Income tax: TFS High Net Worth Sandalwood Project 2015

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 Ruling relates. In this Product Ruling this scheme is referred to as the scheme, the TFS High Net Worth Sandalwood Project 2015 Project, 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 2015.

A Grower will have executed the relevant Project Agreements set out in paragraph 48 of this ruling on or before 30 June 2015 and will hold a 'forestry interest' in the Project.

The class of entities who can rely on this Product Ruling does not include: • who are accepted into this Project before the date of this Ruling or after 30 June 2015 • who participate in the scheme through offers made other than through the Information Memorandum (IM) 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 • whose Establishment Fees, including all loan money, are not paid in full to TFS Corporation Ltd (Investment Manager) by 30 June 2015, or • who enter into finance agreements with Arwon Finance Pty Ltd (Arwon), other than as specified in paragraphs 74 to 81 of this Ruling.

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 48 to 81 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.

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

This Product Ruling applies prospectively from 17 June 2015, the date it is published. It therefore applies only to the specified class of entities that enter into the scheme from 17 June 2015 until 30 June 2015, 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 this 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 income tax 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 participants are fully informed of any legislative changes after this Product Ruling is issued.

All amounts and percentages referred to in this Product Ruling exclude the Goods and Services Tax (GST) unless otherwise specified. The transactions in respect of this scheme may, where appropriate, have GST implications.

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 3 to 7 above) who is accepted to participate in the 'forestry managed investment scheme' described below at paragraphs 48 to 81 on or after 17 June 2015 and on or before 30 June 2015 inclusive.

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 who enters into the arrangement described in this Ruling will be carrying on an enterprise for the purposes of subsection 9-20(1) of the A New Tax (Goods and Services Tax) Act 1999 (GST Act) subject to the exclusions listed in subsection 9-20(2) of the GST Act.

Although not relevant for the purposes of Division 394, a Grower (as described in paragraphs 3 to 7) 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, alone or in partnership, will be subject to the operation of Division 35 of the ITAA 1997 (see paragraphs 42 and 43).

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, other than as specified.

The taxation obligations and benefits set out below have been determined using the information provided to the Commissioner by the Investment Manager, referred to as the 'forestry manager' in Division 394). On the basis of that information the Commissioner has decided that on 30 June 2015 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 Ruling will only apply if the Investment Manager 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 2016.

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 Investment Manager is required by section 394-10 of Schedule 1 of the TAA to notify the ATO if all of the trees are not established by 31 December 2016.

A Grower in the Project can claim deductions for the amounts shown in the Table below that are paid to the Investment Manager (sections 8-5 and 394-10). Fee Amount Year(s) deductible Establishment Fee $1,000,000 per Sandalwood Lot ($70,000 per hectare) 2014-15 Annual Property Management Fees payable under the Annual Investment Option $107,100 per Sandalwood Lot ($7,500 per hectare) for Plantation Age 1 $85,680 per Sandalwood Lot ($6,000 per hectare) for Plantation Age 2 $64,260 per Sandalwood Lot ($4,500 per hectare) for Plantation Age 3 - 5 $49,980 per Sandalwood Lot ($3,500 per hectare) for Plantation Age 6 - 14 The income year in which the Annual Property Management Fee is paid Annual Rent payable under the Annual Investment Option $21,420 per Sandalwood Lot per annum ($1,500 per hectare) The income year in which the Annual Rent is paid Costs of Harvest Actual costs The income year in which the Grower is entitled to proceeds and the Costs of Harvest are paid from those proceeds Selling and Marketing Fees 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 Performance Fees 20% of the amount by which the Actual IRR exceeds the IRR of 7% The income year in which the Performance Fee is paid

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' within four years of the Grower first paying an amount under the scheme (see paragraphs 32 to 35).

The 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 the Investment Manager's bank account in the year in which the deduction is claimed. Any form of payment that does not involve the movement of cash into the Investment Manager's 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.

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 Fees, the Upfront Annual Fee, the Upfront Rent, the Annual Fees and the Rent are not allowable where a 'CGT event' happens in relation to the 'forestry interest' of a Grower before 1 July 2019 (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 after the 'CGT event' (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 by section 394-25 to include in assessable income the market value of the 'forestry interest' at the time of the 'CGT event', or any decrease in the market value of the 'forestry interest', as a result of the 'CGT event'.

However, deductions will not be affected where the 'CGT event' happens because of circumstances outside of the Grower's control and the Grower could not reasonably have foreseen the 'CGT event' happening when they acquired the 'forestry interest' (subsection 394-10(5A)).

