Product Ruling

PR 2000/57

Income tax: Chateau Xanadu Vineyards II

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FOI status:

may be releasedFOI number: I 102766

Preamble

No guarantee of commercial success

The Australian Taxation Office (ATO) does not sanction or guarantee these products as investments. Further, we give no assurance that the products are commercially viable, that charges are reasonable, appropriate or represent industry norms, or that projected returns will be achieved or are reasonably based.

Potential investors must form their own view about the commercial and financial viability of the products. This will involve a consideration of important issues such as whether projected returns are realistic, the 'track record' of the management, the level of fees in comparison to similar products, how the investment fits an existing portfolio, etc. We recommend a financial (or other) adviser be consulted for such information.

This Product Ruling provides certainty for potential investors by confirming that the tax benefits set out below in the Ruling part of this document are available, provided that the arrangement is carried out in accordance with the information we have been given, and have described below in the Arrangement part of this document.

If the arrangements are not carried out as described below, investors lose the protection of this Product Ruling. Potential investors may wish to seek assurances from the promoter that the arrangements will be carried out as described in this Product Ruling.

Potential investors should be aware that the ATO will be undertaking review activities in future years to confirm the arrangements have been implemented as described below and to ensure that participants in the arrangements include in their income tax returns income derived in those future years.

Terms of use of this Product Ruling

This Product Ruling has been given on the basis that the person(s) who applied for the Ruling, and their associates, will abide by strict terms of use. Any failure to comply with the terms of use may lead to the withdrawal of this Ruling.

What this Product Ruling is about

1. This Ruling sets out the Commissioner's opinion on the way in which the 'tax law(s)' identified below apply to the defined class of persons, who take part in the arrangement to which this Ruling relates. In this Ruling the arrangement is sometimes referred to as the Chateau Xanadu Vineyards II, or just simply as 'the Project'.

Tax law(s)

2. The tax law(s) dealt with in this Ruling are:

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section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997);

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section 8-1 (ITAA 1997);

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section 27-5 (ITAA 1997);

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section 27-30 (ITAA 1997);

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Division 35 (ITAA 1997);

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section 42-15 (ITAA 1997);

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section 387-125 (ITAA 1997);

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section 387-165 (ITAA 1997);

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section 82KL of the Income Tax Assessment Act 1936 (ITAA 1936);

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section 82KZM and 82KZMB - 82KZMD (ITAA 1936); and

•

Part IVA (ITAA 1936).

3. On 11 November 1999, the Government announced further changes to the tax system as part of the New Business Tax System. A number of those changes, especially those to do with 'tax shelters', could affect the tax laws dealt with in this Ruling. Some of the changes apply from the date of the announcement and others are proposed to apply from nominated dates in the future.

4. Although this Ruling mentions certain of those announced changes, the information given on the treatment of expenditure which may be affected by them is not binding on the Commissioner. Legally binding advice in respect of those changes cannot be given until the relevant law(s) are enacted.

5. However, if the changes become law the operation of that law will take precedence over the application of this Ruling and, to that extent, the Ruling will be superseded. If requested, when the relevant law(s) are enacted, the Commissioner will formalise the non-binding information shown in this Ruling by issuing a new Product Ruling that describes the operation of those law(s).

Class of persons

6. The class of persons to whom this Ruling applies is those who enter into the arrangement described below on or after the date this Ruling is made. They will have a purpose of staying in the arrangement until it is completed (i.e., being a party to the relevant agreements until their term expires) and deriving assessable income from this involvement as set out in the description of the arrangement. In this Ruling these persons are referred to as 'Growers'.

7. The class of persons to whom this Ruling applies does not include persons who intend to terminate their involvement in the arrangement prior to its completion, or who otherwise do not intend to derive assessable income from it.

Qualifications

8. The Commissioner rules on the precise arrangement identified in the Ruling.

9. If the arrangements described in the Ruling are materially different from the arrangements that are actually carried out:

•

the Ruling has no binding effect on the Commissioner as the arrangements entered into are not the arrangements ruled upon; and

•

the Ruling will be withdrawn or modified.

10. A Product Ruling may only be reproduced in its entirety. Extracts may not be reproduced. As each Product Ruling is copyright, apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the Manager, Legislative Services, AusInfo, GPO Box 1920, Canberra ACT 2601.

Date of effect

11. This Ruling applies prospectively from 17 May 2000, the date the Ruling is made. However, the Ruling does not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Ruling (see paragraphs 21 and 22 of Taxation Ruling TR 92/20).

12. If a taxpayer has a more favourable private ruling (which is legally binding), the taxpayer can rely on the private ruling if the income year to which the private ruling relates has ended, or has commenced but not yet ended. However, if the arrangement covered by the private ruling has not begun to be carried out, and the income year to which it relates has not yet commenced, the Product Ruling applies to the taxpayer to the extent of the inconsistency only (see Taxation Determination TD 93/34).

