Income tax: taxation consequences for a Customer entering into a Prepay and Grow Agreement with Ruralco

This Product Ruling sets out the Commissioner's opinion on the way in which the relevant provisions identified in the Ruling section apply to the defined class of entities who take part in the scheme to which this Product Ruling relates. All legislative references in this Product Ruling are to the Income Tax Assessment Act 1936 (ITAA 1936) unless otherwise indicated.

The scheme described in this Product Ruling involves a prepayment by a Customer under a Prepay and Grow Agreement (the Agreement) offered by Ruralco Holdings Limited (Ruralco) to purchase Goods to be used by the Customer in their business.

This Product Ruling does not address: • the taxation consequences for a Customer that is not a small business entity as defined in section 328-110 of the Income Tax Assessment Act 1997 (ITAA 1997) [1] • the taxation consequences of any fees and charges paid by the Customer for the delivery of the Goods • the taxation consequences upon application of the Reward Amount against the Customer's purchases of Goods • the taxation consequences of any financial accommodation obtained by the Customer in order to fund the Prepayment Amount • the application of the prepaid expenditure provisions under Subdivision H of Division 3 of Part III, other than for section 82KZM • the taxation consequences upon any assignment of the Agreement to another party, and • whether this scheme constitutes a financial arrangement for the purposes of Division 230 of the ITAA 1997 (Taxation of financial arrangements).

This part of the Product Ruling specifies which entities can rely on the Ruling section of this Product Ruling and which entities cannot rely on the Ruling section. Those entities that can rely on the Ruling section are referred to in this Product Ruling as the Customer.

The class of entities that can rely on the Ruling section of this Product Ruling consists of those entities that: • enter into the scheme described in paragraphs 16 to 20 of this Product Ruling on or after 1 July 2018 and on or before 30 June 2021 • use the Goods in carrying on a business for the purpose of gaining or producing assessable income, and • are a small business entity as defined in section 328-110 of the ITAA 1997.

The class of entities that can rely on the Ruling section of this Product Ruling does not include entities that: • are accepted to participate in the scheme described in paragraphs 16 to 20 of this Product Ruling before 1 July 2018 or after 30 June 2021 • are not a small business entity as defined in section 328-110 of the ITAA 1997 • participate in the scheme through offers made other than through the Agreement, 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) in any way • do not satisfy an assumption set out in paragraph 20 of this Product Ruling, or • are subject to Division 230 in respect of this scheme.

This Product Ruling does not address the provisions of the Superannuation Industry (Supervision) Act 1993 (SISA). The Commissioner gives no assurance that the scheme 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 scheme 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 16 to 20 of this Product 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 applies from 1 July 2018. It therefore applies only to the specified class of entities that enter into the scheme from 1 July 2018 until 30 June 2021, being its period of application. This Product Ruling will continue to apply to those entities even after its period of application has ended for the scheme entered into during the period of application.

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 income tax laws enacted at the time it was issued, later amendments may impact on this Product Ruling. Any such changes will take precedence over the application of this Product Ruling and, to that extent, this Product Ruling will have no effect.

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 Commissioner suggests that promoters and advisers ensure that participants are fully informed of any legislative changes after the Product Ruling has issued.

Subject to paragraph 3 of this Product Ruling and the assumptions in paragraph 20 of this Ruling: (a) The Prepayment Amount paid by the Customer to the Company under the Agreement is deductible under section 8-1 of the ITAA 1997 in the income year it is paid. (b) Section 82KZM will not apply to deny the Customer an immediate deduction of the Prepayment Amount incurred under the Agreement and allowable as a deduction under section 8-1 of the ITAA 1997. (c) The anti-avoidance provisions in Part IVA will not be applied to deny the deductibility of the Prepayment Amount incurred under the Agreement by the Customer.

The scheme that is the subject of this Product Ruling is identified and described in the following: • application for a Product Ruling as constituted by documents and information received on 29 May 2018, 28 June 2018 and 5 September 2018, and • the Prepay and Grow Agreement, received on 28 June 2018 (the Agreement). Note: certain information has been provided on a commercial-in-confidence basis and will not be disclosed or released under Freedom of Information legislation.

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 Customer, or any associate of a Customer, will be a party to, which are a part of the scheme. Capitalised terms in this Product Ruling take their meaning from the Agreement referred to in paragraph 16 of this Product Ruling.

The Agreement constitutes an agreement between a customer of Ruralco operating a farming business (the Customer) and the Company, being a subsidiary of Ruralco. The Agreement is, amongst other things, designed to assist in providing the Customer more effective cash flow management, enabling them to time the payment for Goods with their major agricultural sale periods.

