Chapter 3
Managed investment schemes
Introduction
3.1
An aspect of agricultural land use that attracted significant attention
during the inquiry was the emergence of agricultural production via managed
investment schemes (MIS), particularly the effect they are having on
traditional agricultural enterprises.
3.2
In the first part of the chapter, the committee briefly outlines the
structure of agribusiness MIS and related tax arrangements. The committee then specifically
discusses the following concerns relating to the preferential tax treatment for
MIS:
- whether MIS tax incentives have met their objective;
- the inefficient allocation of capital as a consequence of
tax-driven market distortions; and
- the effect of MIS investor capital on land and water availability
and pricing, the oversupply of certain agricultural commodities and the social
fabric of rural communities.
3.3
The committee notes that investor-related issues concerning agribusiness
MIS were examined by the Joint Parliamentary Committee on Corporations and
Financial Services. The focus of this committee's inquiry is primarily on the
implications of MIS for agricultural production. However, at the end of the
chapter the committee briefly discusses the collapse of two major agribusiness
MIS, and concerns about corporate governance and disclosure to markets and
investors.
Agribusiness managed investment schemes
3.4
The term 'managed investment schemes' (MIS) describes collective
investment structures where investors pool their money for a common enterprise.
Agribusiness MIS encompass plantation forestry projects, as well as a range of
horticultural crops such as olives, almonds, wine grapes, stone fruit, citrus
and avocadoes.
3.5
Within the structure of agribusiness MIS, investors receive an interest
in an agricultural project on an allocated parcel of land, which entitles them
to the proceeds of what is grown or harvested on that parcel subject to
management agreements with the scheme's manager. Investors do not own the land
on which plantations or crops are grown.
3.6
Investors in forestry MIS typically pay an up-front fee that
incorporates annual project costs, while non-forestry MIS combine an up-front
fee with annual fees, reflecting different yield patterns between forestry and
non-forestry activities.[1]
3.7
The tax treatment of agribusiness MIS investments has been the subject
of some uncertainty in recent years, following various court decisions and a
revised Australian Taxation Office (ATO) ruling on the tax deductibility of
agribusiness MIS fees. The ATO's recently revised view that investments in
agribusiness MIS are not allowable deductions was subsequently overturned in
the Federal Court. However, the intervening legal uncertainty led to the
government to establish separate legislative arrangements for forestry MIS to
guarantee up-front tax deductibility for investment in that sector. The upshot
is that investment in agribusiness MIS is still an allowable deduction backed
by ATO product rulings, albeit under different legislative arrangements for
forestry and non-forestry MIS.[2]
Is a tax deduction justified?
3.8
From a policy perspective, tax deductible investment in agribusiness MIS
is justified as a means to attract capital to industries where perceived market
failure exists. This has been exemplified by the approach taken to forestry
MIS, where special legislative arrangements were made to protect tax incentives
that attract investment in an industry where the time between investment and
return is substantial, discouraging potential investors. Given the previous
government's objective of trebling Australia's plantation timber output and
declining state involvement in the sector, tax incentives for MIS were central
to attracting the investment capital required to meet this objective.
3.9
However, the National Farmers' Federation (NFF) suggested to the
committee that this policy intent of MIS has been lost:
With almost 35% of MIS now accounted for by non-forestry
projects, NFF questions whether this indirect form of support continues to
effectively deliver targeted assistance to an area of perceived market failure.
The NFF firmly supports the provision of direct and transparent mechanisms that
provide targeted assistance to those sectors of the market that require help in
managing risk. However, the NFF believes that MIS, in its current form, does
not meet these criteria in delivering industry support, particularly given that
a significant proportion of the initial investment is channelled to promoters,
financial advisers, and other peripheral agencies.[3]
3.10
Avocado farmer Mr George Ipsen agreed that MIS had spread beyond their
intended targets:
...MIS [have] now crossed over into mainstream agriculture
with potential to commercially destroy a [range] of industries. The primary
producers, as with all businesses, have lived by the laws of supply and demand.