Withdrawal

13. This Product Ruling is withdrawn and ceases to have effect after 30 June 2002. The Ruling continues to apply, in respect of the tax law(s) ruled upon, to all persons within the specified class who enter into the specified arrangement during the term of the Ruling. Thus, the Ruling continues to apply to those persons, even following its withdrawal, who entered into the specified arrangement prior to withdrawal of the Ruling. This is subject to there being no change in the arrangement or in the persons' involvement in the arrangement.

Arrangement

14. The arrangement that is the subject of this Ruling is described below. This description incorporates the following documents:

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Application for Product Ruling dated 25 February 2000;

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Final Chateau Xanadu Vineyards II Prospectus dated 20 April 2000, issued by Chateau Xanadu Wines Ltd. (Lessor) and Western Australian Viticulture Services Ltd (Responsible Entity). The Prospectus pertains to the Scheme listed below;

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Draft Constitution of Chateau Xanadu Vineyards II Managed Investment Scheme, undated;

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Lease and Management Agreement between Western Australian Viticulture Services Ltd ( the Responsible Entity ), Chateau Xanadu Wines Ltd ( the ' Lessor' ), and the Grower , undated ;

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Grape Purchase and Sale Agreement between Western Australian Viticulture Services Ltd (Vendor) and Chateau Xanadu Wines Ltd (Purchaser), undated;

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Compliance Plan for Chateau Xanadu Vineyards II Managed Investment Scheme, undated;

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Additional correspondence dated 28 April 2000.

Note: certain information received from the applicant has been provided on a commercial-in-confidence basis and will not be disclosed or released under Freedom of Information legislation.

15. The documents highlighted are those the Growers enter into. There are no other agreements, whether formal or informal, and whether or not legally enforceable, which a Grower, or any associate of the Grower, will be a party to, with the exception of finance agreements, to which paragraphs 48 and 49 apply. The effect of these agreements is summarised as follows.

Overview

16. This arrangement is called the Chateau Xanadu Vineyards II Project.

17. Growers applying under the Chateau Xanadu Vineyards II Prospectus enter into a Lease and Management Agreement with Western Australian Viticulture Services Ltd (Responsible Entity) and Chateau Xanadu Wines Ltd (Lessor). The arrangements are set out in the Prospectus for the Project. The Lease and Management Agreement gives a Grower a lease over an identifiable area of land called a 'Vinelot' until the Project is terminated on 30 June 2014. The term of the Project is expected to be 14 years. Each Vinelot is 0.2 hectares in size.

18. Growers are also required to purchase shares in the lessor (Chateau Xanadu Wines Ltd) for an initial outlay of $3,000 which represents a minimum subscription of 10,000 shares at $0.30 per share.

19. The Project Land is situated in the South-West Region of Western Australia, near Kudardup (approximately 35 kms from Margaret River). Chateau Xanadu Wines Ltd (Lessor) owns the land.

20. Chateau Xanadu Wines Ltd (Lessor) will lease the Vinelot to the Grower for the purpose of carrying on a long-term commercial viticulture project.

21. The Chateau Xanadu Vineyards II Prospectus states that there is no minimum subscription. Each investor may subscribe for a minimum of one Vinelot. Western Australian Viticulture Services Ltd (Responsible Entity) will plant approximately 594 vines per Vinelot (approximately 2,970 vine rootlings per hectare) during the period up to 30 September 2000 following the execution of the Lease and Management Agreement.

22. Possible projected returns for Growers are outlined at pages 14 & 15 of the Prospectus. Based on the example set out in page 14 of the Prospectus and Budgeted Returns found therein, a Grower could expect to achieve a pre-tax internal rate of return of 10.06% per Vinelot (average before tax rate of return of 19.14%). The projected returns depend on a range of assumptions and the Responsible Entity does not guarantee the success of, or the financial returns associated with, entering into the project. Investors will be exposed to the usual business risks and agricultural risks inherent in primary production and running a vineyard due to matters beyond the control of the Responsible Entity such as adverse weather conditions, insect attacks and variable market conditions. The projected returns are also subject to the inherent risks of the long-term nature of the venture. Page 49 of the Prospectus for the scheme has outlined these risks.

23. Growers will execute a Power of Attorney enabling the Responsible Entity (Western Australia Viticultural Services Ltd) to act on their behalf as required when they make an application for a Vinelot.

Constitution

24. The Constitution establishes the project and sets out the terms and conditions under which Western Australian Viticulture Services Ltd as the Responsible Entity (RE) agrees to act on behalf of the Growers and to manage the Project. The Responsible Entity:

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ensures that Application Funds are not released until appropriate conditions are met and the proper agreements are in place;

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arranges funds to be placed in Proceeds Fund

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keeps a register of Growers;

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procures a written report to Growers from an Independent Viticulturist each year; and

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distributes profits from the Proceeds Fund

25. A Grower is entitled to assign their Grower's Interest in certain circumstances. The Lease and Management Agreement will be executed on behalf of a Grower following them signing the Application and a Power of Attorney Form attached to the Prospectus.

