In
response to an invitation by the Senate Economics Committee chaired by Sam
Dastyari (with members including Nick Xenophon Bill Heffernan and Peter
Whish-Wilson) to make a submission to their inquiry looking at forestry MISs the
following brief overview of what happened during the MIS debacle was submitted.
Problems
with MIS have been written about for a few years but with the dust almost settled
following insolvency of the three MIS companies which operated in Tasmania (Gunns FEA and Great Southern) which represented
about 50% of the total national MIS
scene, it was important to explain that the aftermath is of Hiroshima
proportions and needs remedial action lest travesties reoccur in the future..
Contents
Issues
1.
Motivation and drivers
2.
How much was lost?
3.
Reasons for failure-the product
4.
Reasons for failure-the model
5.
ATO’s role
6.
ASIC’s role
7.
Yields
8.
Overview of past MISs
9.
Is div 394 the answer?
10. What
now?
Appendix: MIS wind
up notes for Great Southern, Gunns and FEA
Terms of reference
1. Motivation and drivers
a. The wind
up of insolvent MIS companies has revealed the incredible complexities of MIS structures.
Pooling funds from investors is usually more easily achieved with either a
company or a commercial trust. The only reason the current MIS structure was
chosen was to enable growers to get a tax deduction for their upfront investment.
b. Investors
obliged. There is little doubt in my view that most growers bought tax
deductions rather than trees. Future revenue would always exceed the after tax
cost of the trees, so it was said. It was a no brainer especially if MIS
companies arranged 100% finance.
c. From
the MIS companies’ viewpoint upfront payments provided immense cash flow
advantages, in effect outsourcing borrowings to willing growers? Well
remunerated sales teams assisted getting money in the door.
2. How much was lost?
With
windups nearing completion it is possible to survey the aftermath of the three
MIS companies active in Tasmania viz Great Southern, Gunns and FEA. (NB only a
small % of Great Southern’s plantations were in Tasmania).
The
3 companies represented roughly one half of the national MIS forestry sector (Timbercorp
and Willmott Forests were the largest of the remainder).
· Total
MIS area planted 355,000 hectares
· Cost to
growers $2.7 billion
· Tax
expenditure by government (ie tax refunds to investors) $1.08 billion
· Estimated
return to growers $70 million
Private
grower losses were therefore approx $1.55 billion. Plus interest on grower
loans.
Double
that for the whole MIS forestry sector.
The
following table contains the estimates for the 3 MIS companies.
Great
Southern
|
Gunns
|
FEA
|
Total
|
|
Area planted ('000 hectares)
|
179
|
106
|
70
|
355
|
Cost to growers ($ million)
|
1,600
|
650
|
450
|
2,700
|
Return to growers ($ million)
|
35
|
35
|
0
|
70
|
Tax expenditure ($ million)
|
640
|
260
|
180
|
1,080
|
Of
the grower contributions of $2.7 billion to the 3 MIS companies:
· $270
million was paid as commissions to financial planners and spruikers.
· $300
million was paid to shareholders (including hybrid holders). (This is an
estimated figure. Great Southern alone paid $213 million but it was involved in
other agricultural MISs as well).
· $700
million was paid for tree establishment.
Growers
will end up with a return of $70 million (before tax).
It’s
difficult to see how this can be construed as sound public policy, made even
worse by the fact that foreign interests have now acquired assets, heavily
subsidised by Australian taxpayers, at fire sale prices.
A
brief thumb nail sketch of each of the three MIS companies as they proceeded
through the wind up process can be found below in the Appendix.
3. Reasons for failure-the
product
a. Lots of
circumstances have been advanced. Para 62 of the ASIC submission lists 13 circumstances
which coincided and in some case contributed. Conspicuously absent from the
list was the principal reason: the yields
from crops planted over a 15 years period from 1994 were, on average,
only about 60% of what was predicted by the respective PDS.
b. Price
increases failed to eventuate as predicted. Instead wood fibre followed the
pattern experienced by every other bulk commodity over time where real price
decreases are the norm.
c. MISs
principally failed because they were duds.
