Private ruling: Forestry Project
Date of advice: 30 July 2018
Published: October 2018
Ruling period: Income year ending 30 June 20xx
Date scheme commenced: 26 June 20xx

Ruling: Q1: Is the amount paid as the ‘Future Cost Payment’ by Company A to Trust C deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: In the alternative, if the Future Cost Payment is deductible under section 8-1, does Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the scheme so as to cancel the tax deduction under section 8-1 of ITAA 1997 | A2: Yes

Relevant facts and circumstances: 1. The Commissioner makes this ruling based on the precise scheme identified in this Ruling. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. 2. This ruling is made having regard to the following documents provided by you, identified by their subject matter and date and, where applicable, the document name given to the electronic copy of the document that was provided. Documents received : ● Application for a Private Ruling for the Forestry Project ● Forestry Project Documents and supporting material ● An outline of the full scheme was not provided ● Not all requested information was provided The Scheme 3. Company A as the responsible entity (Manager) of the Forestry Project (Project) offers investors the opportunity to participate in a forestry managed investment scheme for the stated purposes of establishing and tending trees for felling in Australia. The term of the Project is 26 years but can be extended by up to five years to a total term of up to 31 years. 4. Company B is the head company of the tax consolidated group of which Company A is a member. Company B has a substituted balance date as its ultimate holding company is a foreign company. 5. The Chief Executive Officer of Company A and Company B is the same person. 6. Company C is the Trustee of Trust C. 7. The Project is an unregistered managed investment scheme under the Corporations Act 2001 and as such, the investors in the schemes (Growers) are wholesale investors. The offer to participate in the Project by entering the Project agreements for a minimum of one Interest which consists of rights over a 0.5 hectare forestry lot, a right to require the Manager to buy back the Interest should they opt to sell, a unit in a trust (Trust A) established to fund statutory costs and insurance and a unit in a trust that owns the Project land (Trust B) 8. The Total Application Price for one Interest (0.5 hectares) is for establishment services, the prepayment of future costs, a unit in Trust A and in Trust B and the cost of acquiring the right to sell the Interest back to Company A. 9. Establishment Services to be provided by the Manager to a Grower in respect of the Interest relevantly includes the following: a. Site preparation; b. Provision of cuttings or seedlings; c. Application of fertilizer; d. Replanting of failed areas; e. Managing and maintaining the Plantation; f. Pest, weed and animal control; g. Maintenance of roads firebreaks gates related infrastructure and fences; h. Arrange for harvesting at first and second thinning and final harvest; i. Harvest preparation; j. Paying the harvest road construction and maintenance costs; k. Assistance to Grower to secure market for Plantation produce; l. Paying all pruning costs; and m. Rehabilitation of the Plantation Land after final harvest. 10. The offer includes the option for a Grower to receive a one year interest free loan from the Manager (Manager Loan) to fund all or some of the Total Application Price, secured by the Growers present and future right, title and interest in and to, and all entitlements and benefits arising from the Project Documents. 11. Two investors/Growers have taken up the offer to participate in the Project. Both of those Growers borrowed 100% of their Total Application Price for their investment through a one year Manager Loan. 12. The estimated direct forestry expenditure (DFE) over the life of the Project is provided with the private ruling application to demonstrate that it is reasonable to expect on that 30 June 20xx that the amount of DFE under the Project is no less than 70% of the amount of the payments (establishment services fee excluding GST) per Interest in the Project. 13. Investment in the Project comprises the following steps: 14. Step 1: Growers complete an application form by 30 June 20xx, indicating their wish to acquire one or more Interests in the Project and for a Manager Loan for 100% of the Total Application Price. By signing the application form, each Grower authorises the Manager and each of its officers and senior managers to act on their behalf under Power of Attorney to enter into the Project documents and instruments. 15. Step 2: Upon acceptance of the application, the Manager does the following: i. The Manager prepares an agreement (Lot Agreement) between the Manager and the Grower granting the Grower a right over a forestry lot (Lot); ii. The Manager executes an agreement (Forestry Agreement No.1) between the Grower and Manager, authorising the Manager to act on the behalf of the Grower to carry out the Grower’s obligations to undertake the forestry establishment services and ongoing services (Forestry Services). Under Forestry Agreement No.1 the Grower understands that the Manager will appoint an independent contractor to provide the forestry establishment services and ongoing services. The Manager agrees to pay to the Grower an amount to pay for the costs of the future services associated with getting the timber to market. In order to meet this future obligation the Manager will pay an amount to a trust (Trust C); iii. The Manager executes an agreement that grants the Grower an option to require the Manager to buy back their Interest(s) in a period four years after the commencement of the Project and ending seven years after the commencement of the Project; iv. The Manager executes the deed to establish Trust B which will own the land for the Project. Units are taken to be issued to a Grower when the application money is received; v. The Manager executes the Manager Loan Deed, between the Grower and the Manager which provides for the borrowing of 100% of the Total Application Price for 12 months on an interest free basis; vi. The Manager executes the agreement (Forestry Agreement No.2) with Company B whereby the Manager appoints Company B to provide the Forestry Services to the Manager and Company B accepts the appointment and identifies an intention to sub-contract the Forestry Services to an independent forestry contractor. 16. Step 3: Company B enters into an agreement (Forestry Agreement No.3) to sub-contract the Forestry Services to an independent forestry contractor (Company D). The director and controlling mind of Company D is also a director of Company B, and is employed by Company B as the Head Forester. 17. Step 4: An employee of Company B as the Settlor of Trust C executes the trust deed. 18. According to the Recitals of Trust C’s trust deed, Trust C is created for the benefit of two state government authorities and tax exempt charities. Company A is the appointer of Trust C and has the power to remove or appoint a trustee, if it is in the best interests of a Grower in the Project. 19. The Trustee of Trust C (Company C) is to exclude as income of the trust, and treat as capital, any money or property added to the trust fund whether it be treated as assessable income or not under any provision of any tax law, whether or not that income or property is ordinarily regarded as income. 