Ta Ann's exceptional year

2014 was an exceptional year for Ta Ann Tasmania Pty Limited (TAT).

It will  likely be the only time TAT gets to pay Australian income tax.

TAT’s belated annual report for the 2014 calendar year was lodged late in June, two months after TAT’s parent Ta Ann Holdings Berhad P/L filed its return.

TAT’s tax bill for 2014 was only $450,000 so it won’t break the bank.

It’s not only Google and Apple who resort to accounting tricks.TAT too managed to shift almost all the taxable income resulting from recent government handouts of $33.3 million back to Malaysia, the home jurisdiction of the Group.

All the handouts are taxable when received by TAT.

The accounting treatment (as distinct from the tax treatment) of the handouts varies depending on the nature of the payment.

A total of $26 million has been received in two tranches in 2013 and 2014 for surrendering 108,000 tonnes of its 265,000 tonne supply contract for peeler billets from Forestry Tasmania, which was given to it gratis a few years earlier. These amounts are included as revenue and taxed in the year of receipt.

A further amount of $7.3 million received in the 2014 year was paid on the condition that TAT constructed a plywood mill at Smithton.

A mill costing $15 million and capable of producing 48,000 m3 of plywood per annum was the ensuing outcome.

The amount of $7.3 million is in addition to the original grant of $10 million paid to TAT to establish the Southwood and Smithton veneer mills about 8 years ago. These capex grants are treated by TAT as deferred income amounts and amortised (included as income in other words) over the life of the mill(s).

Overall TAT has so far received $43.5 million from governments.

Notwithstanding the accounting treatment of capex grants as deferred income amounts, for tax purposes the amounts are taxable upon receipt.

Ouch.

Tax on $33.3 million at 30 cents in the $ is $10 million.

Shift the profits to Malaysia and only pay 25 cents in the $?

That’s a saving of $1.67 million.

There’s no evidence TAT has ever operated with a view to making profits and paying tax in Australia.

Over the past 6 years sales of veneer have totalled $188 million. In four of those years the product was sold below factory cost. Veneer has been TAT’s only product line, and it has only one customer, the Ta Ann Group’s plywood division in Sarawak.

In addition overheads run at about $5 million per year. There was no way TAT could end up with a positive bottom line.

TAT didn’t even bother to record the value of the tax losses in its financial statements because future profits were unlikely.

By way of explanation tax losses have a value to the extent that they can be offset against future profits thus saving tax of 30 cents in the $ for every $ of losses. This is only relevant if future profits eventuate. Accountants include future tax benefits as an asset on the balance sheet if future profits are likely.

The 2013 year saw the first tranche of $20.3 million compensation for surrendering 108,000 m3 per annum of its native forest veneer billet entitlement from FT.

The unexpected increase in taxable income led to evasive action by TAT.

Past tax losses were derecognised and became available to be carried forward. This was perfectly legitimate.

Then trading losses suddenly ballooned to make space for the extra taxable income.

The cost of sales (before overheads) has been fairly constant over the last 4 years at $335 per m3 (+or - 3%).

But the selling price per m3 suffered an extraordinary drop to $203 per m3.

Given that it takes 3 x m3 of green timber to make 1 x m3 of hardwood veneer our native forests were being exported at firewood prices. So much for value adding.

It’s quite revealing to peruse the financial statements for 2013. In that year there was little or no change in receivables (amounts owed by the Group) so one expected to see sales as per the cash flow statement to be similar to sales as per the P&L statement.  TAT however saw fit to make a reduction of $8 million to the latter sales figure, by reclassifying half the sales as a loan from the Group.

The fall in the intra group selling price from $365 per m3 in 2011 to $203 per m3 in 2013 in turn led to a reduction in the value of the stock on hand that had grown during 2013 as a result of a fall in plywood sales mainly to Japan.

TAT always seems to be on the end of adverse foreign exchange movements which contributed to further losses. Presumably, given intra group sales are all with one entity in the Group, any foreign exchange losses by TAT will coincide with foreign exchange gains by the related entity?

The tragic fall in selling prices and inventory value plus the foreign exchange losses created sufficient current year losses which together with past losses carried forward managed to offset the $20.3 million worth of government handouts in 2013.

Plus a little left over to carry forward to 2014.

Some of TAT’s extra cash was used to restock TAT’s wine cellar with 500 cases of wine from a Castle Forbes Bay vineyard owned by TAT’s resident director Evan Rolley, coincidentally CEO of FT when TAT finalised the peeler billet contract in 2006, the partial surrender of which led to TAT’s temporary embarrassment of riches.

Entertaining bankers, investors and customers is often used as a rationale for uncorking a bottle, but TAT was a company with no bank loans, one customer and only two shareholders, all part of the same Group in a country where temperance is more widespread than here in Tasmania.

Spending $150,000 on wine (including GST) for entertainment purposes in these circumstances seems an implausible proposition. Maybe Mr Rolley was simply rewarded for his achievements.

TAT’s 2014 veneer production increased slightly, by 4.4% but intra group sales of veneer more than doubled to 97,000 m3 as inventory that had built up in 2013 was sold.

The selling price for TAT’s veneer in 2014 rose by $144 per m3 up to $347 per m3.

Another sales adjustment (downwards) of $5 million helped keep the figure as low as possible. One suspects trying to maintain a ridiculously low transfer price may have attracted ATO scrutiny given the Group’s plywood sales had picked up and the plywood division had returned to profitability.