4. Reasons for failure-the model
a. In most
instances the deferred fee model was used with varying upfront payments
combined with varying commissions at harvest time.
b. Only a
small portion was spent on tree establishment.
c. Much of
the remainder was lent by the RE to the parent company.
d. Ongoing
costs required funds from the parent. These were greater than expected leading
to cash flow problems.
a. The underestimation of ongoing costs was
highlighted when Gunns assumed management of Great Southern’s MISs. The
constitutions for each scheme were amended to increase the harvest commission
by approx 5% points for each estimated year until harvest. In order words the
newest project due to be harvested in 9 years time ended up with a harvest
commission of over 50%.. Growers can’t make money on that basis.
e. New sales
were continually required to replenish the cash tin.
f. Back up
cash inflow came from so called annuity income from growers repaying loans. But
loan defaults increased over time and cash inflow slowed. Loans were
securitised (bundled up) and sold often at a discount. It was a vulnerable
model.
5. ATO’s role
b. The ATO
was always insistent, correctly so, that a Product Ruling was not an
endorsement of the product stating that the Scheme needed to be conducted in
accordance with the PDS.
c. There’s
a common misconception that once the ATO grants primary producer status to an
activity, expenses incurred thereafter are fully deductible.
d. This is
not so. Whether or not a taxpayer is conducting a business of primary
production with say 1/3rd of a hectare of trees, may vary from year
to year. It’s a test that needs to be satisfied each year. The ATO just wasn’t
equipped for the task. Trees may have been planted but in a lot of instances it
was plain at an early stage that predicted yields would never eventuate due to inappropriate
siting and management neglect. In these instances it is impossible to conclude
a business of primary production was being conducted.
e. Taxpayers
can satisfy the non-commercial loss provisions of the Tax Act by having
turnover of $20,000 in a year. Forest growers get an exemption because of the
long lead time with plantations. They do not even have to satisfy the turnover test,
or be reasonably expected to do so, in the year of harvest. It may be within
the letter of the law but certainly not within the spirit of the law as it
applies to other taxpayers.
f. There
is little doubt that many upfront payments contained prepayments (rent etc)
because the deferred fee at harvest time was woefully inadequate to cover all
post establishment ongoing costs. Prepayments that relate to more than 13
months hence are generally not allowable deductions.
g. Growers
were supposedly allocated a specific woodlot(s). What happened when the
allocated woodlot failed? Was the grower still conducting a business with a
failed woodlot? Was he/she allocated another woodlot? Was he/she informed? Or
did the system gradually break down? Did ATO ever check? How rigorous was the
checking that MISs were conducted in accordance with the PDS as required by
each Product Ruling?
h. It was
highly contrived commercially unrealistic nonsense to continue the pretence
that growers were conducting businesses of growing trees each with a specific
woodlot(s).
i. The MIS
industry weren’t happy with the ATO’s Ruling TR 2007/D2 but at least it gave
broader currency to the problems of the MIS industry which were being ignored
and swept under the carpet by many in the industry. It was a strategic triumph
for sensible public policy which was meandering after the inconclusive (at that
stage) Treasury inquiry into MISs.
6. ASIC’s role
a. There
was general community perceptions that were MIS companies involved in
misleading or deceptive conduct, ASIC as regulator would act.
b. ASIC
was untroubled by the fact that the predicted yield of Great Southern’s 1994
crop harvested in 2005 yielded only 123 tonnes per hectare when 250 tonnes were
predicted and were satisfied that reasonable grounds probably existed for
subsequent PDS statements to continue predicting yields of 250 tonnes.
c. In
response to a clear pattern of Ponzi like behaviour when returns to growers in
early Great Southern Schemes were propped up by funds from new investors a
complaint was lodged with ASIC. ASIC responded that a general indication of a
Ponzi scheme is a lack of assets which wasn’t the case with Great Southern. On
that basis Bernie Madoff would still be a free man.
d. ASIC
adopted a strictly legalistic view of the world which was never going to
identify errant behaviour as investors, maybe unrealistically, expected. Monitoring
form rather than substance was a pointless exercise with MISs.