20. Step 5: An employee of Company B as the Settlor and Company A as trustee executes the Trust A to hold funds on trust for the purposes of paying council rates over the term of the Project and the cost of insurance to cover the cost of replanting for the first four years of the Project. 21. Step 6: After 30 June 20xx a Grower may obtain a GST refund. 22. Step 7: Within five months of the project commencing, the Manager and Company C as trustee of Trust C executed a Novation Agreement and the Manager paid approximately 55% of the Total Application Price to Trust C to pay for the costs of the future services associated with getting the timber to market and Trust C assumed the obligation to pay this amount to the Growers in the future. 23. Step 8: After receipt of the payment from the Manager (Future Cost Payment ) , and repayment of the one year Manager Loan by a Grower, Trust C may loan an amount equal to the Future Cost Amount per Lot to each Grower under a loan agreement (Trust C Loan Agreement) secured by the Borrower’s rights and interests in the Project (Security Property). 24. At least one of the two Growers in the Project repaid the one year Manager loan after 3 months and borrowed approximately 55% of the amount they had repaid from Trust C about two weeks later. The loan amount was equal to the Future Cost Payment paid by the Manager to Trust C (per Lot). 25. The initial term of Trust C loan is seven years, during which no repayments are required, and interest is capitalised and the loan amount increased accordingly. The term of the loan can be extended for a further seven years or until the 26 th anniversary of the date of Trust C Loan Agreement. 26. In accordance with Trust C Loan Agreement, the events of default are triggered: 1) if the Lender (Trust C) makes a demand for payment of an amount due and payable and the Borrower does not pay the amount within 20 days of the demand; or 2) if the Borrower (Grower) is in material default under the terms of any of the Transaction Documents as defined; or 3) any event of insolvency in relation to the Borrower. 27. In the event of a default, the Lender is provided with the option to have the outstanding balance of the loan amount become immediately due and payable. Trust C Loan Agreement however, does not stipulate that the Security Property can be dealt with in any way on the happening of an Event of Default. 28. At the time of entering the Trust C Loan Agreement, the Grower entered into a second agreement (Trust C Loan Agreement Novation) granting the Lender a right to novate its obligation to pay the Future Cost Amount per Lot to the Grower, if the Borrower breaches their repayment obligations or at any time after seven years (being after the period the Grower can require the Manager to buy back their Interest(s)). The Lender assigns the loan to the Borrower and the Borrower will assume the obligation to pay the Future Costs to the Grower, that is, to himself. 29. If the Lender does not cause a novation to occur the Borrower has the right to require that the Lender novate its obligations to pay the Future Costs to the Borrower. 30. A Grower who: a. borrows 100% of the Total Application Price under the one year Manager Loan; b. repays this loan and borrows an amount equal to the Future Cost Amount from Trust C; c. obtains a refund of the GST paid as part of the Total Application Price; and d. obtains a tax saving by claiming a deduction for the Establishment Services Fee potentially has a positive net cashflow within the first year of the Project. 31. Step 9: The Manager may pay a Referral Fee (per Interest) to a distributor who submitted an Application Form on behalf of an investor that was accepted by the Manager. A referral fee of up to 15% may be offered as payment to financial planners, accountants, or other entities following a ‘participant’s’ investment in the scheme. Each distributor decides independently whether they rebate to their client all or any of the referral fee payment. The Manager advised that no referral fees were paid in respect of the two Growers who invested in the Project. 32. Step 10: The Lot Agreement is executed for each Grower, granting them their Timber Rights on land owned by the Manager. The term of the Lot Agreement is 31 years. The Manager will fund all costs associated with the acquisition of the land, and that Council rates and other applicable statutory charges will be funded by the Growers from Trust A. 33. Step 11: The Manager transfers land to Company A (to which the Lots for the Project relate) as Trustee of Trust B for the Land Trust. The acquisition of the land is funded by the cost paid by the Grower for a unit in Trust B, as part of the Total Application Price and by way of a loan between Company A as Trustee of Trust B and Company A as the Manager. By no later than 31 December 20xx, the Manager is to plant all of the trees and expects to do this in the winter of that year. 34. Step 12: Four years after the commencement of the Project and within seven years after the commencement of the Project, the Grower is entitled to sell their Interest(s) in the Project (as described above in connection with Step 2). 35. Step 13: As stated in relation to Step 8 above, Trust C, the Lender, has the right to novate its obligations to pay the Future Costs to the Grower, the Borrower. And if the Lender does not cause a novation to occur, the Borrower has the right to require the Lender to novate its obligations to pay the Future Costs to the Borrower. 36. Step 14: According to the expected future proceeds for the Project and without taking into account the effect of the amount borrowed under the Trust C Loan Agreement, but for a tax saving upfront, a Grower who stays in the Project expects to make a loss on their investment. 37. Step 15: After completion of the Final Harvest, Company A as the Trustee of Trust B may sell or lease the land at market value and apply the proceeds in repayment of any debt owed to the Manager, or its nominees, with the balance of the proceeds being distributed to unit holders pro rata. The Manager expects that an amount per Lot will be distributed after legal costs, stamp duty and rehabilitation costs have been accounted for. 38. An explanatory document provided to the Growers by the Manager advised that the Manager’s payment of Future Costs to Trust C would better manage the Grower’s credit risk but there is no guarantee that Trust C will be able to cover the Future Costs at a later date. 39. The proper construction of certain of the documents (in particular, the Trust C Loan Agreement and Trust C Loan Agreement Novation) is unclear. Some provisions appear to be contradictory or inconsistent. At certain points the reasons allude to parts of agreements that have uncertain constructions. However, in the opinion of the Commissioner, the correctness of the ruling does not depend on which construction is correct where more than one is open, nor does the Commissioner attempt to rule in this ruling which construction, where more than one is open, is correct. 40. This ruling does not consider the taxation implications (including any potential application of Part IVA of the ITAA 1936) of Trust A or Trust B including in relation to: n the acquisition of the land for the Project by the Manager; n the transfer of land for the Project to Trust B; n the issue or sale of units in the Trust B; n the loan between the Manager and the Trust B; or n the sale or ongoing use of the land and Trust B on completion of the Project.