Pursuant to the terms and conditions of the Agreement: (a) The Customer makes a payment to the Company referred to as the Prepayment Amount. The Prepayment Amount (i) shall be a minimum of $10,000 and a maximum of $5,000,000 in the aggregate (or any such other amount as agreed by Ruralco in its absolute discretion) (ii) may be topped up by the Customer at any time during the Term of the Agreement (subject to paragraph 19(a)(i)), and (iii) will only be used by the Customer for the sole purpose of purchasing Goods from the Company. (b) The Goods purchased by the Customer from the Company will (i) be as agreed between those parties under the Agreement, including but not limited to, fertiliser and stock inputs (ii) not constitute trading stock, and (iii) be governed by Ruralco conditions of sale. (c) The Agreement commences on the day on which the Prepayment Amount is received by the Company (the Payment Date) and expires on the End Date, being the earlier of 11 months from the Payment Date or on 31 May the following calendar year. (d) Where the Customer has spent the entire Prepayment Amount prior to the End Date of their Agreement, an amount referred to as the Reward Amount will be offset against any further purchase of Goods made by the Customer from the Company prior to that End Date. The Reward Amount is effectively a discount against the price paid by the Customer for Goods, and is calculated daily by application of the Reward Rate, being 4.15% per annum, on the balance of the Prepayment Amount (that is, the unspent Prepayment Amount at the time). (e) The Company will not at any time during the Term of the Agreement or on the End Date, convert any unspent Reward Amount to cash or other entitlements or benefits for the Customer. (f) Both the Prepayment Amount and the Reward Amount must be spent by the Customer prior to the End Date. Any unspent Reward Amount as at the End Date shall be forfeited by the Customer to the Company and not rolled over into any subsequent Agreement, and any unspent Prepayment Amount is not refundable to the Customer in whole or in part.

This Product Ruling is made on the basis of the following necessary assumptions: (a) The Customer is an Australian resident for taxation purposes. (b) The Customer is a small business entity as defined in section 328-110 of the ITAA 1997. (c) The Customer is carrying on their farming business with a purpose of producing assessable income in excess of its deductible expenditure. (d) The Customer has not chosen to apply section 82KZMD to the expenditure incurred under the Agreement. (e) The Prepayment Amount is not 'excluded expenditure' as defined in subsection 82KZL(1). (f) The scheme will be executed in the manner described in the Agreement and in the Scheme section of this Product Ruling. (g) All dealings between the Customer, the Company and Ruralco will be at arm's length.

A loss or outgoing is deductible under section 8-1 of the ITAA 1997 if it is necessarily incurred in carrying on a business for the purpose of gaining or producing a taxpayer's assessable income. The expenditure must be part of the cost of trading operations and must not be of a capital, private or domestic nature.

Upon entry into the Agreement the Prepayment Amount is both immediately due and non-refundable such that the Customer becomes definitively committed to, and incurs, the Prepayment Amount. As the Prepayment Amount is incurred for the purchase of Goods to be used in the Customer's farming business, it constitutes expenditure which is clearly appropriate from the point of view of the pursuit of the business ends of the Customer's business and is therefore 'necessarily incurred' in the carrying on of that business. The deduction for the Prepayment Amount is allowable under section 8-1 of the ITAA 1997 in the income year the payment is made to the Company (that is, at the time it is necessarily incurred).

Subject to paragraph 24 of this Product Ruling, section 82KZM operates to spread over more than one income year a deduction which, apart from that section, would be allowable under section 8-1 of the ITAA 1997 for the year of income in which the prepaid expenditure (other than excluded expenditure as defined in subsection 82KZL(1)) is incurred under an agreement by a taxpayer that is either: • a small business entity for the year of income that has not chosen to apply section 82KZMD to the expenditure, or • an individual that has not incurred the expenditure in carrying on a business.

Section 82KZM applies if the eligible service period for the expenditure is longer than 12 months, or the eligible service period for the expenditure is 12 months or shorter but ends after the last day of the year of income after the one in which the expenditure was incurred.

In relation to the Prepayment Amount incurred by the Customer under the Agreement, the eligible service period for the purpose of section 82KZM is the period to which the Prepayment Amount relates. That period is: • from the first day of the Agreement (the Payment Date), being the day on which the thing to be done under the Agreement in return for the Prepayment Amount (that is, the purchase of Goods from the Company and the calculation of the Reward Amount to be offset against the price paid for Goods under the circumstances set out in paragraph 19(d) of this Product Ruling) is required or permitted (as the case may be) to commence being done, and • until the last day of the Agreement (the End Date), being the day on which the thing to be done under the Agreement in return for the Prepayment Amount is required or permitted (as the case may be) to cease being done.

The eligible service period in relation to the deductible Prepayment Amount under the Agreement is, pursuant to paragraph 24 of this Product Ruling, 11 months or less. As it is not more than 12 months and does not end after the last day of the year of income after the one in which the expenditure was incurred, section 82KZM will have no application to Customers who (as assumed at paragraph 20 of this Product Ruling) are a small business entity for the year of income and have not chosen to apply section 82KZMD to the expenditure.

Provided that the scheme ruled on is entered into and carried out in the manner described in this Ruling, it is accepted that the scheme is an ordinary commercial transaction and Part IVA will not apply.

The following is a detailed contents list for this Ruling: Paragraph What this Ruling is about 1 Class of entities 4 Superannuation Industry (Supervision) Act 1993 7 Qualifications 8 Date of effect 10 Changes in the law 12 Note to promoters and advisers 14 Ruling 15 Scheme 16 Overview 18 Assumptions 20 Appendix 1 - Explanation 21 Section 8-1 - deductibility of the Prepayment Amount 21 Sections 82KZM - prepaid expenditure incurred by certain small business entities and individuals incurring non-business expenditure 23 Part IVA - anti-avoidance 27 Appendix 2 - Detailed contents list 28