Ato Eyes 'product' Schemes

Sydney Morning Herald

Wednesday October 14, 1998

Anne Lampe

THE recent crackdown by the Tax Office on a large tea-tree, tax-deductible investment scheme called Budplan highlights the risks faced by investors who rush into schemes to obtain a quick tax fix and find themselves in another fix later on when the rules are amended.

For two years now, the ATO has been watching with rising alarm as tens of thousands of PAYE taxpayers have been lured into investment schemes which grow some sort of product and which deliver them a 100 per cent tax deduction.

Usually the schemes involve gearing so interest on borrowed funds increases the tax deductions claimed. There are ongoing fees that are often required to be prepaid and which are also deductible.

Having made the investment the taxpayer then applies for what is called a section 221D variation on his or her tax instalments, reducing the amount of tax paid from weekly, fortnightly or monthly pay.

When these schemes are accepted by the ATO as legitimate, they are a tax effective investment.

But when the deductions are disallowed, they can involve the issue of amended assessments and demands for back tax plus heavy penalties (50 per cent on the amount of tax not paid).

The taxpayer may have to find tens of thousands of dollars in one hit.

And if the scheme reduces taxable income to a point where the taxpayer receives social security benefits, the Department of Social Security also demands repayment.

Sources close to the ATO say the crackdown on several Budplan schemes is the tip of the iceberg. There are hundreds of other schemes undergoing close scrutiny to determine if they are bona fide investment schemes.

In the Budplan schemes, investors were told they were investing in tea tree oil product research and paid an establishment and farm management fee, as well as applying for a loan provided by an associated company, Project and General Finance Pty Ltd, for the total amount of management, research and farm fees payable in the first two years.

The minimum investment ranged from $25,000 to $50,000, depending on the scheme.

In taking up the loan, participants were required to make specified interest and prin-cipal repayments in the first two years.

Beyond that, the loan was only required to be repaid from income derived by the business. In financial jargon, this is a "limited non-recourse loan". If there is no income, the loan does not have to be repaid.

According to the ATO, Project and General Finance lent the money to the investors to pay fees to the manager and the landowner upfront. The manager and the landowner, or the research institute in some cases, placed the funds on deposit with Project and General Finance which onlent the money, and so on.

As a guide, in Budplan No.3 the minimum investment per participation was $50,000, consisting of a $36,000 research fee plus $9,000 management fee in the first year, plus a further $4,000 research fee plus $1,000 management fee in year two.

The payments were made yearly in advance. There was also a one-off $400 establishment fee.

During the first two years, the tax savings or refunds generated by the inflated up-front fees are, in most cases, greater than the amounts required to be paid as loan repayments and interest by participants in that per-iod. The timing of the interest payments is also linked to the receipt of tax advantages.

The interest rate reduces for year two and thereafter, but if no profits are derived from the business, the loans may never be repaid.

Having looked at these elements of the scheme, the ATO has concluded that given the limited liability of the participants, they are not exposed to any commercial risks.

At the time of entering Budplan the financial risks were generally limited to the possibility that the tax deductions would not be allowed.

Further, while the prospectus projections are that income will be derived from about year three, a large part of the net income is required to be paid to the finance company to reduce the loan balance.

Only after the loan has been repaid will participants actually receive a substantial part of the income.

One reason the ATO is cracking down on such schemes is that it could see a large black hole developing in its revenue - some sources close to the ATO put that hole as high as $700 million. It saw the general body of taxpayers forking out deductions for an investment that may never produce taxable income.

Together with the limited power of participants over the manager, the inability to term-inate the business and excessive upfront amounts for research and management fees, the ATO decided the dominant characteristic of the arrangement is reducing tax, rather than being a commercial investment.

The ATO concluded that the business is not one of "research" and the expenditure claimed is claimed too soon to be an allowable deduction.

It also concluded that the research and interest expenses are of a capital nature and the expenditure was incurred for a purpose other than to derive assessable income.

The ATO has sent each investor an offer that they list the deductions already made and seek an amended return. If they co-operate, participants will pay the tax they have avoided, and will have the penalty reduced from 50 per cent to 5 per cent.

The ATO has chosen this scheme to be a test case for disallowance of claims for rural investment schemes. It is likely to be

ATO-funded.

That case may be run later this year or early next year and is expected to further clarify what is and what is not acceptable.

"Our position is that the expenditure has not been carried out too soon. That is supported by the QC opinion that we have got," says Greg McMahon from Budplan promoter Mainstar One Group.

"In assessing the facts, the Tax Office will take a particular position and whether they are right, or whether we are right, is something the courts will decide."

He says that in the meantime, the Tax Office has agreed to defer sending out requests for amended assessments until the outcome is known. He expects that a decision will be made around the middle of next year.

The ATO has warned investors to steer clear of tax-driven investments unless they first obtain a firm product ruling which confirms the scheme is approved by the ATO.

CAPITAL COSTS - Costs associated with buying an asset, rather than generating income.

© 1998 Sydney Morning Herald

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