Relevant legislative provisions: Section 8-1 of t he Income Tax Assessment Act 1997 | Part IVA of the Income Tax Assessment Act 1936

Reasons for decision: Summary: 41. The Future Costs Payment paid by the taxpayer to Trust C is capital in nature, and is therefore not deductible under section 8-1 of the ITAA 1997. 42. If the Future Costs Payment is deductible under section 8-1 of the ITAA 1997, Part IVA of the ITAA 1936 applies to the scheme such that the Commissioner could determine under paragraph 177F(1)(b) of the ITAA 1936 that the whole of the deduction shall not be allowable. | Detailed Reasoning - Question 1: Is the amount paid as the ‘Future Cost Payment’ by Company A to Trust C deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Detailed Reasoning - Answer: No | Detailed Reasoning - Relevant Legislation- Question 1: 43. Subsection 8-1(1) of the ITAA 1997 provides that a taxpayer can deduct from their assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing their assessable income; or (b) It is necessarily incurred in carrying on a business for the purpose of gaining or producing their assessable income. 44. However, pursuant to paragraph 8-1(2), a taxpayer cannot deduct a loss or outgoing under section 8-1 to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; (b) it is a loss or outgoing of a private or domestic nature; (c) it is incurred in relation to gaining or producing their exempt income or non-assessable non-exempt income; (d) another provision of the ITAA 1997 precludes the deduction. | Detailed Reasoning - First positive limb of section 8-1 of the ITAA 1997: 45. Paragraph 8-1(1)(a) of the ITAA 1997 contains the first positive limb of the general deductibility test. For an amount to be deductible under this limb, it must be incurred in gaining or producing the assessable income of the entity claiming the loss or outgoing as a deduction. 46. The Commissioner has provided guidance on what makes a loss or outgoing deductible in TR 95/33 and TR 2006/2. Paragraph 2 of TR 95/33 states that the expenditure will generally be deductible ‘if its essential character is that of expenditure that has a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income, provided that the expenditure is not of a capital nature.’ Paragraph 19 of TR 2006/2 states that the expenditure is not of a capital, private or domestic nature.’ Paragraph 19 of TR 2006/2 states that the characterisation of particular expenditure is by its nature a question of fact. It involves an enquiry about what the expenditure was for and what it is intended to achieve in relation to the taxpayer’s income earning activities or business from a practical and business point of view. 47. In Ronpibon Tin NL v FCT (1949) 78 CLR 47, the High Court said that for a loss or outgoing to be deductible under the first limb of the general deductibility test then appearing in section 51(1) of the ITAA 1936; it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income. 48. In FC of T v. Firth ( 2002) 120 FCR 450; 2002 ATC 4346 at 4348, Hill J said the following in relation to the required connection between the loss or outgoing and assessable income or business: The nature of that connection has been expressed in different ways in the cases. It is sometimes said that there must be a “perceived connection” between the loss or outgoing and the assessable income or business: FC of T v Hatchett 71 ATC 4184 at 4187; (1971) 125 CLR 494 at 499. In other cases it has been said that the expenditure must be “incidental and relevant” to the operations or activities regularly carried on by the taxpayer for the production of income: Ronpibon Tin NL & Tongkah Compound NL v FC of T (1949) 8 ATD 431 at 435; (1949) 78 CLR 47 at 56, FC of T v Smith 81 ATC 4114 at 4117; (1980-1981) 147 CLR 578 at 586. These ways of describing the connection that is a necessary prerequisite to deductibility are but part of the process of identifying the essential character of the expenditure in order to determine whether a particular loss or outgoing is in fact incurred in gaining or producing the assessable income or in carrying on a business which more directly contributes to the gaining or production of the assessable income: Lunney v FC of T (1958) 11 ATD 404 at 413; (1957-1958) 100 CLR 478 at 499. 49. In Morris v. FC of T 2002 ATC 4404, at ATC 4417, Goldberg J relevantly summarised the principles as to whether expenditure is deductible as being expenditure incurred in gaining or producing assessable income as follows Expenditure incurred in the course of gaining or producing assessable income is expenditure incurred in gaining or producing that assessable income: Ronpibon Tin NL & Tongkah Compound NL v FC of T (1949) 8 ATD 431 at 435-436; (1949) 78 CLR 47 at 56-57; Lunney v FC of T (1958) 11 ATD 404 at 411-412; (1957-1958) 100 CLR 478 at 496-497; FC of T v Payne 2001 ATC 4027 at 4029-4030; (2001) 202 CLR 93 at 99-101. The question whether an outgoing is wholly or partly incurred in gaining or producing assessable income is a question of characterisation: Fletcher & Ors v FC of T 91 ATC 4950 at 4957; (1991) 173 CLR 1 at 17. The question to be asked is whether the occasion of the outgoing operates to give it the essential character of a working expense, that is, whether the occasion of the outgoing is to be found in the income-earning activity itself: Ronpibon Tin NL v FC of T (supra) at ATD 436; CLR 57. · It is not sufficient to make an expenditure deductible that it is a prerequisite to, or a sine qua non of, the derivation of assessable income: Lunney v FC of T (supra) at ATD 412-413; CLR 498-499; FC of T v Cooper 91 ATC 4396 at 4412-4413; (1991) 29 FCR 177 at 198; FC of T v Edwards 93 ATC 5162 at 5167 (upheld on appeal 94 ATC 4255 ; (1994) 49 FCR 318). An outgoing, in order to be deductible, must be incidental and relevant to the activities directed at gaining or producing the assessable income: W Nevill & Co Ltd v FC of T (1937) 4 ATD 187 at 196; (1937) 56 CLR 290 at 305; Ronpibon Tin NL v FC of T (supra) at ATD 435; CLR 56; Lunney v FC of T (supra) at ATD 411-412; CLR 497. · It is sufficient and necessary that the occasion of the outgoing be found in whatever is productive of the assessable income, or would be expected to produce the assessable income: Ronpibon Tin NL v FC of T (supra) at ATD 436; CLR 57; John v FC of T 89 ATC 4101 at 4105; (1988-1989) 166 CLR 417 at 426; FC of T v Payne (supra) at ATC 4029; CLR 99. | Detailed Reasoning - Second positive limb of section 8-1 of the ITAA 1997: 50. Paragraph 8-1(1)(b) of the ITAA 1997 contains the second positive limb of the general deductibility test. For a loss or outgoing to be deductible under this limb, it must be necessarily incurred in carrying on a business for the purpose of gaining or producing the taxpayer’s assessable income. 