The business model affected by MIS promoters in the plantation timber industry
enables them to circumnavigate supply and demand...[4]
3.11
The MS&A submission warned that even more traditional agricultural
activities would be 'targeted' by MIS:
Discussion with researchers and promoters would indicate that
the MIS industry will be increasing its activity and influence in more
traditional agriculture industries. Currently, the beef industry is being
targeted and now the MIS industry is looking to target the dairy industry. This
would seem contrary to the spirit of the MIS Act, in that it was enacted to
assist the development of agricultural industries, where it was considered a
market failure had occurred in regard to capital availability. This is
certainly not the case in the wine, cattle and dairy industries.
Even in the case of the almond industry, the fundamentals
were so strong that it was attracting capital without the need to overheat the
market via the MIS industry.[5]
3.12
In addition, MS&A argued that the original forestry objectives of
MIS had proven to be flawed:
The overwhelming majority of schemes have focused on the
short rotation pulpwood industry. There would seem to be a reasonable bodily of
evidence to suggest that future international pulpwood demand will become
increasingly competitive due to increasing global supply. Very little of the
MIS wood has been grown with the saw log end product in mind. The result of
this is that is very likely that we will have a glut in pulpwood product with
and increasing shortage of saw log product. In summary then the MIS solution is
only going to exacerbate the growing trade deficit in wood products as it has
not dealt with the growing shortage of the high value timber products.[6]
3.13
Similarly, Dr Judith Ajani argued that the basis for granting forestry
MIS tax incentives was flawed, because our major export markets for hardwood
chips do not provide sufficient demand. Dr Ajani suggested that Australia is therefore
facing a hardwood woodchip glut:
...from the mid-1990s there has been virtually no growth in
Japan's imports of hardwood chips, and it is unlikely to change in the
immediate future. So, effectively since the launch of the Plantations 2020
Vision to triple Australia's plantation estate, which saw a substantial
increase in investment in hardwood plantations, we have seen absolutely no
growth in the major market for Australia's hardwood chips—and 85 per cent of
Australia's chips are exported to Japan.[7]
3.14
Finally, valuer and agricultural economist Mr Samuel Paton told the
committee that governments are subsidising forestry MIS to grow trees in
unsuitable locations to produce a product that is made more cheaply in other
countries.[8]
Mr Paton stated that:
...on the mainland there has been this headlong rush to grow
blue gums on very marginal land in areas well under the rainfall threshold that
ABARE forecast. And they are so many hundreds of kilometres from a processing
source. I just wonder where the economics and analysis by government are.[9]
3.15
MS&A rejected the suggestion that the same tax options are available
to MIS and traditional farmers:
It is rather disingenuous of the MIS industry to state that
the same tax option is available to your typical family farmer. An MIS is given
special rights under product rulings that place them at a distinct advantage to
the family farm. Under Division 35 of the ITAA 1997, a venture must pass at
least one of four 'objective tests' for the active investor (individual or
partner) to have the right to offset losses from the business activity against
other income. Under product rulings this is waived for investors in MIS
projects under section 35-10.[10]
3.16
MS&A argued that the present MIS arrangements create unequal access
to capital:
...this is an argument about access to capital. In the MIS
case...[investors] can obtain capital which is subsidised by the government up to
nearly 50% of the principal, being the top tax rate, while the farmer must buy
in capital (from the banks) at full cost and with no subsidy on the principal
amount.[11]
MIS tax incentives and capital allocation in rural areas
3.17
The committee recognises deep concern about the market distorting effects
of MIS tax deductibility. Evidence submitted to the inquiry suggested that,
because investment in MIS may be driven by tax incentives rather than
profitability, there has been an inefficient allocation of capital in rural
areas to the detriment of traditional agricultural enterprises.
3.18
Much of the evidence received suggested that many agribusiness MIS are
inherently unprofitable. For example, fruit and vegetable grower representatives
Growcom stated that:
The introduction of [MIS] on a significant scale in
horticulture is of concern to our people because their business is not based on
getting a profit from their horticultural production. There are other ways of
making a profit, so it is not market driven.[12]
3.19
They added:
One of the positives of the MIS is that it has brought in
significant economies of scale and management systems that have been useful in
driving efficiency. That can be replicated by other business enterprises
without that tax advantage issue. I think we have seen a lot of producers and
family farms grow to very big and very professional outfits now without the tax
incentive, so why have it?[13]
3.20
MS&A claimed that many MIS are unprofitable due to the incentive for
promoters to inflate costs:
Using independently sourced data the true cost of planting a
hectare of land is significantly less than the promoter charges. Based on these
figures you can achieve a reasonable return on your establishment costs.