Compliance Plan

26. The Responsible Entity has prepared a Compliance Plan in accordance with Corporations Law. It establishes a compliance committee whose purpose is to ensure that Western Australian Viticulture Services Ltd meets its obligations as the Responsible Entity of the Project and that the rights of the Grower are protected.

Interest in Land

27. A lease is granted by the Landowner (Chateau Xanadu Wines Ltd) to each Grower under the terms of the Lease and Management Agreement. Growers are granted an interest in land in the form of a lease to use their Vinelot for the purpose of long-term viticulture and the Project. Growers must pay rent annually to the Chateau Xanadu Wines Ltd for the term of the lease which is from the Commencement Date until 30 June 2014.

Planting

28. Planting will take place by end September 2000 in accordance with good viticultural practice. Several (7) different varieties of grapes will be planted on the available project land (45 Hectares). The proportion of land allocated to the different grape varieties is set out on page 10 of the Prospectus. After planting, the Responsible Entity will maintain the vineyard (which may include sub-contracting the services) and provide ongoing reports as required by the Lease and Management Agreement.

Harvesting

29. The Responsible Entity will be responsible for the harvesting of the grape produce grown on the vineyard. The Harvest will commence from the date of the first commercially harvestable grape crop from the vineyard at such time or times as, in the opinion of the Responsible Entity, will maximise the price receivable for such grape produce for the purpose of making quality wines. Growers can elect to collect the Collectable Land Produce that is in their interest.

30. The Receipts from the sale of any grape produce will be paid into the Proceeds Fund established by the Responsible Entity according to the constitution of the project.

Lease and Management Agreement

31. A Lease and Management Agreement is entered into between the Responsible Entity (Western Australian Viticulture Services Ltd), the Lessor and Landowner (Chateau Xanadu Wines Ltd) and the Grower.

32. Growers contract with the Responsible Entity to plant, develop, manage and maintain the vines. Growers pay an Initial Management Fee on application with the balance being paid on or before 25 May 2000 in respect of the services outlined in paragraph 32(a) below. Annual Management Fees are payable annually thereafter for the services set out in paragraph 32(b) and will be indexed to accommodate inflation. Fees will also be charged for a range of services such as Vine Establishment (Planting fees) payable on or before 30 September 2000, Trellising Costs payable by 30 September 2000 and Irrigation costs incurred by 30 June 2000 payable in three (3) equal instalments in the first three years of the project by 25 May 2000, 30 September 2000, and 20 September 2001 respectively.

33. The Responsible Entity will carry out a number of services under this agreement. These are identified as establishment services and ongoing annual services and are summarised as the following:

(a)

Establishment Services:

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obtaining all relevant Government approvals for the Vineyard;

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finalising and marking out Vineyard Layout;

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removing internal fencing and remnant vegetation;

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eradicating weeds, pests and vermin from the Vinelots;

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preparing the land;

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establishing a cover crop;

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establishing drainage

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establishing an irrigation system; and

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providing supervision and management of the above activities

(b)

Ongoing Services

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plant suitable vine rootlings (or cuttings) on the Vinelots on the leased area;

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cultivate, tend, train, prune, fertilise, spray, and otherwise care for the vines as when required;

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use all reasonable measures to keep the Vinelot free of, and protect the Land Produce from, vermin, noxious weeds, pests and diseases;

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erect and maintain suitable trellising systems to support the vines;

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maintain a trickle irrigation system to the vines in the Vinelots;

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maintain in good repair and condition adequate firebreaks in and around the Vinelots;

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maintain the Vinelots according to good viticultural practices;

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keep in good repair access laneways within the Vinelot;

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Replace any vines that fail to establish or that die during the first three years of the project; and

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harvest all grapes grown on the Vinelots and deliver them for sale.

34. Applications for Vinelots received by 25 May 2000 will enable the Responsible entity to execute the agreements and perform the Establishment Services by 30 June 2000. However, initial services and execution of agreements for any applications received after 25 May 2000 will take place after 30 June 2000 and before 30 June 2001. Hence, Growers investing after 25 May 2000 are unable to claim deductions for Project expenditure for the year ended 30 June 2000.

35. Under the Lease and Management Agreement a Grower also agrees to pay Annual Rental fees for the duration of the life of the project. This fee will be indexed annually.

36. The Responsible Entity, on behalf of Growers, will endeavour to organise insurance of the Vineyard against destruction or damage by fire or other usual risks to the vineyard, property and produce at the expense of the Grower. The Responsible Entity will be responsible for the payment of the annual cost of public liability insurance on the Vinelot (to a maximum liability of ten million dollars) and any rates and taxes in respect of each Vinelot.

37. A Grower may elect to collect and market their collectable land produce. These Growers are referred to as Electing Growers. A Grower may do so by notifying the Responsible Entity on or before 30 August 2000 or one month after application, whichever is later. However, where no election is made, Non-Electing Growers accept that the Responsible Entity will harvest the collectable land produce on their behalf.