51. The Commissioner provides guidance on what makes a loss or outgoing deductible under the second limb of section 8-1(1) of the ITAA 1997 in TR 95/25. Paragraph 24 of TR 95/25 states: Where the taxpayer carries on a business the second limb of section 8-1 requires there to be a relevant connection between the outgoing and the business. In deciding whether the [expense] is 'necessarily incurred' in the sense of 'clearly appropriate' to that business (FC of T v. Snowden and Willson Pty Ltd (1958) 99 CLR 431), regard must be had to the nature of the business activity (Magna Alloys & Research Pty Ltd v. FC of T 80 ATC 4542; 11 ATR 276), the business purpose for which the outgoing was incurred (FC of T v. The Midland Railway of Western Australia Ltd (1952) 85 CLR 306), the objective circumstances surrounding the incurring of the expenditure (FC of T v. South Australia Battery Makers Pty Ltd (1978) 140 CLR 645) and the character of the expense (John Fairfax & Sons Pty Ltd v. FC of T (1959) 101 CLR 30). (Emphasis added) 52. A majority of the High Court observed in Spriggs v. FC of T; Riddell v. FCT (2009) ATC 20-109, that: ‘one must consider the whole of the operations of the business concerned in determining questions of deductibility’. | Detailed Reasoning - Carrying on a business: 53. Whether a business is being carried on is a question of fact and degree to be determined objectively on the specific facts of each case. The following indicia as to the existence of a business have emerged from the many court and tribunal decisions concerning the question of whether a business is being carried on. (a) the existence of an intention to make a profit-making purpose; (b) the size and scale of the activities must be in excess of domestic needs, but need not be the only activities of the taxpayer and can be carried on in a small way; (c) the commercial character of the transactions; (d) repetition and regularity of the activities; however, the expression ‘carry on’ does not necessarily require repetition and an isolated activity may constitute the commencement of a business; (e) the activities being carried on in a systematic and businesslike manner usual for that type of business (e.g. detailed and up-to-date records and accounts are kept); and (f) the existence of a business plan. 54. The above factors are non-exhaustive and as a whole, and no one factor is likely to be decisive. A person may carry on a business even if not actively engaged in the business. | Detailed Reasoning - First negative limb of section 8-1 of the ITAA 1997: 55. Pursuant to paragraph 8-1(2)(a) of the ITAA 1997, where a loss or outgoing is of capital, or is of a capital nature, that loss or outgoing is not deductible under section 8-1 of the ITAA 1997. 56. Dixon J stated in Sun Newspapers Ltd v. FCT (1938) 61 CLR 337 at 359: ‘The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.’ 57. Dixon J considered, in this respect, there to be three matters to be taken into account in determining the nature of an outgoing: (a) the character of the advantage sought, and in this its lasting qualities may play a part; (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part; and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment. These considerations are addressed below in further detail | Detailed Reasoning - Character of the advantage sought: 58. As to the character of the advantage sought from expending the outlay in Sun Newspapers Ltd & Anor v. FCT (1938) Dixon J said: [m]ore often than not an outlay of capital in establishing an organization or obtaining an asset of an intangible nature does not produce a permanent condition or advantage. Its effects are exhausted over a period of time. … The result or purpose of the expenditure may be to bring into existence or procure some asset or advantage of a lasting character which will endure for the benefit of the organization or system or “profit-earning subject.” It will thus be distinguished from the expenditure which should be recouped by circulating capital or by working capital. 59. In Sun Newspapers Ltd & Anor v. FCT (1938) Latham J referred with approval to the statement of Viscount Cave in British Insulated and Helsby Cables Ltd v. Atherton (1926) A.C. 205 that : …when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, … there is a very good reason for treating such an expenditure as properly attributed not to revenue but to capital. 60. It was also explained that the word ‘enduring’ was not to mean that the advantage would last forever; and the distinction to be made was ‘between more or less recurrent expenses involved in running a business and an expenditure for the benefit of the business as a whole.’ | Detailed Reasoning - The manner in which it is to be used, relied upon or enjoyed: 61. In Sun Newspapers Ltd & Anor v. FCT (1938), Dixon J explained that whatever the form a business structure or entity may assume, its source of income will consist of a ‘profit-yielding subject’, or in other words, an instrument for earning profits. The outlay expended to establish, replace or enlarge the profit-yielding subject would generally be a one-off payment and be capital in nature. Dixon J compared this to expenditure on the process of operating the ‘profit-yielding subject’, or the continued use of the instrument for earning profits, which tend to generate a continual flow of working expenses, hence being revenue in nature. 62. However, Dixon J recognised the difficulty in distinguishing between revenue and capital in situations where ‘… the extent, condition and efficiency of the profit-yielding subject is often as much the product of the course of operations as it is of a clear and definable outlay or work or money by way of establishment, replacement or enlargement.’ 63. Dixon J considered the example of a profitable enterprise dependent on the advertisement of a patent medicine. Where the enterprise makes a large one-off outlay for a widespread advertising campaign to establish its goodwill at the initial stages of the business, the outlay might properly be considered to be of a capital nature. On the other hand, where the goodwill was established over a period of time through continuous advertising, the expenditure on advertising might be regarded as an ordinary business outgoing on revenue account. | Detailed Reasoning - The means adopted to obtain it – ‘Once and for all’ or Recurring: 64. In Sun Newspapers Ltd & Anor v. FCT (1938), Dixon J commented that in an attempt to refer to an expenditure or outlay as capital or revenue, the Courts have differentiated between ‘an outlay which is recurrent, repeated or continual and that which is final or made ‘once and for all’’. Dixon J suggested recurrence did not need to be yearly or for every accounting period and cited Rowlatt J in Ounsworth v. Vickers Ltd (1915) 3 K.B., at p.273; 6 Tax Cas. 671 for the proposition that ‘the real test is between expenditure which is made to meet a continuous demand, as opposed to an expenditure which is made once for all’. | Detailed Reasoning - Application of the law to your circumstances- Question 1: 65. In determining whether the Future Costs Payment is deductible under section 8-1 of the ITAA 1997, paragraph 8-1(1)(b) of the ITAA 1997 is relevant to your circumstances. | Detailed Reasoning - Carrying on a business: 66. In addition to the Project, you are the Manager of a number of past Projects which are managed on behalf of investors. 