7. Yields
a. There
were always ready excuses for poor yields from the early MISs harvested from
2005 onwards.
b. An
article in The Australian in April 2007 drew attention to Great Southern’s poor
yields and Ponzi like behaviour in propping up returns to early growers.
c. The most
telling admission of poor yields was an August 2008 ASX announcement by Great
Southern as part of Project Transform designed to swap growers’ trees for Great
Southern shares, with the aim that harvest proceeds would go 100% to Great
Southern rather than simply the harvest commission of 5.5%. All other sources
of cash had dried up and this was the only solution to try and forestall cash
flow doom.
d. Projected
yields for 55,000 hectares of trees from the 1998 to 2004 crops were predicted
to be only 160 tonnes per hectare compared with PDS predictions of 250 tonnes.
e. Crucially
however was the revelation that harvest yields could be reliably predicted
after 4 years. This meant there was sufficient certainty from an income recognition
viewpoint for Great Southern to book future harvest commission, possibly six years
hence, as income This boosted net assets and no doubt convinced ASIC it wasn’t
carrying on a Ponzi scheme!
f. Gunns
used the same technique. When it assumed control of Great Southern’s MIS
Schemes paying only about $8 million for a few minor assets, it immediately
booked $68 million in income from future harvest commissions. Two years later
the certainty principle recorded future MIS obligations as a liability after
prices collapsed. Shortly thereafter Gunns collapsed.
g. If
there was sufficient certainty that yields could be predicted after 4 years,
enough to bring future commissions to account, the impending MIS crisis should
have been obvious to insiders well before, particularly to foresters responsible
for site selection. These same foresters however never wavered from their
assessment that 250 tonnes was reasonably achievable despite overwhelming
evidence to the contrary based on past actuals.
h. Liquidators
look for signs of insolvent trading and voidable contracts but what about who
knew what and when about yields? There are plenty of disgruntled investors that
deserve an answer.
i. Earlier
and more widespread dissemination about poor yields would have been enough to dissuade
many investors.
j.
The administrators who assumed management
of MISs after MIS companies became insolvent have been even more remiss in
reporting to growers about crops yields. Growers have been forced to make
decisions with inadequate knowledge and taxpayers and policy makers may have to
make decisions regarding future MISs in the absence of crucial information
about what happened this time.
8. Overview of past MISs
a. The complexity
of MISs made regulation much harder and as a consequence too much was
overlooked. Investor/growers’ faith in regulators was misplaced. However it
wasn’t all the regulators’ fault. The system was designed by lawyers. The realities
of the commercial world and farming in
particular soon revealed the flaws.
b. The amount
of leakage of funds to spruikers, hangers on and shareholders relative to the
actual cost of tree establishment has meant the avowed aim of more plantations
has come at a very high price.
c. It
wasn’t driven by demand for timber but rather demand for tax deductions which
far exceeded the supply of suitable sites to grow timber and achieve the
predictions of the PDSs.
d. Revelation
of poor growth rates, underestimation of ongoing costs and reckless management
predicated on an inexhaustible supply on new growers coincided with the GFC.
e. Parent
companies took over the woodlots of early loan defaulters, and became the
biggest woodlot owners in most projects. It is not known whether the early
defaulters were pursued with the same vigour as the later recalitrants.
f. MIS
schemes should be properly seen as another manifestation of the excesses
leading up to the GFC. Similar to, perhaps even a sub-set of, the Macquarie
model where infrastructure assets were packaged with management fees sufficient
to choke a hippopotamus and floated off to eager investors, so too were MIS
trees packaged with leased land and inflated management fees and sold off to
grower/investors.
g. MISs was
always bad public policy if allocating resources in an efficient way to grow
trees was the aim. Grower losses exacerbated by MIS complexities and falling
prices surely is the final nail in the coffin. It’s a model that needs to be
assigned to the history bin. It shouldn’t be given legislative encouragement. It’s
beyond redemption.