38. Under the Lease and Management Agreement, each Grower agrees to pay to the Responsible Entity a bonus equivalent to 25% of the value of grape produce received each year in excess of the projected total returns per Vinelot as set out in the Prospectus

39. The termination of the Project is the date of payment of the final distribution from the proceeds fund to Non-Electing Growers, the date of payment of any unpaid rent or of the collection of the final Land Produce for Electing Growers or 30 June 2014, which ever is the later.

40. The Responsible Entity may be removed from its appointment by an ordinary resolution of Growers if the Growers take action under Division 1 of Part 2G.4 of the Corporations Law if the Responsible Entity:

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is involved in any breaches of its obligations;

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goes into liquidation; and

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has retired or is removed as the Responsible Entity.

Fees

41. The following is a summary of the fees payable.

42. Growers will incur Management fees throughout the life of the project. An Initial Management fee of $1,000 is payable on application with a further $3,100 payable by 25 May 2000. Management fees for the following two (2) years amounting to $2,858 and $2,276 will be payable on 30 September 2000 and 30 September 2001 respectively. Annual Management fees for the remainder of the project will be indexed and payable on 31 March of each year. The Management fees for these respective years are set out on page 14 of the Prospectus. The following equation will be used to calculate the Annual Management Fee:

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the immediately previous financial year's indexed Annual Management Fee, increased by 3%; or

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the immediately previous financial year's indexed Annual Management Fee, increased by CPI for 12 months ending the immediate previous year.

43. Annual Rent payable to the Lessor (Chateau Xanadu Wines) is charged on the lease of the land and indexed annually. In the first year of operations, $800 is payable by 30 September for the year ending 30 June 2001. For the year ending 30 June 2002, Annual Rent equal to $824 is payable by 30 September 2001. For further years (ending 30 June 2003 onwards), Annual Rent is to be paid by 31 March of each year and indexed using the following equation:

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the immediately previous financial year's indexed Annual Rent Fee, increased by 3%; or

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the immediately previous financial year's indexed Annual Rent Fee, increased by CPI for 12 months ending the immediate previous year.

44. A Grower will incur Irrigation costs amounting to $1,440 by 30 June 2000. Three (3) equal payments of $480 are scheduled to be paid on 25 May 2000, 30 September 2000 and 30 September 2001 respectively.

45. Fees are also associated with planting activities. Trellising costs amounting to $1,620 is payable by 30 September 2000. Vine Establishment costs amounting to $732 are also incurred and payable by 30 September 2000.

46. Any applications for subscription received after 25 May 2000 and on or before 30 June 2000 will not be executed until after 1 July 2000.

47. The Subscription Monies will be held in the Proceeds Fund by the Responsible Entity according to the rules set out in the Constitution of the scheme.

Finance

48. Growers can fund their investment in the Projects themselves, borrow from an independent lender or borrow through finance arrangements offered by Australian Agribusiness Finance Pty Ltd, an associate company of the Norgard Clohessy Equity Group.

49. This Ruling does not apply if a Grower enters into a finance agreement that includes or has any of the following features:

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there are split loan features of a type referred to in Taxation Ruling TR 98/22;

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there are indemnity arrangements or other collateral agreements in relation to the loan designed to limit the borrower's risk;

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'additional benefits' are or will be granted to the borrowers for the purpose of section 82KL or the funding arrangements transform the Project into a 'scheme' to which Part IVA may apply;

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the loan or rate of interest is non-arm's length;

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repayments of the principal and payments of interest are linked to the derivation of income from the Project;

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the funds borrowed, or any part of them, will not be available for the conduct of the Project but will be transferred (by any mechanism, directly or indirectly) back to the lender, or any associate of the lender; or

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lenders do not have the capacity under the loan agreement, or a genuine intention, to take legal action against defaulting borrowers.

Ruling

Goods and Services Tax

50. For a Grower who invests in the Project, sections 27-5 or 27-30 of the ITAA 1997 will apply to reduce the amount of any deduction allowable by any GST input tax credit to which the Grower is entitled or, in the case of section 27-5, a decreasing adjustment that a Grower has.

Allowable Deductions

51. For a Grower who invests in the project, the deductions available for some expenses will depend upon the date the investment is made and, in some cases, whether or not they are small business taxpayers.

IMPORTANT: Paragraph 52 & 53 (relating to 'small business taxpayers') and paragraphs 54 to 55 (relating to taxpayers who are not 'small business taxpayers') describe the deductions allowable under the current law.

52. For a Grower who ' is a small business taxpayer' and invests in the Project by 25 May 2000 , the following deductions will be available for the years ended 30 June 2000 to 30 June 2002:

Deductions available each year per Vinelot

(Note: all figures are shown exclusive of GST).

Notes:

(i)

A deduction under section 387-165 for expenditure on acquiring and planting the vines is calculated on the basis of the grapevines, as horticultural plants, entering their first commercial season in the year ended 30 June 2003 and a Grower determining, under section 387-175, that they have an 'effective life' for the purposes of section 387-185 of greater than 13 but less than 30 years. This results in a write-off rate of 13%.

