Wednesday, 24 May 2006

Consultation on taxation of plantation forestry

I am writing in response to the invitation to comment on the proposed forestry arrangements attached to the press release of the Assistant Treasurer on 9thMay 2006. ( reproduced below).

It’s a little disappointing that the Government didn’t release a copy of the review submitted to Government and referred to in the Minister’s press release. It would make the whole review process a little more transparent if we could see a copy of the review findings. The review was not simply about MIS schemes, it was supposed to cover much wider issues including whether the current tax regime impeded longer rotation sawlog crops. What happened to that part of the review? Or is it covered in the proposed arrangement to develop standards for best practice in forestry, regional planning, land use and natural resource planning? Sounds awfully like a motherhood statement. One can only agree that best practice is a good idea, but are sawlog crops going to be encouraged or will they just have to take pot luck behind the short term aspirations of most MIS plantation investors and hell, why not just let the market sort it out. Maybe that is the best solution, so long as MIS investors aren’t provided with too many tax breaks unavailable to others.

I agree with the removal of the need to maintain the legal fiction that a MIS investor is carrying on a business. A person living on the North Shore who is allocated maybe only 1/3rd of a hectare in seedlings in some distant part of the country is no more carrying on a business than I was with my stamp collection as an eight year old. To maintain the fiction it only took a Constitution, a Lease or Forest Right Agreement with the Responsible Entity, a Compliance Plan, a Plantation Management Agreement, a Lease with the Landlord and possibly a Loan Deed. With all those agreements you’ve just got to be carrying on a business! A little bit of integrity may be restored to the Tax Act if we are no longer insulted by seeing the bar set so low with regard to the deductibility of expenses.

Also there will no longer be a need to seek the Commissioner’s discretion in order to claim plantation establishment costs pursuant to the non commercial loss provisions. This too was making a joke of the Tax Act. The harvest proceeds didn’t even have to meet the objective test ($20,000) that other taxpayers face under the non-commercial loss provisions. MIS investors only had to make a profit in the harvest year

So what is being proposed with removal of the need to be carrying on a business? Will MIS investors simply rely on the other provisions of Div 8-1(that an outgoing to be deductible is incurred in gaining assessable income)? This would be a good solution because there are the fall back clauses in Div 8-1(2) which disallow outgoings of a capital nature and also outgoings denied deductibility under other sections of the Act such as certain prepayments.

Or will reliance be placed on Div 8-5 which allows for specific deductions elsewhere in the Act, and then proceed to introduce new clauses to cover MIS deductions. If this latter approach is followed, then any deductions have to specifically exclude amounts that could be reasonably expected to be capital payments or prepayments such as rent.

What is the basis for selecting a cap of $6,500 per hectare for deductible expenditure in the first year with the balance deductible in the following year? I don’t think the cap achieves much. It seems a little arbitrary. More crucially is the need for the Commissioner to be able to determine, despite any agreement to the contrary, whether an outgoing contains a capital component or a component of prepaid rent, rather than give MIS investors carte blanche approval for all MIS claims provided they’re spread over at least 2 financial years. Allowing the Commissioner to determine whether an outgoing contains a capital or other component is perfectly consistent with the way other taxpayers are treated.

Take an old Tax Ruling (IT 209) for example written in very reader friendly form.

Taxpayers there tried to claim lease payments on farm sheds over a 4 to 5 year period. The sheds had a residual value of only 10% at the end of the lease. The Commissioner simply ruled that

“the agreements, despite their form, would not be considered lease agreements but a form of sale of the building on deferred payment terms.”

Also take a much more recent ruling (TR 2006/2) where Commissioner ruled on the deductibility of certain outgoings that

”It is not for the Commissioner to decide how much a taxpayer ought to spend in obtaining their income; it is only for the Commissioner to determine, as a question of fact, how much the taxpayer has spent…………………If, however, a broader inquiry is undertaken and it is determined that the expenditure was in fact incurred partly or wholly in the pursuit of an independent advantage then, to that extent, based on a fair and reasonable apportionment, the expenditure will not be deductible.”

In other words the Commissioner should be able to determine if an amount is fully deductible, in the case of an establishment fee, if it contains a capital component or if it contains rent or other prepayments.”

Most MIS investors pay rent at harvest time, say 2.5% of the net harvest proceeds. With 250 tonne per hectare at say $20 per tonne net, this only gives a total rent of $125 over a 12 year period. Doesn’t seem much for land that may be worth $7,500 per hectare. It’s only $10 pa. Even if net proceeds were double it’s still an inadequate rental return.

Forest companies also enter into lease arrangements with landowners and plant their own trees. Rents are struck at 8% of land value indexed over the term of the lease.

Less common are share farming arrangements entered into with landowners where forest companies plant the crop, the landowner supplies the land and the crop proceeds are split 65:35. These arrangements seemed to have gone out of favour lately, landowners preferring a simpler and more certain 8 % return.