However, the current tax policy induces the promoter to highly inflate this
upfront cost. Based on this cost, investors are destined never to achieve a
reasonable return on their money. Why would the investor invest? For two
reasons: firstly, the inducement of the tax deduction – the higher the better
as far as the investor is concerned; secondly, the lack of any credible
independent analysis about the real returns that investors are likely to
receive from the investment and what it should cost.[14]
3.21
MS&A argued that the 'fundamental reason behind investors investing
in these schemes can only be explained in terms of tax avoidance', which suggests
that the tax avoidance measures in Part IVA of the Income Tax Assessment Act
1936 should apply to these schemes.[15]
3.22
In addition to these concerns, Mr Ipsen also argued that inflated costs,
driven by tax deductions, have made many of the MIS projects unprofitable:
What is going on in the MIS industry? Why do we need it? Why
don't farmers grow trees?
There is a simple answer. There is no money in it. There is an example in my
area. The MIS promoters next door to me were charging investors $9,000 a
hectare to plant a hectare of blue gums. I have planted and grown commercial
blue gums. It costs me $1,000 a hectare. You can allow another $500 and say it
was $1,500 over that 10-year period. For that $1,500 I get bugger-all taxation
deduction. The guy who invests $9,000, the promoter, gets 48c or 45c in the
dollar tax deduction for that. It is just a totally inequitable situation. They
were paid $9,000. At the end of that 10-year period when I sell my trees they
will be doing exactly the same on the property adjacent to me and they will get
back about $4,500. The dumb investors put in about $9,000 and they will get
$4,500 back.[16]
3.23
The National Association of Forest Industries (NAFI) conceded that there
have been 'cases where the performance of plantations has not been good', but
noted that the drought had contributed to this underperformance.[17]
3.24
The presence of investment drivers other than commercial profitability
has, it is claimed, distorted investment decisions in rural areas. The NFF
stated:
...in many instances, the MIS mechanism does not promote
sound investment decisions in rural and regional Australia. The NFF believes
that many MIS projects have created negative distortions of resource allocation
in regional areas.
The NFF believes that decisions to invest in MIS are largely
based on the tax deductibility of the investment, rather than driven by
long-term profitability. As a result, MIS have traditionally been primarily
focused on industries with a high proportion of up-front expenses, with little
regard given to the output returns generated.[18]
3.25
NFF stressed the importance of agricultural activity being guided by
price signals rather than tax incentives:
...prices are a fundamental signal for farmers about what to
produce, where and in what quantities. Farmers need governments to allow market
forces to work, and in doing so, create a global food production environment
that is more flexible, reliable and sustainable. As is the case with the
current plethora of government distortions within the global trade of
agricultural goods, the NFF believes that the MIS mechanism is also acting to
mask price signals for farmers, leading to inefficient allocation of the world's
scarce resources and exacerbating the global food security issue.[19]
3.26
The NSW Farmers Association also argued that MIS 'send incorrect market
signals and distort investment decisions':
When firms are selling products (i.e. woodlots, olive groves
etc.) and investors are primarily focused on buying something else (receiving a
tax deduction), issues develop when the financial focus is shifted away from
the commercial viability of the business'
productive operation. The result sees a business entity not operating under the
normal market supply and demand forces that guide sound operating
decisions.[20]
3.27
The Sunraysia Horticultural Branch of the Victorian Farmers Federation
wrote that MIS investment monies get widely distributed across scheme promotion
activities, rather than actually utilising economies of scale for profitable
agricultural production:
Conventional enterprises taking advantage of possible
economies of scale are far more likely to achieve a valid economic outcome with
respect to the resources consumed than are MIS because the imperative driving
conventional enterprises is a return on funds invested directly in the
enterprise.