9. Is div 394 the answer?
a. There
is no longer a need for grower/investors to satisfy the standard Tax Act
requirement for deductibility viz to be carrying on a business.
b. Instead
deductibility requires satisfaction of the 70% DFE rule ie that 70% of the
upfront fee is used for direct forestry expenses, eg establishment, growing ,
harvesting, the lot, even prepaid expenses, a provision not available to other
taxpayers.
c. There
is nothing in the new division that will overcome the problems we have just witnessed.
d. If
anything the problems will be exacerbated, with upfront fees as high as $66,000
per hectare ( see detailed analysis The MIS Phoenix ).
e. Div 394
is not the answer.
10. What now?
a. It must
be remembered that the immediate deductibility for plantation tree
establishment gives growers an advantage over horticultural tree growers who
can only write off tree establishment over a period as provided by Div 40 of
the Tax Act.
b. If
vehicles to pool investors funds are needed for trees there is a need to
greatly simplify structures to make them easier to administer, more
understandable and easier to quit at any stage with a secondary market
mechanism with full and transparent disclosure about yields and prices.
c. Companies
are easier to understand than complex MIS structures and much easier to
administer regulate and wind up. Getting money out of companies can be easy;
franked and unfranked dividends, share buybacks and reductions. Cooperative
companies are even able to deduct unfranked dividends.
d. On the
other side it would be an easy matter to allow initial contributions to be tax
deductible if it were deemed necessary for sensible public policy, provided
prepayments were outlawed. These distort resource allocation.
e.
There was a recommendation of the 2005
Treasury inquiry into MIS schemes that deductibility
should also be conditional on the certification to ensure best practice in forestry,
regional planning, land use and natural resource management, under arrangements
to be developed. That seemed a sensible idea and one that would have limited
some of the excesses which inevitably flowed from the open ended nature of the
past system.
f.
A well informed
secondary market would have helped overcome some of the regulatory failures by
transmitting price signals that all was
not well long before the 2009 collapses
g.
Of the 800,000
hectares of MISs, roughly 1/3rd will be replanted, 1/3rd has
or will fall by the wayside. The jury is still out on the remaining 1/3rd.
At current wood fibre prices there are few if any plantations where the crop
value exceeds the remediation cost for return to pasture. This is the dilemma
facing landowners, former lessors to MIS companies with trees on their
properties. The recent FEA sale highlights that 10 year old trees are worth
less than remediation costs. Underlying land is worth less that the purchase
price 10 to 15 years ago. A few made money on the merry go round, but not many.
APPENDIX
MIS wind up notes -Great
Southern
Great
Southern operated agricultural MISs, two thirds of which were forestry schemes.
From
1994 to 2009 GSL planted 179,000 hectares of MIS plantations, at a cost to
investors of approx. $1.6 billion (excluding GST).The majority was on GSL’s
land, some was on leased land.
Gunns
took over 9 GSL MIS schemes (the 1998 to 2006 Schemes) after GSL went under
.When PPB Advisory was appointed as administrator by Gunns, it was managing
119,000 hectares of GSL schemes.
Growers
received proceeds from the 1994 to 1997 Schemes. These were relatively small in
total. The 2007 and 2008 Schemes were abandoned as they were completely non
viable when GSL became insolvent.
New
Forests ( as managers) having already acquired 279,000 hectares of GSL land from liquidator McGrath Nicol for $415 million in
2009, acquired the MIS trees on that land in 2014 for $38.5 million from PPB
Advisory after Gunns folded. After fees to insolvency practitioners and
advisors, growers might get to share $28 million.
Add
the proceeds of the 1994 to 1997 crops gives total grower proceeds of about $35
million, compared to the initial outlay of $1.6 billion.
Tax
expenditure by the government on GSL MIS Schemes, assuming a 40% marginal tax
rate by growers, was $640 million.
Yields
(estimated and actual) for a 10 year GSL crop averaged 160 tonnes per hectare
when 250 tonnes was the PDS prediction.
The
only growers who got their money back were the early growers, 1994 (yield 123
tonne per hectare), 1995 (163 tonne) and 1996 (197 tonnes) but this required
the interposing of a GSL subsidiary to
acquire the crops at grossly inflated prices in order to keep faith with
investors so new funds would keep rolling in.
