Saturday 27 May 2006

Plantations: An accountant's view


I’ve never been a fan of MISs, initially because I’ve never seen any investor make a respectable return, but in the last few years because of the associated negative impact on our community. After considerable reflection I think the current proposed arrangements announced at budget time give us a chance to move on.


It’s a little disappointing that the Government didn’t specifically address the question of longer rotation sawlog crops because this was specifically mentioned in the terms of reference in June 2005.

The proposed arrangements don’t make a distinction between short rotation and longer rotation crops. Hopefully these issues can be addressed in the proposed certification process under arrangements yet to be developed.

 I agree with the removal of the need to maintain the legal fiction that a MIS investor is carrying on a business. A person living on the North Shore who is allocated maybe only 1/3rd of a hectare in seedlings in some distant part of the country is no more carrying on a business than I was with my stamp collection as an eight year old.

To maintain the fiction it only took a Constitution, a Lease or Forest Right Agreement with the Responsible Entity, a Compliance Plan, a Plantation Management Agreement, a Lease with the Landlord and possibly a Loan Deed. With all those agreements you’ve just got to be carrying on a business!

A little bit of integrity may be restored to the Tax Act if we are no longer insulted by seeing the bar set so low with regard to the deductibility of expenses.

Also there will no longer be a need to seek the Commissioner’s discretion in order to claim plantation establishment costs pursuant to the non commercial loss provisions.

 

This too was making a joke of the Tax Act.

 

The harvest proceeds didn’t even have to meet the objective test ($20,000) that other taxpayers face under the non-commercial loss provisions. MIS investors only had to make a profit in the harvest year

 

It appears that because there will no longer be a need to pretend to be carrying on a business, the general deductibility provision of Division 8 of the Tax Act won’t apply and a new Division will be introduced.

 

But I don’t understand the basis for selecting a cap of $6,500 per hectare for deductible expenditure in the first year with the balance deductible in the following year? I don’t think the cap achieves much. It seems a little arbitrary.

More crucially is the need for the Commissioner to be able to determine, despite any agreement to the contrary, whether an outgoing contains a capital component or a component of prepaid rent, rather than give MIS investors carte blanche approval for all MIS claims provided they’re spread over at least two financial years.

Allowing the Commissioner to determine whether an outgoing contains a capital or other component is perfectly consistent with the way other taxpayers are treated.

It is often claimed that investors’ monies aren’t used to purchase land.

The assertion is at best a half truth.

What is almost certainly true is that establishment fees contain a large element of prepaid rent and the resulting profits are used at some stage by companies in the same group either directly, or to support further loan and equity raisings, which are then used for further business expansion that includes the purchase of land.

Most MIS investors pay rent at harvest time, say 2.5% of the net harvest proceeds. With 250 tonne per hectare at say $20 per tonne net, this only gives a total rent of $125 over a 12 year period.

Doesn’t seem much for land that may be worth $7,500 per hectare. It’s only $10 pa. Even if net proceeds were double it’s still an inadequate rental return.

At the same time we know that the market rent on land suitable for forestry is 8% pa and that plant establishment costs for a forest company are approximately $2,000 per hectare.

So if an investor pays $10,000 per hectare for establishment of seedlings, expected to be harvested in 12 years time on land worth $7,500 per hectare, then the break-up of the establishment fee from the forest company’s perspective is roughly $7,200 for rent, $2000 to reimburse plantation costs and $800 profit.

From the investor’s viewpoint, of his $10,000 payment $3,400 is deductible in the first year and the balance being prepaid rent is deductible over the remaining 11 years.

The Commissioner can issue guidelines as to what he regards as a reasonable basis to determine the prepaid rent component.

I think this is preferable to putting an arbitrary cap of $6,500 in the first year. And boutique schemes such as sandalwood will not require special treatment. Once the prepaid rent is excluded the balance is deductible in full immediately.

 

The secondary market for MIS investments is a sensible idea.

But why do MIS investors have to wait four years? Why not from Year 2 onwards? If the market has a role at all then let them become involved as soon as possible.

The price signals that will be transmitted back to other potential investors will only help them make informed decisions.

It is sometimes argued that a fair market price won’t be obtained until Year 8 because there’s too much ‘agricultural risk’ in the early years.

However MIS investors are about to be classified as passive investors not farmers.

If a MIS interest needs to be sold then this should be permitted at any time. After all what fire sale price is a fair price?

Secondary market disposals to associates, however, should be prohibited and the usual anti avoidance measures should be put in place to ensure this provision is not circumvented.

If the prohibition is not instituted then the Government runs a real risk of receiving very little tax at harvest time.

If a lawyer can create the legal fiction via six documents that a person owning a few seedlings is carrying on a business, he could easily arrange to transfer a MIS interest to an exempt or low rate associate and that is contrary to the intent of the proposals which is to treat all returns to the investor as assessable income.

I understand that the need to allow for seasonal conditions is the reason behind the extension from 12 to 18 months for the period within which planting must occur.

However as a quid pro quo a MIS Product Disclosure Document (PDS) should be required to set out the actual land areas that the Promoter intends to plant.

He doesn’t have to acquire the land he could merely take out an option to acquire it on the condition that sufficient subscription monies are forthcoming.

What happens now is that when the subscription monies are in the door the forest companies start rampaging around the countryside looking for land.

It is highly disruptive and traumatic for rural communities to have forest companies with enough cash to buy the entire landscape, sweeping through their neighbourhoods causing complete havoc.

Details of the land certified by the Department of Agriculture Fisheries and Forestry needs to be included in the PDS.

Then they can have 18 months to plant; let them have two years if they want.

 

The certification procedure needs to cover a range of matters some of which are arguably outside the Department’s area of expertise, areas such as local government planning, salinity and hydrology questions, flora and fauna protection, and the social effects to name a few.

Even investors need more protection than has been forthcoming from ASIC.

Not only that, but where limited expertise is being used to arbitrate on matters where there are inevitable conflicts of interest between stakeholders, the process has less chance of gaining widespread acceptance.

Community angst will continue.

The certification process needs to include experts other than just from one department in Canberra if community interests are to be fully represented.

I think the move to treat MIS investors as passive investors reflects reality.

Presumably this means they can’t access the primary industry concessions available in the Tax Act. This is sensible.

Access to the concessions will probably change anyway if the legal interest of the MIS investor changes from the current one of a Grower owning a Woodlot on leased land to a passive investor with a share, unit, or some other interest. And I think being passive investors rather than primary producers will make it a little easier for the community to extract a more equitable share of rates and land taxes from the absent and largely disinterested participants in what is essentially an attempt to avoid income tax.

The superannuation Plan announced in the Budget makes super more attractive for most people. I think this Plan should be the benchmark to assess proposals like the current MIS ones. The Government has produced a pretty reasonable plan to simplify and streamline retirement savings.

I fail to see why MIS investors should get too much additional help. If a specific industry requires assistance, then the Tax Act is an inappropriate vehicle.

The proposals do however give special treatment to MIS investors by creating a new Division in the Tax Act. They will no longer have to run the gauntlet of trying to establish that they are conducting a business.

That’s got to be a big step forward for the MIS industry.

So it is only reasonable for the community to be able to scrutinise their activities.

In the main the proposals are a good start. The most glaring need is to ensure that otherwise non deductible expenses are excluded from establishment fees. The next need is that the certification process represents a broad cross section of stakeholders, and that this process precedes the issue of a PDS rather than the other way around.

Published in Tasmanian Country 26th May 2006

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