In contrast, the MIS enterprise is one entity in a chain of
entities artificially constructed in order to yield tax deductible items for
sale in order to yield profits for scheme promoters. Most of the money gets
blown in fees, charges and commissions.[21]
3.28
Mr Ipsen argued that MIS create an uneven playing field for traditional
enterprises:
MIS promoters do not borrow funds and incur interest charges
for project development, tax driven investor funds. MIS promoters are not
constrained by the laws of supply and demand. Investors own the production and
therefore carry the risk. MIS promoters are not exposed to industry failure as
they made their profit upfront and ongoing through management fees. Non-MIS
producers receive their project tax deductions over time, over the life of the
crop in my case. Non-MIS producers borrow funds for project development and
incur interest costs. Non-MIS producers'
projects are constrained by the forces of supply and demand. Non-MIS producers'
projects are exposed to industry failure.[22]
3.29
NAFI stated that investment in forestry MIS is not diverting capital
that would otherwise be applied to traditional agriculture:
Retail forestry investment constitutes a very minor part of
the greater investment market. Any view that retail investments in forestry or
non-forestry divert available funds away from other productive investment in
rural and regional Australia is incorrect. Retail investment forest growers are
not generally focused on the flow-on socio-economic consequences (such as
regional employment) of their investments. Rather they are motivated by
traditional financial growth incentives. The capital that retail forestry
projects attract would otherwise be invested in other investment markets such
as the share or property markets and may not necessarily result in increased
economic activity in rural and regional Australia.[23]
3.30
NAFI noted that, in fact, forestry attracts investment and benefits to
areas that would otherwise miss out:
Retail forestry investment does not 'crowd out' investment in
rural and regional Australia, because without retail forestry, rural and
regional Australia would not be able to attract a similar level of investment.[24]
3.31
Dr Jacki Schirmer suggested that the effects of MIS-driven plantation
expansion on food production needed to be kept in perspective, and observed that
MIS-related declines were localised and of negligible national consequence.[25]
3.32
Evidence to the inquiry also suggested that the recent failure of MIS
caused investors to lose confidence in the whole agricultural sector as a sound
investment.[26]
Effects on agricultural producers and rural communities
3.33
Evidence to the committee suggested that the investment distortions
created by tax deductible MIS were having the following detrimental effects on
traditional food producers:
- artificially increasing demand for, and prices of, agricultural
land and water;
-
creating an oversupply in certain commodities; and
- affecting the social fabric of rural communities.
Land and water availability and prices
3.34
A number of submitters argued that the lower cost of capital for MIS
distorts the market for agricultural land. For example, NFF argued that the relative
advantage of MIS in terms of access to capital caused such schemes to bid up
land prices to levels local farmers cannot compete with.[27]
The NSW Farmers Association, for example, submitted:
The Association is aware that land acquisition markets should
enable the transfer of title to the highest bidder. However competitive
bargaining for land needs to be done between potential bidders from a level
playing field. The Association is, therefore, of the view that the lower cost
of capital available to MIS affords them an advantage that enables them to
outcompete farmers for land acquisitions.[28]
3.35
Further, MS&A suggested that it will cost $2200 per hectare to
restore timber country to profitable grazing country, which will in many cases
be too expensive for the exercise to be economical, leaving the land
unproductive.[29]
Mr Sam Paton, a Senior Valuer and Agricultural Economist with Sam Paton &
Associates, suggested that the cost of tax incentives for MIS would be better
used towards rehabilitating land under failed MIS projects.[30]
3.36
In response to such claims, NAFI commented that forestry still accounted
for a very small proportion of agricultural land use:
Land degradation, urban development and rural residential
development are having a far greater impact on land use change than plantation
expansion. Although timber plantations are very obvious and do change the
appearance of local landscapes, the total amount of rural land being planted is
very small.
In the five regions that in 2000 accounted for about 70
percent of total plantations as well as having major timber processing industries,
no more than 6 per cent of the land was under plantations. Even in Local
Government Areas with the highest concentrations of plantations, maximums of 5
to 20 per cent of agricultural land are used for plantations.[31]
3.37
NAFI argued that rural land prices had been increasing everywhere, irrespective
of the presence of MIS:
Rising values of rural land have been driven by a combination
of factors that include low interest rates, high commodity prices, strong
international demand for Australian farm products, rationalisation in the rural
sector with farm amalgamations, competition for farms from overseas buyer, and
multiple changes in land use.
