12/11/2009 - 00:00

Promoters, advisers reap harvest while projects and investors go begging

12/11/2009 - 00:00

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It’s a taxing time for the agribusiness managed investment scheme sector.

Promoters, advisers reap harvest while projects and investors go begging

IN 1973, a senior investigations officer of the Australian Taxation Office in Perth smelled a rat.

A money-saving scheme was on the rise, whereby ‘resourceful’ business types would strip the assets of a company before tax time, rendering it unable to pay the bill.

The business owner would sell the company for the value of the pre-tax profits, less a commission.

The new owner would take his cut and figuratively send the company to the ‘bottom of the harbour’; a term that came to describe the 700 or so companies that side-stepped hundreds of millions of dollars in tax by adopting the strategy.

The Perth investigations officer, Rod Todman, received limited support from those entrusted to prosecute the test case, and by the late 1970s the potentially far-reaching legal action wound up in the same watery grave as the discarded companies.

Yet the tide had started to turn, and by 1980 legislators had made the practice a criminal offence.

Authorities went on to claim a few high-profile scalps, including that of colourful Perth businessman Peter Briggs, who spent several months in jail in 1987 for tax evasion, years after the actual offence.

Fast forward to 2009 and Western Australia is again at the centre of a debate over tax. This time, agribusiness managed investment schemes are in the spotlight.

“The whole thing has been bastardised,” says Coogee Chemicals chairman Gordon Martin.

Mr Martin, who is also bankrolling a bid to take over the management of the defunct Great Southern timber schemes, is a keen supporter of the state’s agricultural sector, having invested in several projects over the years.

But he says some of the corporate practices to emerge in MIS, such as spending huge portions of an investor’s capital on commissions and promotions, have gotten out of hand.

With tens of thousands of investors nursing wounds from the collapse of industry heavyweights Great Southern and Timbercorp, the sector has suffered a formidable blow.

Stakeholders are waiting to see if a parliamentary inquiry into the tax-effective MIS sector goes for the jugular.

Road to ‘bastardisation’

In the 1990s, Australians started jumping on a bandwagon of tax minimisation, or income deferment, which included investing in everything from emu farms to lingerie distribution.

The precursor to the MIS sector served two idyllic purposes: for the promoters, it was a form of capital raising to enable businesses and entire sectors to flourish; and for investors, it gave them access to new opportunities coupled with a tax incentive.

In not dissimilar circumstances to the bottom of the harbour schemes, the ATO lumbered into the picture long after the practice became widespread.

Years after claiming their deductions, Australians were suddenly liable to pay tax arrears, plus penalties and interest, as the tax office started its crackdown.

A company called Budplan, which ran a series of tea-tree projects heavily promoted in WA, became one of the tax man’s main targets. A successful tax office-led court action left thousands of investors short-changed. Thousands more in similar schemes started cracking open their piggy banks in order to pay the ATO.

About 40,000 people, who had claimed more than $4 billion in total, were given fresh assessments from the tax office.

But the crackdown was a public relations disaster for the tax office and, by extension, the federal government. Media outlets ran images of protesters holding signs saying ‘the ATO are the real tax cheats’ to represent the public mood of the day.

A compromise of sorts emerged called the managed investment scheme. Legitimate promoters were subject to a system of product rulings, whereby the tax office would give a rudimentary tick of approval showing that, on the face of it, the prospectus met its conditions.

No longer would investors need to run the gauntlet of claiming deductions while never quite sure if they would get a tap on the shoulder from the tax man in years to come. For their part, MIS promoters could raise money from the public with increased confidence.

Great Southern founder John Young was one step ahead of the pack, as his timber schemes had received the rudimentary tick of approval before others could get their paperwork together.

Rather than receiving push-back from the federal government, timber plantations were in vogue.

In 1997, the federal government’s Plantations 2020 Vision backed the sector, calling for regional wealth creation and international competitiveness through an increase in plantation resources.

With a background in financial services, Mr Young knew financial planners and accountants were key to the distribution of the schemes, and so he started personally ferrying key stakeholders out to the plantations in his Jaguar.

The rides in the Jaguar were essentially a marketing expense. Throw in a high upfront commission that comes off the investor’s capital and suddenly an MIS promoter has distribution a television or newspaper ad is unlikely to generate.

In one case of an illegitimate promoter prosecuted in the courts, a network of advisers aggressively recommended an investment scheme that paid commissions as high as 23 per cent.

Several years ago, research house van Eyk told a Senate Economics Committee that the problem in the agribusiness sector was the imbalance between the returns offered to investors, and the often-exorbitant returns accruing to both the promoters and their distribution networks.

“It is inconceivable to us how any project, or any business for that matter, can expect to be successful when between 70 per cent and 80 per cent of the funds invested are immediately diverted into what is basically non-productive expenditure,” the researcher said.

Legislators have sought to address this problem, forcing timber schemes to put 70 cents in the dollar directly into developing forestry in order to reap tax benefits.

Andrew McBain, managing director of WA-based grain co-production group AACL, says that percentage should be lifted to 80 or 90 cents in the dollar.