(ii)

A deduction under section 387-125 for capital expenditure for the irrigation system is calculated on the basis of one third of the capital expenditure in the year in which the expenditure is incurred, and one third in each of the next 2 years of income.

(iii)

For Growers who are 'small business taxpayers' and who comply with the conditions in section 42-345, the deduction for depreciation of trellising is determined using the rates in section 42-125 and the formula in either subsection 42-160(1), 'diminishing value method', or subsection 42-165(1), 'prime cost method'. For the year ended 30 June 2000 the deduction allowed will depend upon the number of 'days owned', being the number of days in the income year in which the Grower owned an interest in the trellising. The Project Manager is to advise Growers of this for the year ended 30 June 2001. The deductions available for succeeding years have been calculated using the prime cost method at a rate of 13%, assuming that is the method that the Grower has chosen under section 42-25. If the Grower elects to use the diminishing value method the rate for calculating the deduction will be 20%.

53. For a Grower who ' is a small business taxpayer' and invests in the Project after 25 May 2000 , the following deductions will be available for the years ended 30 June 2000 to 30 June 2002:

Deductions available each year per Vinelot

(Note: all figures shown are exclusive of GST).

* Agreements for Growers investing after 25 May 2000 will not be executed until after 30 June 2000, accordingly no deductions will be available for the year ended 30 June 2000.

54. For a Grower who is not a ' small business taxpayer' and invests in the Project on or before 25 May 2000 and is carrying on a business, the following deductions will be available for the years ended 30 June 2000 to 30 June 2002:

(Note: All figures shown are exclusive of GST)

Notes:

(iv)

For Growers who are not 'small business taxpayers' the deduction for depreciation of trellising is determined using the formula in either subsection 42-160(3), 'Diminishing value method', or subsection 42-165(2A), 'Prime cost method'. Those formulae use 'effective life' to determine the deduction for depreciation. For the year ended 30 June 2000 the deduction allowed will depend upon the number of 'days owned', being the number of days in the income year in which the Grower owned an interest in the trellising. The Project Manager is to advise Growers of this for the year ended 30 June 2000. The deduction for succeeding years has been calculated using the prime cost method on the assumption that the effective life of the trellising is 13 years - (that is, the length in years of the project).

55. For a Grower who is not a'small business taxpayer' and invests in the Project after 25 May 2000 and is carrying on a business, the following deductions will be available for the years ended 30 June 2000 to 30 June 2002:

(Note: All figures shown are exclusive of GST)

•

Agreements for Growers investing after 31 May 2000 will not be executed until after 30 June 2000, accordingly no deductions will be available for the year ended 30 June 2000.

Division 35 - Deferral of losses from non-commercial business activities

Section 35-55 - Commissioner's discretion

55.1 For a Grower who is an individual and who entered the Project between 17 May 2000 and 27 May 2001 the rule in section 35-10 may apply to the business activity comprised by their involvement in this Project. Under paragraph 35-55(1)(b) the Commissioner has decided for the income years ended 30 June 2001 to 30 June 2002 that the rule in section 35-10 does not apply to this business activity provided that the Project has been, and continues to be, carried on in a manner that is not materially different to the arrangement described in this Ruling.

55.2 This exercise of the discretion in subsection 35-55(1) will not be required where, for any year in question:

•

the exception in subsection 35-10(4) applies;

•

a Grower's business activity satisfies one of the tests in sections 35-30, 35-35, 35-40 or 35-45; or

•

the Grower's business activity produces assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsection 35-10(2)); or

•

the Commissioner is precluded from exercising the discretion under paragraph 35-55(1)(b) because of subsection 35-55(2).

55.3 Where the exception in subsection 35-10(4) applies, the Grower's business activity satisfies one of the tests, or the discretion in subsection 35-55(1) is exercised, section 35-10 will not apply. This means that a Grower will not be required to defer any excess of deductions attributable to their business activity in excess of any assessable income from that activity, i.e., any 'loss' from that activity, to a later year. Instead, this 'loss' can be offset against other assessable income for the year in which it arises.

55.4 Growers are reminded of the important statement made on Page 1 of this Product Ruling. Therefore, Growers should not see the Commissioner's decision to exercise the discretion in paragraph 35-55(1)(b) as an indication that the Tax Office sanctions or guarantees the Project or the product to be a commercially viable investment. An assessment of the Project or the product from such a perspective has not been made.

Sections 82KZM, 82KZMB - 82KZMD, 82KL and Part IVA

56. For a Grower who invests in the Project the following provisions have application as indicated:

•

The expenditure by Growers does not fall within the scope of section 82KZM or sections 82KZMB - 82KZMD;

•

section 82KL does not apply to deny the deductions otherwise allowable; and

•

the relevant provisions in Part IVA will not be applied to cancel a tax benefit obtained under a tax law dealt with in this Ruling.

57. Gross sales derived from the sale of grape produce harvested from the Project will be assessable income of the Growers, under section 6-5.