...
Nationally, average prices of broad-acre farms sold in
Australia rose by 34 per cent in 2004-05, following an average increase of 19
per cent in 2003-04. At that time, plantation investment companies had
purchased around 3 per cent of the total of around 10,000 broad-acre properties
sold in each of the previous four years. It is simply not possible that 3 per cent
of sales could drive a 34 per cent increase in land values.[32]
3.38
Dr Schirmer indicated to the committee that her research in Western
Australia and Tasmania suggested MIS-driven plantation expansion had partially
contributed to land price rises:
The studies found that during periods of rapid plantation
expansion, MIS companies have paid higher than average prices for rural land,
and there has been somewhat higher than average land price increase in regions
where large areas of plantation are being established.
Land prices have, however also increased rapidly in many
other rural areas. In particular, regions where there is considerable demand
for 'rural residential' or 'seachange' properties have often experienced
greater land price growth than regions where rapid plantation expansion is
occurring.
In high rainfall regions, even where few/no plantations are
established, there have been some periods of rapid land price growth in the
last 20 years similar to those seen in plantation regions during rapid
plantation expansion phases, driven by demand from industries such as the dairy
industry. This indicates that in the absence of plantation expansion, land
prices would have grown but perhaps not as much as particular points in time.[33]
3.39
NSW Farmers' Association complained that MIS plantations are excessive
water users, due to deeper root systems than pasture and crops and the depth of
contour furrows used by plantation operators.[34]
NFF also expressed concern about water use and the capacity for MIS to distort
water availability of water through developing water markets.[35]
Mr Ipsen told the committee:
On the next block up the road, Great Southern came in and
planted it wall to wall with blue gums. They consume hundreds and hundreds of
megalitres of water on that side. They have no licence. There is no
restriction.[36]
3.40
Evidence was also provided about the water entitlements being used by
irrigated crops grown as part of MIS projects. For example, Mr Paton advised
that:
...two of the largest recipients of...[MIS] money were olive and
almond schemes, which have drawn off huge amounts of water.[37]
3.41
NAFI recognised the potential effects of forestry on water availability
and indicated support for further research:
The effect on streamflow of converting agricultural land to
timber plantation is related to the catchment area affected. In smaller
catchments, it is difficult to detect an impact when less than 20 percent of
the catchment is planted. In major plantation regions, plantations occupy
between 1 and 6 percent of large catchments.
Some plantations in some parts of some catchments in some
soil and rainfall conditions have the potential to reduce environmental flows.
The retail forestry sector strongly supports and contributes
to research that will enable plantations to be more strategically located in
different catchments, in the context of the impacts of all land uses on water
yield and quality.[38]
Oversupply
3.42
Tax incentives for agribusiness MIS have also been blamed for
contributing to an oversupply of certain commodities. Evidence suggested that
reduced profit motives for MIS had caused scheme operators to pursue projects
where pre-existing market conditions have not justified it. NSW Farmers
Association commented that:
The rapid expansion of non-forestry MIS has significantly
affected the supply levels of certain commodities which inevitably has a
deflationary effect on the prices received by traditional farm producers of
those commodities.[39]
3.43
Grape plantings via MIS have been of particular concern. Wine Grape
Growers' Australia argued that MIS were exacerbating existing oversupply
problems in their industry:
...the continuation of Vineyard Managed Investment Schemes
(MIS) under the current tax structures and disclosure regulations would only
serve to exacerbate the chronic oversupply of wine grapes and wine within the
Australian wine industry, to which Vineyard MIS have been a significant
contributor. Vineyard MIS now represents 10% or 16,000 hectares of the national
vineyard estate – growing from a zero base little more than a decade ago.
