Stewart McArthur (Corangamite, Liberal Party) Share this | Hansard source

I rise to speak on the Tax Laws Amendment (2007 Measures No. 3) Bill 2007. This bill is an omnibus bill which amends a number of provisions related to income tax law. The provisions I rise to make specific reference to are the government’s changes to the tax treatment of forestry managed investment schemes, which are provided in schedule 8 of the bill.

There has been a lengthy debate across rural Australia about managed investment schemes for forestry and for horticultural enterprises. There have been concerns that managed investment schemes have benefited from tax advantages not available to other agricultural enterprises that are competing for land. The government has undertaken extensive consultation on forestry managed investment schemes. The Minister for Revenue and Assistant Treasurer, the Hon. Peter Dutton, has held a review of the taxation treatment of forestry managed investment schemes and consulted widely with farmers, timber community representatives and the MI scheme promoters.

The regional forest agreements process was introduced to bring about some scientific and reasoned evaluation of timber harvesting activities and to ensure forest activities were environmentally sustainable. The environmental forest debate of the 1980s was partly resolved with the creation of the regional forest agreements. These agreements were signed off by state governments with the federal government, with designated areas identified for locking up national parks, and other designated areas being accepted as areas for timber harvesting. In reaching this difficult compromise, environmental values and sustainable harvesting regimes were taken into account. Both Labor and Liberal governments accepted this compromise. However, in Corangamite the Bracks government overrode the RFA and locked up the Otways.

The national forest statement issued by the previous Keating government in 1992 gave a clear direction as to the way in which sustainable forestry should be undertaken in Australia. Part of this statement was the development of plantation forestry to fill the gaps that locking up former forest areas had created. Again there was general agreement on this policy position. The development of the policy position of Plantations for Australia: the 2020 vision was a plank which gave the imprimatur to plantation investments. I have always agreed with growing trees and supporting the forest industry and the timber workers, but I have come to the view that plantation investments were skewed by the overwhelming tax considerations. For instance, $1,600 per hectare is the actual cost of growing trees, whereas the MIS promoters were charging investors up to $9,000 per hectare. Also there were some concerns that plantations were in locations where trees would not grow very well. My very strong view is that it is bad public policy to run any industry, be it forestry or agriculture, on tax breaks. The key element of forestry investment should be the final return—actually growing trees for profit, not for tax.

It is interesting to note that around the world the experience has been that forestry has a long investment horizon. In the case of Australia, the blue gums have an investment horizon of between 12 and 15 years, softwood trees have an investment horizon of 25 to 30 years and, of course, hardwoods have a longer growing period and have an investment horizon of about 50 years. The blue gums now have a shorter growing rotation, coming from 14 years to 11 years, and this has changed the approach of the taxation arrangements.

The blue gum, Eucalyptus globulus as they are known, should be grown in areas that have 650 millimetres, or 26 inches, of rain and a good soil type, and preferably in areas that have over 30 inches of rain. They are evident in the Heytesbury settlement in southern Victoria and in a large part of western Victoria in the seat of Wannon. Promoters of the MI schemes for blue gums emphasise the tax advantages rather than productive investment. That has been my main argument over the last 12 months.

Tax minimisation is the objective of investors who are trying to deal with an income tax problem at the end of the financial year, in June. They are less concerned with the end profitability of the MI scheme. They hope to get a return or to get their money back, in the end, but they invest for the up-front tax deduction. It is interesting to note that the cost to Commonwealth revenue was in the area of $600 million in 2005. I am pleased that the government has decided that horticultural MI schemes will no longer be allowed by the Australian Taxation Office in relation to almonds, olives, walnuts and cattle stations. These schemes have not taken into account market signals but have been driven purely by tax. Horticultural MI schemes developed using the forestry model enable people to rearrange their tax affairs. The bigger MIS companies rely totally on fees-for-service for their profitability, not on timber outputs. They do not have an ongoing commitment to the final forestry woodlots.

I have given this issue a lot of thought and made a public submission to the Dutton Review of the Taxation of Plantation Forestry. It is on the minister’s website. In that submission I covered a number of issues, which I would like to list: plantations, 2020 Vision, investment horizons, forestry policies around the world, the woodchip export industries, imports of timber products, managed investment schemes, tax incentives for selected industries, globulus blue gums, the current position of MI schemes in Australia, investor costs and investor returns, timber companies’ profitability and capitalisation, world market and woodchip values, MI schemes for other land users, value of the investment, the ATO and the MIS tax regime, and the production of timber for the national good. I made some observations and recommendations relating to: tax incentives being provided at the end of the production cycle; the sale of woodlots in a secondary market, which is something the government has agreed to; investors in the agricultural business of growing trees; MI schemes for other agricultural products; and horticultural products. As I said, the government has agreed with my recommendation that those schemes be discontinued. The Taxation Office has raised concerns at the uncertainty of whether investors in MI schemes are ‘carrying on a business’ or are passive investors, and the ATO commissioner has foreshadowed that the ATO will change the way they assess MI schemes.