But it meant that the gross profit (before overheads) for veneer was only $12 per m3.

Overhead expenses, a foreign exchange loss and the carried forward losses from 2013 was almost enough to offset the tax effect of the last tranche of the TFA peeler billet compensation ($5.7 million) and the Smithton plymill handout ($7.3 million).

The resultant taxable income was only $1.5 million. Tax payable was $450,000.

No further performance bonus for Mr Rolley however.

The Smithton plywood mill is yet to commence production but as at the end of calendar year 2014 most of capex appears to have been spent. Capital works under construction was listed at $13.4 million. The initial project cost was stated to be just over $15 million. TAT’s financials confirm $5.5 million worth of plant came from the Group, currently being modified to meet Australian standards.

When considering whether or not the handouts that have been showered upon TAT have been soundly based public policy, it’s important to get TAT in perspective ,as part of a  plywood division which forms part of the Ta Ann Group, and also as part of the local forest industry dealing with FT.

The Group’s net equity at December 2014 was $400 million. In the 2014 year it made $63 million before tax. From a pure accounting perspective that’s a pretty good result.

The plywood division contributed $7.5 million or 12% of the Group’s bottom line after the oil palm division (49%) and logging (39%).

The plywood division only has borrowings of $29 million.

TAT has no external borrowings. In fact during 2014 as it embarked on significant capital expenditure to build the Smithton ply mill and add another 25% to the manufacturing capacity of the plywood division, the division was reducing debt using the proceeds of Australian government handouts.

Quite an achievement, possibly indicating the capex grant for the plywood mill wasn’t needed?

If paying TAT compensation for the partial surrender of a loss making contract is bad enough, then a capex grant being used to reduce division borrowings is stretching matters a bit.

The plywood division’s borrowings are now, in effect, underwritten by FT. Given that 40% of TAT’s peeler billet entitlement was surrendered for $26 million, the remaining entitlement must be worth more than current borrowings of $29 million.

Servicing the borrowings from Tasmanian native forests is an easy matter. Profit shifting is not a difficult task.

Since TAT’s inception, TAT has roughly broken even from a tax viewpoint. Given that $43.5 million in taxable handouts has been received during the period, it is likely that $43.5 million in taxable trading profits has been shifted offshore.

Whoever planned it that way probably earned a performance bonus?

A few years ago FT’s net equity was $400 million. When it agreed to underwrite the Ta Ann Group via long term supply contracts it was larger than the Group.

Now however FT’s net equity is zero, yet it is still underwriting the Group.

Or at least the State government is, FT being insolvent.

Whether FT is receiving deficit funding from the State government, back door transfers from TasNetworks or proceeds from the sale of FT’s hardwood plantations funded by Australian taxpayers, the effect is the same. FT is being propped up by the public purse so that FT can continue to supply TAT its timber entitlement at below cost facilitating profits which are then shifted overseas.

FT’s own data suggest a mill door delivered price for logs at $62 per tonne which means the stumpage return to FT is not much more than $20, not enough to cover wages, overheads, roading and regeneration costs.

More insidious than the cash loss is the gradual erosion of FT’s balance sheet. Some foresters may believe that the forest resource is ecological sustainable but as yet there is nothing to suggest that native forest harvesting as practised by FT is financially sustainable.

Every time TAT is supplied with timber from a clearfelled forest, FT’s balance sheet shrinks. If there was a more than offsetting increase in the assets of the private domestic sector there may be justification. However TAT’s balance sheet will shrink too as it shifts profits overseas. The usual end in these cases is the bottom of a cliff.

Overall the social balance sheet (public and private) keeps shrinking. The saving grace in some eyes is employment but this too fell from 82 to 74 during 2014 despite increased production.

There is little doubt however that the biggest beneficiaries of Australian government largesse has been the Malaysian government which has collected more tax revenue and the Malaysian elites who own the Ta Ann Group.

All this at a time when foreign aid to more deserving cases is being pruned.

Thank you Australia.

A further grant of $200k is expected for the Smithton plywood mill making the total grant $7.5 million. How much value will that add? The Group indicates plywood prices are about US$530 per m3. Let's say AUD$700. Making veneer into plywood may add, let's say $300 per m3. With an annual capacity of 48,000 m3 the additional value may be $15 million. Dairy farmers add $2000 in value for every extra cow. 7,500 cows will add $15 million. That's another 60 workers. Cheese factories another $60 million at least. Why was it deemed to be good public policy to give $7.5 million to TAT to add only $15 million in value each year?

Neither FT nor TAT as presently constituted offers much of a base to rebuild the forest industry.

FT has always been predisposed to enter into third party deals with gay abandon. The contractual arrangements with Gunns for instance. The deal to underwrite the purchase of the Triabunna mill by a highly geared loss maker operated by a couple of bushies was another. The TAT arrangements are yet another.

FT is moral hazard in corporate form par excellence.

The rationale for TAT’s peeler billet contract in the first instance was to provide an alternative outlet for arisings from native forest harvesting....an alternative to woodchipping. In practice the contractual arrangements have driven more harvesting rather than adding value to existing arisings.

The mooted sale of FT’s hardwood plantations may bring temporary cash flow relief but longer term problems will occur as these plantations were earmarked to supply TAT in the future. It’s a problem for FT not TAT. The latter is well protected. The problem for FT and its owner the State Government is to find a way to continue subsidising Ta Ann as contractually required until 2027.

If ever public policy makers need an example of what not to do, then TAT is it.