MIS wind up notes -Gunns
Gunns
was originally a native forest sawmiller but expanded to become an export
woodchipper of native forests, and for a brief time the nation’s biggest
integrated timber business with softwood plantations and sawmills as well.
Gunns grew its own hardwood plantations as well as MISs.
Gunns
planted 106,000 hectares of MIS crops, via 9 Schemes from 2000 to 2009, half on
its own land and half on land leased from third parties. Growers paid an
estimated $650 million.
Gunns’
Receivers Korda Mentha recently sold all Gunns’ Tasmanian plantation estate
including freehold land, Gunns’ own trees and 54,000 hectares of MIS trees belonging
to the 2002 to 2009 Schemes growing on
its land, to New Forests.
The
proportion of the sale proceeds to be split with MIS is $40 million. Fees will
reduce the figure to $30 million.
The
2000 and 2001 Schemes are proceeding to harvest with a new RE and might return
$4 million to growers.
Only
a few weeks ago a further 1,500 hectares of softwood MIS in Tumbarumba NSW was
sold which will return another $1.5 million before fees.
MIS
crops growing on leased land are unlikely to realise any value. At best, leases
will be cancelled and landowners will take over the trees in return for
agreeing not to pursue legal action for any contractual breaches.
All
up growers might get $35 million after outlaying $650 million. The cost to government
was approx $260 million.
The
yields from Gunns’ MISs are not known but are believed to average around 160
tonne per hectare for a 10 year crop, similar to GSL. Forestry consultants URS
acting for Gunns’ Liquidator noted in correspondence that Gunns had not
maintained its inventory program and most of its yield estimates were based on
site quality assessments at the time of establishment.
MIS wind up notes-FEA
FEA’s
business was MIS plantations. Towards the end it built a state of the art
sawmill but was dragged down by the failure of MISs.
FEA
planted about 70,000 hectares of MIS plantations from 1993 to 2009, some on
leased land, the majority in Tasmania but later in NSW and Queensland.
Early
crops were profitable but tiny in size.
FEA
appointed BRI Ferrier as Administrator in 2009. At the same time the banks
appointed Deloitte to act as Receivers to take control of secured assets.
When
the Receiver finally sold 98,000 hectares of land growing 46,000 hectares of MIS
plantations with an average age of at least 10 years to Alabama based Resources
Management Services LLC for only $125 million there was a feeling of disbelief
that prices had plummeted to such disastrously low levels.
The
amount to be split to growers is not known at this stage but based on GSL and
Gunns split ups growers will be lucky to get $20 million. Payments to the
insolvency firms and preferential reimbursements to growers who have made
voluntary payments to help BRI Ferrier fund continuing MIS expenses will mean
that growers who paid $450 million for their trees will be lucky to get anything.
The
cost to government has been about $180 million.
Note: The cost to government used above is
the tax expenditures resulting from the deductibility of growers’ up front
contributions. MIS companies were enormously profitable during the boom days
and paid tax accordingly, as did others who shared the spoils. These latter
amounts probably halved the total cost to government.
Committee terms of reference
The structure and development of forestry managed investment schemes
(MIS), including:
a. the motivation and drivers that
established the framework for the schemes initially;
b. the role of governments in
administering and regulating forestry MIS;
c. the current policy and regulatory
framework of forestry MIS;
d. the role of some in the financial
services industry in promoting and selling forestry MIS;
e. compensation arrangements for small
investors in forestry MIS who have lost life savings and their homes in the
face of the collapse of forestry MIS;
f. the burden on farmers and other
agricultural producers who have been left with the uncertainty of timber
plantations linked to forestry MIS on their land;
g. the options for reforming forestry MIS
to protect investors and rural communities;
h. any other related matters.
All submissions
to the Senate inquiry can be found HERE
Excellent overview John. The entire mess appeared to be created by greedy forestry interests who wanted everything biased to their interests. I cannot understand why the governments were so compliant unless their public service superannuation schemes were part of the nudge'nudge arrangements.
ReplyDeleteThank you for sharing your thoughts. I really appreciate your efforts and
ReplyDeleteI will be waiting for your next write ups thanks
once again.