WGGA maintains that the tax-driven nature of many Vineyard
MIS has been at odds with the prevailing market conditions within the wine
grape sector and Australian wine industry – meaning that despite general
indications of the buoyancy of the sector within some Vineyard MIS
prospectuses, beyond the initial tax deductions available to investors, there
is limited likelihood of generation of profits from many of these vineyards
over the longer term.[40]
3.44
The Sunraysia Horticultural Branch of the Victorian Farmers Federation
informed the committee that even more grapes are being planted under MIS:
The wine industry in currently in surplus despite the
drought, yet currently thousands of hectares are being developed by MIS in
Sunraysia and the Barossa Valley and elsewhere, over inflating production
capability and destroying the prospects of existing growers and their
communities.[41]
Rural communities
3.45
There were concerns raised throughout the inquiry that investment in MIS
had altered the social fabric of rural communities, due to the changed
personnel and working patterns of those employed by scheme operators.
3.46
Mr Robert Belcher, the Managing Director of Sustainable Agricultural
Communities Australia Limited, observed:
...you might take a property that was a wool-growing property
that was generating, say, $400,000 a year gross. A lot of that money went
through the community: there were children getting on the school buses, there
was a mail delivery, the grocery store depended on it and so did the doctor and
what have you. Once it becomes a plantation and the planting is completed, you
have got one employee who is there every now and then every week or so.[42]
3.47
The NSW Farmers' Association noted that the different workforce required
by MIS projects affected community participation more broadly:
Plantation workers, are often transient seasonal workers, and
rarely replace the families who formerly lived on the farms purchased by MIS
managers. This affects the demographic composition of communities, often
undermining local community participation in schools and local services loss of
participants and population drift to larger centres.[43]
3.48
However, NAFI claimed that the presence of the forestry industry
increased local employment:
Plantation forestry is more labour-intensive than local
agriculture, providing 2.5 jobs for every 1000 ha of plantation, compared with
1.8 jobs per 1000 ha used by other agriculture.[44]
3.49
Dr Schirmer suggested that MIS plantations will increase total
employment over time, but shift employment to larger regional centres:
MIS plantations generate more jobs in total than broadacre
sheep and beef grazing and cropping. However, they only generate more jobs once
plantations are mature and enter a cycle of harvesting and replanting, and when
the downstream processing generated after harvest is included in the analysis.
Jobs in the plantation industry are typically located in regional towns and cities,
whereas agricultural jobs are typically located in smaller towns and on rural
land, indicating that a shift to plantations is accompanied by a change in the
location of employment.[45]
3.50
Dr Schirmer indicated that the de-population effect from this land use
shift is not significant, however, she acknowledged that an influx of new
residents can be socially challenging:
The expansion of plantations, whether MIS funded or
otherwise, leads to a small net loss of resident population from properties
established to plantation via sale or lease of land to a plantation company.
The population loss resulting from plantation expansion at the individual
property scale is no larger than that resulting from other trends such as farm
amalgamation on other properties, and as such there is no observable impact on
rural population at scales larger than the individual property. It is, however,
common for previous residents to shift away from properties established to
plantation, and for new residents to shift onto these properties. This turnover
in population can create significant social change in rural communities.[46]
3.51
Dr Schirmer noted that 'these new residents may not always integrate
well into local communities'.[47]
Recent MIS collapses
3.52
In 2009, MIS companies Great Southern and Timbercorp collapsed,
generating widespread concern among investors and rural communities about the
fate of the schemes for which they were the responsible entity. These included
timber plantations, almonds, olives, grapes, citrus, avocadoes and mangoes and
between the two companies represented over half the total value of all
agricultural managed investment schemes.[48]
3.53
The Australian Securities and Investment Commission (ASIC) informed the
committee that the business models of Great Southern and Timbercorp were flawed
as they involved the taking of investment capital up-front, and this was not
sufficient or well-managed enough to last over the course of projects:
...you need to look at the business models, and the business
model of Great Southern and Timbercorp: why it declined and the way it was
structured in terms of the way they priced the future service
delivery—basically, taking it up-front. They clearly underestimated what it
cost to do what needed to be done and there was also the issue of the way they
managed their working capital and not having...[adequate] working capital.[49]
3.54
Mr Ron Willemsen of Macpherson and Kelly Lawyers described the flawed
business model of Timbercorp, which he suggested collapsed when new revenue was
threatened by the government's proposed changes to the taxation of MIS:
The significance of early 2007 is the government announcement
that the application of the tax laws was going to change for horticultural MIS
projects. The up-front tax deduction was no longer going to be allowed, which
had a very significant impact on the sales of new MIS projects outside of
forestry, and it seems that Timbercorp, and many other agribusiness companies
like it, relied heavily on the new sales revenue in order to fund the ongoing
operations of their business.[50]
3.55
Mr Willemsen also alleged that Timbercorp deceived new investors about
the company's prospects prior to its collapse:
Investors made fresh financial commitments throughout 2007
and 2008, not knowing the Timbercorp group was on the verge of collapse. Their
long-term projects were going to cost the investors a lot of money and were not
going to deliver the expected returns, or anything remotely near the expected
returns.