In responding to the ATO’s decision, the government is introducing a new, specific tax deduction for investors in MIS forestry schemes, to encourage further investment in growing trees and to help achieve the government’s forest industry policy Plantations for Australia: the 2020 Vision. The key element of the legislation is that, to qualify for tax deductibility, 70 per cent of the cost of forestry MI schemes will need to comprise direct forestry expenditure, or DFE. Under these reforms, the whole definition, accounting, tax reporting, structure and management of forestry MI schemes will hang on the 70 per cent DFE test. The 70 per cent test is likely to lead to ongoing conjecture, debate and legal court challenges over what costs are allowed and what are not. The proposed court case on the passive investor compared to the active investor could pale into insignificance by comparison. Direct forestry expenditure is defined as ‘amounts spent by the scheme manager, or an associate of the scheme manager, under the scheme that are attributable to establishing, tending, felling and harvesting trees; and amounts of notional expenditure reflecting the market value of land, goods and services provided by the scheme manager that are used for establishing, tending, felling and harvesting trees’. The provisions apply specifically to forestry for growing timber—not for tree plantings for the purpose of growing horticultural produce, such as avocados or olives et cetera. The legislation also provides for a change from the current 12-month rule to an 18-month pre-payment rule. The act states:

The 18-month pre-payment rule provides for ‘seasonally dependent agronomic activities, including ripping and mounding a plantation site, applying fertiliser, tending the seedlings prior to planting, and the actual planting’.

The changes also allow for the introduction of a secondary market in MIS plantations whereby investors are able to sell their investment after four years. It is intended that this will encourage additional investment in plantation forestry, particularly in long rotation softwoods and hardwoods, by unlocking investors from a 14-year or 25-year investment commitment before seeing a return.

There are concerns about how the 70 per cent on-ground expenditure test will apply to forestry MI schemes. This measure is being introduced to discourage potential rorting of MI schemes with unreasonably high profits at the expense of taxpayers and to address concerns under the previous arrangements that MIS promoters were charging $9,000 per hectare for MIS trees when the actual cost of putting trees in the ground was only around $1,600. Given the long lead times of investment and production before harvest, it will be difficult to legislate for the 70 per cent direct forestry expenditure test. The detail of how the 70 per cent direct forestry expenditure test will work is covered in the fine detail, buried away in schedule 8 of the bill and in the explanatory memorandum.

In an attempt to define what MIS company costs may and may not be included in the 70 per cent on-ground direct forestry expenditure, the bill states that the following costs may not be included: MI scheme marketing—including advertising, sponsorships, sales and entertainment; insurance; contingency funds or provisions for MI scheme financing; lobbying activities; general business overheads, which include the salaries of MIS promoter company CEOs but not overheads directly related to forestry; subscriptions to industry bodies; and commissions for financial planners or financial advisers. The perceived high commissions paid by MIS promoters to financial advisers have been a key concern of those who fear these schemes have been abused. Compliance with requirements related to the structure and operations of the forestry management scheme, supervision of contracts and legal fees relating to any matter mentioned in subsection 394-45(3) also may not be included.

This list of costs specifically excluded in the bill from the items of allowable direct forestry expenditure under the 70 per cent rule is not an exhaustive list. There may be other costs that cannot be included in the 70 per cent list. The definition of allowable direct forestry expenditure is wide enough to hide many sins. Establishing a plantation includes: planting, coppicing and grafting activities, and other methods of plant propagation; site preparation costs, such as ground clearing, fence clearing, deep ripping and mounding, fertilisation pre-planting, weed control, constructing channel irrigation, roads or fire breaks; pre-establishment costs such as site selection; costs of tending plantations, including inspection, monitoring, pest control, fire hazard reduction, re-planting, coppice management, fertilising, pruning and thinning; and felling costs, including harvesting activities, felling trees, lopping off branches and bark removal.

