Product Ruling

PR 2000/45

Income tax: Norfolk Ridge Vineyards Project - Stage 3

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FOI status:

may be releasedFOI number: I 102724

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 this arrangement is sometimes referred to as the Norfolk Ridge Vineyards Project - Stage 3, 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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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

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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. 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

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the Ruling will be withdrawn or modified.

9. 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

10. This Ruling applies prospectively from 19 April 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).

11. 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

12. 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

13. 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 18 February 2000;

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The Norfolk Ridge Vineyards Project Draft Third Supplementary Prospectus, undated;

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Draft 2000 Lease and Management Agreement between Egerton Vineyard Management Ltd (the Manager), Egerton Vineyards Mt Barker Ltd (the 'Lessor'), Charters Securities Ltd ('the Trustee') and the Grower, undated;

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Trust Deed between Egerton Vineyard Management Ltd, Charters Securities Ltd and Egerton Vineyards Mt Barker Ltd; and

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Additional correspondence dated 18 February 2000 and 6 April 2000.

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

14. 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 40 and 41 apply. The effect of these agreements is summarised as follows.

Overview

15. This arrangement is called the Norfolk Ridge Vineyards Project - Stage 3.

16. Growers applying under the Draft Third Supplementary Prospectus, undated, enter into a Lease and Management Agreement. The arrangements are set out in the Trust Deed for the Project. The Lease and Management Agreement gives a Grower a lease over an identifiable area of land called a 'Leased Area' until the Project is terminated on 31 December 2013. The term of the Project is expected to be 13 years. Each Leased Area is 0.4 hectares in size.

17. The Project Land is situated in the South West Region of Western Australia, near Mt Barker. Egerton Vineyards Mt Barker Ltd owns the land.

18. Egerton Vineyards Mt Barker Ltd will lease the Leased Area to the Grower for the purpose of carrying on a long term commercial viticulture project.

19. The Draft Supplementary Prospectus states that there is no minimum subscription. Each investor may subscribe for a minimum of one Leased Area. The Manager will plant approximately 666 vines per Vinelot (1,667 per hectare) during the period up to 30 June 2000 following the execution of the Lease and Management Agreement.

20. Possible projected returns for Growers are outlined at Appendix 3 of the Draft Supplementary Prospectus. The Manager does not guarantee the success of the vineyard. Investors will be exposed to the usual business risks and agricultural risks inherent in primary production due to matters beyond the control of the Manager such as adverse weather conditions, insect attacks and variable market conditions. The projected returns are subject to the inherent risks of the long term nature of the venture. Egerton Vineyard Management Ltd has outlined these risks in the Prospectus for the Project. Based on the example set out in Appendix 3 of the Draft Supplementary Prospectus, a Grower could expect to achieve a pre-tax internal rate of return of 14.5% per Leased Area.

21. Growers will execute a Power of Attorney enabling the Manager, Egerton Vineyard Management Ltd, to act on their behalf as required when they make an application for a Leased Area.

Trust Deed

22. The Trust Deed for the Project sets out the terms and conditions under which the Manager agrees to act for the Growers and to manage the Project. The Manager will keep a register of Growers. 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 Draft Third Supplementary Prospectus. Growers are bound by the Trust Deed and the Lease and Management Agreement by virtue of their participation in the Project.

Interest in Land

23. A lease is granted by the Land Owner to each Grower under the terms of the Lease and Management Agreement (cl.3.1). Growers are granted an interest in land in the form of a lease to use their Leased Area for the purpose of long term viticulture and the Project (cl.5.2). Growers must pay rent annually to the Lessor for the term of the lease which is from the Commencement Date until 31 December 2013.

Lease and Management Agreement

24. Each Grower enters into a Lease and Management Agreement with the Manager. The termination of the Project is the date on which the trust is terminated under the trust deed, the date of payment of the final distribution from the proceeds fund to the Grower or 31 December 2013, whichever is the earlier (Item 6 of schedule). Growers contract with the Manager to plant, develop, manage and maintain the vines. Growers pay an Initial Management Fee on application and annual Management Fees thereafter.