Explanations

Sections 27-5 and 27-30 ITAA 1997 - Goods and Services Tax

58. Section 27-30 of the ITAA 1997 operates to deny a deduction that would be otherwise available under section 8-1 for the year ended 30 June 2000 to the extent that the loss or outgoing (incurred after 30 November 1999 and on or before 1 July 2000) includes an amount relating to an input tax credit to which a Grower will be entitled on or after 1 July 2000.

59. Section 27-5 of the ITAA 1997 operates to deny a deduction, that would be otherwise available under section 8-1, to the extent that the loss or outgoing incurred (on or after 1 July 2000) includes an amount relating to an input tax credit to which a Grower is entitled or a decreasing adjustment that a Grower has.

Subdivision 960-Q ITAA 1997 - Small business taxpayers

60. In this product ruling the term 'small business taxpayer' is relevant for the purposes of the depreciation of trellising.

61. Whether a Grower is a 'small business taxpayer' depends upon the individual circumstances of each Grower and is beyond the scope of this product ruling. It is the individual responsibility of each Grower to determine whether or not they are within the definition of a 'small business taxpayer'.

62. A 'small business taxpayer' is defined in section 960-335 of the ITAA 1997 as a taxpayer who is carrying on a business and either their 'average turnover' for the year is less than $1,000,000 or their turnover recalculated under section 960-350 is less than $1,000,000.

63. 'Average turnover' is determined under section 960-340 by reference to the average of the taxpayer's 'group turnover'. The group turnover is the sum of the 'value of business supplies' made by the taxpayer and entities connected with the taxpayer during the year (section 960-345).

Section 8-1 ITAA 1997

64. It is appropriate, as a starting point, to consider whether lease and management fees are deductible under paragraph 8-1(1)(a). This consideration proceeds on the following basis:

•

the outgoing in question must have a sufficient connection with the operations or activities that directly gain or produce the taxpayer's assessable income;

•

the outgoing is not deductible under paragraph 8-1(1)(b) if it is incurred when the business has not commenced; and

•

where a taxpayer contractually commits themselves to a venture that may not turn out to be a business, there can be doubt about whether the relevant business has commenced and, hence, whether paragraph 8-1(1)(b) applies. However, that does not preclude the application of paragraph 8-1(1)(a) in determining whether the outgoing in question would have a sufficient connection with activities to produce assessable income of the taxpayer.

65. A vineyard project can constitute the carrying on of a business. Where there is a business, or a future business, the gross sale proceeds from grapes from the scheme will constitute gross assessable income under section 6-5. The generation of 'business income' from such a business, or future business, provides the backdrop against which to judge whether the outgoings in question have the requisite connection with the operations that more directly gain or produce this income. These operations will be the planting, tending, maintaining and harvesting of the vines.

66. Generally, a Grower will be carrying on a vineyard business where:

•

the Grower has an identifiable interest in specific grape vines coupled with a right to harvest and sell the grapes produced;

•

the vineyard activities are carried out on the Grower's behalf; and

•

the weight and influence of the general indicators of a business, as used by the Courts, point to the carrying on of a business.

67. Under the Lease and Management Agreement, Growers have rights in the form of a lease over an identifiable area of land consistent with the intention to carry on a business of a commercial vineyard. Growers appoint Western Australian Viticulture Services Ltd, as Responsible Entity, to carry out a viticulture project in accordance with the agreement. The agreements give Growers full right, title and interest in the grapes produced and the right to have the grape produce sold for their benefit.

68. Under the Lease and Management Agreement, Growers appoint the Responsible Entity to provide services such as the planting of suitable callused cuttings or vine rootlings, the installation of trellising and irrigation, and maintaining the leased area according to good viticultural practices. The Responsible Entity is also responsible for harvesting and selling the grape produce. The specific cost of these services provided in the initial period is $14,650.

69. The Lease and Management Agreement gives Growers ownership and an identifiable interest in specific vines and a legal interest in the land by virtue of a lease. Growers can elect to use the Manager to market the produce for them.

70. Growers have the right to use the land in question for the cultivation of vines and harvesting of grapes and to have the Responsible Entity enter the land to carry out its obligations under the Lease and Management Agreement. The Growers' degree of control over the Responsible Entity, as evidenced by the Agreement and supplemented by the Corporations Law, is sufficient. Growers are able to terminate arrangements with the Responsible Entity if a resolution is passed under paragraph 7.12.15(10)(g) of the Corporations Regulations. The activities described in the Lease and Management Agreement are carried out on the Growers' behalf.

71. The general indicators of a business, as used by the Courts, are described in Taxation Ruling TR 97/11. Growers to whom this Ruling applies intend to derive assessable income from the Project. This intention is related to projections in the Prospectus that suggest the Project should return a 'before-tax' profit to the Growers, i.e., a 'profit' in cash terms that does not depend in its calculation on the fees in question being allowed as a deduction.

72. Growers will engage the professional services of a Responsible Entity with appropriate credentials. The services are based on accepted viticulture practices and are of the type ordinarily found in viticulture activities.