There is great potential here for MIS promoters to overstate the cost of these allowable direct forestry expenditures. How will the tax office monitor and determine whether the proposed expenses are reasonable or overstated? Australian taxpayers have reason to be concerned at any costings for forestry MI schemes that claim to comply with the 70 per cent  DFE because many of the schemes we have seen would not comply. The Bureau of Rural Sciences undertook a survey of the costs of plantation investment in the first year of MI schemes for the Department of the Treasury’s review of MIS schemes last year. The findings were that, on average, the eligible DFE costs as under this bill were $2,180 and the non-DFE costs were $3,870. Therefore, on average, MI schemes surveyed by the BRS would not have complied with the new provisions. If we see many forestry MI schemes complying with the 70 per cent DFE test under the new legislation then we should be concerned that something is wrong. How will the tax office be able to effectively assess the accuracy of claimed expenses?

Despite the best of intentions, it does not appear that the reforms introduce a ‘market pressure’ test on forestry MI scheme expenditure. There are no market signals on direct forestry expenditure. On the contrary, there is an incentive for MI scheme managers to incorporate gold-plated costs under the DFE to achieve the 70 per cent test. A concern with the current MIS arrangements is that there are no market signals limiting the expenses of promoters—high commissions, full-page advertising in national newspapers and the latest and most expensive technology use on the ground. These are things normal farmers could never afford to pay, but anything is affordable under MIS so long as you can market the scheme to an investor desperately looking for a tax deduction in June.

The MIS promoter will need to demonstrate ‘reasonable expectation’ that costs will be incurred, and this ‘reasonableness’ will need to be assessed by the tax commissioner. But at no time is there a requirement that the DFE costs be assessed compared with the costs a normal farmer could be expected to incur to establish a hectare of trees on his land for profitable timber production. In the long debate on MI schemes I have established through consulting with people in the industry and on the ground that it costs around $1,600 per hectare to establish tree plantations. An independent valuer in Western Australia quoted establishment costs of $1,427 per hectare. The Forest and Wood Products Research and Development Corporation’s 2005 report Eucalypt plantations for solid wood products in Australia—a review put the cost of establishment for pulp logs at $970 per hectare, before rent. At a meeting I was challenged by a departmental official in the forestry sector who claimed establishment costs were really in the order of $4,000. There is a lot of difference between $1,600 and $4,000, and the taxation commissioner will have a hard time finding the truth! The BRS survey also demonstrates what a difficult time the tax commissioner will have sorting out reasonable costs. The survey found land lease costs varied between $175 and $420 per hectare.

It was always going to be difficult for any government to legislate that 70 per cent of the cost to an investor of a forestry MI scheme be for direct forestry investment. The range of costs the BRS has found for land leases just demonstrates the potential for an MIS promoter, with a slick accountant, to manipulate the DFE costs. Forestry MIS arrangements last over many years—around 14 years for pulpwood or longer for softwoods—and this bill provides that the lifelong payments by investors and lifelong DFE expenditure be assessed under the 70 per cent rule at day one. There will be no audit several years into the forestry MI scheme to assess whether or not the DFE share claimed at the start of the project is in fact the reality. The concern would be that as the scheme progresses the actual share of allowable DFE costs will slip below the 70 per cent rule. It is important that the assessment of the 70 per cent rule be rigorous because the taxman will potentially lose a lot of revenue to these schemes which may have otherwise been directed to improving government services or general tax cuts. By incorporating land leases, or effective lease rates, in the allowable direct forestry expenditure, it will still be possible for MIS promoters to use these schemes to pay off massive investments in land—and in doing so to push up the price of agricultural land in competition with farmers, as we have seen occur in Heytesbury and in south-west Victoria in my electorate of Corangamite.

In times past there has been a lot of debate in this place over tax complexity, with the GST being an example. When it comes to the 70 per cent DFE, this bill would fail the birthday cake test. The wages for a project coordinator who undertakes ‘community liaison’ or ‘education programs’ are included; the wages for a project coordinator who undertakes lobbying are not. Legal advice for drawing up contracts for forestry contractors is included; legal advice for drawing up contracts for forestry investors is not. Wages for accounts staff who deal with both MIS forestry workers and head office need to be apportioned—and therefore would be both allowable and not allowable. Harvesting and lopping off branches is included in DFE; in-field chipping or milling is not. There are a lot of frills and icing on the MIS forestry cake. Some of it is allowable direct forestry expenditure and some is not. It will be very complex for the tax commissioner to sort it out.

In conclusion, I have been a strong advocate for sustainable forestry and for the jobs of our hardworking timber workers. These men and women have been forced out of the public forests. If Australia is to supply the demand for timber and paper products, we need to encourage investment in plantations. The challenge is to encourage legitimate investment in forestry where the motive is growing useable timber and generating a profit. Any scheme that relies on generous tax breaks is subject to failure and may not deliver the timber our industries need. The government has decided to close down MI horticulture schemes because of concerns they are tax driven. The government will need to monitor the implementation of these new provisions, which I have set out in my speech, very carefully.

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