67. Furthermore, your offer and implementation of the Projects are conducted on a yearly basis. These factors indicate a repetition and regularity of your activities. 68. You have provided documents to support the product ruling applications that indicate that your activities are being carried on in a systematic and businesslike manner. 69. Based on the repetition and regularity of, size and scale of, and manner in which you conduct your activities, it should be considered that you are carrying on a business. | Detailed Reasoning - Outgoing necessarily incurred in carrying on a business: 70. Under paragraph 8-1(1)(b), an outgoing must be ‘necessarily incurred’ in carrying on a business for the purpose of gaining or producing assessable income. 71. In Magna Alloys & Research Pty Ltd v FC of T 80 ATC 4542 Deane and Fisher JJ stated that: The requirement that the claimed outgoing be ‘necessarily’ incurred in carrying on the relevant business does not … mean that the outgoing must be either ‘unavoidable’ or ‘essentially necessary’. Nor does the word ‘necessarily’ import a requisite of logical necessity. What is required is that the relevant expenditure be appropriate and adapted for the ends of the business carried on for the purpose of earning assessable income…. (ATC 4557) 72. Brennan J stated that : purpose is not the test of deductibility nor even a conception relevant to a loss involuntarily incurred, in cases where a connection between an outgoing and the taxpayer’s undertaking or business is affected by the voluntary act of the taxpayer, the purpose of incurring that expenditure may constitute an element of its essential character, stamping it as expenditure of a business or income-earning kind. 73. In determining whether a voluntary outgoing was incurred, the majority of the Full Federal Court suggested that it will depend on: whether the outgoing was reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of that business and, if so, whether those responsible for carrying on the business so saw it. 74. The stated objective of the Novation Agreement is to novate the Future Cost obligations by replacing Company A as Manager with Company C as Trustee for Trust C, so that the Manager is no longer obligated to pay the Future Costs. 75. The Future Costs Payment incurred by you as a result of entering into the Novation Agreement is a voluntary outgoing. 76. When viewed objectively, the Future Costs Payment incurred as a result of the Novation Agreement form part of the Project you have been operating as your business. 77. Therefore, the Future Costs Payment is necessarily incurred, in the relevant sense, in carrying on your business for the purposes of gaining or producing your assessable income. | Detailed Reasoning - Capital v Revenue: 78. In the circumstances where a loss or outgoing satisfies one of the two positive limbs of section 8-1 of ITAA 1997, the loss or outgoing will not be deductible under section 8-1 of ITAA 1997 where the amount is capital in nature. | Detailed Reasoning - Character of the advantage sought: 79. There is an enduring benefit to you which arises from the extinguishment, under the Novation Agreement, of your obligation to pay the Future Costs under the Forestry Agreement 1. The benefit obtained through payment of the Future Costs Payment pertains to the preservation of your business structure and assets, which may deliver a long term economic benefit, and confers continuing legal rights on which you may rely for the duration of the Project. | Detailed Reasoning - The manner in which it is to be used, relied upon or enjoyed: 80. Within approximately three months of the offer closing date, a novation agreement is entered into with Company C as Trustee for Trust C and the Manager pays the Future Costs Payment. Under the Novation Agreement, Company C, as the Substituting Party, is obligated to pay the Future Costs. 81. The stated purpose of the Novation Agreement was to replace the Manager with Company C so that the Manager would no longer be obligated to meet the Future Costs. 82. An explanatory document provided to the Growers advised that the Manager’s payment of Future Costs to Trust C would better manage the Grower’s credit risk but there is no guarantee that Trust C will be able to cover the Future Costs at a later date. 83. Within the Project’s term of 26 years, the Future Costs are expended when thinning occurs, usually when the trees are at around year 12 and year 20, and at final harvest at around year 26. The Future Costs Payment which releases you from the obligation to cover these costs is paid by you within the same year as the Project offering, being 12 years prior to when the initial Future Costs would be expended. 84. In Ransburg Australia Pty Limited v Federal Commissioner of Taxation 80 ATC 4114, the taxpayer entered into an agreement with a company to indemnify the taxpayer against its liability to its employees for holiday and long service leave pay. The taxpayer made two payments to the company for two consecutive income years as part of the agreement. The taxpayer claimed a deduction for the two payments under subsection 51(1) of ITAA 1936. 85. A majority of the Full Federal Court found the two payments to be capital in nature and, therefore, not deductible under subsection 51(1) of ITAA 1936. 86. Deane J at ATC 4116 said: The outgoings in the present case which were made to provide future funds which were intended to, but which need not necessarily, be applied in relation to such future payments to employees cannot, however, any more be properly so characterised than could a payment by a taxpayer to the credit of a savings bank account properly be characterised, for the purposes of s.51(1) of the Act, by reference to the object or objects to which the taxpayer proposed, at some future time, to apply the proceeds of the account. ...They represented capital set aside to provide for revenue contingencies of the business rather than outgoings of revenue incurred in meeting such contingencies. They were not deductible pursuant to s.51(1) of the Act. 87. Fisher J at 4118 was of the view that each payment of the taxpayer ‘was made in order to establish a fund which would be available to the taxpayer, at least in part, at the time when it or an associated company made payments to its employees in respect of the … liabilities.’ 