A Grower in the Project can claim deductions for interest incurred on a loan to fund their investment in the Project (paragraph 8-1(1)(a)). This Ruling only applies to loans between a Grower and Arwon. 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.

The Application Fee of $300 plus 0.5% of the loan amount is payable to Arwon is a borrowing expense and is deductible under section 25-25. The deduction for the borrowing expense is spread over 5 years 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 is outside the scope of this Ruling.

Where a 'CGT event' (other than a 'CGT event' in respect of a thinning [7] ) happens to a 'forestry interest' held by a Grower 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 in respect of a thinning of the trees grown in this Project is not received as a result of a 'CGT event' and is not otherwise assessable under Division 394. The amount is a distribution of ordinary income that arises as a result of a Grower holding a 'forestry 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) less any GST payable on those proceeds (section 17-5).

For each of the income years from 2014-15 to 2030-31, 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 forestry 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 48 to 81, the following provisions of the ITAA 1936 have application as indicated: • interest paid by a Grower to Arwon does 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 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 30 April 2015 • Draft Information Memorandum (IM) for the TFS High Net Worth Sandalwood Project 2015 to be issued by TFS Corporation Ltd (Investment Manager), received 30 April 2015 • Draft Investment Management Agreement between TFS Corporation Ltd (Investment Manager), T.F.S. Properties Ltd (Lessor) and the Grower, received 30 April 2015 • Draft Loan Agreement between Arwon Finance Pty Ltd (Lender), the Borrower and the Guarantor, received 30 April 2015 • Land Acquisition Due Diligence Report addressing the TFS Land Selection Criteria, received on 30 April 2015 • Amended Draft Loan Agreement between Arwon Finance Pty Ltd (Lender), the Borrower and the Guarantor, received 15 May 2015, and • Correspondence received on 22 May 2015, 27 May 2015 and 29 May 2015. 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 Investments 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 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 Kununurra, Western Australia Burdekin region of northern Queensland, and the Douglas Daly region of the Northern Territory. Species of trees to be planted under the scheme Indian Sandalwood (Santalum album) Term of the Project 14-16 years Date all trees are due to be planted on scheme land 31 December 2016 Number of trees per hectare Targeted survival rate of approximately 5,997 trees per Sandalwood Lot (420 Trees per hectare) Number of hectares offered for cultivation Approximately 850 hectares Size of each 'forestry interest' 14.28 hectares Minimum allocation of 'forestry interests' per Grower One forestry interest (Sandalwood Lot) Minimum subscription Not applicable Initial cost $1,000,000 ($1,100,000 inc. GST) per Sandalwood Ongoing costs and other costs Annual Property Management Fees Annual Rent Insurance costs Costs of Harvest and Processing Selling and Marketing Fees, and Performance Fee.

The Project will involve establishing an Indian Sandalwood Plantation. Approximately 14-16 years after the Establishment Period the Sandalwood will begin to be harvested, processed and sold.

The Project will be conducted on the land surrounding Kununurra, Western Australia and may also include land in the Burdekin region of northern Queensland and the Douglas Daly region of the Northern Territory. All land selected will be deemed suitable in accordance with the TFS Land Selection Criteria.

An offer to participate in the Project will be made through an IM. The offer under the IM is for 60 Sandalwood Lots of 14.28 hectares each. There is no minimum subscription for the Project.

An entity that participates in the Project as a Grower will do so by acquiring a 'forestry interest' in the Project on or before 30 June 2015, which will consist of a minimum of one Sandalwood lot.

For the purposes of this Ruling, Applicants who are accepted to participate in the Project and who execute the Investment Management Agreement on or before 30 June 2015 will become Growers in the Project.

The Investment 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.

Growers participating in the Scheme will enter into a Lease and an Investment Management Agreement (Lease and IMA) with TFS Corporation Ltd as the Investment Manager and T.F.S. Properties Ltd as the Lessor Investment Manager. 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 16 years commencing on the date on which the Grower's Application is accepted by the Investment Manager (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.

Under the IMA, each Grower appoints the Investment Manager to perform the Services and the Investment Manager accepts the appointment. The Investment Manager will supervise and manage all silvicultural activity on behalf of the Grower in accordance with good silvicultural practice.

The Establishment Services include: • carrying out weed control, surveying and ground preparation for each Sandalwood Lot • planting Sandalwood seedlings on each Sandalwood Lot at a rate which, at a rate which would reasonably be expected to provide an average survival rate of 420 trees per hectare and harvestable timber within 15 years • planting short term host trees on the Sandalwood Lot • irrigation, cultivation, tending, culling, pruning, fertilising, and spraying, as required in support of planting, and • the use of all reasonable measures to keep the Sandalwood Lot free of infestation from rabbits and other vermin.

