Issue No 9, January 1998.

NOTICE: Hard copies of the Australian New Crops Newsletter are available from the publisher, Dr Rob Fletcher. Details of availability are included in the Advice on Publications Available.

9. New crops investment schemes

Some of the bad publicity associated with new crops in the past has come from investment schemes which have proven to be not as successful as was hoped. Why was this so?

Recently, there has been a sharp increase in the number of investment prospectuses and collective investment schemes being issued for new industry schemes. There have been projects involving lemon myrtle, ostriches, tea tree, forestry plantations, mushrooms, olives, worms, etc.

Many of these schemes are attractive and successful business ventures, some have been around for years and have happy clients that are reinvesting, but there have been failures. Unfortunately, the failures make attractive fodder for the media and cynics and many good projects have been tainted by bad press received by shonky or ill-conceived projects.

Most schemes offer higher than average returns, making them attractive in the current environment of low interest rates. Investors need to be aware that the nature of the market for the new product is uncertain. Investors are undertaking a speculative investment with the attendant risks of substantial loss.

A significant part of the attraction in these projects can be the tax benefits to be realised as a primary producer. These tax deductions are most attractive to high income earners who can offset their top marginal rate of personal tax by claiming the legitimate deductions of establishment and maintenance costs, management fees and loan interest associated with maintaining the investment.

For developers of new crops, an investment project may seem an attractive way to raise capital to get their business off the ground.

In practice, it is rarely the potential producer of a new crop product that is the instigator or major participant in the projects. Projects are usually floated by well structured groups of companies with substantial experience in corporate finance. A typical structure involves up to five interrelated companies; land holding companies, a management company and a financier, all controlled by the same parent company. The industry is not primary production. It is the agricultural and investment prospectus industry.

Typically, the only involvement that the investor has is to provide the money, which the finance company will lend. The interest on that loan is tax deductable as well.

The tax benefits in these projects are derived from the investor's status as a primary producer but in many instances, there seems to be little relationship between the investor and the land. The Australian Tax Office has been investigating the validity of project-related deductions. A new draft ruling on afforestation projects has been made to clarify:

• whether the taxpayer is truly in the business of afforestation,
• what expenses are reasonable deductions,
• the system of "internal" financing of these projects, and
• the commercial reasonableness of the deductible management fees.

The general opinion in the industry is that the ruling is fair and preserves tax deductibility for well structured projects. Although the ruling is concerned with forestry schemes, the text of the ruling makes it clear that it is going to apply to more than just forestry.

The Australian Securities Commission also has an interest in these schemes. Because the public's money is at stake, the Commission plays the role of watchdog and enforces the relevant sections of the Corporation Law. Corporation Law and many other pieces of legislation and regulations prescribe the requirements for raising investment capital.

These requirements, as one would expect, are voluminous, detailed and convoluted. The law covers areas such as the need for a prospectus, the structure of such a document, the necessary company structures and safeguards, the role of trustees and managers, advertising and hawking of the investment (including verbal sales pitches), financial forecasting and so on.

Despite the sensational press reports of agricultural investment schemes going bad, there have been few cases in which the Securities Commission has moved to a major prosecution.

One recent case has highlighted many of the pitfalls of collective investments and was detailed in a periodical entitled Growing Wealth, published by Teys McMahon Pty Ltd. The Commission has taken the promoters of a North Queensland new crop project to the Australian Federal Court.

The news was all bad for the promoters who were given 28 days to put in place a trust deed, trustee and a prospectus for the project. They were not able to do this, so a receiver was appointed.

The outcome of the case was a reminder that cleverly drafting documents to try to get around the law's requirements is a risky business if the fact of the matter is that the project is being operated in such a way as to require a prospectus.

In this particular case, the promoters were one of five companies in a group controlled by one family. The group had all the companies normally associated with agricultural projects and had raised about AUD 6.5 million in investment capital. The system of agreements that the investors entered into was as follows:

• The investors received a right to occupy a strip of land;
• The investor appointed the promoter to plant and manage the trees on the land for the first 13 months;
• A finance package was available;
• Investors were told of the potential to make a profit from the product harvested from their land, although the written agreements very carefully did not offer harvesting, distillation or marketing services.

The Commission argued that this system constituted a package of services which constitutes a "prescribed interest" under the Corporations Law. The promoters and the other respondents argued that each investor had separate and distinct contracts and an identifiable land area.

Because there was no pooling of produce or harvesting services provided as part of the contract, there was no sharing by investors in the assets of the farm.

In this case a "prescribed interest" occurs if the produce of each parcel of land is combined with that from other parcels such that the investors share in part of the whole, as opposed to processing the harvest from each block discreetly and returning that profit to each individual grower.

Some investors will do better than others because there is no pooling of product across the strips of land.

Where there is no prescribed interest, then certain provisions of the Corporations Law do not apply and a prospectus is not required.

These requirements are easy to meet on paper but difficult to abide by in a practical sense.

Essentially, the Commission won the case because they were able to prove that the selling and operation of the business was very different from the account told by the company's documents.

Agents acting for the promoters in selling the investment were told to clearly explain that the agreements were offered on a "strictly individual basis" and that the investors were at liberty to make their own arrangements for management, harvesting, processing and marketing the crop.

In fact, the court found that the selling agents actually told the investors of the tax deductions and returns from the harvesting of the product. The representations from the agents led the investors to believe that they were going to receive harvesting services.

As a result of Federal Police inquiries, there was evidence of mis-management and withholding of management services (such as treatments for the plants).

As well, the promoters had harvested some strips of land without the investor's consent, which denies individual control of the land parcels. So the Commission won the case and stopped the promoters with this project. Essentially the promoters lost the case by trying to dodge the legal requirements (or they misunderstood the law) and then over-sold the package that they were offering to investors.

In general, the Australian Securities Commission advises that potential investors should obtain a prospectus for the project and have it looked at by a licensed investment advisor or a lawyer with experience in corporate law. Individuals can do some homework on companies that they are dealing with and on investment advisers by calling the ASC InfoLine (1300 300 630).

The Commission can tell if a company is registered, who the directors are, the names of any associated companies and whether they have been guilty of misconduct in the past.

There is also an Internet site (http://www.asc.gov.au) that has more information and the facility to undertake basic company searches (or to pay for more in-depth commercial services). This site also contains a lot of useful advice for small business operators.

Those who may be promoting a project or working for the promoters can also phone the InfoLine or use the web site for advice on the legal requirements of company directors, trustees and managers.

The Commission also has regional offices which are listed in local telephone books.

Many new crop industries are capital intensive and collective investments which offer tax benefits which can offset the real risk exposure of the investor are an established way of raising funds.

Unfortunately, many of the companies involved are not primarily concerned with actually reaping a harvest from the crop at the centre of the project. Given that the investor has received significant tax breaks along the way, there is no imperative to maximise returns from the product harvested.

Good projects may establish or prove a new industry, the mediocre and the poor projects taint the reputation of a crop so that it is removed from everybody's wish list for a generation.

Contact: Dr Rob Fletcher, School of Land and Food, The University of Queensland Gatton College, 4345; Telephone: 07 5460 1311 or 07 5460 1301; Facsimile: 07 5460 1112; International facsimile: 61 7 5460 1112; Email: r.fletcher@mailbox.uq.edu.au

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originally created by: GK; latest update 6 June 1999 by: RF