Forest companies and their supporters often trumpet that the establishment fees do not contain any amount for the purchase of land. As recently as 19th May in a letter to the Tasmanian Country the Minister for Fisheries Forestry and Conservation claimed that the review that resulted in the current proposals ”found no evidence that the companies were using investors’ funds to purchase land”.Naturally we have to take the Minister’s word about the findings of the review because we haven’t seen a copy. I’m willing to accept it is true but only in a very narrow legalistic sense. OK so the investors’ funds go into a bank account and are used to pay establishment costs and other running costs of the Manager or Responsible Entity or whoever and then they pay some tax and then they get mixed up with previous years retained earnings and other debt and equity amounts, whereas the land purchases are made by a separate land owning entity, so on no account can it ever be shown that investor’s funds were used to purchase land.. The assertion is nonsense. What is almost certainly true is that establishment fees contain a large element of prepaid rent and the resulting retained earnings are used at some stage by companies in the same group for further business expansion that includes the purchase of land.

So it is crucial that prepaid rent be excluded from establishment costs in determining the immediately deductible amount. If it’s deductible then allow the deduction in full in the first year. Staggering it over 2 years doesn’t seem to have much merit.

We know that the market rent on land suitable for forestry is 8% pa and that plant establishment costs for a forest company are approximately $2,000 per hectare then if an investor pays $10,000 per hectare for seedlings, expected to be harvested in 12 years time on land worth $7,500 per hectare then the break-up of the establishment fee from the forest company’s perspective is roughly $7,200 for rent, $2000 to cover plantation costs and $800 profit. Seems fair to me. From the investor’s viewpoint, $3,400 is deductible in the first year with the balance being prepaid rent being deductible over the remaining 11 years.

The Commissioner can issue guidelines as to what he regards as a reasonable basis to determine the prepaid rent component. I think this is preferable to putting an arbitrary cap of $6,500 in the first year. And boutique schemes such as sandalwood will not require special treatment. Once the prepaid rent is excluded the balance is deductible in full immediately.

The secondary market for MIS investments is a sensible idea. But why do MIS investors have to wait four years? Why not from Year 2 onwards? If the market has a role at all then let them become involved as soon as possible. The price signals that will be transmitted back to other potential investors will only help them make informed decisions. This will help overcome to a certain extent what I would regard as a critical lack of pertinent information for such people.

Secondary market disposals to associates, however, should be prohibited and the usual anti avoidance measures should be put in place to ensure this provision is not circumvented. If the prohibition is not instituted then the Government runs a real risk of receiving very little tax at harvest time. Most MIS investors would have the wherewithal to run a DIY super fund and a family trust. With all the changes since 1st July 2005 not to mention the recently announced Plan to Simplify and Streamline Superannuation, income from segregated pension assets can easily be tax free once a member turns 55. And if a person is under 55, then I am sure income could be streamed out of a family trust to a much lower rate taxpayer, a spouse, kids at university etc. The Revenue would suffer.

But aren’t there restrictions from transferring assets from members to their DIY Funds. Yes there are but there are exemptions that could be exploited. If a lawyer can create the legal fiction via six documents that a person owning a few seedlings is carrying on a business, he could easily arrange to transfer a MIS interest to an exempt or low rate taxpayer and that seems contrary to the intent of the proposals which is to treat all returns to the investor as assessable income.

It is highly likely that the actual legal interest held by the MIS investor will alter if the proposals are accepted in anything like their current form. I presume that a MIS interest will have to be defined in the Act. It should be such to ensure that all returns to an interest holder are counted as assessable income. Attempts to staple or attach other entitlements such as options or other derivatives with the aim altering the nature of the harvest receipts should be prohibited.

I understand that the need to allow for seasonal conditions etc is the reason behind the extension from 12 to 18 months for the period within which planting must occur. But as a quid pro quo, when defining a MIS investor and a MIS scheme (including the minimum standards) in the Tax Act, I think as part of the standards, a MIS PDS should be required to set out the actual land areas that the Promoter intends to plant. He doesn’t have to acquire the land he could merely take out an option to acquire it on the condition that sufficient subscription monies are forthcoming. As it happens now, the PDS often just refers to the maximum number of hectares in anything up to 3 different States. Not much information for an informed investor. Then when the subscription monies are on the way, the forest companies traipse round the countryside, at times rampage round the countryside, buying farms to plant. (Carefully avoiding of course using any current subscription monies, other monies are of course used instead) It is highly disruptive and traumatic for rural communities to have forest companies with enough cash to buy the entire landscape, sweeping through their neighbourhoods causing complete havoc. Details of the land certified by the Department of Agriculture Fisheries and Forestry needs included in the PDS. Then they can have 18 months to plant; let them have 2 years if they want.