The Investment Services include: • using commercially reasonable efforts to ensure that the Interest and the operation and maintenance of the same comply with all applicable Australian Laws • the preparation of all reports required to be prepared pursuant to any future credit arrangements between the Investor or any of its Affiliates and any financial institution with respect to the Interest provided that any costs in this regard are borne by the Investor • maintaining accounts and records relating to the Interest in accordance with International Financial Reporting Standards • soliciting annually, and, at the Investor's cost, obtain and maintain on the most favourable terms commercially available, insurance coverage on behalf of the Investor with respect to the Interest • overseeing and coordinating the efforts of all third parties that provide services to the Investor relating to the Interest, including, but not limited to, the Property Manager, and • performing such other services as may be required from time to time for management or other administrative activities relating to the Interest as the Investor shall reasonably request provided that any costs in this regard are borne by the Investor.

The Property Management 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 be considered 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 Investment Manager deems it necessary, with the replanting costs to be paid by the Investment Manager • the use of all commercially reasonable measures to ensure proper land protection, including but not limited to pest prevention, control and monitoring, and fire prevention and fire suppression activities • the use of all commercially reasonable measures to maintain the Leased Area, and • 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.

The Selling and Marketing Services include: • maintaining an international list of potential buyers of Sandalwood in the years preceding • advertising to attract potential purchasers of Sandalwood, and • managing the sale of the Forest Produce.

The Investment Manager plans to Harvest and Process all Trees by year 16 and may engage a suitably qualified person for this process.

The Investment Manager is appointed to market and sell the Forest Produce on behalf of the Growers, on such terms and conditions as the Investment Manager considers appropriate.

The Investment Manager must ensure that the Gross Proceeds of Sale are deposited into the Proceeds Fund (clause 6 of the IMA). The Investment Manager will pay any outstanding fees from the Proceeds Fund, with the remaining balance to be paid to the Grower.

Under the terms of the IMA, a Grower will make payments as described below on a per Sandalwood Lot basis.

The Establishment Fee payable to the Investment Manager on application is $1,000,000 per Sandalwood Lot (Item 2 of the Schedule to the IMA).

Growers can elect to pay the Annual Property Management Fee and the Rent on an annual basis (the Annual Investment Option) or defer payment of these amounts (the Annual Deferred Investment Option). Annual Property Management Fees and Rent are payable from Year 1 (the year after the Establishment Period ends) until Year 14.

For those Growers who have elected to pay these fees, the Grower is entitled to a percentage of the Gross Proceeds of Sale for each financial year as per the table below: Years 1 - 2 3% per year Years 3 - 4 2% per year Years 5 -14 1% per year

Alternatively, for those Growers who have elected to defer these fees under the Annual Deferred Investment Option, the Investor is not entitled to any further interest in the Gross Proceeds of Sale for each financial year as per the table above.

The following amounts are payable to the Investment Manager from the Project's proceeds: • Costs of Harvest and Processing payable from the Grower's Gross Project Proceeds • Selling and Marketing Fees, being 5% of the Grower's Gross Proceeds of Sale, and • A Performance Fee equal to 20% of the amount, if any, by which the Actual IRR exceeds an IRR of 7%.

To finance all or part of the cost of their 'forestry interest' a Grower can enter into a Principal and Interest Loan with Arwon or, alternatively, borrow from an independent lender external to the Project.

Only the finance arrangement 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 an independent lender external to the Project other than the Principal and Interest Loan with 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 Ruling if the Establishment Fee is not paid in full by 30 June 2015 either by the Grower or by a lending institution on the Grower's behalf.

A Grower may choose to pay the Establishment Fee by entering into a principal and interest loan with Arwon. The Application Form must be completed.

Growers who enter into such agreement will be bound by the terms and conditions of the loan agreement which requires: • a loan term of up to ten years • monthly payments of principal and interest; • an application fee of $300 plus 0.5% of the amount of the finance • a deposit of 10% in certain circumstances, and • the loan to be secured by a charge over the Grower's Interest(s) in the Project.

The finance provided by Arwon is made on a full recourse commercial basis and normal debt recovery procedures, including legal action will be taken in the case of defaulting borrowers.

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

This Ruling does not apply if the 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 supporting agreements, the holding of a 'forestry interest' in the Project gives each Grower a right to the proceeds of the Harvest of the Trees grown on the Leased Area.