88. The character of the Future Costs Payment paid by the Manager under the Novation Agreement was a one-off payment providing a pre-determined benefit to the Manager. The payment is similar to that of ‘a payment … to the credit of a savings bank account’ as the Future Costs Payment is paid to Company C as Trustee for Trust C which, when the money is required for use in 12, 20 or 26 years’ time, will have the obligation previously held by the Manager to pay for the Future Costs. As in Ransburg, the payment of the Future Costs Payment can be seen as capital set aside to provide for future revenue requirements that would have fallen to the Manager, absent the novation. 89. Therefore, the manner in which the Future Costs Payment is to be used suggests that the Future Costs Payment is capital in nature. | Detailed Reasoning - The means adopted to obtain it – ‘Once and for all’ or Recurring: 90. Each timber project is offered and implemented as a standalone arrangement as demonstrated by the separate product rulings sought for each project and the separate information memoranda issued in respect of them. In the context of any individual project, the Future Costs Payment paid by you to Company C is a payment that is made once and for all. The Future Costs Payment should be considered to be capital in nature. 91. The facts in your case can relevantly be distinguished from those in Re Fanmac Limited (formerly First Australian National Mortgage Acceptance Corporation Limited) v Commissioner of Taxation [1991] FCA 386. In that case, the relevant activities of the taxpayer were the carrying on of the business of establishing, marketing, managing and administering trusts which issued fixed rate securities. The costs incurred by the taxpayer in establishing, managing and administering the trusts were found by Beaumont J to have been incurred on revenue account. His Honour noted however that if the only relevant activity of the taxpayer had been concerned with the one trust, then there would be much to be said for the view that expenditure thereon was an affair of capital. In your case, Trust C received payment of the Future Costs Payment from Company A as the Manager. The establishing, managing and administering of Trust C is not undertaken by Company A which is not in the business of managing and administering trusts. Further, while Company A was in the business of managing timber projects, the mere fact that the Novation Amount was paid in relation to each year’s project does not make that payment analogous to those found to be deductible in Fanmac. 92. Furthermore, your case can be distinguished from the facts in ATOID 2003/797, which found that a payment made by a taxpayer in respect of the novation of hedge contracts that were entered into to set the future sale price of a commodity produced by the taxpayer’s group members gave rise to an allowable deduction under section 8-1 of the ITAA 1997. It was noted that the advantage gained by the novation of the hedge contracts did not result in a benefit of an enduring nature, since each hedge contract related to part only of the group’s commodity production, and, further, that the payment on novation did not alter the profit-yielding structure of the taxpayer’s business or the framework in which the taxpayer produced its assessable income, as subsequent to the novation of the hedge contracts, the taxpayer continued to provide a treasury function to group members. Here, in contrast, upon payment of the Future Costs Payment for any given project, the Manager no longer has any obligation or function in respect of providing future services or paying future costs 93. Having considered the indicia relevant to whether the Future Costs Payment was incurred on capital or revenue account, it is concluded that the Future Costs Payment paid to Company C as Trustee is capital in nature. Therefore, our position is that the Future Costs Payment is not deductible under section 8-1 of ITAA 1997. | Detailed Reasoning - Relevant Legislation- Question 2: 94. In the alternative, if the novation amount is deductible under section 8-1 of the ITAA 1997, the deduction would be liable to be disallowed by the Commissioner under paragraph 177F(1)(b) of the ITAA 1936 on the basis that a ‘tax benefit’ would otherwise arise for the taxpayer. 95. Part IVA of the ITAA 1936 gives the Commissioner the power to make a determination to cancel a 'tax benefit' that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies. 96. In broad terms, the Commissioner may make a determination under subsection 177F(1)(b) of the ITAA 1936 to cancel a tax benefit where: 1. there is a scheme as defined in section 177A of the ITAA 1936; 2. a taxpayer has obtained, or would but for section 177F of the ITAA 1936 obtain, a tax benefit as identified in sections 177C and 177CB of the ITAA 1936 in connection with that scheme, and 3. having regard to the eight factors listed in section 177D of the ITAA 1936, the dominant purpose of one or more persons who entered into or carried out all or part of that scheme was to enable one or more taxpayers (including the taxpayer) to obtain a tax benefit as identified in section 177C and 177CB of the ITAA 1936 in connection with that scheme. 97. Section 177A of the ITAA 1936 defines ‘a scheme’ to mean: ● any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and ● any scheme, plan, proposal, action, course of action or course of conduct. 98. Subsection 177D(1) of the ITAA 1936 provides that Part IVA of the ITAA 1936 applies to a scheme if it would be concluded (having regard to the matters in subsection 177D(2) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers.) 99. Section 177C of the ITAA 1936 provides that a tax benefit referred to in Part IVA of the ITAA 1936 includes (among other things): ● an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included (or might reasonably be expected to be included) in assessable income of that year of income if the scheme had not been entered into or carried out; or ● a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out. 100. Section 177CB of the ITAA 1936 applies to schemes entered into or commenced to be carried out after 15 November 2012. This scheme is such a scheme. Section 177CB provides the basis for positing an alternative postulate under section 177C so as to assess what ‘would have’ or ‘might reasonably be expected to have’ happened, absent a particular scheme. The ‘would have’ limb (subsection 177CB(2)) and the ‘might reasonably be expected to have’ limb (subsection 177CB(3)) are alternative bases for identifying the existence of a relevant tax benefit listed in section 177C. 101. Subsection 177D(2) of the ITAA 1936 sets out the matters to have regard to in determining whether the purpose of a scheme is to obtain a tax benefit. The matters are: i. the manner in which the scheme was entered into or carried out; ii. the form and substance of the scheme; iii. the time at which the scheme was entered into and the length of the period during which the scheme was carried out; iv. the result in relation to the operation of the Act that, but for the application of Part IVA of the ITAA 1936, would be achieved by the scheme; v. any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme; vi. any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme; vii. any other consequence for the relevant taxpayer, or for any person referred to in vi above, of the scheme having been entered into or carried out; viii. the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in vi above. 