73. Growers have a continuing interest in the vines from the time they are acquired until they reach the end of the most productive period of their life. There is a means to identify which vines Growers have an interest in. The vineyard activities, and hence the fees associated with their procurement, are consistent with an intention to commence regular activities that have an 'air of permanence' about them. The Growers' vineyard activities will constitute the carrying on of a business.

74. The management fees and lease fees associated with the vineyard activities will relate to the gaining of income from this business and, hence, have a sufficient connection to the operations by which this income (from the sale of grape produce) is to be gained from the business. They will, thus, be deductible under the first limb of section 8-1. Further, no 'non-income producing' purpose in incurring the fee is identifiable from the arrangement. No capital component is identifiable. The tests of deductibility under paragraph 8-1(1)(a) are met. The exclusions of subsection 8-1(2) do not apply.

Expenditure of a capital nature

75. Any part of the expenditure of a Grower entering into a horticultural business that is attributable to acquiring an asset or advantage of an enduring kind is generally capital or capital in nature and will not be an allowable deduction under section 8-1. In this Project, the costs of irrigation, trellising, and rootlings are considered to be capital in nature. The fees for these expenditures are not deductible under section 8-1. However, expenditure of this nature can fall for consideration under specific capital write-off provisions of the ITAA 1997.

Section 42-15 ITAA 1997: trellising expenditure

76. Growers accepted into the Project incur expenditure on trellising upon which the vines are attached. The trellising is to be used on their behalf in the operation of the vineyard business. The trellising is attached to the land as a fixture. This expenditure is of a capital nature.

77. Under section 42-15, a taxpayer can deduct an amount for depreciation of a unit of plant used for the purpose or purposes of producing assessable income where they are the owner or quasi-owner of that plant. However, where an item is affixed to land so that it becomes a fixture, at common law it becomes part of the land and is legally, absolutely owned by the owner of the land.

78. It is, however, accepted in certain circumstances that a lessee is entitled to claim depreciation where they are considered to be the owner of those improvements. Income Tax Ruling IT 175 sets out the Australian Taxation Office's (ATO's) views on this issue. Where a lessee is considered to own the improvements under a state law, as detailed in the Ruling, or where they have a right to remove the fixture or are entitled to receive compensation for the value of the fixture, the ATO accepts the lessee is entitled to claim depreciation for the fixture.

79. Under section 42-15 Growers are entitled to depreciation deductions for expenditure of $1,620, relating to the acquisition and installation of trellises on the land. The deduction available, however, will depend on whether or not a Grower is a 'small business taxpayer' as defined in section 960-335 and, if so, whether the Grower complies with the conditions contained in section 42-345.

80. The depreciation deduction available to a Grower who is a 'small business taxpayer' and who complies with the conditions contained in section 42-345 is calculated using the cost of the trellising and a rate of 13% prime cost or 20% diminishing value. These accelerated rates of depreciation are shown in section 42-125 and apply to plant with an effective life of between 13 and 30 years.

81. Growers who are not 'small business taxpayers' will have entered the Project after 11:45am, AEST, 21 September 1999, and will not be able to claim accelerated depreciation on plant used in the Project because of section 42-118. The deduction for such Growers is calculated using the cost of the trellising and its effective life only. Subdivision 42-C provides the choice of methods available for determining the effective life of plant.

82. A Grower accepted into the Project enters into a lease for a right to occupy certain land upon which they are entitled to grow grapes to conduct a viticulture business. Subject to the terms and conditions of the Lease, Growers have the right to remove their trellising at the end of the lease term.

83. The Manager will advise Growers the date the trellising is installed and begins to be used for the purpose of producing assessable income. Therefore, the cost that relates to the acquisition and installation of trellises on the land will be eligible for depreciation deduction by the Growers, who are small business taxpayers, under section 42-125, at a rate of 13% prime cost or 20% diminishing value from this date. Growers, who are not small business taxpayers, will be eligible for a depreciation deduction under subsections 42-160(3) or 42-165(2A), at a rate of 9% prime cost or 13.5% diminishing value from this date.

Subdivision 387-B ITAA 1997: irrigation expenditure

84. Subdivision 387-B allows a taxpayer, who is carrying on a business of primary production on land in Australia, to claim a deduction for capital expenditure on conserving or conveying water. The deduction is allowed over a three year period and applies to plant or a structural improvement primarily or principally used for the purpose of conserving or conveying water for use in a primary production business. Irrigation systems of the kind proposed would be covered by this Subdivision.

85. As the taxpayer who can claim the deduction does not have to actually own the land but can be a tenant or lessee, a deduction would be available to the Growers in the Project at a rate of 33.3% per annum for the cost of the irrigation system.