25. The Manager will carry out the following services under this agreement:

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Plant suitable callused cuttings or vine rootlings 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 leased area free from vermin, noxious weeds, pests and diseases;

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Maintain the leased area according to good viticultural practices; and

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

26. A Grower may elect to collect and market their own collectable produce. However, where no election is made, the Manager will harvest (cl 17) from the date of the first commercially harvestable grape crop the grape produce grown on the vineyard at such time or times as, in the opinion of the Manager, will maximise the price receivable for such grape produce for the purpose of making quality wines. The Manager will be responsible for paying for the annual cost of public liability insurance on the Leased Area (cl. 21.1). The Grower will be responsible for additional insurances as required by the Grower such as vine and crop protection (cl. 21.2).

27. Any applications for Leased Areas received after 31 May 2000 and on or before 30 June 2000 will not be executed until 1 July 2000.

28. Under the Lease and Management Agreement, each Grower agrees to pay to the Manager a bonus equivalent to 50% of the value of grape produce received each year in excess of the projected total returns per Leased Area set out in the Prospectus (cl.22.1.3).

Fees

29. The initial amount payable on application under the Lease and Management Agreement for the Project is $12,550 per Leased Area. This amount includes $6,322 of the total Management Fee of $14,322, which is payable in three instalments. The first instalment of $6,322 is payable on application. The second instalment of $4,000 is payable on 1 October 2000 and the third instalment of $4,000 is payable on 31 January 2001. The balance of the amount payable on application is made up of the costs of establishing and planting Rootlings of $478, Irrigation costs of $2,500, Trellising expenses of $3,000 and Rent of $250 (schedule to the Lease and Management Agreement). The services included in the initial Management Fee of $6,322 will be provided by 30 June 2000 where Growers subscribe by 31 May 2000. The Rent is for the period from the date of application until 31 December 2000.

30. A Management Fee of $4,224 is payable for services to be carried out in the period commencing 1 July 2001 until 30 June 2002 and is payable in two instalments of $2112 on 31 July 2001 and $2112 on 31 January 2002.

31. An indexed Management Fee is payable for the period commencing 1 July 2002 to 30 June 2003. The amount of the annual Fee will be the amount for the immediately preceding year, increased by the greater of 3% or the percentage increase in the Consumer Price Index and is payable in two equal instalments on 31 July 2002 and 31 January 2003.

32. For the years from 1 July 2003 to 31 December 2013, Management Fees, indexed as in paragraph 31 above, are payable annually for the periods 1 July to the following 30 June in two equal instalments on 31 July and 31 January of each year.

33. Rent of $500 per year, indexed annually as in paragraph 31 and from 31 July 2002, is payable by the Grower in two equal instalments on 31 July and 31 January of each year.

34. The Viticulturist's report states that with appropriate establishment procedures and sound management, this project can achieve its aims and objectives as outlined in the Prospectus.

35. Any applications for subscription received after 31 May 2000 and on or before 30 June 2000 will not be executed until 1 July 2000

36. The Subscription Monies will be held in the Trust Account by the Trustee under the Project's Trust Deed (cl 9.6).

Planting

37. During the period up to 30 June 2000, the Manager will be responsible for planting suitable callused cuttings or vine rootlings on the leased area. After 30 June 2000, the Manager will maintain the lease area according to good viticultural practices. The services to be provided by the Manager over the term of the project are outlined in the Lease and Management Agreement (Item 9 of schedule).

Harvesting

38. The Manager 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 Manager, will maximise the price receivable for such grape produce for the purpose of making quality wines.

39. The Receipts from the sale of any grape produce will be paid into one or more produce funds established by the Trustee. Receipts received by the Trustee are to be distributed in the following order of priority:

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any amount to which the Trustee is entitled under clause 33.4 of the Trust Deed to deduct or recover;

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any annual contributions payable by a non-electing grower that are due and unpaid;

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payment of the portion of the Manager's bonus payable under clause 22.1.3 of Lease and Management Agreement;

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any amount payable by a non-electing grower to the Manager or Trustee under the Lease and Management Agreement; and

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to the non-electing Grower in proportion to their respective proportional interest in the net sales proceeds (cl 20.3 of Lease and Management Agreement).

Finance

40. All Growers are required to fund their investment in the Project themselves or borrow from an independent lender.

41. 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

42. 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

43. For a Grower who invests in the Project, the deduction available for the Lease Fee will depend upon the date that the investment is made.