“Too much has gone to promoters and advisers and not enough into projects,” he says.

Mr McBain says at AACL, where investors partner with farmers to grow crops, 95 cents in the dollar goes to the farmer or is spent on actual crop costs.

He says this simple measure will go a long way to cleaning up the sector and ensuring the survival of MIS, which is critical for farmers.

“It would be a real shame to farmers if their only access to alternative forms of capital were cut off,” Mr McBain says.

Crystal ball gazing

Researcher, consultant and investment adviser Australian Agribusiness Group points out that business issues are to blame for the collapse of many MIS projects, not a failure of the agribusiness sector.

“It wasn’t the projects in administration or receivership, it was the companies that went into receivership and administration,” AAG executive chairman Marcus Elgin says.

“My point is this sector is not just a huge bucket of garbage.”

Mr Elgin says agribusiness MIS gets blamed for all sorts of things, including the squeeze on small horticultural providers. He says the duopoly in the groceries sector should really shoulder more of the responsibility for making it difficult for farmers without significant scale.

AAG has several suggestions to improve agribusiness MIS, including the quarantining of investor money to be drawn down over the life of a scheme.

In the event of a collapse, money would still be there for a buyer to take over the projects.

Historically, the opposite has often been the case. Great Southern used a form of the ‘rob Peter to pay Paul’ trick to prop up prices paid to investors to compensate for early disappointing yields.

Key stakeholders were told at the time the agribusiness provider was just ironing out its processes, and that early investors shouldn’t suffer for that. Besides, future yields were going to be spectacular.

AAG extends its defence of MIS to the controversial 10 per cent commissions by calculating that commissions would be higher over a 16-year period if an investor used a managed fund charging a 2 per cent upfront fee and trailing commission.

The calculation, which relies on 16 years to prove its point, fails to take into account the investor backlash over managed fund entry fees, which can almost always be avoided by a savvy investor.

Some financial planning groups are now introducing 4 per cent caps on MIS commissions.

AAG says more than 75 per cent of funds raised through agricultural MIS over the past two years have gone into forestry plantations. This has a lot to do with the historical support from government stemming from the 2020 Vision.

Other areas of the agribusiness sector have had their fair share of collapses.

On Christmas Eve 1998, a vineyard prospectus for a company called Preston Vale was published. Backed by some prominent names such as Perth corporate lawyer Martin Bennett, the prospectus had some impressive projections.

Wine sales, grape prices and gross profits were all projected out to 2019.

Mr Elgin says long-term projections should be signed off by MIS directors to introduce more accountability into the figures that investors rely on so heavily.

Preston Vale also had some impressive vineyard costs to go with its forecasts. Investors in the ill-fated Donnybrook-based scheme were told the project would cost more than $150,000 per hectare to establish.

Leading WA winemakers believed in the late 1990s that it would cost no more than $65,000/ha to establish a vineyard, including land.

Like Palandri Wines, the MIS structure at Preston Vale failed, although the assets live on.

WA Sandalwood Plantation managing director Keith Drage says companies need to get some growth rates behind them before publishing realistic long-term projections.

“That’s something that’s so speculative that the best paid analysts don’t know what’s going to happen on the Dow Jones tomorrow,” he says.

Mr Drage says the MIS structure was never that appealing to him when he worked as a broker, although there are some great assets in agribusiness.

“For our investors, it really is the commodity play if you believe in the sandalwood story,” he says.

A taxing problem

Several out-of-pocket Great Southern investors told WA Business News that patriotism – in that the investment would support the rural sector – played a part in their investment decision making. But that love of country doesn’t equate with love for the tax office.

Former banker and agribusiness specialist David Cornish wrote in a government submission that investor support of the high fee schemes had led to promoters being able to generate profits out of step with the wider financial community.

“This can only occur due to the current tax policies making the high upfront fee attractive to the investor due to its tax deductibility,” Mr Cornish wrote.

The 2020 Vision included a statement that “care would need to be taken to ensure that any incentive would not distort investment decision”.

Financial planner Wayne Leggett, of South Perth-based Paramount Wealth Management, says the investment schemes can be a valuable add-on to the portfolio of a suitable investor, although the tax break can cloud judgement.

“The tax benefit means that people don’t tend to be as critical of the investment; that’s not how it should be,” Mr Leggett told WA Business News.

The sector still has many supporters.

In a research report on WA-based TFS Corporation, broker Ord Minnett says that what has been forgotten in all the noise is that it is not the MIS model as such that has failed, but rather the quite conventional issue of normal business risk.

Yet some things don’t appear to change.

According to the TFS 2009 prospectus, commissions paid to financial intermediaries can be up to 10 per cent.

WA Business News does not infer the current MIS promoters are akin to the ‘bottom of the harbour’ strategists of more than 30 years ago.

But, once again, an ability to side-step the tax man is clearly the driving force behind many of these strategies.

As we approach the end of 2009, the agribusiness MIS sector is waiting to see whether legislators will also send their sector to a watery grave.

 

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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