Hance v Commissioner of Taxation  FCAFC 196
In a test-case decision handed down on 19 December 2008, the Full Federal Court ruled against the Commissioner of Taxation and held that rent, management fees and other charges payable under a Managed Investment Scheme for the production of almonds are deductible to investors. The decision has not been well-received by farmers who consider that the decision exposes them to unfair competition. However, it will be welcomed by potential investors in managed investment schemes.
Mr Hance and Mr Hannebery both propose to invest in a managed investment scheme (MIS) for the production of almonds. The MIS is to commence in June 2009. Mr Hance also proposes to accept finance from the manager of the scheme. The scheme is to be established under a common structure as follows:
- investors will sub-lease almond lots. The almond lots will be divided into quarter acre lots and each investor can sub-lease a minimum of half an acre. Both Mr Hance and Mr Hannebery propose to sub-lease 4 lots, being one acre;
- investors will pay $7,500 per almond lot initially, covering rent, management fees and responsible entity fees to 30 June 2009. Thereafter, rent, management fees and responsible entity fees are payable annually, together with all outgoings associated with the management of the lots, such as the cost of pesticides and labour for pruning and harvesting;
- once the trees reach maturity, the almonds will be pooled, and each investor will be entitled to a share of the sale proceeds in proportion to the amount of almond lots sub-leased.
Both Mr Hance and Mr Hannebery submitted private ruling applications to the Australian Taxation Office, asking whether their entitlement to gross proceeds from the almond sales would be assessable income, and whether the rent, management fees and responsible entity fees would be deductible. Mr Hance also sought a ruling as to whether the interest payable by him under the finance arrangement would be deductible.
The Commissioner issued private rulings stating that the entitlement to the gross proceeds would be assessable income, but the rent, management fees and responsible entity fees would not be deductible. The Commissioner ruled that the interest payable on the finance would be deductible.
The taxpayers appealed against the private rulings.
Taxation Ruling TR 2007/8 sets out the Commissioner's view that, under a registered agricultural MIS, investors make a capital investment and therefore have no entitlement to deduct the rent or other fees payable under the MIS. The Commissioner treats the investors as analogous to unitholders in a unit trust. Under the Commissioner's view, the investors acquire rights to an income producing asset, being their interest in the MIS. Consequently, their contributions are not deductible but are on capital account.
Similarly, Draft GST Ruling GSTR 2008/D1 states the view that investors in an MIS do not carry on any enterprise but are merely passive investors. The enterprise is carried on by the responsible entity of the MIS. Therefore, any entitlement to input tax credits lies with the responsible entity and not with the investors. In addition, the Commissioner's view is that the responsible entity makes a financial supply to investors of their interest in the MIS. As it is a financial supply, the investors cannot claim any input tax credits.
The Full Federal Court found that, under this particular MIS, investors would be carrying on a business and therefore upfront payments for rent, management fees and other charges would be deductible. The Court held that businesses can take many forms, and can include a silent partner who delegates all responsibility for the business to another. The Court considered it important in this case that the production of almonds would take place over an extended period of time of approximately 23 years, that the work was repetitive and would be paid for on a regular basis and that the return would be received year by year in the form of almonds. Although each investor did not have control over the farming of their particular lot, the Court considered this to be "an incident of their grouping for the purposes of management". In relation to the pooling of the almonds the Court stated: "This scheme, allowing both for pooling and for the easy ascertainment of a grower's entitlement on sale, seems to us to reflect no more than a commercially sensible mechanism which, it is probably envisaged, will be fair and economical to all growers in the circumstances."
Why is this case important?
This case overturns the Commissioner's recent treatment of registered agricultural investment schemes for income tax and GST purposes. The Commissioner has stated that the ATO does not intend to seek special leave to appeal to the High Court. As a result, the Commissioner has stated that Taxation Ruling TR 2007/8 and Draft GST Ruling GSTR 2008/D1 will be withdrawn and a new income tax ruling will be published in 2009.
This case turned on its facts and each MIS must be examined to determine the correct taxation treatment. However, the case is important as it has caused the Commissioner to re-think his taxation treatment of managed investment schemes and widened the scope for investors to deduct fees payable under managed investment schemes.
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