...
The case is essentially about nondisclosure of material
financial information that we believe ought to have been disclosed about the
viability of the company at the time.[51]
3.56
With regard to Great Southern's forestry MIS, Mr David Mond argued that by
2005 at the latest—when it became apparent that yields were below expectations
and new capital would be required to prop up existing schemes—these has become
nothing more than a ponzi scheme.[52]
3.57
A former Great Southern board member, Mr Jeffrey Mews, explained that an
up-front fee made it easier for the company to attract investors:
Other companies had an ongoing fee situation. The Great
Southern model did not have that ongoing fee situation. It was felt, and I have
no difficulty with the logic, that getting smaller fees from relatively small
investors on an annual basis over a 10-year period was probably not a good
commercial way of going about things. You get fallout. People have different
fortunes on the way through.[53]
3.58
Mr Bruce Dennis informed the committee that actual woodlot yields
suggested that Great Southern was providing misleading information about
potential results in its marketing material. He commented that:
...with the woodlots it had always been marketed as a
management objective to get 250 cubic metres per hectare per 10 years of wood
growth. Yet it appeared from looking at the GSL investment update for May 2008
that the results were that the 1994 project showed 123 cubic metres, the 1995
project showed 166 cubic metres and the 1996 project showed 197 cubic metres,
and it was estimated that the 1997 project would show only 135 cubic metres,
the 1998 project 157 cubic metres and the 1999 project 162 cubic metres. So
there seemed to be a pattern of actual results very much less than the projected
results in the marketing program from Great Southern Ltd. Notwithstanding the
riders in the disclosure documents ... the results were so dismal that that
really should have been revealed more significantly.[54]
3.59
Mr Dennis also suggested that the practice of the company purchasing
underperforming crops masked poor returns to potential investors:
The 1994 crop, for instance, was bought in full from
investors by a Great Southern Ltd subsidiary in July 2005 for $6.4 million. The
crop that was harvested gave a loss to that subsidiary of about $4.3 million.
That would have meant that investors would have only received $2.1 million if
that subsidy had not been put through by Great Southern Ltd. The effect of that
was to give credence to new investors after July 2005 to think that the
investments were showing a good return.[55]
3.60
Former Chairman of Great Southern Mr Peter Patrikeos informed the
committee that he disagreed with that decision to acquire investors' woodlots
using a subsidiary of Great Southern, at shareholders' expense.[56]
The committee also heard evidence concerning the sale of Great Southern shares
by then Chief Executive John Young in February 2005, prior to the company's
belated disclosure to the market and investors that crops would not meet
expected yields.[57]
3.61
ASIC noted that the current regulatory regime, administered by ASIC,
does not preclude investment failure for products ,such as MIS, which are not
prudentially regulated. ASIC Commissioner Mr Greg Medcraft stated:
...the Corporations Act regime is premised on an economic
philosophy that markets drive efficiencies and markets operate most efficiently
when there is a minimum of regulatory intervention, hence the regime
administered by ASIC is designed to promote market integrity and consumer protection
solely through the conduct and disclosure regulation. Of course, conduct and
disclosure regulation does not involve any guarantee that regulated products
and institutions will not fail and that promises made to retail investors will
be met.[58]
3.62
ASIC informed the committee that it is the responsibility of the
regulator to ensure that an MIS constitution and compliance plan meets the
requirements of the Corporations Act, and that disclosure material is not
misleading or deceptive.[59]
It is then for investors to make their own judgment about the MIS business
model and likely performance of the investment. Not being a prudential
regulator, ASIC stated that it can have a limited preventative role:
Inevitably, ASIC come in after a collapse has occurred. We
are there as an oversight body to see the law is complied with and, as such, we
will often arrive at the scene of the accident—that is, after the accident has
occurred and to see who caused it. Our powers are limited to act ahead of time.