The certification procedure needs to cover a range of matters some of which are arguably outside the Department’s area of expertise, areas such as local government planning, salinity and hydrology questions, flora and fauna protection, and the social effects to name a few. Even investors need more protection than has been forthcoming from ASIC. Not only that, but where limited expertise is being used to arbitrate on matters where there are inevitable conflicts of interest between stakeholders, the process has less chance of gaining widespread acceptance. Community angst will continue. The certification process needs to include experts other than just from one department in Canberra if community interests are to be fully represented.

I think the move to treat MIS investors as passive investors reflects reality. Presumably this means they can’t access the primary industry concessions available in the Tax Act. This is sensible. Access to the concessions will probably change anyway if the legal interest of the MIS investor changes from the current one of a Grower owning a Woodlot on leased land to a passive investor with a share, unit, or some other interest. And I think being passive investors rather than primary producers will make it a little easier for the community to extract a more equitable share of rates and land taxes from the absent and largely disinterested participants in what is essentially an attempt to avoid income tax.

The superannuation Plan announced in the Budget makes super more attractive for most people. In terms of deductible contributions people under 50 will be able to put more into super, $50,000 pa. Those over 50 will have a five year transitional period to maintain deductible contributions at $100,000 pa so most will not be adversely affected. Once in a super fund a Trustee can decide where to invest the monies. If short rotation forest crops can produce an adequate rate of return then so be it. And remember that an investment in a MIS will under the current proposals, be tax deductible, thereby reducing the net tax paid as a result of the contribution and subsequent investment into an MIS to nil, if the whole subscription amount is deductible. It can’t get much better than that. The focus will then be on an assessment of expected returns rather than on the immediate tax deduction. This can only assist sensible investment decisions. I think the super Plan should be the benchmark to assess proposals like the current MIS ones. The Government has produced a pretty reasonable plan to simplify and streamline retirement savings. I fail to see why MIS investors should get too much additional help. If a specific industry requires assistance, then the Tax Act is an inappropriate vehicle.

I regard it as important to maintain as much horizontal equity in the tax system as possible .The proposals do, prima facie, give special treatment to MIS investors by creating a new Division in the Tax Act. They will no longer have to run the gauntlet of trying to establish that they are conducting a business. That’s got to be a big step forward for the MIS industry. So it is only reasonable for the community to be able to scrutinise their activities, and in the main the proposals are a good start. The most glaring need is to ensure that otherwise non deductible expenses are excluded from establishment fees. The next need is that there is sufficient diversity amongst those involved in the certification process, and that this process precedes the issue of a PDS rather than the other way around.


In the 2005-06 Budget, the Government announced that it would be extending the operation of the 12 month prepayment rule for forestry managed investment schemes (MIS) until 30 June 2008 and that it would undertake a review of the taxation treatment of plantation forestry.

The Government has now considered the findings of the review and is seeking the views of industry and other interested parties on proposed new taxation arrangements for investments in forestry MIS. The media release announcing the consultation is available from the website of the Minister for Revenue and Assistant Treasurer.

The proposed arrangements are as set out below. The arrangements are designed to remove the uncertainty surrounding whether MIS investments are deductible under the current law in respect of the requirement that investors be carrying on a business. In addition they will reduce the administrative and compliance burden on investors and MIS companies:

·       the 12 month prepayment rule for forestry MIS investors and its associated requirement that investors be carrying on a business would be replaced with new rules in the income tax law governing the deductibility of investments in MIS;

·       forestry MIS investors would be able to deduct the full cost of their investment, subject to a cap of $6,500 per hectare in the year of expenditure, with the balance (if any) of the investor's contribution deductible in the following year;

·       the period within which planting must occur as a condition of deductibility would be extended from 12 months to 18 months;

·       trading in forestry MIS investments acquired after 30 June 2008 would be allowed such that:

·       interests are required to be held by initial investors for a period of four years from the date of entering the arrangement for deductions to be maintained;

·       all returns to an investor treated as assessable income; and

·       the cost of acquiring a MIS interest on the secondary market to be deductible against income received at disposal or harvest.

·       deductibility would also be conditional on the certification of the MIS company to ensure best practice in forestry, regional planning, land use and natural resource management, under arrangements to be developed by the Department of Agriculture, Fisheries and Forestry;

·       in recognition that there are higher costs associated with boutique forestry schemes, such as sandalwood, an appropriate treatment for such schemes is to be considered in consultation; and

·       the administration of the goods and services tax (GST) for MIS arrangements would be simplified, by ensuring that individual investors in a MIS are treated as passive investors for GST purposes (thereby removing them from the GST system), subject to the agreement of the States and Territories.

The proposed taxation arrangements for forestry MIS investors would be fully reviewed in 2011 to examine the appropriateness of the arrangements in the context of the Government's forestry and broader policy objectives.

Interested parties are invited to provide written comments on the forestry taxation arrangements by 14 July 2006 to to the following address:

Review of the Taxation of Plantation Forestry
C/- Department of the Treasury
Langton Crescent

All comments will be treated as public and may be placed on the Treasury's website.

The Government intends to conduct further consultation with industry on the application of the new taxation arrangements to agricultural MIS other than forestry MIS.


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