102. Subsection 177A(5) provides that the purpose referred to in Part IVA of the ITAA 1936 is the dominant purpose if there are 2 or more purposes. | Detailed Reasoning - Application of the law to your circumstances- Question 2: 103. This ruling does not consider the taxation implications (including any potential application of Part IVA of the ITAA 1936) in relation to Trust B or Trust A including in relation to: ● the acquisition of the Project Land by the Manager; ● the transfer of land to Trust B; ● the issue or sale of units in Trust B; ● the loan between the Manager and Trust B; or ● the sale or ongoing use of the Project Land and Trust B on completion of the Project. 104. Therefore the analysis set out below does not include any potential Part IVA implications in relation to the Trust B or Trust A, or of any arrangements entered into with or in respect of the Trust B or Trust A. | Detailed Reasoning - The Scheme: 105. The scheme within the meaning of section 177A of the ITAA 1936 is, or alternatively includes: ● the creation of Trust C at Step 4, ● the execution and performance of the Novation Agreement at Step 7, ● the execution and performance of the Trust C Loan Agreement at Step 8; and ● the execution and performance of the Trust C Loan Agreement Novation at Step 8. 106. On the premise that the Future Costs Payment is on revenue account, the Manager obtains a tax benefit, being an allowable deduction of the Future Costs Payment under section 8-1 of the ITAA 1997, in connection with the scheme because but for the scheme no loss or outgoing would be incurred by the Manager in respect of the novated amount (subsection 177CB(2) of the ITAA 1936). It should be concluded, having regard to the factors in subsection 177D(2) of the ITAA 1936, that the Manager entered into or carried out the scheme for the dominant purpose of, either (a) enabling itself to obtain a tax benefit in connection with the scheme within the meaning of subsection 177D(1)(a); or (b) enabling itself and the Growers each to obtain a tax benefit in connection with the scheme within the meaning of subsection 177D(1)(b). 107. Purpose | Detailed Reasoning - i. the manner in which the scheme was entered into or carried out: At Step 4, Trust C was settled for the benefit of 2 state government authorities that are tax exempt entities. All of the objects of Trust C (Specified Beneficiaries and Default Beneficiaries) are tax exempt entities. The Trust C Deed confers broad investment powers on the Trustee including (among other things the advancing of credit to any person for any purpose, whether at call or for a fixed term, whether or not deriving interest or secured by any security interest or guarantee). At Step 7, the Manager and Trustee of Trust C executed the Novation Agreement such that the obligation to pay for the Future Costs (which were the obligations of the Manager under Forestry Agreement 1) was novated to the Trustee of Trust C. The effect of the Novation Agreement is that the Manager is no longer obligated to pay for the Future Costs. Instead the Trustee of Trust C assumes the obligations of the Manager under the Forestry Agreement 1 in relation to the Future Costs. From the execution of the Novation Agreement within five months of the commencement of the Project, the Manager was released from all obligations and liabilities under the Forestry Agreement 1 in relation to the Future Costs. As the consideration for taking on the obligation, Trust C is paid a Novation Amount of approximately 55% of the cost of all Lots sold. At Step 8, after the receipt of the Novation Amount from the Manager; and the repayment of the one year interest free Manager loan by the Grower, Trust C loaned 55% of the cost of a Lot, in respect of each of one Grower’s Lots, to the Grower (the Trust C Loan Agreement). Under the Trust C Loan Agreement, the Grower is not obligated to make any payments in the first seven years of the loan and accrued interest is capitalised and added to the principal of the loan After the first seven years of the loan, the loan may be extended for a further term, however, there is a lack of clarity in the terms of the Loan Agreement as to the circumstances in which interest is payable in respect of that further term and how that interest is calculated. At the time of entering the Trust C Loan Agreement, the Grower also entered into the Trust C Loan Agreement Novation whereby, if certain conditions are satisfied, Trust C has the right to novate its obligations to pay the Future Costs to the Grower. The Grower (being the Borrower in the Trust C Loan Agreement) also has the right to require such a novation in certain circumstances of the Trust C Loan Agreement Novation. At the same time, all the Lender’s right, title, benefit and interest in the Trust C Loan Agreement is assigned to the Grower, and the Grower assumes all of the Lender’s obligations and liabilities in respect of the Trust C Loan Agreement. The manner in which Trust C was settled as described in Step 4, the execution and performance of the Novation Agreement as described at Step 7 and the execution and performance of the Trust C Loan Agreement and the Trust C Loan Agreement Novation as described in Step 8 points, individually and collectively, to a purpose of obtaining a tax benefit (for Company A and the Growers) and away from a purpose of pursuing commercial gains through forestry management. | Detailed Reasoning - ii. the form and substance of the scheme;: Company A, is the Manager of the Project in form only as it subcontracted the Forestry Services under the Forestry Agreement 2 to Company B who subsequently subcontracted those services to a third party forestry contractor. The Forestry Services which the Manager subcontracted are the very services which the Establishment Services Fee paid by the Grower covered. Trust C, which the taxpayer states was settled to receive the Future Costs Payment and assume the obligation to pay the Future Costs so as to protect the Growers from the credit risk of the Manager, receives such amounts in form only - under Clause 8.4(h) the Trustee is permitted to advance credit to any person for any purpose, whether at call or for a fixed term, whether or not deriving interest or secured by any security interest or guarantee. Furthermore, the combined effect of Trust C Loan Agreement and the Trust C Loan Agreement Novation can result in the Novation Amount never being repaid to the Trustee by the Borrower. Such an outcome is inconsistent with this stated purpose. The Forestry Agreement 1, which provided for Trust C is to be established for the benefit of the Grower, is in form only, given that