An entity may be registered for GST if it is carrying on an 'enterprise' (section 23-10 of the GST Act).

The term 'enterprise' is defined in section 9-20 of the GST Act and includes an activity, or series of activities, done in the form of a business (paragraph 9-20(1)(a) of the GST Act). The use of the phrase 'in the form of' has been interpreted to indicate a wider meaning than the word 'business' in isolation.

However, subsection 9-20(2) provides that the term 'enterprise' does not include an activity, or series of activities, done by an individual or partnership without a reasonable expectation of profit or gain.

Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number (MT 2006/1) sets out the Commissioner's views on when an entity is carrying on an enterprise for the purposes of section 9-20 of the GST Act.

ATO Interpretative Decision ATO ID 2010/197 Goods and Services Tax: GST and agricultural managed investment scheme - investor carrying on an enterprise considers a managed investment scheme similar to that described in this Ruling. This decision applies the principles set out in MT 2006/1 to conclude that the 'Grower' in that scheme was carrying on an enterprise for the purpose of section 9-20 of the GST Act.

Application of these principles to the arrangement set out in this Ruling leads to the conclusion that a Grower (as described in paragraphs 3 to 7 of this Ruling) will be carrying on an enterprise for the purpose of section 9-20 of the GST Act where there is a reasonable expectation of profit or gain from their participation 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 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), who stay in the Project until its completion, will be carrying on a business of primary production involving forestry 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).

Payments that relate to processing are not deductible to Growers as a payment under a 'forestry managed investment scheme'. However, a deduction will be available under section 8-1 as Growers will be carrying on a business activity.

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 2015, 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 Investment Manager, 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 (i.e., 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 2015 taking into account: • the timing requirements in subsections 394-35(4) and (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 Investment Manager of the Project the Commissioner has determined that the Project will satisfy the '70% DFE rule' on 30 June 2015.

The requirements of paragraphs 394-10(1)(a) and (b) are met as a Grower will hold a 'forestry interest' in the Project (see paragraph 6 of this Ruling) and will pay an amount under the Project. The requirement of paragraph 394-10(1)(d) is clear from the Project agreements that Growers in the Project do not have day to day control over the operation of the Project (despite having a right to be consulted or give directions). The requirement of paragraph 394-10(1)(e) relating to the number of Growers in the scheme and the Investment Manager's role in other managed investment schemes is also met.

The final requirement for deductibility requires all the Project trees to be established within 18 months of 30 June 2015 (see paragraph 394-10(1)(f) and subsection 394-10(4)). The planting timeline provided with the application for this Ruling by the Investment Manager indicates that all the trees required to be established under the scheme will be planted on the Project land by 31 December 2016.

Accordingly, subject to the qualifications set out below, amounts paid by Growers to the Investment Manager in relation to 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 under subsection 394-10(1).

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

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

For the purposes of this provision, the Commissioner is able to amend the assessment of a Grower within two 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)).

Where a 'CGT event' happens to the 'forestry interest' of a Grower within four years, the market value of the forestry interest at the time of the 'CGT event' or the decrease in the market value of the 'forestry interest' as a result of the 'CGT event' is still included in the assessable income of the 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.

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

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

Under the first positive limb of subsection 8-1(1) the interest incurred by a Grower will be deductible if it is incurred in gaining or producing a Grower's assessable income and is not excluded by one of the negative limbs in subsection 8-1(2): 'The question of whether an outgoing [is] ... incurred in gaining or producing the assessable income is a question of characterisation' (Fletcher & Ors v. Federal Commissioner of Taxation (1991) 173 CLR 1; (1991) 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; (1992) 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'. 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. Therefore, the tests of deductibility of interest under the first limb of subsection 8-1(1) are, therefore, met unless one of the exclusions in subsection 8-1(2) apply.

For the purposes of this Project, only the capital exclusion in paragraph 8-1(2)(a) is relevant. The use of borrowed funds to purchase a capital asset, such as a 'forestry interest', does not mean that the interest outgoings are on capital account (see Steele v. Federal Commissioner of Taxation (1999) 197 CLR 459; (1999) 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; (1988) 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, subject only to the potential application of the prepayment provisions, a deduction for the interest can be claimed in the year in which it is incurred (Note: The meaning of 'incurred' is explained in Taxation Ruling TR 97/7 Income Tax: section 8-1 - meaning of 'incurred' - timing of deductions).

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 section 82KZMF of the ITAA 1936.

