The professional bodies welcome the opportunity to comment on Draft Taxation Ruling TR 2007/D2 (the draft ruling).
General comments
We note that the draft ruling raises various complex and diverse arguments to justify the view that investor contributions in agricultural managed investment schemes are not deductible under section 8-1 of the Income Tax Assessment Act 1997. As the draft ruling only issued on 11 April 2007 we have not had the opportunity to address all relevant issues canvassed in the ruling given the tight deadline imposed for review.
However, we do make the following general comments:
Certain important aspects of the draft ruling turn upon the question as to what rights constitute scheme property under the Corporations Act. This is a matter which should be the subject of comments from appropriate legal practitioners as we are of the view that it involves complex trust law and corporations law matters. We are concerned by comments in the draft ruling such as paragraph 54 in Appendix 1 where the ATO concludes by saying It would seem to follow therefore, that investors are beneficiaries of a trust for tax purposes (emphasis added).
Irrespective of whether or not participants are regarded as beneficiaries of a trust created under the Corporations Act this does not impact on the tax treatment of amounts incurred by scheme participants. Ultimately it is still necessary to apply well established tests (e.g. Sun Newspapers) to determine whether expenditure is capital or revenue in nature.
There is a significant amount of case law directly relevant to horticultural and forestry schemes on this point. In our view, there is a relatively clear distinction between the circumstances where a fee will be capital (e.g. Vincent, Anderson, Taylor, partly Puzey, Clowes, Milne) or revenue (e.g. partly Puzey, Sleight, Cooke, Lau, Brand) in nature. Applying this case law, fees payable under most MIS projects will be revenue in nature.
Given these observations we recommend that the arguments briefly considered in Appendix 2 - Alternative Views be expanded to more closely detail the above arguments especially given the complexity of the issues involved.
The draft ruling also discusses whether or not a participant in an MIS will be regarded as carrying on a business. We are of the view that in most cases the tax deductibility of MIS project expenditure will not turn on whether or not a participant is carrying on a business. Nevertheless, we note that this issue has been the subject of extensive recent case law and the Commissioner has lost on this point in three consecutive recent full federal court decisions (Puzey, Sleight, Cooke). Accordingly, we submit that the Commissioner should be required to apply the law on this issue as determined by the courts. (see e.g. Commissioner of Taxation v Indooroopilly Children Services [2007] FCAFC 16 ).
The draft ruling apparently applies to both initial and ongoing fees, with the result that for a typical agricultural project, 100 per cent of all fees payable over the life of a project will be non-deductible capital expenditure, but 100 per cent of all harvest proceeds will be assessable income. In our view there is no question that irrespective of the whether or not MIS projects are passive investments, ongoing annual fees will be tax deductible.
We also refer to the Commissioners media release 2007/11 in which he confirmed that he would urgently identify and expedite a test case to clarify the issues associated with such investments, and whether the reconsidered view in the draft ruling should prevail over the long standing ATO tax treatment of such investments as set out in numerous Product rulings issued over the last 10 years. We fully support this issue being judicially clarified whether by way of a test case, or alternatively we support the Commissioner seeking declaratory relief.
Specific comments
We make the following specific comments in respect of the draft ruling:
Paragraph 3 defines the class of entities/scheme potentially subject to the draft ruling. We draw your attention to the last two bullet points listed. In our view the second last point is a subjective characterisation of a management agreement as being a profit share agreement, and not a service agreement which is typically the case. The last point could be seen to imply that since the key attraction is the tax deduction, Part IVA could apply.
Paragraphs 18 to 24 treat investors as beneficiaries of a division 6 trust, (or in some cases as a division 6C trust), or alternatively as being in receipt of property income. We are of the view that more guidance on distinguishing the first two assertions from the last is needed in the draft ruling. In particular, distinguishing division 6C cases from property income cases is important because the primary incidence of tax is different.
Paragraphs 129-135 indicate that, notwithstanding that the term unit trust is not defined, because the definition of a unit encompasses beneficial interests in trust property or income whether described as units or not, a trust estate which is a registered managed investment scheme which holds scheme property for members can be a unit trust for the purposes of section 102P. The draft ruling should clearly indicate whether this outcome is impacted by whether the deed allows for units to be purchased, re-purchased or redeemed - see ATO ID 2003/43 and private binding ruling number 69969.
Paragraph 45 commences the discussions on scheme property and repeats the statement that the responsible entity holds the property as trustee. The draft ruling then goes on to consider the trustees role under division 6 or division 6C. It is only a brief comment on alternative views in paragraph159 that it is considered possible that the trustee is only a nominee. There is no explanation as to why the ATO does not adopt that view. Further, this view is discussed in the CCH Corporations Law Reporter at paragraph 183-200 which takes the position that the better view of 601FC(2) of the Corporations Law is that the trustee role is as nominee.
The discussion in the draft ruling on whether it is the trustee or the investor carrying on a business is extensive. However it does not refer to the decision in Ferguson v FC of T 9 ATR 873 which we have always understood to set the scene for small players to take an interest in the affairs of the manager to be regarded as carrying on a business. We believe that this issue must be adequately considered in the draft ruling (and also the relevance of the ATOs view in respect of other circumstances outside the scope of the draft ruling).
We note that investors may have effective control over the managers activities under particular management agreements. In certain constitutions we have seen, the investors have the capacity to call a meeting and instruct the manager, or even dismiss the manager and appoint a new one. Thus, it may not be appropriate to assume that members do not have effective control over their investment as is asserted under paragraph 3 of the draft ruling.
If the practical hands-off approach means that the investor is not carrying on a business, does that meant the next step in the application of the view is that silent or sleeping partners are not actually partners? Such a view would have an enormous impact if extrapolated to family businesses.
We question what happens from a tax perspective given the ATOs reconsidered view when schemes have been unwound or are currently being unwound because, amongst other things, the original fees paid have proved to have been too low. In these cases, investors generally receive shares in a new company for giving up their various interests in the scheme.
Date of effect
We are concerned with the proposal in paragraph 24 that the finalised ruling will apply to agribusiness investment schemes which are begun to be carried out on or after 1 July 2008.
Should the reconsidered view prevail it will have a profoundly detrimental impact on investment in the agribusiness sector if the industry is only given a 12 month window period in which to develop new capital raising structures. This could be extremely damaging as various taxpayers in that sector are still recovering from the severe and protracted effects of the drought.
Given these concerns we therefore contend that it would be preferable to provide a longer transitional period than the one-year period currently proposed under the draft ruling.
For example, one potential approach may be to phase out the current deductibility rules over a five-year period so that the availability of any deduction is progressively reduced by 20 per cent annually over each year of the five-year transitional period. Assuming the above phase out period commenced on 1 July 2008 any deductible relief on capital investment would therefore fully expire by 1 July 2013.