Trust C, was settled for the benefit of the Specified beneficiaries and other Default beneficiaries which are all tax exempt entities who are not Growers. The ability for the Trustee to characterise income as capital for the purposes of determining the trust income effectively gives the Trustee a discretion as to whether any distributions will be made to the beneficiaries. In addition, if there is a loan novation, then no further amounts would appear to be available for distribution to the beneficiaries. Conversely, if all amounts of income are in fact distributed to the beneficiaries, then that would seem inconsistent with the trustee appropriately managing the investment of the Novation Amount so as to ensure that the trustee will have sufficient funds to pay the Future Costs later. All of these steps point to a purpose of obtaining a tax benefit for the Manager (or for the Manager and Growers) without creating an offsetting liability to tax elsewhere. | Detailed Reasoning - iii. the time at which the scheme was entered into and the length of the period during which the scheme was carried out;: The Novation Agreement was entered into just before the end of the Manager’s income year. This points to a purpose of obtaining a tax benefit. iv. the result in relation to the operation of the Act that, but for the application of Part IVA of the ITAA 1936, would be achieved by the scheme ; But for the application of Part IVA of the ITAA 1936, the scheme gives rise to a deduction equal to the Novation Amount for the Manager under section 8-1 of the ITAA 1997 (on the premise the amount is in fact deductible). This deduction offsets part of the amount included in the Manager’s assessable income under section 15-46 of the ITAA 1997. The Trustee can exclude the Novation Amount from the trust income and treat it as capital, which could result in a small portion of the Novation Amount being treated as trust income. As such, only that small amount would need to be applied, under the Trustee’s discretion, in equal shares to the two tax exempt beneficiaries in order for the beneficiaries to be deemed to be presently entitled to all of the income of the trust (under section 101 of the ITAA 1936). Even if the novation payment forms part of the net income of the trust for Division 6 of the ITAA 1936 purposes, any net income will be assessed, in equal shares, to the two specified tax exempt entities: Bamford v FCT [2010] HCA 10; resulting in no tax payable by either of the beneficiaries or the Trustee of Trust C. The creation of the deduction of the Future Costs Payment to the Manager with no offsetting tax liability for the Trustee of Trust C or the beneficiaries of Trust C points to a purpose of obtaining a tax benefit. v. any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme; As a result of the scheme, the Manager novated all of its obligations to pay the Future Costs, notwithstanding it is required to arrange the associated roading, harvest, haulage and pruning services under the Forestry Agreement 1 (subject to subsequently subcontracting that obligation to third parties). The Manager’s assessable income under section 15-46 of the ITAA 1997 (which was enacted to ensure that the Grower’s deduction under Division 394 of the ITAA 1997 is matched by an amount assessable to the Manager) is reduced by the deduction for the Novation Amount. This does not align with the financial position of a person engaged in the business of forestry management as the Manager is left with no obligations to perform any forestry services, and points to the purpose of obtaining a tax deduction for the Manager. vi. any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme; The Trustee of Trust C through the Novation Agreement assumed the financial position of a person with forestry obligations, although not the obligation to arrange or perform those services. As a result of the scheme, the obligations assumed by the Trustee of Trust C may be extinguished as a result of the Trust C Loan Agreement Novation which novates the obligation to pay for the Future Costs back to the Growers in certain circumstances, leaving the Trustee of Trust C with no obligations in relation to the Future Costs and potentially with no assets if the Growers are not required to repay their loans. The Grower is in the financial position of a person who has provided funds sufficient to cover all of the costs associated with the Project. However, part of those funds are returned to the Grower via the Loan Agreement and if a subsequent novation occurs in accordance with the Trust C Loan Agreement Novation, the Grower will retain those funds, and will be liable to meet the Future Costs themselves, despite having paid for the those costs as part of the Establishment Services Fees. Trust C’s financial position points to a purpose of enabling the Manager to obtain a tax benefit. The Grower’s financial position as a consequence of entering the scheme points to the scheme having the purpose of enabling the Grower to obtain a tax benefit. vii. any other consequence for the relevant taxpayer, or for any person referred to in vi above, of the scheme having been entered into or carried out; The Specified Beneficiaries of Trust C are likely to receive a nominal sum of money as the Trustee, in accordance with the Trust C Deed, may exclude as income of the trust, and treat as capital, any money or property added to the trust fund whether it be treated as assessable income or not under any provision of any tax law, whether or not that income or property is ordinarily regarded as income. Although the trees may be planted, the Manager is not involved in planting or maintaining the plantation. These services have all been subcontracted to Company B and subsequently to Company D, a third party contractor under Forestry Agreement 3. viii. the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in vi above. The Appointor of Trust C is Company A, the Manager, which has the power to remove any trustee without having to give any reasons. Company A therefore has ultimate control over Trust C. This means that the Manager and Trust C are ultimately under the control of the same entities and therefore are not arm’s length parties. The Specified Beneficiaries are passive recipients of the income of Trust C and are therefore not involved in the scheme. However, the relationship between the Manager and Trust C points to a tax benefit purpose. 108. Having regard to the above factors, the dominant purpose of the scheme should be viewed as being to enable the Manager to receive a tax benefit being the deduction of the Novation Amount or to enable the Manager and the Growers to receive a tax benefit. 109. The Commissioner considers that Part IVA of ITAA 1936 would apply to the scheme, so that on the premise that the Future Costs Payment is deductible, the Commissioner could determine to cancel the whole of the deduction under paragraph 177F(1)(b) of the ITAA 1936.