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

Accordingly, under the scheme to which this Product Ruling applies, only deductions for interest payable under a loan with Arwon will potentially fall within the prepayment provisions. However, the conditions applying to the loans to which this Ruling applies (see paragraphs 74 to 81 above) do not require any prepayment of interest over the term of the loan. Accordingly, the prepayment provisions have no application to Growers who enter into those loans.

If a Grower chooses to prepay interest on these loans that Grower may request a private ruling on how the prepayment provisions will affect the timing of their interest deduction.

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 borrowing costs 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.

Borrowing expenses of $100 or less are deductible in the year in which they are incurred (subsection 25-25(6)). Where the amount exceeds $100, 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' (other than for a 'CGT event' in respect of a thinning [11] ) happens to a 'forestry interest' held by a Grower, 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 27 to 31 and paragraphs 93 to 94 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.

Section 394-25 specifically excludes from the operation of Division 394 a 'CGT event' that happens in respect of a thinning (see paragraph 394-25(1)(c)).

Thinning amounts received by a Grower do not arise as a result of a 'CGT event' and are not otherwise assessable under Division 394. 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 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 year ended 30 June 2015 who carries on a business of forestry as an individual (alone or in partnership) is expected to incur losses from their participation in the Project which will be subject to Division 35 [12] . 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 Ruling.

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

Where a Grower with income for NCL purposes of less than $250,000 (i.e., the Grower satisfies the income requirement in subsection 35-10(2E)) 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 forestry 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 (2C).

Where a Grower with income for NCL purposes of $250,000 or more (i.e., the Grower does not satisfy the income requirement in subsection 35-10(2E)) 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 [forestry] industry, the Grower's business activity will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C).

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 paragraph 134 or paragraph 135 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 8-1.

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

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 31 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 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 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 Ruling: Paragraph What this Ruling is about 1 Class of entities 3 Qualifications 8 Superannuation Industry (Supervision) Act 1993 10 Date of effect 11 Changes in the law 13 Note to promoters and advisers 15 Goods and Services Tax 16 Ruling 17 Stucture of the Project 17 Carrying on an enterprise 20 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, 394-20 and Division 27 27 'CGT event' within 4 years for Growers who are 'initial participants' 32 Subsections 394-10(5), 394-10(5A) and 394-10(6) 32 Interest on loans to finance the 'forestry interest' of a Grower 36 Section 8-1 36 Borrowing costs 37 Section 25-25 37 Assessable income, 'CGT events' and the 'forestry interests'of Growers who are 'initial participants' 39 Sections 6-10, 17-5 and 394-25 39 Amounts received by Growers where the Project trees are thinned 42 Section 6-5 42 Division 35 - deferral of losses from non-commercial business activities 43 Section 35-55 - annual exercise of Commissioner's discretion during the period beginning with the income year ended 30 June 2015 and concluding with the income year ended 30 June 2031 43 Prepayment provisions and anti-avoidance provisions 47 Sections 82KZM, 82KZME, 82KZMF, 82KL and Part IVA of the ITAA 1936 47 Scheme 48 Overview 51 Lease and Investment Management Agreement 59 Entitlement to Net Proceeds of Sale 65 Fees 68 Establishment Fee 69 Annual Property Management Fee and Rent 70 Other Fees 73 Finance 74 Finance offered by Arwon 77 Other qualifications relating to finance 81 Appendix 1 - Explanation 82 Structure of the Project 82 Is the Grower carrying on an Enterprise? 84 Is the Grower carrying on a business? 90 Allowable deductions 93 Sections 8-1, 8-5, 12-5, 394-10 and 394-20 93 The '70% DFE rule' 95 Paragraph 394-10(1)(c) and section 394-35 95 The other elements for deductibility under subsection 394-10(1) 100 Loss of deductions previously allowed under subsection 394-10(1) 105 Interest on loans to finance the 'forestry interest' of a Grower 111 Section 8-1 111 Prepayment provisions 116 Sections 82KZL to 82KZMF of the ITAA 1936 116 Borrowing costs 120 Section 25-25 120 Assessable income, 'CGT events' and the 'forestry interests'of Growers who are 'initial participants' 123 Sections 6-10, 10-5, and 394-25 123 Subsection 394-25(2) 124 Market value rule applies to' CGT events' 125 Amounts received by Growers where the Project trees are thinned 128 Section 6-5 128 Deferral of losses from non-commercial business activities and the Commissioner's discretion 130 Sections 35-10 and 35-55 130 Recouped expenditure 137 Section 82KL of the ITAA 1936 137 General tax avoidance provisions 138 Part IVA of the ITAA 1936 138 Appendix 2 - Detailed contents list 141