Private ruling: Forestry managed investment scheme
Published: February 2012
Ruling period: 01 July 2010 - 30 June 2011
Date scheme commenced: The 2008 Income year

Ruling: Q1: Are upfront management fees you paid to the replacement responsible entity for the forestry managed investment scheme deductable against ordinary income? | A1: No | Q2: Can the initial asset value, establishment services fee paid in an income year, be written off as a capital loss? | A2: No | Q3: If the upfront management fees are not deductable against ordinary income can they be added to the assets capital loss calculations? | A3: Yes

Relevant facts and circumstances: Your client entered into a forestry managed investment scheme. The scheme went into administration Leases were terminated and land was sold Participants in the scheme voted for a new replacement responsible entity The replacement responsible entity charged an upfront management fee which was used in litigation over the reinstatement of the leases Your client paid the fee to the replacement responsible entity

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 subsection 110-25(6) | Income Tax Assessment Act 1997 subsection 110-55(4) | Income Tax Assessment Act 1997 subsection 118-5(1) | Income Tax Assessment Act 1997 subsection 40-880(2) | Income Tax Assessment Act 1997 paragraph 40-880(5)(d) | Corporations Act 2001 section 9

Reasons for decision: Summary: This summary outlines why upfront management fees paid to the replacement responsibly entity are considered capital in nature and are not deductable against ordinary income. | Detailed Reasoning - Detailed reasoning: Under subsection 8.1(1) of the Income Tax Assessment Act 1997 (ITAA) you can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a * business for the purpose of gaining or producing your assessable income. Under subsection 8.1(2) of ITAA you cannot deduct an amount if: (a) it is a loss or outgoing of capital, or of a capital nature. Information provided to participants from the replacement responsibly entity states the management fees have been used for legal fees, viability assessments, calling meetings and keeping participants informed. Where the expenditure relates directly to a structural rather than an operational purpose, the expenditure is of a capital nature and therefore not deductible. Leases pertaining to woodlots planted with trees to form the profit yielding structure of the business are considered capital in nature. Without the leases the taxpayer is not carrying on a business. A taxpayer cannot claim deductions for legal expenses incurred in defending or settling a matter were it relates to a business structure. In relation to the project the legal fees utilised in litigation was for the purpose of the reinstalment of the leases which directly underpins the existence of the business. As the leases on the woodlots had been terminated maintenance could not be carried out as the asset essential for the carrying on of the business did not exist. As the court proceedings to reinstate the leases failed, the expenditure is considered capital in nature and therefore not deductable against ordinary income. Subsection 40-880(2) of the ITAA states: (2) You can deduct, in equal proportions over a period of 5 income years starting in the year in which you incur it, capital expenditure you incur: (a) in relation to your * business; or (b) in relation to a business that used to be * carried on; or (c) in relation to a business proposed to be carried on; or (d) to liquidate or deregister a company of which you were a * member, to wind up a partnership of which you were a partner or to wind up a trust of which you were a beneficiary, that carried on a business. Expenditure of legal expenses to reinstate head leases is considered capital in nature. Deductions of capital expenditure under section 40-880 of the ITAA are also not allowable as paragraph 40-880(5)(d) excludes expenditure in relation to a lease or other legal or equitable right. You cannot deduct anything under this section for an amount of expenditure you incur to the extent that: (d) it is in relation to a lease or other legal or equitable right | Summary: Can the initial asset value, establishment services fee paid in an income year, be written off as a capital loss? | Detailed Reasoning - Detailed reasoning: The initial fee paid for the establishment and services of the forestry managed investment scheme were fully deductable under a product ruling and therefore cannot be included in the cast base. Section 110-55(4) of the ITAA states: The reduced cost base does not include an amount to the extent that you have deducted or can deduct it (including because of a balancing adjustment) or could have deducted apart from paragraph 43-70(2)(h). | Summary: This summary explains why upfront management fees paid to the replacement responsibly entity for the forestry managed investment scheme can be allowed as a capital loss at the termination of the scheme. | Detailed Reasoning - Detailed reasoning: A participant in a forestry scheme holds an interest which is considered an asset for CGT purposes. A CGT asset is defined under subsection 108-5(1) of the ITAA as a legal or equitable right that is not property. The upfront management fees are not deductable against ordinary income as outlined in question 1 as they are considered to be capital in nature. On entering the scheme the scheme participants receive an 'interest' in a managed investment scheme. Defined in section 9 of the Corporations Act 2001 as a right to benefits produced by the scheme (whether the right is actual, prospective or contingent and whether it is enforceable or not). The scheme interest would be an asset for CGT purposes once the participant is accepted to be a member of the scheme and entered into the schemes members register. The upfront management fee paid by participants to the replacement responsibly entity would have been placed into the schemes bank account and would have formed part of scheme property. 'Scheme property' is also defined in section 9 of the Corporations Act and includes at paragraph: (a) contribution of money or money's worth to the scheme. The management fee has been applied by the replacement responsibly entity for the purpose of the scheme. This purpose was to challenge the termination of the leases. Section 110-25 of the ITAA outlines the general rules about cost base. The fifth element of the cost base is defined in subsection 110-25(6) as: Capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset. In the judgement for a relevant court case the court found that the replacement responsibly entity had no rights over the assets and therefore no right to bring the case to court. However as the costs were for the purpose of the scheme interest and a capital loss could occur on termination of the scheme interest i.e. deregistration of the scheme by the replacement responsibly entity. Based on this we should allow a capital loss on termination of the scheme interest.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.