' held by a Grower in this Project, subsection 394-25(2) includes an amount in the assessable income of the Grower if: • the Grower can deduct or has deducted an amount under section 394-10; or • the Grower would have met the condition immediately above if subsection 394-10(5) had not applied to disallow the deduction(s). Paragraphs 32 to 34 and paragraphs 119 to 123 of this Ruling explain when deductions will be disallowed under subsection 394-10(5).

If, as a result of the 'CGT event' the Grower either: • no longer holds the 'forestry interest'; or • otherwise - where the Grower continues to hold the 'forestry interest', but there is a decrease in the market value of the 'forestry interest'; then the market value of the 'forestry interest' at the time of the event, or the reduction of the market value of the 'forestry interest' as a result of the event, is included in the assessable income of the Grower in the income year in which the 'CGT event' happens (subsection 394-25(2)). A market value rule applies rather than the amount of money actually received from the 'CGT event' (subsection 394-25(3)). 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 'forestry interest' just before the 'CGT event', or where the Grower continues to hold their interest after the event, the amount by which the market value of the 'forestry interest' is reduced as a result of the 'CGT event' (subsection 394-25(2)).

Section 394-25 will apply where the 'forestry interest' is sold, is extinguished, or ceases, and will include 'CGT events' such as a full or partial sale of the 'forestry interest' or from a full or partial clear-fell harvest of the Trees grown under the Project.

The receipt of an amount arising from the payment of insurance proceeds is a distribution that arises as an incident of the Grower holding a 'forestry interest' in the Project. It is an item of ordinary income and is assessable under section 6-5 in the year in which it is derived.

Based on information provided with the application for this Product Ruling, a Grower accepted into the Project in the 2009-10 income year 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. [11] These losses will be subject to the loss deferral rule in section 35-10 unless an exception applies or, for each income year in which losses are incurred, the Commissioner exercises the discretion in subsection 35-55(1) 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 Product 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 Non-commercial Loss (NCL) purposes of less than $250,000 (that is, the Grower satisfies the income requirement in subsection 35-10(2E)) 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 Product Ruling, and the discretion in paragraph 35-55(1)(b) 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; 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 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 35-10(2C)).

Where a Grower with income for NCL purposes of $250,000 or more (that is, the Grower does not satisfy the income requirement in subsection 35-10(2E)) 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 Product Ruling, and the discretion in paragraph 35-55(1)(c) 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 afforestaton 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 35-10(2C)).

A Grower will satisfy the income requirement in subsection 35-10(2E) 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.

In each individual year where the Commissioner's discretion is exercised a Grower within either paragraphs 145 or 146 of this Ruling who would otherwise be required to defer a loss arising from their participation in the Project under section 35-10 until a later income year is able to offset that loss against their other assessable income.

The operation of section 82KL of the ITAA 1936 depends, among other things, on the identification of a certain quantum of 'additional benefit(s)'. Insufficient 'additional benefits' will be provided to trigger the application of section 82KL of the ITAA 1936. It will not apply to deny the deduction otherwise allowable under section 8-5 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' and a Grower will obtain a 'tax benefit' from entering into the 'scheme', in the form of tax deductions for the amounts detailed at paragraphs 27 to 41 of this Ruling 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.

Growers to whom this Product Ruling applies will derive assessable income from holding or disposing of their 'forestry interest' in the Project. 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 Product 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 Growers will enter into the scheme for the dominant purpose of obtaining a tax benefit.

The following is a detailed contents list for this Product Ruling: Paragraph What this Ruling is about 1 Class of entities 3 Superannuation Industry (Supervision) Act 1993 8 Qualifications 9 Date of effect 12 Changes in the law 14 Note to promoters and advisers 16 Goods and Services Tax 17 Ruling 18 Structure of the Project 18 Carrying on a business 21 Concessions for 'small business entities' 22 The '70% DFE rule' and the establishment of the trees 24 Section 394-35 and subsection 394-10(4) 24 Allowable deductions 27 Sections 8-5, 394-10 and 394-20 and Division 27 27 'CGT event' within 4 years for Growers who are 'initial participants' 33 Subsections 394-10(5) and 394-10(6) of the ITAA 1997 and section 170 of the ITAA 1936 33 Interest on loans to finance the 'forestry interest' of a Grower and insurance costs related to the 'forestry interest' 36 Section 8-1 36 Borrowing costs 39 Section 25-25 39 Assessable income, 'CGT events' and the 'forestry interests' of Growers who are 'initial participants' 42 Sections 6-10, 394-25 and 17-5 42 Amounts received by Growers where insurance proceeds are paid 45 Sections 6-5 and 17-5 45 Division 35 - deferral of losses from non-commercial business activities 46 Section 35-55 - annual exercise of Commissioner's discretion during the period beginning with the 2009-10 income year and concluding with the 2023-24 income year 46 Prepayment and anti-avoidance provisions 50 Sections 82KZM, 82KZME, 82KZMF and 82KL and Part IVA 50 Scheme 51 Overview 54 Constitution 64 Compliance Plan 69 Head Lease 70 Lease and Management Agreement 73 Agreement for Sub-Lease 77 Pooling of Timber and Grower's Entitlement to Net Proceeds 78 Fees 82 Establishment Fee 83 Annual Fee and Rent 84 Other fees 88 Insurance 89 Finance 90 12 Months Interest Free Loan offered by Arwon 93 Principal and interest finance offered by Arwon 96 Appendix 1 - Explanation 103 Structure of the Project 103 Is the Grower carrying on a business? 105 Allowable deductions 108 Sections 8-5, 12-5, 394-10 and 394-20 108 The '70% DFE rule' 109 Paragraph 394-10(1)(c) and section 394-35 109 The other elements for deductibility under subsection 394-10(1) 114 Loss of deductions previously allowed under subsection 394-10(1) 119 Interest on loans to finance the 'forestry interest' of a Grower and insurance costs related to the 'forestry interest' 124 Section 8-1 124 Prepayment provisions 129 Sections 82KZL to 82KZMF 129 Borrowing costs 133 Section 25-25 133 Assessable income, 'CGT events' and the 'forestry interests' of Growers who are 'initial participants' 136 Sections 6-10, 10-5 and 394-25 136 Subsection 394-25(2) 137 Market value rule applies to 'CGT events' 138 Insurance proceeds 141 Section 6-5 141 Sections 35-10 and 35-55 - deferral of losses from non-commercial business activities and the Commissioner's discretion 142 Section 82KL - recouped expenditure 149 Part IVA - general tax avoidance provisions 150 Appendix 2 - Detailed contents list 153