For example, we do not have power to regulate capital adequacy or to prohibit
certain business models.[60]
Great Southern's Project Transform
3.63
Although the collapse of Great Southern and Timbercorp affected a great
number of individual agricultural projects, one project involved in the Great
Southern collapse was significantly prominent during the inquiry, so as to
warrant further discussion in this report. That is, the Great Southern scheme
called Project Transform.
3.64
Under Great Southern's Project Transform scheme—which was proposed prior
to the company's eventual demise—investors were asked to vote in favour of
converting their interests in woodlot and cattle MIS into shares in the
company. Ultimately, these shares became worthless when the Great Southern
group of companies collapsed.
3.65
The circumstances of the cattle MIS related to Project Transform were of
particular interest to the committee.
3.66
Project Transform was supported as being in the best interests of
investors by an independent report from KPMG, a national company which provides
audit, tax and advisory services.[61]
In evidence to the committee Mr Gary Wingrove, a National Managing Partner with
KPMG, stated that KPMG's role was not to make a judgment on the merits of Great
Southern's cattle MIS:
The fact that particular people might have a view that the
cattle schemes were not worth anything because of the way they were set up, of
itself, does not mean that a particular transaction was not fair and
reasonable. It is a relative assessment of the value of something you hold
before and the value you hold after.[62]
3.67
Mr Wingrove told the committee that, with the assistance of advice from
cattle experts, KPMG concluded that investors would have more value in the
company's shares than in units in the MIS.[63]
3.68
However, the committee notes concerns about the independence of these
experts and the quality of the advice provided. In particular, the committee
received evidence that Dr Ross Ainsworth of Australian Livestock Services, who was
responsible for the independent advice, was also responsible for overseeing the
welfare of the relevant cattle stock on behalf of Great Southern itself (uncertainty
about the actual existence of the leased cattle is noted below at paragraph
3.70). ASIC advised the committee that it had sought more prominent disclosure
of information relating to the low-end nature of the valuations pertaining to
the relevant cattle stock, the interest being surrendered and the high-end valuation
of the company's shares.[64]
3.69
The committee heard evidence that there may have been significant
pressure exerted on some investors to support Project Transform, as well as
procedural breaches associated with the constitutional amendments required to
enable it.[65]
ASIC informed the committee that it had ensured scheme members were given
appropriate disclosure material in the lead-up to the meeting and vote, but
that it would prejudice ASIC's investigations to make any comment on the
question of whether any undue pressure was applied to investors.[66]
3.70
Evidence to the committee also raised concerns about the cattle which were
said to comprise Great Southern's cattle MIS. In particular, it was suggested
that the cattle were sold as being premium King Island cattle with high calving
rates, when the majority were in fact grazed on rangelands in the north of
Australia. Furthermore, the committee notes there was also uncertainty about
the very existence of all the leased cattle that were subsequently traded by
investors for shares under the Project Transform scheme.[67]
Committee view
3.71
The committee is of the view that it is now time to reconsider the tax
advantages applied to investments in MIS. Tax breaks for forestry are
undesirable when there is a looming woodchip glut, and there has never been a
reason to provide these incentives for growing horticultural products or beef.
The effect of MIS is to distort investment decisions to the detriment of
traditional farmers in these industries, and those competing for the same land
and water resources. The allocation of resources towards agricultural activity
should always be guided by price signals and profitability, rather than by personal
tax incentives.
3.72
The committee also holds the view that these schemes have a tendency to
develop a ponzi-like character, where new capital becomes constantly required
to prop up previous projects' underperformance. This undermines the reputation
of agriculture as a sound investment and devastates communities that have
become dependent on their existence.
3.73
Finally, the committee wishes to express its grave concern about
corporate conduct associated with Great Southern and the Project Transform
debacle. These matters need to be examined to the fullest extent possible to
ensure that a repeat of this type of reckless corporate behaviour within the
agricultural sector does not re-occur.
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