IMPORTANT: Paragraphs 44 and 45 (relating to 'small business taxpayers') and paragraphs 46 and 47 (relating to taxpayers who are not 'small business taxpayers') describes the deductions allowable under the current law, but Growers are advised to carefully examine the information contained in paragraphs 50 and 51 relating to proposed changes to the prepayment rules. Growers who invest in the Project after 1pm, AEST, 11 November 1999 may be affected by these changes.

44. For a Grower who 'is a small business taxpayer' and invests in the Project by 31 May 2000, the following deductions will be available for the years ended 30 June 2000 to 30 June 2002:

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

Notes:

(i)

Proposed legislative change applying to expenditure incurred after 1.00pm AEST 11 November 1999 means that for all Growers the full deduction may not be allowed in the year ended 30 June 2000.

See non-binding advice in paragraphs 50 and 51.

(ii)

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%.

(iii)

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.

(iv)

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 2000. 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%.

45. For a Grower who 'is a small business taxpayer' and invests in the Project after 31 May 2000, the following deductions will be available for the years ended 30 June 2000 and 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.

46. For a Grower who is not a 'small business taxpayer' and invests in the Project by 31 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:

(v)

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).

47. For a Grower who is not a 'small business taxpayer' and invests in the Project after 31 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.

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

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

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

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

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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.

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

Proposed new laws

Proposed changes to prepayment rules

50. On 11 November 1999, the Government announced a number of changes to the deductibility of certain prepaid expenditure incurred in respect of 'tax shelter arrangements'. Provided the proposed changes are enacted as announced, the Project will be a 'tax shelter arrangement' and all Growers, including 'small business taxpayers', who invest in the Project after 1pm, AEST, 11 November 1999, will be subject to these changes.

51. For these Growers the amount of deduction available in respect of the Lease Fee is calculated using the formula shown below. In the calculation, the term 'expenditure' refers to expenditure otherwise allowable under section 8-1 ITAA 1997 whose 'eligible service period' ends not more than 13 months after it is incurred by the taxpayer. The 'eligible service period' (defined in subsection 82KZL(1)) means, generally, the period over which the services are to be provided.

Deduction = Expenditure X (Number of days of eligible service period in the expenditure year/Total number of days of the eligible service period)


The excess remaining after the application of this formula is deductible in the year that the services to which the excess relates are performed.

Note to promoters and advisers

52. Product rulings were introduced for the purpose of providing certainty about tax consequences for investors in projects such as this. In keeping with that intention, the Tax Office suggests that promoters and advisers ensure that potential investors are fully informed of the announcement requiring prepayments in respect of 'tax shelter' arrangements to be deductible over the period services are provided. Such action should minimise suggestions that potential investors have been negligently or otherwise misled.

Explanations

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

53. 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.

54. 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

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

56. 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'.

57. 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.

58. '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

59. 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:

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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.

60. 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.

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

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

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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.

62. 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 Egerton Vineyard Management Ltd, as Manager, 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.

63. Under the Lease and Management Agreement, Growers appoint the Manager 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 Manager is also responsible for harvesting and selling the grape produce. The specific cost of these services provided in the initial period is $12,550.

64. The Lease and Management Agreement gives Growers 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.

65. Growers have the right to use the land in question for the cultivation of vines and harvesting of grapes and to have the Manager enter the land to carry out its obligations under the Lease and Management Agreement. The Growers' degree of control over the Manager, as evidenced by the Agreement and supplemented by the Corporations Law, is sufficient. Growers are able to terminate arrangements with the Manager 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.

66. 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.

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

68. 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.

69. 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

70. 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

71. 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.

72. 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.

73. 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.

74. Under section 42-15 Growers are entitled to depreciation deductions for expenditure of $3,000, 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.

75. 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.

76. 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.

77. 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.

78. 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

79. 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.

80. 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

81. 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.

82. 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.

83. 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.

84. 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 82KZM: prepaid expenditure for small business taxpayers

85. Section 82KZM operates to spread over more than one income year a deduction for prepaid expenditure incurred by a 'small business taxpayer' that would otherwise be immediately deductible, in full, under section 8-1. The section applies if certain expenditure incurred under an agreement is in return for the doing of a thing under the agreement that is not wholly to be done within 13 months after the day on which the expenditure is incurred.