Section 387-165 ITAA 1997: horticulture expenditure

86. Section 387-165 allows capital expenditure on establishing horticultural plants for use in a horticultural business to be written off for tax purposes. Costs of establishing horticultural plants may include the cost of acquiring the plants, the cost of establishing the plants, and the costs of ploughing, contouring, top dressing, fertilising and stone removal. Expressly excluded is expenditure incurred on draining swamps or clearing land. Under subsection 387-170(3), the definition of 'horticulture' includes the cultivation of grapevines. For the purpose of this Subdivision, a lessee or licensee of land carrying on a business of horticulture is treated as owning the plants growing on that land rather than the actual owner of the land.

87. The write-off commences from the time the vines are used or held ready for use for the purpose of producing assessable income in commercial horticulture. The write-off deductions will commence when the vines enter their first commercial season. Where the vines are planted in or about June 2000, it is projected that these vines will become commercially productive after a period of 2.5 years. The Manager will advise the Grower of this event.

88. Under this Subdivision, if the effective life of the plant is more than 3 years, an annual deduction is allowable on a prime cost basis during the plant's maximum write-off period.

89. The effective life of a plant is to be determined objectively and should take into account all relevant circumstances. It is estimated that the vines will have an effective life in excess of 13 years. The write-off rate for horticultural plants with an effective life of 13 to 30 years is 13%.

Section 82KL ITAA 1936

90. The operation of section 82KL depends, among other things, on the identification of a certain quantum of 'additional benefits'. In the project, insufficient 'additional benefits' will be provided to trigger the application of section 82KL. It will not apply to deny the deductions otherwise allowable under section 8-1.

Part IVA ITAA 1936

91. For Part IVA to apply there must be a 'scheme' (section 177A), a 'tax benefit' (section 177C), and a dominant purpose of entering into the scheme to obtain a tax benefit (section 177D). The Project will be a 'scheme', commencing when the Prospectus is issued. The Growers will obtain an initial 'tax benefit' from entering into the scheme, in the form of the deduction for the initial fee, allowable under section 8-1, that would not have been obtained but for the scheme. However, it is not possible to conclude that the scheme will be entered into or carried out with the dominant purpose of obtaining this tax benefit.

92. Growers to whom this Ruling applies intend to stay in the scheme for its full term and derive assessable income from the eventual harvesting of the trees. The Independent Viticulturist's Report contained in the Prospectus states that the Project should achieve its financial objective if the viticulture regimes set out in the report are followed, good marketing arrangements are put in place and the international economy and climatic factors (especially annual rainfall) are favourable. There are no features of the Project that might suggest the Project was so 'tax driven', and so designed to produce a tax deduction of a certain magnitude that would attract the operation of Part IVA.

Section 6-5 ITAA 1997: assessable income

93. Gross sale proceeds derived from the sale of grape produce from the project will be assessable income of the Growers, under section 6-5 of ITAA 1997.

94. Once harvested, a Grower's grape produce will be trading stock of the Grower. As a consequence, if grapes or grape juice are on hand at the end of the income year, the Grower will need to account for that trading stock in accordance with the trading stock provisions in Part 2-25 of ITAA 1997.

95. Each Grower will be notified by Western Australian Viticulture Services Ltd of the respective amounts to be brought to account in proportion to their total holding in the Project, in accordance with Part 2-25 and Taxation Ruling IT 2001.

Detailed contents list

96. Below is a detailed contents list for this Product Ruling:

Commissioner of Taxation
17 May 2000

Not previously issued in draft form

References

ATO references:
NO 2000/006765

Related Rulings/Determinations:

PR 1999/95
TR 92/1
TR 97/11
TR 97/16
TR 92/20
TR 98/22
IT 175
IT 2001
TD 93/34

Subject References:
carrying on a business
commencement of a business
interest expenses
harvesting expenses
management fees
primary production
primary production expenses
producing assessable income
product rulings
public rulings
schemes
tax avoidance
tax benefits
viticultural expenses

Legislative References:
ITAA 1997 8-1
ITAA 1997 27-5
ITAA 1997 27-30
ITAA 1997 Div 35
ITAA 1997 35-10
ITAA 1997 35-10(2)
ITAA 1997 35-10(4)
ITAA 1997 35-30
ITAA 1997 35-35
ITAA 1997 35-40
ITAA 1997 35-45
ITAA 1997 35-55
ITAA 1997 35-55(1)
ITAA 1997 35-55(1)(b)
ITAA 1997 35-55(2)
ITAA 1997 42-15
ITAA 1997 42-118
ITAA 1997 42-125
ITAA 1997 42-160
ITAA 1997 42-165
ITAA 1997 42-345
ITAA 1997 387-55
ITAA 1997 387-125
ITAA 1997 387-165
ITAA 1997 960-335
ITAA 1997 960-340
ITAA 1997 960-345
ITAA 1997 960-350
ITAA 1936 82KL
ITAA 1936 82KZM
ITAA 1936 82KZMB
ITAA 1936 82KZMC
ITAA 1936 82KZMD
ITAA 1936 PtIVA
ITAA 1936 177A
ITAA 1936 177C
ITAA 1936 177D
TAA 1953 Pt IVAAA
Copyright Act 1968