Tax breaks set to evaporate

Shane Kelly

It was shaping up as a bonanza year for agribusiness schemes, but then the Federal Government threw in a hand grenade.

The announcement that non-forestry managed investment schemes (MIS) will lose their tax effective status from July 1 this year puts a cloud over almost half of this year’s projects.

Adviser Edge Investment Research managing director Shane Kelly said this is a major development for the sector, but it had been on the cards for more than 12 months.

“While the change is not surprising, the speed with which the final announcement was made caught project managers offguard,” he said.

“There has been some concern within the Government regarding the impact of non-forestry schemes on agricultural markets, land prices and commodity prices.”

It was the scale of horticulture projects in the past couple of years that has caused the Government to focus on the taxation treatment of these schemes.

“It is fair to assume that the current drought has not helped the industry’s cause, with water security being at the forefront,” Kelly said.

“Unfortunately, many of the smaller players in the market, and particularly those with non-horticultural projects, were caught in the crossfire as the Government and the Australian Taxation Office (ATO) sought to rein in the larger players.”

The largest manager in the managed investment schemes sector is Great Southern, and its chairman made no attempt at hiding the company’s disappointment with the Government’s decision.

“The company is very disappointed that the Government has failed to consult with industry on this issue, as had been previously promised,” Great Southern chairman David Griffiths told shareholders at the recent annual general meeting.

“Our first priority now is to seek clarification on the new arrangements and actively engage with the ATO and the Government in an attempt to get the consultation process back on track.”

The non-forestry projects that Great Southern has launched this year will go ahead with the tax breaks, but the problem will come with next year’s offering, which won’t get a product ruling from the ATO, which effectively stops the tax effectiveness component of the investment.

“In terms of 2008 and beyond, it is still too early to assess the impact,” Griffiths said.

“But one way or another, we are confident the business will have sufficient investment products to meet the requirements of the market next year.”

Australian Agribusiness Research (AAR) director Tim Lee said uncertainty created by this decision, and in particular the lack of any sensible ‘grandfathering’ arrangements, will not just push over-investment in the sector this financial year (2007), but potentially dry up inflows next financial year.

“It is now incumbent on the Government to act immediately to treat this segment of the economy the same as it would any other segment and provide certainty, time to plan and act, and time to secure jobs and the futures of thousands of employees in regional areas,” he said.

AAR is calling on the Government to defer the changes until June next year to enable sensible investment decisions this financial year and to allow the managed investment schemes industry to undertake planning for the 2008 tax year.

It is also calling for an independent review of the managed investment sector to allow any decisions on changes to tax treatment to be based on facts, Lee said.

However, despite the degree of uncertainty on the number of schemes next year, this financial year has seen 66 projects being announced (at the beginning of February), of which almost 30 were timber schemes.

Kelly said while the number of projects was up by 10, there were no new industries introduced to the sector this year.

“There are more offerings in each class of agribusiness and the existing managers are expanding the number of schemes on offer,” he said.

“But there are half-a-dozen managers new to the agribusiness MIS sector, although some are very experienced in the particular market.”

While traditional pine and gum timber projects are still numerous, tropical timber offerings have expanded this year and the old favourite of the past, vineyards, has seen seven offerings this year, which marks a degree of resurgence compared to recent years.

“People have been looking at the value of growing tropical timber, and it provides an alternative to the traditional timber projects,” Kelly said.

In previous years Great Southern and Timbercorp have secured about 50 per cent of the $1.2 million raised last year.

“The top five companies in the agribusiness sector snared 70 per cent of the capital raising last year,” he said.

“However, there is still an opening for managers looking to raise between $5 to $15 million for a project as agribusiness is a big industry.”

Kelly said with the more exotic offerings, investors must look at the rate of return to reflect the risk incurred with the crop.

“It must also be remembered that a high production rate often means low returns from sales,” he said.

“Also, if the production costs are high, and there is a downturn in markets, then there is no slack to generate a forecast return.”

Kelly said if project costs are fixed throughout the investment period, then there is greater scope for the manager to outperform to deliver the returns.

“The risk in the project needs to be accommodated on both sides of the fence, and if the manager makes a big profit, then they must be accountable for the risk.”

Kelly said he liked to see a fee structure in the project linked to performance.

Lee said there is a good chance that schemes will raise more than $1 billion this year as investors rush in before the taxation changes.

“There are still a lot of good projects out there and that means there is a good chance the industry will exceed $1 billion of fund flows this year,” he said.

“Next year will be a different story, but there is the opportunity for managers to restructure their offers to meet the taxation changes.”

Lee argues the good schemes with strong business models will survive and will probably be converted to a unit trust or some other investment vehicle not dependent on tax breaks.

“We think a number of schemes will stack up with the tax-effective structure,” he said.

“We don’t think this is the death knell of the agribusiness sector.”

Kelly said the challenge now will be for project managers to develop new investment structures with appeal to the retail investment market.

“Given that there has been forward warning that changes were potentially going to occur, companies operating in the sector have had ample time to undertake contingency planning,” he said.

“We would be very surprised if planning in relation to different investment structures is not well advanced.”

Kelly believes there will be an increase in the number of timber projects in the future to take advantage of the existing tax structure, especially in solid wood and tropical timber schemes.