86. Under the Lease and Management Agreement, the initial Lease Fee will be incurred upon execution of the Agreement. This fee is charged for providing services to Growers for a period of up to 13 months from the date of execution of the Agreement. For this Ruling's purposes, no explicit conclusion can be drawn from the arrangement's description that the fee has been inflated to result in reduced fees being payable for subsequent years. The fee is expressly stated to be for a number of specified services. There is evidence this fee is for services to be provided within 13 months of the fee being incurred.

87. Thus, for the purposes of this Ruling, it is accepted that no part of the initial Lease Fee is for the Manager to do 'things' that are not to be wholly done within 13 months of the fee being incurred. On this basis, the basic precondition for the operation of section 82KZM is not satisfied and it will not apply to the expenditure for the Lease Fee by Growers who are 'small business taxpayers'.

Sections 82KZMA - 82KZMD - Prepaid expenditure for taxpayers other than small business taxpayers

88. For a Grower who is not a 'small business taxpayer' and is carrying on a business, sections 82KZMA to 82KZMD determine the amount of a deduction otherwise allowable under section 8-1 where expenditure is incurred under an agreement for the doing of a thing that is not to be wholly done within the income year in which the expenditure is incurred (the expenditure year). Generally, these provisions operate to limit the amount of deduction available in the expenditure year to the amount that relates to that income year.

89. However, subparagraph 82KZMA(4) excludes expenditure of less than $1,000 from the scope of sections 82KZMB to 82KZMD. The Lease Fee payable on application for the period commencing on application to 31 December 2000 is less than $1,000. Again, the basic precondition for the operation of sections 82KZMB to 82KZMD is not satisfied and they will not apply to the expenditure for the Lease Fee by Growers who are not 'small business taxpayers'.

Proposed changes to prepayment rules

90. The changes announced by the Government to apply from 11 November 1999 but not yet enacted will affect all taxpayers that participate in a 'tax shelter arrangement' and prepay expenditure for up to 13 months. It is proposed that deductions otherwise allowable under section 8-1 of the ITAA 1997 be spread over the period to which the prepayment relates. Under the proposed changes, there will be no exemption for small business taxpayers and no transitional rules will apply.

91. A tax shelter arrangement is described as existing where:

•

under the arrangement, the taxpayer's allowable deductions exceed the assessable income for that year; and

•

all significant aspects of the arrangement during the income year are conducted by people (e.g., a manager) other than the taxpayer; and

•

either:

•

more than one taxpayer participates in the arrangement; or

•

the manager, or an associate of the manager, also manages similar arrangements on behalf of others.

92. The arrangement relating to the Project and described at paragraphs 13 to 42 of this product ruling is within the description of a 'tax shelter arrangement'. Therefore, the Lease Fee incurred by Growers who invest in the Project after 11 November 1999 will be deductible over the period the services are provided. The formula for this apportionment is expected to be the same as that currently shown in subsection 82KZMD(2).

Section 82KL ITAA 1936

93. 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

94. 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.

95. 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 Forester's Report contained in the Prospectus states that the Project should achieve its financial objective if the forestry 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

96. 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.

97. 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.

98. Each Grower will be notified by Egerton Vineyard Management 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

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

Commissioner of Taxation
19 April 2000

Not previously issued in draft form

References

ATO references:
NO 2000/3336

Related Rulings/Determinations:

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

Subject References:
carrying on a business
commencement of business
primary production
primary production expenses
management fee expenses
producing assessable income product rulings
public rulings
schemes and shams
taxation administration
tax avoidance
tax benefits under tax
avoidance schemes
tax shelters

Legislative References:
ITAA 1997 6-5
ITAA 1997 8-1
ITAA 1997 27-5
ITAA 1997 27-30
ITAA 1997 42-15
ITAA 1997 42-118
ITAA 1997 42-125
ITAA 1997 42-345
ITAA 1997 42-160
ITAA 1997 42-165
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 1997 387-170
ITAA 1936 82KL
ITAA 1936 82KZL
ITAA 1936 82KZM
ITAA 1936 82KZMB
ITAA 1936 82KZMC
ITAA 1936 82KZMD
ITAA 1936 Pt IVA